Regional Reserves Update: Broad Stability Even As Global Rebalancing Takes A Toll

BMI View: We expect foreign reserves stockpiles in the major commodity exporting economies of Latin America to remain under pressure in the coming months, as a relatively subdued outlook for goods exports, combined with weaker investment inflows, could leave current account deficits underfunded, putting downward drag on reserves. That said, import cover in most major economies remains sufficiently robust to prevent balance of payments crises. Elsewhere in the region, strong growth in exports in Mexico and Colombia should provide a boost to reserves positions, while rapid reserves depletion in Venezuela and Argentina amidst substantial external imbalances are likely to drive further currency adjustments.

In line with our long-held view, global economic rebalancing has prompted a deterioration in the trade and investment dynamics throughout Latin America, leading to a drop in foreign reserves growth across most of the major economies in the region ( see 'Regional Reserves: Global Rebalancing Leaving Its Mark', July 12 2013). Indeed, the combination of weaker external demand for commodities exports from China, and capital outflows from emerging markets as developed market bond yields rise, have taken their toll on reserves stockpiles in Latin America in recent quarters.

That said, we believe that most of the region's economies are relatively well positioned to withstand the reversal in capital flows, having shifted to free floating exchange rates and built up vast piles of reserves in recent years. While external accounts will remain broadly under pressure in the coming months, we expect that 2014 will be a moderately stronger year for exports across the region, due to favourable base effects and improved economic competitiveness following substantial exchange rate depreciation in 2013, providing some cushion for reserves stockpiles ( see 'Regional Exports Update: Some Upside In 2014', December 13 2013). Moreover, remittance inflows could see an uptick across the board as economic growth strengthens in the US, a major destination for foreign workers. Therefore, with the exceptions of Venezuela and Argentina, where structural economic imbalances will necessitate further currency adjustments, we believe that balance of payments crises stemming from rapid reserves depletion are highly unlikely across Latin America in the coming months.

Reserves Stockpiles Moderately Eroding
Latin America - Foreign Reserves, % chg y-o-y 12mma

BMI View: We expect foreign reserves stockpiles in the major commodity exporting economies of Latin America to remain under pressure in the coming months, as a relatively subdued outlook for goods exports, combined with weaker investment inflows, could leave current account deficits underfunded, putting downward drag on reserves. That said, import cover in most major economies remains sufficiently robust to prevent balance of payments crises. Elsewhere in the region, strong growth in exports in Mexico and Colombia should provide a boost to reserves positions, while rapid reserves depletion in Venezuela and Argentina amidst substantial external imbalances are likely to drive further currency adjustments.

In line with our long-held view, global economic rebalancing has prompted a deterioration in the trade and investment dynamics throughout Latin America, leading to a drop in foreign reserves growth across most of the major economies in the region ( see 'Regional Reserves: Global Rebalancing Leaving Its Mark', July 12 2013). Indeed, the combination of weaker external demand for commodities exports from China, and capital outflows from emerging markets as developed market bond yields rise, have taken their toll on reserves stockpiles in Latin America in recent quarters.

Reserves Stockpiles Moderately Eroding
Latin America - Foreign Reserves, % chg y-o-y 12mma

That said, we believe that most of the region's economies are relatively well positioned to withstand the reversal in capital flows, having shifted to free floating exchange rates and built up vast piles of reserves in recent years. While external accounts will remain broadly under pressure in the coming months, we expect that 2014 will be a moderately stronger year for exports across the region, due to favourable base effects and improved economic competitiveness following substantial exchange rate depreciation in 2013, providing some cushion for reserves stockpiles ( see 'Regional Exports Update: Some Upside In 2014', December 13 2013). Moreover, remittance inflows could see an uptick across the board as economic growth strengthens in the US, a major destination for foreign workers. Therefore, with the exceptions of Venezuela and Argentina, where structural economic imbalances will necessitate further currency adjustments, we believe that balance of payments crises stemming from rapid reserves depletion are highly unlikely across Latin America in the coming months.

But Import Cover Still Reasonably Robust
Latin America - Months Of Import Cover, 12mma

Indeed, although growth in reserves across the region has trended down, import cover has remained relatively steady due to weaker imports as exchange rates depreciate and domestic demand weakens ( see 'Regional Private Consumption Update: Rebalancing To Keep Households Under Pressure', January 31). As the chart above illustrates, all of the major countries in Latin America remain well above the 3.0 month threshold typically cited as a mark of external account stability, and, excluding Argentina and Venezuela, we forecast import cover to remain above 5.0 months for major regional economies through 2015. Over the long term, macroeconomic fundamentals and attractiveness to investors - built on business environment and political risk profiles - will increasingly become differentiating factors within the region with regards to capital inflows, helping to determine the trajectories foreign reserves positions.

Upside For Exports To Provide Cushion For Reserves
Latin America - Real Effective Exchange Rates, Feb 1 2004=100 (LHS) & Goods Exports, % chg (RHS)

Brazil, Chile And Peru: Underfunded C/A Deficits Could Put Moderate Downward Drag On Reserves

In Brazil, we forecast import cover will fall to 15.2 months by end-2015, from 17.2 months (US$358.8bn in reserves) as of December 2013, as we believe that weak investment levels may see the country's financial account surplus be insufficient to cover its current account shortfall on some occasions as metals exports suffer from waning external demand, forcing the central bank to dip into its foreign reserves. Indeed, given a mild growth outlook for 2014, a key general election in October, as well as numerous structural problems facing the Brazilian economy, we believe that investment levels are likely to remain relatively weak in the coming quarters ( see 'Current Account Deterioration To Continue', January 13). Moreover, the country's substantial foreign reserves stockpile provides an important buffer against exchange rate volatility, and we believe that in times of intense selling pressure, the central bank will dip into its reserves stockpile to defend the real.

Similarly, weaker foreign investment in the respective Chilean and Peruvian mining sectors could see the countries' financial accounts come in at a deficit going forward, leaving current account deficits underfunded and putting downward pressure on reserves. Indeed, as we have previously noted, net direct investment in Chile has fallen for nine consecutive quarters, with the Q313 deficit of US$3.1bn marking the widest figure seen in the past decade ( see 'Improving Balance Of Payments Dynamics Ahead', December 24 2013). We also cannot rule out a scenario in which inflation concerns prompted by further weakness in the Chilean peso prompt the central bank to use its reserves in order to bolster the exchange rate ( see 'CLP: More Downside In H114', January 8). These factors underpin our forecast that Chile's import cover will fall to 6.2 months by end-2015, from 6.5 months (US$40.5bn in reserves) in December 2013. In Peru, we forecast the import cover will dip to 18.7 months by end-2015, from 18.9 months (US$66.2bn in reserves) in November 2013. However, we believe that reserves will be supported by a fairly robust outlook for metals exports, as rising volumes will help to offset declining prices, and stronger growth in non-metal traditional exports (fishing, agriculture, and crude oil), as export competitiveness improves following the recent sell-off in the sol ( see 'Despite Headwinds, Some Encouraging Signs For External Accounts', October 17 2013).

Mexico And Colombia: Stronger Exports To Keep Reserves Stockpiles Robust

We maintain our view that those economies most closely tied to a strengthening economy in the US - namely, Mexico and Colombia - will likely see the strongest growth in exports in 2014, and will be the recipients of some of the strongest investment inflows, bolstering reserves positions. In Mexico, robust foreign investment on the back of the government's ongoing reform drive will also bolster the financial account surplus in the coming quarters ( see 'Manufacturing Pick-Up To Drive Narrower Current Account Shortfall', January 15). Given these factors, we forecast the country's reserve stockpile to increase from US$176.5bn as of end-2013 to US$188.0bn by end-2015, equivalent to 5.7 months of import cover.

In Colombia, bucking the regional trend, foreign reserves increased from US$37.9bn in January 2013 to US$43.6bn in December, accounting for about 8.0 months of import cover, and we forecast reserves to surpass US$50.0bn in 2015. This is on account of our forecast for goods exports growth to accelerate to 8.0% in 2014, from 1.0% in 2013, driven by a recovery in coal exports, and stronger oil output. In addition, we expect investment flows to increase as the country's regulatory environment continues to improve, further providing support to the country's reserves position ( see 'Regulatory Changes To Improve Risk Profile', February 12). Moreover, the Banco de la República continues, for the time being, to focus on stockpiling reserves by purchasing US dollars on the foreign exchange market.

Venezuela and Argentina: Further Currency Adjustments Likely Amidst Falling Reserves

In Venezuela, foreign reserves have fallen to historic lows in recent months, coming in at US$21.5bn (representing about 4.7 months of import cover) as of November 2013, due to external imbalance stemming from an overvalued exchange rate and a deteriorating business environment. We forecast that reserves will fall further - to US$22.0bn, or 4.4 months of import cover - by end-2014, underpinning our view for another currency devaluation by the end of the year ( see 'Bolivar Time Bomb To Keep Ticking, Towards 2014 Devaluation', October 1

No Respite From Severe External Imbalances
Venezuela - Official And Black Market Exchange Rates (LHS) & Foreign Reserves (RHS)

Meanwhile, in Argentina, we believe that the recent 13.7% devaluation of the peso on January 23 will be insufficient to reduce the selling pressure on the official exchange rate, meaning that the central bank will be forced to resume its policy of gradually weakening the currency, drawing down foreign currency reserves in order to prevent a sharper sell-off ( see 'Fall In Reserves Keeps Devaluation Risk High', January 29). As such, we forecast import cover will fall to 3.4 months by the end of this year, from as high as 11.7 months (US$48.0bn in reserves) as recently as 2009.

Drawdown Likely To Continue
Argentina - Exchange Rates, ARS/US$ (LHS) & Foreign Reserves (RHS)

Indeed, scenarios that would replenish Argentina's reserves remain unlikely in our view. These include, for example, the announcement of a massive hard currency loan from China, or the speedy resolution of outstanding issues with the Paris Club, allowing a resolution of multilateral lending to Argentina.

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Related sectors of this article: Economy, Balance of Payments
Geography: Latin America, Argentina, Brazil, Chile, Colombia, Mexico, Peru, Venezuela
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