Who knew U.S. monetary policy filters through Peru?
This article is by Joseph Greco, Ph.D., the director of the Center for the Study of Emerging Markets at California State University, Fullerton. We asked him to share his views on the effect of U.S. Federal Reserve policies on global markets.
Q: What impact has the Federal Reserve’s Quantitative Easing program had on emerging economies around the world?
A: U.S. Federal Reserve Chair Ben Bernanke’s comments on June 19 2013 regarding the Federal Reserve’s plan to end the quantitative easing policy has placed emerging market economies around the world in a strange new position.
In the months leading up to Bernanke’s remarks, gold prices had fallen, interest rates, including mortgage rates, had begun to rise, and the long-term value of the dollar seemed promising. This all seemed to indicate that the U.S. recession was at an end.
With such positive signs, especially the increased demand for homes and mortgages, many wondered how these positive signs could spell trouble for emerging markets, especially those in the South American economies. While Brazil is often cited as the most important Latin American emerging market, it is the economy of Peru that will be the focus of this article.
The chief executive of the Latin American Export Bank (Bladex) was quoted as saying that Peru has the conditions to raise the competitiveness of its productive activity and is set to become a leading foreign trade power. As is the case in many emerging market economies, Peru’s trade balance is heavily dependent on American trade and the prices of global commodities. Consequently, when the U.S. economy experiences major economic changes, it impacts the global economy, especially emerging markets like Peru.
Peru is vulnerable to changes in the U.S. economy
While Peru has emerged as one of the fastest-growing economies in Latin America from 2002 to 2012, the downside for Peru is that it is an emerging market that is closely integrated to the U.S. and vulnerable to changes in the American economy. As is the case with most emerging markets, its global vulnerability is a result of being a primary commodity exporter.
Consequently, global price fluctuations in commodities have immediate consequences on Peru’s exports. At the domestic level, economic prospects reflect a projected real GDP growth level of 6.3 percent for 2013. At the same time, inflation levels have fallen. As a result of fundamental economic factors, Peru has recorded the highest growth rate in Latin America and the highest levels of American foreign direct investment (FDI) during 2012.
The U.S. Quantitative Easing policy
Quantitative easing (QE) is an unconventional monetary policy which usually targets the interbank interest rate and used by central banks to stimulate the national economy when standard monetary policy has become ineffective.
The U.S. central bank, the Fed, implements QE when it buys specified amounts of financial assets from U.S. commercial banks. While first introduced in 2008, the Fed announced in June 2013 their intentions to taper its annual $85 billion QE stimulus once certain economic conditions improve. Stimulus reductions are projected to successively decline during 2013.
QE’s influence on Peru
Due to their integrated position with the global and dependence on the U.S. economy, the expected changes in the U.S. QE policy have economic downsides for emerging markets such as Peru.
The potential impacts of such changes on the emerging market economy of Peru can be measured in three areas:
- The country’s stock market index (IGBVL)
- The balance of trade
- Its foreign currency reserves
IGBVL Index decline
The IGBVL (Bolsa de Valores de Lima General Sector Index) reacts to the performance of the largest and most actively-traded stocks listed on the Lima Stock Exchange. In conjunction with economic reform sponsored by the Peruvian government, the index has been able to attract and retain investors at record high numbers.
External capital has reached U.S. $12.2 billion for 2012, representing a U.S. $4 billion increase from 2011. As of August 2013, the index has declined roughly 4,600 points to 16,600 year, a result of positive U.S. economic data. To prevent economic chaos resulting from potential capital flight, the Peruvian central bank has countered stock market speculation by increasing its foreign-exchange reserves.
Peru’s foreign-exchange reserves increase
In light of the June announcement that QE purchase will eventually taper, institutional investors have been migrating out of Peru and into the U.S. capital markets.
As a result of expectations of more capital outflows, the IGBVL has experienced a decline in value, especially in commodities prices. To soften the blow, Peru’s central bank has steadily increased foreign exchange reserve holdings from U.S. $47.7 million in July 2011 to U.S. $66.7 million by July 2013.
With the threat of further capital flight, the bank’s goal is to prevent a collapse in value of exchange rates. Foreign reserves would act to prevent short-term economic disruptions in the markets by replacing migrating FDI and to stabilize the exchange rate.
As the global and U.S. economies recover, commodities should decline in value, representing a direct threat to the volume of exports and to a vulnerable Peruvian economy.
Peru’s exports, imports decrease
As a result of anticipated QE changes, the Central Bank of Peru has reported a drop in the amount of goods shipped out of Peru with export figures declining by U.S. $713.3 million. Peru’s main exporting partners are the U.S. receiving 16 percent of Peru’s exports in volume, followed by China with 14 percent, Chile with 5 percent and Canada accounting for 4.8 percent.
Similarly, imports have plunged to U.S. $3.2 million, making it obvious the U.S. economy still heavily impacts emerging markets such as Peru. As of June 2013, Peru reported a trade deficit of U.S. $114 million, the first gap in more than a decade
QE’s impact on global economy
When the U.S. Federal Reserve announced eventual policy changes to its QE program in June of 2013, it impacted the global economy--especially emerging markets like Peru--in the three areas of:
- Equity markets
- Exchange rates
- The balance of trade
Ironically, the positive economic outlook in the U.S. has resulted in negative capital outflows and slower global demand for Peruvian exports. In turn, it has created tremendous uncertainty in Peru’s equity markets as seen by the decline in the IGBVL index.
During the U.S. recession, Peru integrated itself further into the global economy and achieved success by expanding its exports, taking advantage of increased commodities prices while accelerating its foreign reserves acquisition; positioning the country as an extremely attractive investment alternative to U.S. and global investors.
The coming year will be critical to the emerging markets of the world, especially Peru. Given its strong economic fundamentals, the country should recover more quickly than its emerging market counterparts such as Brazil from the potential and still unknown changes in the U.S. quantitative easing policy.