Chile unexpectedly halts forex interventions

In December, interventions helped peso appreciate, but it has resumed downward trend
The Central Bank of Chile

The Central Bank of Chile has unexpectedly halted the foreign exchange interventions it had been using to support the weakening national currency.

From today (January 13), the institution suspended the daily dollar auctions it started on December 2. It will only renew the stocks of exchange hedging instruments it sold during these weeks, worth $4.5 billion.

When it unveiled the programme on November 28, 2019, the central bank said it planned to maintain the interventions until May 29, 2020. The sudden halt caught investors off-guard.

The central bank’s statement does not provide the rationale behind the decision. It only adds that “any increase in this level [of hedging instruments], or restart of spot sales, will be communicated in due course by the board, and decided on the basis of market conditions considering the prevailing volatility and liquidity”.

The central bank decided to intervene in the foreign exchange market in a bid to stem the sharp depreciation of the peso. Following mass protests across the country, the currency depreciated by more than 14% between October 21 and November 28.

Total interventions amounted to $20 billion, the largest since 1999. International reserves totalled $40.5 billion in December 2019.

The peso recovered to 732 per dollar on December 30, from 828 on November 29. But it started to fall again this year, despite the central bank’s efforts. On January 10, it was trading at 768 per dollar.

Officials may have concluded that selling such a large portion [DH1] of the reserves portfolio while the peso is volatile entailed too much risk.

Most EM currencies tumbled this week following the assassination of Iranian General Qassem Soleimani
John Ashbourne, Capital Economics

Some of the factors placing pressure on the peso are beyond the control of the Chilean government.

“Most EM currencies tumbled this week following the assassination of Iranian general Qassem Soleimani,” says John Ashbourne, senior emerging markets economist with London-based consultancy Capital Economics.

Nonetheless, in the coming days the peso may suffer higher volatility than other EM currencies precisely because of the central bank’s decision to abandon the programme of interventions. In fact, today it declined further to 773 pesos to the dollar.

Additionally, the currency’s outlook is “particularly vulnerable because of an increased risk premium caused by uncertainty over protests and what is likely to be a permanent loosening of fiscal policy”, says Quinn Markwith, Latin America economist with Capital Economics.

“This seems to have caused the peso to behave more like traditionally volatile EM currencies such as the Brazilian real and the South African rand,” says Ashbourne.

Social unrest in Chile has been fuelled by deep-rooted social grievances derived from economic inequality. The conservative government of president Sebastián Piñera has agreed to call a referendum in April to reform the constitution and it is in negotiations to increase public spending.

Brighter future

Despite present difficulties, the South American economy has solid fundamentals. One of them is being the world’s largest copper producer and exporter.

“We think that copper prices, which have anchored the exchange rate for most of the past two decades, should once again become the main driver of the peso before too long,” says Markwith.

He estimates the peso is about 10% weaker in real effective terms in comparison to its past relation with copper prices.

“What’s more, copper prices are likely to rise this year due to tight global supply. We continue to expect the peso will strengthen to 730 per dollar by the end of the year, and 685 per dollar by the end of 2021,” adds Markwith.

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