Some central bank governors in Latin America have been able to find the sweet spot, guiding their countries’ economies through a morass of recession, inflation, and currency and trade issues.
Each year, LatinFinance surveys economists and financial analysts to identify who has been the most effective central bank governor in the region. We examine the institutions’ results in managing monetary policy, controlling inflation and ensuring financing stability. We also take into account the banks’ transparency and effectiveness in communicating with markets.
This year, Julio Velarde Flores, the longtime governor of the Central Reserve Bank of Peru, wins LatinFinance’s Central Bank Governor of the Year Award. Central bankers from Chile, Mexico and Costa Rica also won praise for their work during the period between July 2015 and June 2016.
An economist by training, Velarde, 64, has been at the helm of Peru’s central bank since 2006. His reappointment in 2011 helped calm financial markets spooked by the election of President Ollanta Humala. Peru’s new president, Pedro Pablo Kuczynski, has already reappointed Velarde for another five-year term.
Bankers and analysts cited Velarde’s solid approach to monetary policy. He has built up a level of “high credibility, not only for the central bank but also for Peru as a sovereign”, says Bertrand J. Delgado, senior emerging markets strategist with HSBC, pointing to Velarde’s strong management of risks associated with the foreign exchange market, dollarization and the handling of the external environment.
Peru has at times faced challenges, some particular to the country and others shared with its Latin American and Caribbean neighbors. To understand why Peru’s 2015 GDP growth rate of 3.3% and forecast of 3.5% for 2016 (as estimated by the World Bank) are impressive, consider the context: The World Bank sees output in the region as a whole declining 1.3% this year after contracting 0.7% in 2015, marking the first two years of consecutive recession in more than three decades.
Anemic commodity prices, not to mention weakness in Chinese trade, led to an export shock for many countries, while tighter monetary policy in the region also affected exports and production.
As the World Bank noted in its latest Global Economics Prospects, some South American economies are struggling with above-target inflation that is limiting the ability of their central banks to run counter cyclical monetary policies.
In contrast, headline 12-month inflation in Peru was a business-as-usual 2.96% through the end of July. Taking food and energy out of the mix, inflation was slightly lower at 2.87%. One recent report noted that since Peru adopted inflation targeting in 2002, inflation has averaged 2.7%, one of the lowest for Latin America in the 2001 to 2015 period.
“I think that we were lucky in having controlled inflation in the last few years,” Velarde tells LatinFinance.
Although Peru has faced inflationary pressures, especially from the supply side, the central bank’s focus has remained focused on keeping consumer prices within a tight 1% to 3% target range.
In the second half of last year, the central bank started bumping up its reference interest rate in 25-basis-point increments from 3.25% to 4.25%, where it has remained steady since February. The central bank has also relied heavily on commercial bank reserve requirements to modulate monetary policy, adding liquidity when needed and tightening when called for.
Velarde has clearly distinguished between inflation pressures coming from the more volatile supply side and those from the demand side. For example, prices for food, a sector that weighs heavily in the consumer price index basket, were affected by the El Niño warm weather patterns last year.
“Velarde has been able to accurately differentiate cyclical from temporary factors affecting inflation,” says Alejandro Arreaza, Latin America economist at Barclays Capital. “He has gradually hiked interest rates, ensuring that inflation converges to the target range, while allowing the economy to gradually recover from the recent slowdown, pointing to register the fastest growth in LatAm this year.”
Velarde says there will always be a little volatility that can push consumer prices higher, which is acceptable if it doesn’t feed inflationary expectations.
“The problem that we saw last year is that inflation expectations were starting to increase, and we thought that controlling inflation would be more costly afterwards. That is why we increased the reference interest rate in September, December, January and in February, raising it from 3.25% to 4.25%, where it is now,” he says.
Central bankers have no “magic button” to reposition inflation to a target range, Velarde says, but fast, decisive actions give a clear indication to investors and financial markets the central bank is on the case.
“When inflationary expectations are increasing, a sign that the central bank is ready to lift its interest rate has a quick impact,” he says.
Peru’s focus on containing inflation elicited praise from central bank watchers. “The results of a higher-than-average growth compared to most other Latin American countries have been well managed with inflation under control,” says Mexico City-based independent economist Jonathan Heath.
A recent central bank statement noted that the consensus forecast calls for a GDP expansion of 3.7% for 2016 and a region-leading 4.1% for next year, both above World Bank estimates. Forecasts see inflation at 3.1% this year as supply shocks ease. For 2017 the forecast calls for the CPI to rise 2.7%, down nearly a percentage point from last year’s 3.6% increase.
One factor pushing inflation in Peru above the central bank’s target range the past couple of years has been the depreciation of the sol. The economy still has various prices fixed in dollars, such as rent for middle-class housing, and even some locally produced goods. “The effects of the transfer of the depreciation of the exchange rate on inflation are somewhat higher than in other countries of the region,” Velarde says.
Still, from 2001 to 2015, dollarization has declined steadily. Analysts say the reduction in the use of dollars reflects macroeconomic stability and prudent policies.
The central bank’s war chest of net international reserves remains a solid bulwark against speculation. Over the past five years, reserves have risen by about $13.75 billion. Economists note that Peru, one of the world’s largest producers of precious and base metals sold for dollars, wisely managed the commodity boom of the last decade.
Rounding out the top spots
A runner-up who received strong support for the award, for the second year running, is Chile’s Rodrigo Vergara. Central bank watchers praised various factors in Chile’s nomination, including restrained inflation (Chile’s CPI rose 4.3% last year), the ability to keep the reference interest rate in a neutral position and a lack of volatility in the exchange rate.
“Chile is less opaque than other countries, such as Brazil, which is a major reason inflation expectations are much more contained,” says Edward Glossop, Latin American economist with Capital Economics.
Mexico’s central bank governor, Agustín Carstens, who was LatinFinance’s winner last year, also received praise. Mexico’s central bank has been able to keep inflation expectations well anchored, despite a very complicated scenario, with the sharp depreciation of the peso. Mexico’s consumer price index gained 2.7% in 2015.
Other central bank governors who received votes included Federico Sturzenegger of Argentina, where the new administration is working to tame soaring inflation, and Costa Rica’s Olivier Castro Pérez, praised for the Central American country’s healthy growth and low inflation. Costa Rica’s consumer price index rose a meager 0.8% last year. José Darío Uribe, governor of Colombia’s central bank, also received a mention. LF