Two Latin American currencies – the Brazilian real and the Mexican peso – have outperformed G10 nations and other emerging markets in 2022 despite the sharp appreciation of the US dollar.
In late September 2022 the Dollar Index, which compares the dollar to a weighted average of six other currencies, reached a 20-year high, at 114 points. However, as of early October the real was up 7.2% against the dollar in 2022, and the Mexican peso was up 2.5%.
The Brazilian real started 2022 at 5.5 to the dollar, fell to a low of 4.6 in April, but returned to 5.5 in August and has since hovered between 5.0 and 5.5. The Mexican peso has been even more stable, reaching a rate of 21.4 to the dollar in February but falling to as a low as 19.5 in June and hovering around 20.0 into the autumn.
While other Latin American currencies such as the Peruvian nuevo sol and the Colombian peso have not made net gains against the dollar this year, they are still performing better than their advanced economy counterparts like the euro, the UK pound and the Japanese yen.
Active central banks
One reason for the relative strength of the real and the Mexican peso is sound central bank policies that aggressively raised domestic interest rates in anticipation of and in response to US interest rate hikes this year.
In June 2022 OBG detailed how emerging markets were better positioned to handle the fiscal challenge of rising US rates than in the past thanks to active policy measures from central banks, larger foreign currency reserves, and more diversified economies and trade relationships.
Brazil’s central bank was the most aggressive, implementing 12 straight hikes to push its rate from 2% in March 2021 to 13.75% last month, but it has signalled that it will halt these moves after consumer prices recorded two consecutive monthly drops.
Mexico has likewise pushed its rate up 5.25 percentage points since June 2021, including a 0.75-percentage-point increase on September 29 so that it reached 8.5%, as inflation hit a two-decade high in the first half of the month.
By comparison, the value of the Colombia peso fell after the country’s central bank enacted a smaller-than-expected rate hike of 1 percentage point in late September.
Higher interest rates in Brazil and Mexico have also created stronger yields for investors compared to declining yields on US Treasury bonds, contributing to the positive performance of the real and the Mexican peso – trends that are expected to continue.
By being ahead of the curve in terms of US interest rate increases, both countries have helped protect their economies.
In a similarly proactive move with a longer-term horizon, Mexico’s central bank is preparing to launch green and sustainable bonds in line with its commitment to the 2030 Agenda for Sustainable Development, as OBG detailed last week.
The rise in global commodity prices following Russia’s invasion of Ukraine and the EU’s announced ban on Russia’s seaborne oil imports in June opened up opportunities for Latin American countries to increase production and capture global market share. This had a favourable impact on major oil-producing countries such as Brazil and Mexico.
Crude oil export revenue from Mexico’s government-owned petroleum company Pemex rose to $22.3bn during the first eight months of 2022, a 42% increase from the same period in 2021.
The decision last week by members of the Organisation of the Petroleum Exporting Countries (OPEC) and other leading oil-producing nations – an alliance known as OPEC+ – to limit production should accelerate the trend of developed economies seeking supply security in Latin America, though the cut will restrict Mexico from producing more than 1.75m barrels per day (bpd), after it averaged 1.85m bpd in August.
Meanwhile, non-OPEC member Brazil has been steadily increasing its oil production in recent years, and its roughly 3m-bpd production contributed to the country’s first budget surplus since 2013 in 2022.
Given Russia’s surging oil exports to China, Brazil’s share of exports to the country – its largest buyer – dropped by 36% in the first half of the year, but it increased exports to other markets, notably the US and Spain. Its revenue climbed by 30% year-on-year to $19.3bn in the first half of 2022 thanks to higher oil prices.
The country is targeting a 70% increase in oil production by the end of the decade, and state-owned oil firm Petrobras announced last year that it would invest $68bn under its Strategic Plan 2022-26 to meet these goals.
Shifting supply chains
As the US-China trade war and the Covid-19 pandemic have shifted manufacturing away from China, Brazil and Mexico have drawn new investment with a view to meeting demand in nearby developed economies.
Last year many analysts were predicting that the US would look to Latin America to meet its manufacturing and imports needs closer to home, and trade has indeed increased.
After ranging between $30bn and $35bn in 2021, Mexican imports to the US surged to all-time highs in 2022, ranging from $37bn to $41bn. Mexico became the US’ top trading partner in August, with the export of computers, passenger vehicles and motor vehicle parts leading the way.
China has even sought to invest in manufacturing facilities in Mexico to skirt US tariffs and cut delivery costs to the US. Chinese investment in Mexico rose from $154m in 2016 to $271m in 2017 and $420m in 2018 during the US-China trade war. While it slowed in 2019 and even further during the pandemic, the figure reached $493m in 2021.
Brazil-US trade, meanwhile, reached a record high of $42.7bn in the first half of 2022, a 43% increase from 2021, when the two countries had the largest trade volume in history. Last month the countries signed a mutual recognition agreement that allows recognised Brazilian companies to achieve quicker exports and bypass red tape.
Risks going forwards
Currency strength against the US dollar is in most aspects a positive development, but it can cause challenges as a global economic slowdown or recession could also weaken commodity prices, as well as the Brazilian real and the Mexican peso.
This concern is more pronounced for Mexico, whose economy is intricately tied to the US. Moreover, remittances from the US, which surged during the pandemic and have remained strong in 2022, would likewise decline in such a scenario, reducing the flow of dollars to the country and weakening the Mexican peso.
Tourism has been considered another key component of the Mexican peso’s performance, bringing in $16.5bn from January to July if this year, a 65% increase from the same period of 2021. However, overall tourist visitors are down compared to 2019, so this sector offers potential for further growth going forwards.
Brazil’s risks are more varied, but the most immediate concern is political. The real enjoyed its best-performing week in October since late July due to a jump in oil prices, although volatility is expected in the coming weeks considering ongoing uncertainty surrounding the presidential elections, the final round vote of which is set for October 30.
Another major risk for Brazil is its dependence on China for exports. Among Brazil’s top-three export commodities in 2020, China accounted for 73.1% of soybean exports, 70.1% of iron ore and 57.3% of petroleum.
China’s GDP growth is expected to moderate from 8.1% in 2021 to roughly 3.2% in 2022 due to a housing market crisis and lockdowns prompted by its zero-Covid-19 policy, underscoring the knock-on impact a slowdown in China could have on key partners.
By Oxford Business Group
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