Chile Plans $4 Billion of Currency Swaps to Boost Plunging Peso

(Bloomberg) -- Chile’s central bank moved to stem a 6% slump in the peso in the past three days amid a wave of social unrest and investor concern about a new constitution.

The bank will offer $4 billion of 30-day and 90-day currency swaps, officially to ease liquidity in both the peso and the dollar. The measures come into affect Thursday and will continue until Jan. 9, the bank said in an e-mailed statement.

The peso plunged to a record low against the dollar Tuesday as security forces struggled to maintain control across the country and after the government backed plans to rewrite the constitution. It may have fallen further if the central bank hadn’t said it stood ready and able to take action. Yet, the swaps may prove only a temporary solution.

“I wouldn’t take this as something that will turn the market around,” said Alejandro Cuadrado, a currency strategist at BBVA SA in New York. “It will accommodate any liquidity squeeze, but it’s not fighting the depreciation. I don’t think it’s a game-changer.”

Chile has been wracked by a wave of protests and riots since Oct. 18. It wasn’t until this week though that the peso started to plunge after the government backed plans to rewrite the constitution, spooking traders concerned about extended uncertainty.

Long-Haul

The swaps announced today will provide liquidity in dollars without draining central bank reserves, since they will have to be repaid. Brazil’s central bank uses a similar system of swaps, which it either rolls over or allows to mature.

“What it’s doing with the swaps is to increase the availability of foreign currency,” said Nathan Pincheira, an economist at Fynsa SA in Chile. “Whoever asks for the dollars will have to return them. It’s trying to relieve the short-term drought.”

Chile’s options market shows investors are preparing for a long period of instability in a country that used to be famed as an oasis of calm in a tumultuous region.

The short-end of the Chilean peso implied volatility curve has soared, as expected, given the market turmoil. What’s more, the mid and long-end of the curve are also rising, indicating the crisis is expected to last.

Wealth Fund

The peso declined Wednesday even after the government said yesterday that it would pull $1 billion from its sovereign wealth fund in the next few days and another $1.4 billion in early 2020. That money will end up being exchanged into pesos.

It may be a sign of how bad the outlook is for the peso that the announcement failed to bolster the currency.

Yet, the currency isn’t as weak as it might seem.

While the peso slumped to its lowest ever against the dollar on Tuesday, the trade-weighted, real effective exchange rate calculated by the central bank remains above its previous lows.

The latest data available from central bank on the real effective exchange rate dates from September. Since then the currency has probably declined about 8.5%, in line with the peso/dollar rate.

Based on that assumption, the current trade-weighed index is about 85, much stronger than levels in 2002 and 2009 when central bank last stepped into the foreign exchange market.

--With assistance from Davison Santana and George Lei.

To contact the reporters on this story: Sebastian Boyd in Santiago at sboyd9@bloomberg.net;Eduardo Thomson in Santiago at ethomson1@bloomberg.net

To contact the editors responsible for this story: Eric J. Weiner at eweiner12@bloomberg.net, Philip Sanders

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