XCV MEETING OF CENTRAL BANK GOVERNORS OF THE CENTER FOR LATIN AMERICAN MONETARY STUDIES

Julio Velarde Governor

Central Reserve Bank of Peru

Normalization of the Monetary Policy in the Industrialized Economies and Possible Effects on

the Latin America and Caribbean Region

Contents

1.  Withdrawal of monetary stimulus: associated risks.

2.  Impact on the LAC region and Peru. 3.  Policy response to a sudden capital reversal event.  

2

After the 2008 crisis, the major central banks expanded their balance sheets and have kept historically low interest rates since then.

Central  Banks:  Total  Assets  

Forecast

Source: Credit Suisse.

3

0,00

1,00

2,00

3,00

4,00

5,00

6,00

7,00

2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013

U.S. nominal yields(per cent)

Nominal yield-Short term (3 M) Nominal yield-Long term (10 y)Average 90-06 (Short term 3 m) Average 90-06 (Long term 1 y)

Source:  Bloomberg

The withdrawal of monetary stimulus implies two kinds of risks: (i) unexpected increase in interest rates…

Interest rate: disorderly increase or overshooting vs. gradual and predictable adjustment:

•  Capital losses on fixed-rate securities. •  Increase in banks’ credit risk. •  Spillovers to other countries or markets.

IMF: “Shifting expectations for the path of future interest rates can lead to financial flows between markets and countries that could be sudden and potentially disruptive, especially if the timing of tightening differs across central banks”.

Source: IMF, GFSR, April 2013.

4

U.S. Treasury sell-off episodes (In percent)

Asset Holdings of Major Central Banks Related to MP-Plus, 2008-13Dec-08 Dec-11 Dec-12 Abr-13 % of assets

ECB (in billions of euros)Total liquidity 843 864 1109 852 32,6Assets Purchases Covered Bonds (CBPP) 62 69 63 2,4 Goverment Bonds (SMP) 213 208 203 7,8

Memorandum items: Total assets 2043 2736 3011 2611 Total assets % GDP 22 29 32 28FED (in billions of U.S. dollars)Total liquidity 828 110 10 9 0,3Asset Purchases Agency MBS - GSE 837 887 1121 33,4 Agency Debt - GSE 20 104 77 72 2,1 Treasuary Securities 476 1672 1657 1848 55,0Memorandum items: Total assets 2241 2928 2949 3359 Total assets % GDP 16 19 19 21Source: IMF, Global Financial Stability Report April 2013.

… and (ii) unexpected assets sales.

5

MBS: 10% of marketable debt. Treasury: 20% of marketable debt.

Asset sale risks:

•  Shifts in market sentiment may lead to sharp increases in yields.

•  Policy missteps may disrupt markets. If central banks sell assets before underlying market vulnerabilities are addressed, dysfunction could resurface.

IMF: “This risk is heightened in markets where central banks hold a large share of outstanding securities or played an important market-making role, especially if ongoing market dysfunction is now masked by central bank intervention”.

Foreign and commercial banks would be the most affected by a sell-off.

6

Source: Deutsche Bank

Source: Deutsche Bank

Contents  

1.  Withdrawal of monetary stimulus: associated risks. 2.  Impact on the LAC region and Peru. 3.  Policy response to a sudden capital reversal event.  

7

Transmission channels of QE withdrawal and rate increases

8

Global recovery and decreasing risks

Withdrawal of monetary stimulus in developed economies

Appreciation pressures

Growth pressures

Capital outflows

Fall in speculative demand for

commodities

Fall in commodity

prices

Contraction of nonbank financing

Fall in bank credit

Fall in asset prices

Depreciation

pressures

Increase in emerging economies’ exports

Recession pressures

Increase in international interest rates

Asset sales

Lower demand for emerging

economy assets

Capital flows to the region have surged due to abundant international liquidity. Higher current account deficits increase the risks of a sudden capital reversal event.

Capital inflows respond to short-term (interest differentials) as well as structural factors (better growth prospects and credit ratings).

Lack of financial depth, which in a context of persistent capital inflows may contribute to: –  Generating unsustainable expansion in the non-tradable sector –  Accelerating credit expansion. –  Formation of asset bubbles. –  Increasing household and firm indebtedness.

-3000

-2000

-1000

0

1000

2000

3000

4000

Jan-1

0F

eb-1

0M

ar-

10

Apr-

10

May-1

0Jun-1

0Jul-10

Aug-1

0S

ep-1

0O

ct-

10

Nov-1

0D

ec-1

0Jan-1

1F

eb-1

1M

ar-

11

Apr-

11

May-1

1Jun-1

1Jul-11

Aug-1

1S

ep-1

1O

ct-

11

Nov-1

1D

ec-1

1Jan-1

2F

eb-1

2M

ar-

12

Apr-

12

May-1

2Jun-1

2Jul-12

Aug-1

2S

ep-1

2O

ct-

12

Nov-1

2D

ec-1

2Jan-1

3F

eb-1

3M

ar-

13

Apr-

13

Portfolio flows to Latin America*(weekly flows, US$ million)

*Includes dedicated and non-dedicated funds.Source: Barclays.

QE2 LTRO1 LTRO2 QE3

-5,0

-4,0

-3,0

-2,0

-1,0

0,0

1,0

2,0

3,0

4,0

5,0

2007 2008 2009 2010 2011 2012 2013*

LAC5: Current account balancePercent of GDP

Brazil Chile Colombia

Mexico Peru LAC5

*Forecast.LAC5: Weighted average of listed economies.Source: IMF and BCRP.

9

Contents  

1.  Withdrawal of monetary stimulus: associated risks. 2.  Impact on the LAC region and Peru. 3.  Policy response to a sudden capital reversal

event.  

10

1.  Lower asset prices in emerging markets

Then, depending on how the withdrawal is executed… 2.  Lower appreciation pressures (or even a switch to depreciation) 3.  Reduction in liquidity both in foreign and domestic currency

(depending on pressures coming from FOREX market) 4.  Capital losses if the financial system holds an important position

in these assets 5.  Contraction of foreign funding

Withdrawal of monetary stimulus in industrialized economies would imply new equilibrium interest rates and…

In Latin America, these impacts would be cushioned by preventive measures and policy actions.

11

The region’s macroeconomic strengths limit risks, thereby maximizing the benefits from capital inflows. Unlike pre-crisis years, current account deficits are financed mainly by FDI flows.

Several countries’ foreign positions are stronger than in the runup to the global financial crisis.

-15

-10

-5

0

5

10

15

20

2006 2007 2008 2009 2010 2011 2012*

Latin America: Current and Capital Acount BalancePercent of GDP

Non-FDI Reserves

FDI CA Def icit

*Forecast.Source: IFM.

0

50

100

150

200

250

300

Brazil Chile Colombia Mexico Peru

External Vulnerability Indicator (EVI)

2006

2012*

EVI=(Short-Term External Debt + Currently Maturing Long-Term External Debt + Total Nonresident Deposits Over One Year)/Of f icial Foreign Exchange Reserves.*Forecast.Source: Moody's.

12

Most Latin American economies had implemented precautionary rules even before the current surge of international capital inflows.

Measures\Countries Argentina Bolivia Brazil Chile Paraguay Peru Uruguay

Spot

Forward

Swap  transactions

Reserve  requirements

Private  Pension  Funds

Insurance  Companies

Entry

Exit

Central  Bank  Notes

Fixed  Income  Notes

Variable  Income  Notes

FX  Forwards

1/  Limit:  the  lowest  of  US$  3  bn  or  the  level  of  regulated  equity  in  the  FX  short  position.2/  Increase  in  the  net  FX  position-­‐to-­‐effective  equity  ratio.3/  Decrease  in  the  aggregate  FX  over-­‐purchase  position  and  the  net  FX  derivate  position  relative  to  the  effective  equity.Source:  central  bank  websites  and  other  reports.

Foreign  

Exchange  

Interventio

nsMacroprudentia

l  Policies

Non-­‐remunerated  deposits  as  percentage  of  capital  inflows

Limits  on  the  permanence  of  capital  flows

Modifications  to  net  FX  position  limits

Modifications  to  capital  requirements

Taxes  and  charges  ondomestic  asset  holdings

Taxes,  charges,  and  limits  on  entry/exitof  international  capital  flows

Foreign  exchange  market  intervention

Increase  in  the  limit  on  investments  abroad

13

Credit easing before cutting policy rates

Ac$ons  

•  Rapid and drastic cuts in reserve requirement ratios in soles and US$.

•  Maturity extensions of REPOS up to a year.

•  New instruments such as dollar SWAPS. •  Purchase of CDBCRP in the secondary

market

Mone

y ma

rket  

Capit

al ma

rket  

Objec$ves  

• Provide liquidity to markets

•  Induce corrections in asset prices.

• Reduce pressures on short-term funding in the banking system.

Avoid steeper yield curve and illiquidity in the credit markets

Recover the effectiveness of the transmission of monetary policy actions through interest rates

The experience of Peru’s Central Bank with external shocks has shaped its policy response.

Bids for BTP in the secondary market 14

Monetary  Policy  Responses  since  September  2008  

The preventive actions taken by the Central Bank increased its capacity to face capital outflows during the recent financial crisis.

q  Sales of foreign currency (US $ 7,128 millions). q  Issuance of central bank dollar-indexed CDs (US

$ 4,625 millions).

Ac$ons  Avoid transitory large exchange rate depreciations that could damage the ba lance shee ts o f f i rms and households (liability dollarization).

Fore

ign

Exch

ange

Ma

rket  

Objec$ve  

-600

-400

-200

0

200

400

600

2,60

2,70

2,80

2,90

3,00

3,10

3,20

3,30

3,40

05-D

ec-0

701

-Jan

-08

28-J

an-0

824

-Feb

-08

22-M

ar-0

818

-Apr

-08

15-M

ay-0

811

-Jun

-08

08-J

ul-0

804

-Aug

-08

31-A

ug-0

827

-Sep

-08

24-O

ct-08

20-N

ov-0

817

-Dec

-08

13-J

an-0

909

-Feb

-09

08-M

ar-0

904

-Apr

-09

01-M

ay-0

928

-May

-09

24-J

un-0

921

-Jul

-09

17-A

ug-0

913

-Sep

-09

10-O

ct-09

06-N

ov-0

903

-Dec

-09

30-D

ec-0

926

-Jan

-10

22-F

eb-1

021

-Mar

-10

17-A

pr-1

014

-May

-10

10-J

un-1

007

-Jul

-10

Millio

ns o

f dol

lars

PEN

soles

per

dol

lar

Peru: Exchange rate, Net Forex purchases and Readjustable Central Bank at maturity

(In US$ millions, exchange rate in PEN soles per US$)

Total net purchases CDR BCRP at maturiy Exchange rate

Purchases1/

Accumulated 2007 10 306Accumulated 2008 2 754Accumulated 2009 108Accumulated 2010, at 7 de july 3 568Accumulated 2007 - 2010 16 7351/ Negativ sign indicates sales of US$ dollars.

Source:  Central  Bank  of  Peru  15

A quick and effective policy response during the turmoil of 2007-2009 prevented a major impact of the financial crisis on the Peruvian financial system, preserving adequate credit

conditions and a stable business environment.

Number  of    insolvency  applicaAons    to  INDECOPI  

170

344

766 824

1698 1635

926

505 481403

556

376 376268

0

200

400

600

800

1000

1200

1400

1600

1800

1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009*

Source:  Central  Bank  of  Peru,  Superintendence  of  Banks  and  Indecopi  

46,4 44.0

20.00

30.00

40.00

50.00

60.00

70.00

Jan/

08

May

/08

Sep

/08

Jan/

09

May

/09

Sep

/09

Jan/

10

May

/10

Sep

/10

Jan/

11

May

/11

Sep

/11

Jan/

12

May

/12

Sep

/12

Liquidity Ratio (Percentage)

Domestic Currency Foreign Currency

53  58  

61  63   64   65  

63  63  

67  66  

62   64  

Jan/08  

Apr/08  

Jul/0

8  

Oct/08  

Jan/09  

Apr/09  

Jul/0

9  

Oct/09  

Jan/10  

Apr/10  

Jul/1

0  

Oct/10  

Jan/11  

Apr/11  

Jul/1

1  

Oct/11  

Jan/12  

Apr/12  

Jul/1

2  

Oct/12  

Lending  Access  Index  

Dec-­‐12

 

 1.00    

 3.00    

 5.00    

 7.00    

 9.00    

 11.00    

 13.00    

Jan/97  

Jul/9

7  Jan/98  

Jul/9

8  Jan/99  

Jul/9

9  Jan/00  

Jul/0

0  Jan/01  

Jul/0

1  Jan/02  

Jul/0

2  Jan/03  

Jul/0

3  Jan/04  

Jul/0

4  Jan/05  

Jul/0

5  Jan/06  

Jul/0

6  Jan/07  

Jul/0

7  Jan/08  

Jul/0

8  Jan/09  

Jul/0

9  Jan/10  

Jul/1

0  Jan/11  

Jul/1

1  Jan/12  

Jul/1

2  

EvoluAon  of  non  performing  raAo  of  banks  (In  percentage)  

16

•  These measures can be classified in 2 categories: – Prevention: using non conventional monetary policies

such as reserve requirements to prevent the system from taking excessive risk in a context of low international interest rates and high and persistent capital flows.

– Capacity build-up: accumulating international reserves to ensure the Central Bank has the means to contain exchange rate volatility.

In the aftermath of the crisis, Peru’s Central Bank has been taking precautionary measures to confront the possibility of a reversal in capital flows

17

Now, the Central Bank holds its interest rate at 4,25%. Large reserve requirements on foreign currency liabilities are in place to limit the impact of

capital flows on lending and prevent credit booms.

18

20.0

30.0

00

05

10

15

20

25

30

35

Apr-­‐07

Jul-­‐0

7Oct-­‐07

Jan-­‐08

Apr-­‐08

Jul-­‐0

8Oct-­‐08

Jan-­‐09

Apr-­‐09

Jul-­‐0

9Oct-­‐09

Jan-­‐10

Apr-­‐10

Jul-­‐1

0Oct-­‐10

Jan-­‐11

Apr-­‐11

Jul-­‐1

1Oct-­‐11

Jan-­‐12

Apr-­‐12

Jul-­‐1

2Oct-­‐12

Jan-­‐13

Apr-­‐13

 1/

Domestic currency reserve ratios(As percentage of total obligations subject to legal requeriments)

Average  required   Marginal

%

1/ Forecast

43.1

55.0

20

25

30

35

40

45

50

55

60

Apr-­‐0

7Jul-­‐0

7Oc

t-­‐07

Jan-­‐08

Apr-­‐0

8Jul-­‐0

8Oc

t-­‐08

Jan-­‐09

Apr-­‐0

9Jul-­‐0

9Oc

t-­‐09

Jan-­‐10

Apr-­‐1

0Jul-­‐1

0Oc

t-­‐10

Jan-­‐11

Apr-­‐1

1Jul-­‐1

1Oc

t-­‐11

Jan-­‐12

Apr-­‐1

2Jul-­‐1

2Oc

t-­‐12

Jan-­‐13

Apr-­‐13

 1/Foreign Currency Reserve Ratios

(As percentage of total obligations subject to legal requeriments)

Average  required  FC Marginal

%

1/ Forecast

1.0

1.5

2.0

2.5

3.0

3.5

4.0

4.5

5.0

5.5

6.0

6.5

7.0

1.0

1.5

2.0

2.5

3.0

3.5

4.0

4.5

5.0

5.5

6.0

6.5

7.0

Jan-

06M

ar-0

6M

ay-0

6Ju

l-06

Sep-

06No

v-06

Jan-

07M

ar-0

7M

ay-0

7Ju

l-07

Sep-

07No

v-07

Jan-

08M

ar-0

8M

ay-0

8Ju

l-08

Sep-

08No

v-08

Jan-

09M

ar-0

9M

ay-0

9Ju

l-09

Sep-

09No

v-09

Jan-

10M

ar-1

0M

ay-1

0Ju

l-10

Sep-

10No

v-10

Jan-

11M

ar-1

1M

ay-1

1Ju

l-11

Sep-

11No

v-11

Jan-

12M

ar-1

2M

ay-1

2Ju

l-12

Sep-

12No

v-12

Jan-

13M

ar-1

3

Central Bank Policy Rate(percentage)

4,25

The Bank’s balance sheet reflects the NIR build-up policy and prudential fiscal savings

19

Simplified Balance Sheet of the Central Bank(as percentage of Net International Reserves)

Net Assets mar-13I. International Reserves 100%

(US$ 67 918 mills.)Net LiabilitiesII. Public sector deposits 35%

In domestic currency 21%In foreign currency 14%

III. Reserves requirements 28%In domestic currency 12%In foreign currency 1/ 15%

IV. Central Bank's instruments 20%CDs 13%Deposits 7%

V. Currency 17%

VI. Other net liabilities 0%1/ Includes banks' overnight deposits with the Central Bank.

Net international reserves (NIR) are around US$ 68 billion. The high NIR stock greatly enhances Peru’s responsiveness to potential financial external shocks.

20

8.6   9.6   10.2   12.6   14.1  17.3  

27.7  31.2   33.1  

44.1  48.8  

64  68,5  

Dec-­‐01   Dec-­‐02   Dec-­‐03   Dec-­‐04   Dec-­‐05   Dec-­‐06   Dec-­‐07   Dec-­‐08   Dec-­‐09   Dec-­‐10   Dec-­‐11   Dec-­‐12   Mar-­‐13*  

Net  InternaAonal  Reserves  (US$  billions)  

2011   2012   2013*  

NIR  (US$  millions)   48  816   63  991   68  450  

NIR  /  GDP  (%)   27,6   32,0   33,3  

NIR  /  Short-­‐term  debt  (#  $mes)   5,3   5,8   5,2  

NIR  /  Liquidity  (%)   84,0   92,7   99,6  

* Peru: as of march 08, 2013, other countries: february 2013

%GDP  

Chile   14,7  

Brazil   15,5  

Mexico   14,2  

Colombia   10.6  

Argen$na   8,8  

Venezuela   8,1  

The private sector is in better shape as well: dollarization of the private bond stock has decreased significantly and the participation of bond issues with maturities longer than 5

years has increased…

*  Data  as  of  September  

4.7  

25.4  

43.7  48.1  

19.2  10.1   9.8   9.8  

76.1  

64.5  

46.5  42.1  

2001   2006   2011   2012  Nominal  Soles   Indexed  Soles   Dollars  

Private  Bond  Stock  by  currency    (%)  

19.2   16.5   15.4   13.2  

45.6  

27.5  32.0   31.1  

35.1  

56.0   52.6  55.7  

2001   2006   2011   2012  Up  to  3  years   Between  3  and  5  years   More  than  5  years  

Private  Bond  Stock  by  original  maturity  (%)

21

… and interest rates of private bond issues show a downward trend in both currencies.

11.5  

7.1   7.0  6.1  

8.0  6.2  

5.3   5.5  

2001   2006   2011   2012*  

Interest  rates  of  private  bond  issues  (%)  

Domes$c    currency   Foreign  currency  *  Data  as  of  September  

22

Given the size of the BTP market and the limited participation of domestic financial institutions, the negative impact of higher interest rates can be limited with liquidity

injection policies.

23

1.1 1.5 1.4 1.12.8 2.7 3.4

3.9

5.6 5.2 5.56.5 5.9 6.0

0.0

2.0

4.0

6.0

8.0

2006 2007 2008 2009 2010 2011 2012

BTP  Stock(Percentage  of  GDP)

Non  Resident Resident .

Non  Residents56,2%

Pension  Funds  (AFPs)

29,9%

Banks5,1%

Insurance4,3%

Others4,5%

BTP  Holdings  by  Type  -­‐ 2012(percentage)

The banking sector is solid as well: Peru’s bank indicators are among the best among LAC countries in profitability, portfolio quality, solvency and operating efficiency.

Source:  Na$onal  supervisors,  IMF  

1,11,4 1,5

1,7 1,7

2,2 2,2 2,32,5 2,5

2,7 2,7

0

0,5

1

1,5

2

2,5

3

Uru Ven Peru Bol. Par Ecu. Nic. Chil. Col. Mex. Pan. Dom.  Rep.

Non  performing  loans  ratio

15,7 15,6 14,8 14,6 14,2 13,3 13,0 13,0 12,7 12,3

9,2 8,8

02468

1012141618

Mex. Pan. Nic. Dom.  Rep.

Col. Peru Chil. Ecu. Ven Bol. Par Uru

Regulatory  capital  ratio

47,4 48,0 50,2 53,1 56,4 56,5 59,4 59,8 62,3 62,771,4

88,1

0

20

40

60

80

100

Chil. Peru Pan. Par Mex. Ven Nic. Ecu. Col. Bol. Dom.  Rep.

Uru

Operating  Efficiencyoperating  expenses  /  (net  financial  and  non  

financial  income)

24

•  Peru’s experience shows that an appropriate mix of fiscal, monetary and regulatory policy can limit the risks associated with a sudden reversal of capital flows.

•  Reserve accumulation can improve the central bank’s response capacity in the event of an adverse shock; and reserve requirement management discourages risk-taking during capital inflow surges.

•  The policy response to a capital reversal will depend of the nature of the shock: –  An orderly reversal can actually be beneficial, as it can alleviate

demand pressures. –  In contrast, the central banks would need to respond to a disorderly

capital reversal using all the tool at its disposal.

Concluding Remarks

25

XCV MEETING OF CENTRAL BANK GOVERNORS OF THE CENTER FOR LATIN AMERICAN MONETARY STUDIES

Julio Velarde Governor

Central Reserve Bank of Peru

Normalization of the Monetary Policy in the Industrialized Economies and Possible Effects on

the Latin America and Caribbean Region