Currency Controls Implemented to Combat Dollar Fall

In a sign of increasing desperation, some central banks are imposing currency controls in an effort to arrest the dollar’s decline. Oddly, none of them seem to be taking the most direct measure, which would be to sell their own currency. This may be due to the fact that traditionally, the job of trying to shore up a battered currency has fallen to its own central bank, and it’s generally a losing battle, since weak currency countries general don’t have abundant reserves. The alternative would be to cut rates, but that can stoke domestic inflation.

From Bloomberg:

Central banks from Bogota to Mumbai are imposing foreign-exchange curbs to take control of their soaring currencies from traders dumping the dollar.

In Colombia, international investors buying stocks and bonds must leave a 40 percent deposit at Banco de la Republica for six months. The Reserve Bank of India created a bureaucratic thicket to curb speculation by foreign money managers. The Bank of Korea is investigating trading of currency forward contracts to limit gains in the won, now at a 10-year high….

“Central banks are struggling to find new ways to intervene against their currencies and some of the proposals simply can’t work,” said Mirza Baig, an analyst in Singapore at Deutsche Bank AG, the world’s biggest currency trader. Some plans are “truly bizarre,” he wrote in a report…..

Stephen Jen, head of currency research at Morgan Stanley in London, said on Nov. 2 that the dollar’s slide threatens to turn into a “more violent correction” that may require joint intervention by the U.S., European Union and Japan. The dollar will trade at $1.51 per euro by year-end, Jen said on Nov. 8….

There’s little evidence this year’s decline is hurting the economy…..

The pain is being felt elsewhere. U.S. sales for Hyundai Motor Co., South Korea’s third-biggest exporter, may decline for the first time in nine years with the won the “No. 1 obstacle,” Vice Chairman Kim Dong Jin said in an interview last month. The won’s 3 percent gain in the past year helped send Hyundai’s shares down 9 percent.

Infosys Technologies Ltd., India’s second-largest software exporter, cut its full-year earnings forecast on Oct. 11, blaming the rupee’s 13 percent rise. The shares fell 24 percent this year.

India may miss its $160 billion target for exports in the year through March 31 as local goods become more expensive abroad, Commerce Secretary G.K. Pillai said on Oct. 8.

Munich-based Bayerische Motoren Werke AG, the world’s biggest manufacturer of luxury cars, and Paris-based Hermes SCA, the maker of Kelly and Birkin handbags, blamed the currency market for disappointing profits.

European Central Bank President Jean-Claude Trichet said Nov. 8 that the decline in the dollar has been “brutal,” while Canadian Finance Minister Jim Flaherty said he’s “concerned” by the surge in his currency. French President Nicolas Sarkozy told a joint session of the U.S. Congress on Nov. 7 that the Bush administration must stem the dollar’s plunge or risk a trade war.

“The weaker dollar causes central banks to look at foreign inflows differently,” Robert Fullem, vice president of U.S. corporate-currency sales at Bank of Tokyo-Mitsubishi UFJ Ltd. in New York. “The market is pushing the central banks into corners. I don’t have faith in them. They may have to push the envelope further.”

Trading on Colombia’s stock exchange fell 27 percent to an average 80 billion pesos ($39 million) a day as the Finance Ministry struggled to control the dollar’s 10 percent decline.

The Finance Ministry imposed controls on short-term capital in May by requiring foreign buyers of stocks and bonds to deposit 40 percent of their purchases with the central bank for six months. If the peso weakens, investors won’t be able to pull out until the period has expired unless they pay a fee of as much as 9.4 percent of the investment.

“New mechanisms need to be considered because the exchange rate is affecting us a lot,” Colombian President Alvaro Uribe said in a May 9 speech in Medellin.

“It’s absolutely frustrating,” said Urban Larson, who co- manages about $500 million for F&C Investments in Boston. “The currency control is keeping foreign investors on the sideline. It’s unfortunate because there are a lot of attractive stocks in Colombia and the economy is quite good.”

Overseas investors have bought $18.8 billion of stocks and bonds in India this year, double the previous record in 2005. The increase “is building bubbles” in the country’s stock market and real estate, Finance Minister Palaniappan Chidambaram said last month.

To curb speculative flows, regulators in Mumbai adopted measures in October to bar some funds from investing in Indian equities and imposed investment caps and deposit requirements.

Foreign companies licensed to invest in India can only issue participatory notes, or offshore derivatives linked to local stocks, backed by 40 percent of the shares they hold. They were barred from selling notes backed by other derivatives, contracts whose values are derived from other assets.

Trading on India’s Sensitive Index was suspended and $120 billion of its market value was wiped out in a minute on Oct. 17, when the regulator proposed the measures.

The Bank of Korea and the Financial Supervisory Service said Oct. 23 that they will study forward currency transactions by exporters and financial companies. Companies use forward contracts to lock in exchange rates at a future date, helping fuel gains in the currency.

“We need to find out the cause of excessive forward sales,” said Park Shin Young, an economist at the Bank of Korea. Interbank transactions jumped to $850 million a day in the third quarter, up 35 percent from the previous three months, central bank data show.

Policy makers told parliament in October that they will probably lose more than $1 billion for a third year because dollars purchased to stop the won’s advance earn less interest than the bonds sold to control money supply.

“Central banks are trying noninterest rate methods to stabilize growth and capital flows,” said Bank of Tokyo- Mitsubishi’s Fullem. “It’s something extraordinary. They haven’t used these venues for a long time. It’s sort of the last resort the central banks would like to tap.”

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  1. Anonymous

    the controls are really intended to reduce their currencies appreciation (and thus indirectly the dollar’s decline) and generally have been implemented by countries facing very rapid reserve growth. Steps to deter inflows thus can be considered an alternative to appreciation, costly sterilized intervention (i.e. buying fx and then sterilizing it) or monetary easing (unsterilized intervention/ cutting rate to deter inflows).


  2. alan greenspend

    aside from the very unlikely event of the Fed raising interest rates, whats to prevent the dollar depreciating further and therefore eventually the latter choice Dr. Setser mentioned, other central banks cutting rates?

    not a great choice, as global inflation would increase. perhaps a moratorium on FCB’s buying our debt, which would force our rates up is a more likely choice.

  3. Anonymous

    So basically every central bank in the world combined can’t bail out the dollar. And we’re supposed to be the bedrock of the world’s financial system? Sounds more and more like we’re becoming the deadweight.

    And why do they do it? Because we buy their stuff. Once we can longer do that (as the last article states, our ability to consume is headed down fast) they’ll no longer have any reason to support the dollar. That’s when the euro hits 2/dollar…

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