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Currency controls are already in operation to counter dollar's fall

Section: Daily Dispatches

Currency Controls Return
as Central Banks
Fight Dollar Freefall

By Gavin Finch and Ye Xie
Bloomberg News Service
Monday, November 12, 2007

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.

Instead of using currency reserves or interest rates to influence foreign exchange markets, central banks and finance ministries are setting up obstacles to keep the falling dollar from threatening company profits and economic growth. The U.S. currency slumped 10 percent this year against its biggest trading partners, the steepest decline since 2003, while Treasury Secretary Henry Paulson has reiterated that the U.S. supports a "strong" dollar.

"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.

The U.S. hasn't attempted to stop the decline as the worst housing slump in 16 years forced the Federal Reserve to lower interest rates. The dollar has weakened 19 percent against the Canadian currency this year to a record 90.58 cents, and fell 18 percent versus Brazil's real.

The euro strengthened 1.2 percent last week and reached an all-time high of $1.4752 on Nov. 9. The yen rose 3.6 percent in its biggest weekly gain since December, and touched 110.51 per dollar on Nov. 9, the highest level since May 2006.

...'More Violent Correction'

An index tracking the dollar against seven major trading partners dropped to 71.11 on Nov. 2, the lowest ever, a week after the Fed reduced its target rate for overnight loans between banks by a quarter-percentage point to an 18-month low of 4.5 percent.

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.

The extent of the dollar's slump reminds some traders of 1973, when former President Richard Nixon's Treasury Secretary John Connally abandoned the gold standard while the U.S. was in recession and inflation exceeded 10 percent. The dollar lost 40 percent against the yen in the next five years.

Since 2002, the U.S. currency has fallen 40 percent against the Canadian dollar, 33 percent versus the euro and weakened 24 percent compared with the British pound.

...Exports Increase

There's little evidence this year's decline is hurting the economy. Gross domestic product increased 3.9 percent in the third quarter, the highest since March 2006, the Commerce Department said on Oct. 31. The annual inflation rate was 2.8 percent in September, the Labor Department reported on Oct. 17.

The U.S. trade deficit unexpectedly narrowed 0.6 percent in September to $56.5 billion, as exports increased 1.1 percent, the Commerce Department said Nov. 9.

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.

...Profit Squeeze

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.

...In a Corner

"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 billion) 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"

"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.

...Indian Restrictions

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 non-interest-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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