INTELLGENCE MEMORANDUM BRAZIL, CHILE, AND COLOMBIA: EXPERIENCE WITH 'CRAWLING PEG ' EXCHANGE RATES

• Document Type: CREST
• Collection: General CIA Records
• Document Number (FOIA) /ESDN (CREST): CIA-RDP85T00875R001600030172-8
• Release Decision: RIFPUB
• Original Classification: C
• Document Page Count: 15
• Document Creation Date: December 22, 2016
• Document Release Date: October 31, 2011
• Sequence Number: 172
• Publication Date: December 1, 1970
• Content Type: IM

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DIRECTORATE OF
INTELLIGENCE
Intelligence Memorandum
Brazil, Chile, And Colombia:
Experience With "Crawling Peg" Exchange Rates
DOCUMENT SERVICES BACII
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ER IM 70-171
December 1970
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WARNING
This docwnenit contains information affecting the (iationnl
defense of the United States, within tl(o mcar-ing of Title
18, sections 793 and 791, of the US Code, as amended,
Its transmission or revelation of its contents to or rc-
eeipt by no unnnthorized person is prohibited by law,
OIQUP 1
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CONFIDENTIAL
CENTRAL INTELLIGENCE AGENCY
Directorate of Intelligence
December 1970
INTELLIGENCE MEMORANDUM
Brazil Chile And Colombia: Experience With
"Crawling Peg xc range Rates
Introduction
Brazil, Chile, and Colombia have been con-
fronted in recent decades with recurrent balance-
of-payments strains caused partly by currency over-
valuation. This overvaluation arose because they
were slow to adjust exchange rates for rapid in-
flation. Inflation has continued in recent yes:s,
but in order to live better with it these countries
have adopted "crawling peg" adjustments, which
consist of small devaluations every few weeks.*
This memorandum describes tl:e new procedure and
assesses its impact -- in part through comparisons
with Argentina, Peru, and Uruguay, which retained
more conventional adjustment procedures.
Between ad,juotmente, crawling peg rates (or
smoothly moving parities) are held at fixed levclc
by government intervention in the exchange market.
Crawling peg rates are distinct from "floating"
rates, which are allowed to move more or less freely
in response to supply and demand conditional with, at
most, only tacit government support. Outside of
South America, only South Korea has a crawling peg
system. The fluctuating exchange parities currently
in use in Canada and used temporarily in the Philip-
pines and West Germany in recent years are proparly
classified as floating rates.
Note: This memorandum was produced solely by CIA.
It was prepared by the Office of Economic Resecreh
and wa/i coordinated with the Office of Current
Intelltitgence.
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CONIC IDENTIAL
The Problem of Currency Overvaluation
1. Exchange rate adjustment has been important in
most South American countries because of rapid (in
some instances, raging) inflation. Brazil, Chile, and
Colombia have experienced the problem in varying de-
grees, with average annual cost-of-living increases
since 1958 of 45%, 26%, and 11%, respectively (see
Figure 1). Their inflation primarily reflects large
government deficits
financed partly with
r riure, central bank credit,
COST-OP-LIVING INDEXES WLLJ. ` JJrvuynti Rest-ices
monetary expansion.
in Brazil and Chile,
toeo-l1)
4000,1 _ . 1. ! _! ' /1 1 as businessmen and
organized labor sought
4511.
30001 Oraril -
-- ; 1 1 / ! I to maintain their real
countries have repeat-
uuLy initiated finan-
cial stabilization pro-
grams to control infla-
tion and have had some
'0001- ' ! f I success in recent years.
.oo I So far, however, politi-
moo
- ; / % veloped countries im-
doo
portant to their trade.
2. The countries'
rapid inflation called
for prompt, substantial
currency devaluations,,
but they were delayed
because of expected ad-
verse p\1itical reper-
cussions and the added
inflationary impact.
CONI''IU')ENTIAL
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CONFID, i N'i AL,
ror example, from 195G until it adopted the crawling
peg in 1962, Chile did not adjust the exchange rate
despite a 90% cost-of-livi'ltg rise. During 1959-66,
while the cost of living increased about 140%,
Colombia made only four major adjustments, permitting
its currency to be overvalued for extended periods.
In the decade before adopting crawling pegs, Brazil
devalued an average of once a year, but rampant
inflation nevertheless caused substantial currency
overvaluation between adjustments.
3. Currency overvaluation caused severe balance-
of-payments strains by deforming trade balances and
provoking capital flight. Reduced profitability
of foreign sales rand inability to sell some goods)
at established exchange rates restricted export ex-
pansion; at the same time, import demand was greatly
stimulated by making some foreign products relatively
cheap. As foreign payments strains mounted, growing
prospects of a large devaluation or import and ex-
change controls usually prompted speculative flights
of capital. Instead of devaluing frequently, the
countries drew down reserves, imposed import and
exchange controls, and (in some instances) subsidized
major exports.
4. Currency overvaluation thus distorted re-
source allocation and slowed economic growth. Ex-
port diversification was discouraged (especially into
manufacturing), leaving Brazil and Colombia dependent
on coffee for 40%-60% of exports and Chile on copper
for 65% of exports when they adopted crawling pegs.
Actual or threatened exchange controls, particularly
over profit and capital repatriation, at times
deterred private foreign investment. Slackening
exports and capital inflows and weakened foreign
reserves limited import capacity and economic growth.
Introduction of Crawling Peg Adjustments
5. The three countries introduced crawling peg
exchange rate adjustme;,lts over a six-year period.
Chile initiated them in October 1962, when the
Alessandri govern nt's initially successful stabili-
zation program was giving way to accelerating in-
flation and when trade and exchange controls imposed
the preceding January were proving ineffective. In
Colombia, the'newly elected Lleras government adopted
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the crawling peg system in March 1967, along with
trade and exchange controls and sweeping financial
stabilization measures. Brazil's military regime
introduced the now provedure in August V.,,681 when --
after four years' stabilization efforts -- further
slowing of inflation seemed problematic.
6. At the time, the three countries were losing
substantial foreign reserves because of trade deficits
and (in Brazil and Chile) capital flight in antici-
pation of large devaluations. Brazil and Chile de-
valued moderately at the outset and th(ea', sought to
maintain suitable exchange rates through crawling
peg adjustmPnts. Brazil devalued by 12% immediately,
and Chile spiaad an initial 32% reduction over tytree
months, devaluing by 18% the first month. Colombia,
on the other hand, used trade and exchange controls
to ease immediate paymerts difficulties and aimed
at improving the exchange rate gradually, through
crawling peg adjustments that would outweigh con-
tinuing inflation. Bimonthly adjustments made
within six months devalued Colombia's currency by
12%. For Chile and Colombia, these initial devalua-
tions were grossly inadequate, compensating for only
40%-50% of inflation since the preceding devaluation.
For Brazil, however, the initial adjustment accOuhted
fully for the interim price increase and gave the
cruzeiro a reasonable value.
7. Under the crawli"g peg system, the three
countries' central banks which control nearly all
foreign exchange) have fixed new buying and selling
rates every few weeks.* The banks support these
rates at exactly the level announced. The timing
and extent of rate adjustments do not follow rigid
patternn -- an apparently deliberate feature that
the banks hope will minimize speculation. Changes
in foreign reserves and domestic prices have been
the general criteria for adjustments, but little
The ci: a .Zing peg proaadure applies primarily
t genercil exchange rates for trade, but the
countries' other rates have b:ren adjusted commen-
burately. When crawling pegs were adopted, Chile
had rates for trade and capital transactions;
Colombia, rates for general trade, capital (since
abolished), and cc'f f e; and Brasil;, rates for coffee
and all other transactions.
4 -
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CONI.'Ii)ENTI.'IAL,
is known of how the banks data minod their precise
extent and timing. The International Monetary Fund
(IMF) approved crawling pegs as part of standby
credit agreements with the eour,ttries, but it
apparently has not tried to enforce strict rules
regarding adjustments.
8. Although crawling pegs generally promised
to boost export earnings, Brazil and Colombia
necessarily were concerned about stimulating coffee
output through increased proceeds (in domestic cur-
rency) for growers. Since the countries were already
fulfilling their export quotas under the International
Coffee Agreement (ICA) and increased output would
simply boost stocks, they limited the rise in pr'-
ducer profits by raising support prices lass than
devaluation raised coffee export proceeds. This
step also helped to moderate inflation by limiting
coffee growers' incomes and swelling government
revenues, which include nearly all profits on cof-
fee exports.
Impact of the Crawling Peg Procedure
Movement of Real Exchange Rates
9. Since adopting crawling peg adjustments,
all three countries have held their real exchange
rates* below earlier levels (see Figure 2). Chile
has had both the most extended experience and the
greatest success in maintaining the initial devalua-
tion. By the end of 1963, Chile reduced its real
exchange rate for general trade by 33%. In October
1963, however, following sharply rising world
copper prices, it adopted a special rate for copper
exports that was permitted to rise through 1964 to
limit copper company profits, in terms of escudos.
Chile also permitted the general rate to rise during
1964-65 but abolished the copper rate at the end of
1966 and by December 1969 had reduced the reunified
rate almost to its earlier low.**
10. Both Brazil and Colombia have lost ground
in holding down real exchange rates. Dy the second
Defined as the nominal rates adjusted for
inflation.
** Since August 1970, Chile has not made any
crawling peg adjustments despite continuing
rapid inflation. The Allende government, in-
augurated in early November, has eeverely criti-
cized the crawling peg system and indicated that
it will be abando;-ed.
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INDEXES OF REAL EXCHANGE RATES*
Chile
000-
\ (nnnrnll
Trndo Rate
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91 Mar 21 Auo
Brazil
colomlvle
I
I ~ ~ I
1 , 11 , III, IV I , II, Ill, IV I , it III , Iy
loge 11063 1oe4 foes foes 1oe7 loge logo
'Obtained by dividing Indexer of the currencies' external
value (expressed In US $ ) by indexes of their Internal value
(oxprosr ad no reciprocals of cost-of-living Indexes). A declining
Index of real exchange rates Indlcntes develuntlon that more
than offr,eti price Increases -generally n favorable development
for the b ilanco of pnymonts.
half of 19611, Brazil's rate was only 2%-3% below the
earlier level. Colombia made good progress for
2 years but suffered a partial setback in 1969.
Crawling peg adjustments nevertheless gave both
countries more favorable Teal exchange rates than
under the old procedure, under which inflation
commonly offset devaluation within six months.
11. The recent movements of real exchange rates
in Brazil and Colombia do not differ greatly from
those experienced in Argentina, Peru, and Uruguay
under more conventional procedures. In 1967 the lat-
ter three countries sought to ease balance-of-payments
strains by means of large devaluations and harsh
anti-inflation programs. Nominally, Argentina
devalued by 29% in March 1967, Peru by 31% in
September 1967, and Uruguay by 50% in November 1967
and 20% in April 1968. The real devaluations of
Argentina and Uruguay were considerably smaller,
however, because the countries raised export taxes
to capture much of the gain in exporters' profits.
Peru accomplished somewhat the same result by
advancing the payment schedule for corporate income
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taxes. The return of real exchange rates to the
pro-devaluation level was slowed by the three
countries' considerable progress its checking
inflation and, in Argentina and Uruguay, by gradual
cuts in export tax rates. By the end of 1969,
Argentina's and Uruguay's real exchange rates (like
Brazil's) were back near where they started, since
nearly all of the initial improvement in their ex-
change rates had been offset by domestic price rises.
Peru's real rate remained about 10% below its pre-
devaluation level, however.
Effects on Trade and Capital Flows
12. After Brazil, Chile, and Colombia adopted
crawling pegs, growth of export earnings accelerated,
capital inflows rose, and speculative capital flight
generally stopped. Crawling pegs contributed to
these gains but played a large part only in Brazil
and Colombia.
13. Brazil's export earring from items other
than coffee -- the expected bei.eficiaries of im-
proved exchange rates -- rose from about $950 mil-
lion (57% of exports) in 1967 to $1.4 billion (61%
of exports) in 1969 (see Figure 3) and are doing
well in 1970. The gain averaged 22% annually,
compared with 6% during 1959-67, and was by far
the largest two-year rise during the 1960s. It
was paced by cotton, beef products, and cocoa, with
manufactured goods remaining a very small share of
sales. Apart from a reduced real exchange rate,
export expansion was aided by favorable crop condi-
tions, generally strong markets for coffee and other
farm products, and increased government export
promotion. Import growth moderated in 1969, con-
tributing to the emergence of a small trade surplus.
Brazil's receipts of short-term private capital
accelerated further after crawling pegs were intro-
duced. Growing strength in the balance of payr_,:nts
boosted Brazil's foreign reserves from $200 million
to $600 million during 1969 and probably was a major
factor in allowing the real exchange rate to rise.
14. In Colombia, exchange rate adjustments and
trade promotion have contributed to substantially
increased exports of items other than coffee and
petroleum. These sales -- led by cotton, textiles,
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ides ia'as toes 1C 4 1O idea tda,- io'an loan
provIslonal
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and paper -- rose from $110 million (22% of exports)
in 1966 to more than $205 million (34% of e::ports)
in 1969. The average annual gain for these exports
was 23%, compared with 13% during 1959-66. Total
exports, however, have increased only moderately
since 1966, because ICA quotas restricted the growth
of coffee exports and declining reserves prevented
expanded earnings from oil. Crawling peg adju'it-
ments have been insufficient to permit import re-
strictions to be removed, and export expansion has
merely reduced the trade deficit somewhat from the
substantial 1966 level. At the same time, the new
system has strengthened business confidence and
helped to attract more private capital, which --
with increased foreign aid -- has raised foreign
reserves gradually.
15. Chile's initial devaluation and subsequent
exchange rate adjustments were too small either
to snake non-traditional exports very profitable or
to permit import controls to be abolished, despite
soaring copper export revenues. Exports other than
copper rose only from about $165 million in 1962 to
abcut $235 million in 1969. Dramatically increased
world prices, however, pushed copper exports from
about $325 million in 1962 to about $950 million in
1969, when they made up 80% of the total. The crawl-
ing peg system, along with tight exchange controls,
generally eliminated capital flight, although it
revived in presidential election years. The marked
improvement in foreign reserves since the mid-1960s,
however, reflects mainly increased foreign aid,
large US-financed copper investment, and continuing
moderate trade surpluses generated by booming copper
exports.
16. Argentina, Peru, and Uruguay, using con-
ventional procedures, also have improved their
payments positions since 15;66, but export gains
have been far less striking than in Brazil, Chile,
and Colombia. There was little or no growth in
Peruvian exports in either 1967 or 1969, and part
of Argentine and Uruguayan gains represented a
recovery to earlier levels. In Argentina, trade
surpluses have been shrinking, and the speculative
capital movements associated with its traditional
devaluation practices have continued to be a problem.
Its foreign reserves rose greatly after the 1967
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devaluation becau;te of short-term capital inflows,
increased a little in 1968, and then fell sharply
in 1969 as capital flight recurred in anticipation
of devaluation. Peru's trade balance improved
sharply in 1968-69, largely, because imports dropped.
Foreign reserves, however, registered little gain
because of continuing capital flight and reduced
inflows of foreign aid and long-thrm private capital,
both attributable to expropriation of the US-owned
international Petroleum Company properties and other
government measures dampening the investment climate.
Uruguay's foreign reserves rose moderately in 1S67-
69, following the devaluation, partly because sub-
stantial capital flight gave way to small capital
inflows.
Crawling Pegs and Fiscal Irresponsibility
17. Some observers believe that a cxawling peg
system may encourage fiscal irresponsibility by
reducing the adverse balance-of-payments effects
of inflation. Without the discipline of fixed
exchange rates, they argue, governments are freer
to incur budget deficits and let private credit
expand unrestrainedly. Experiences in South America,
though brief in Brazil and Colombia, provide little
support for this fear. Colombia's average infla-
tion rate amounted to only 8% during 1967-69,
compared with 11/% in 1959-66. Since adopting
crawling pegs, Brazil has reduced its average
inflation rate to less than 25%, compared with 50%
in 1959-67. Although Chile's average inflation
rate of 31% since 1962 exceeds that during 1959-62,
it is an improvement over the preceding decade.
16,. It is true, nevertheless, that Argentina,
Peru, and Uruguay, using conventional adjustment
procedures, made strikingly greater progress toward
curbing inflation. Though their inflation rates
rose or remained high under the initial impact
of devaluations, they were cut decisively in the
following years. Argentina did especially well,
paring the rate from 32% annually in 1959-66 to
only 7% in 19.69. The inflation rate dropped in Peru
from 9% annually in 1959-66 to 6% in 1969 and in
Uruguay from 42% annually in 1959-67 to 14% in 1969.
Progress in this area probably depends mainly on the
government's character and strength rather than on
specific :evaluation practices.
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Conclusions
19. Chile, Colombia, and Brazil all benefited
from adopting crawling peg exchange rate adjust-
ments. But the benefits of the change (which occur-
rod in 1962 in Chile, 1967 in Colombia, and 1960 in
Brazil) varied widely. The proc.idure helped con-
siderably in expanding exports other than coffee
in Brazil and other than coffee and petroleum in
Colombia. Chile's spectacular rise in export earn-
ings, however, mainly refle^ted, high copper prices.
Growth of non-traditional exports in Chile and (to
some extent) Colombia was handicapped by inadequate
devaluation when crawling pegs were introduced.
Speculative capital flight was avoided by Brazil
and Colombia and was eliminated by Chile in most
years. Crawling peg adjustments contributed to a
dramatic rise in short-term private capital inflows
in Brazil and increased inflows of long-term private
funds in Colombia but were outweighed in Chile by
rising copper prices and by other government measures
effecting foreign investors.
20. Use of crawling pegs does not seem to have
encouraged fiscal irresponsibility, as some observers
have feared. Both Brazil ant' Colombia reduced their
average annual inflation rates, compared with earlier
years, and Chile's rate (though higher than the
average for the preceding four years) remained below
the average for the previous decade. Nevertheless,
Argentina, Peru, and Uruguay -- which retained con-
ventional exchange rate procedures -- made strikingly
better progress in checking inflation than did
countries using crawling pegs.
21. Although South America's brief experience
with crawling pegs is encouraging, experience in
Argentina, Peru, and Uruguay suggests that occasional
major devaluations combined with periodic changes
in export taxes and import tariffs can achieve some
success. Speculative capital movements, however,
remain a problem under this procedure. Although
these often can be minimized by devaluing before it
is generally considered necessary, such an approach
is unusually troublesome politically and probably
cannot be indefinitely successful. The more con-
ventional approach probably works best where the
government has the will and power to pursue a strong
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financial stabilization program. Crawling peg
adjustments, on the other hand, seem an alternative
worth consideration, most of all whore, for political
and social reasons, the inflation rate in likely to
remain high.
22. The experience of the throe countries using
crawling pc is not particularly rolovont to
developed countries. Developed countries are in a
better position to control inflation and are under
greater international pressure to do no rather than
accommodate the exchange system to it. Adoption of
crawling pegs has been discussed as one of several
possible reforms of the international financial
system. But the method usually proposed calls for
automatic parity changes in accordance with an agreed
sot of rules, not occasional changes determined
independently by national governments.
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