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Currency deteriorates amid political
uncertainty and regional concerns
The strengthening in the exchange rate observed at the beginning of the
year has now been clearly left behind. In July, the peso depreciated 8.6%,
the highest monthly rate since the 1998 devaluation and well above the
3.2% depreciation registered in June. As a result, the currency has lost
12.7% of its value since the beginning of the year. The currency weakening
is likely to be a welcome boost to the export-sector, which had been
suffering from a loss of competitiveness, particularly in the United
States, amid devaluations in other regional economies earlier this year.
Political uncertainty about the incoming administration’s economic policy
priorities and concerns about regional contagion on the economy’s growth
prospects prompted a sell-off in Colombian assets. The spread on
Colombia’s key sovereign risk indicator, the J.P. Morgan EMBI+ bond spread
to comparable US Treasuries, widened by 297 basis points since June. At
911 basis points, the Colombian sovereign bond spread is now at historical
highs.
To avert a more precipitous fall in the value of the peso, the Central
Bank intervened in the foreign exchange markets on 29 July and 1 August.
The current peso intervention policy was adopted in 1999, following the
decision to let the currency float freely, but was never carried out. The
policy allows monetary authorities to sell US$ 180 million daily in US$
call options if the peso depreciates 4% above the preceding 20 day average
exchange rate. The intervention failed to stabilize the currency, as the
peso depreciated an additional 0.9% by the end of 9 August.
Despite the more accelerated currency depreciation observed in the past
three months, panellists remain confident that the peso will recover lost
ground by the end of the year. The Consensus now expects the currency to
appreciate 4.8% from its level at the end of July by the end of the year.
This would represent a 8.6% depreciation. Next year, the currency is
likely to strengthen.
Inflation
moderates amid lower economic activity
In July, consumer prices rose 0.02%. The July figure was the lowest
monthly increase observed this year and brought down the annual inflation
rate from 6.3% in June to 6.2% in July. At its current level, annual
inflation is just a notch above the Central Bank’s 6% target for this
year. If the current declining trend in inflation persists, the Central
Bank will gain further room to ease monetary policy. In July, the Central
Bank further eased its stance and again lowered the benchmark DTF interest
rate by 0.47 basis points. The Central Bank has now lowered interest rates
an accumulated 377 basis points since the beginning of the year, as
significant inflationary pressures have remained absent. However, if the
recent currency weakening should persist, concerns about the pass-through
of a weaker currency on domestic prices, may force monetary authorities to
reverse its policy and tighten. In fact, participants expect the Central
Bank to gradually raise interest rates through the end of the year.
Panellists appear not to have factored the recent currency weakening into
their inflation forecasts, as the annual inflation rate for this year has
remained unchanged from last month. Assuming the Consensus is on target,
this year would be the fourth consecutive year of single digit inflation.
The favourable trend is expected to persist through next year with annual
inflation dropping further from this year, but
remains above monetary official’s expected inflation range between 4% and
6% in 2003.
Note:
The above text is an abridged version of the LatinFocus Consensus Forecast
briefing on Colombia. For more details please click here.
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