Colombia - Economic Briefing August 2003

Decelerating Inflation Keeps Interest Rates Low

Strong inflationary pressures at the beginning of the year appear to have abated, which has left the Central Bank confident to maintain interest rates at historical lows. As a result, investment activity is rebounding strongly. The external sector is profiting from a competitive exchange rate and is also recovering strongly. Private consumption, however, is growing very moderately, as Colombians continue to battle deteriorating real incomes and rising unemployment.

Economic activity continues to evolve favourably
The favourable interest rate setting and improved credit conditions continued to drive a strong recovery in the economy in the second quarter. According to the National Statistical Department (DANE), industrial production rose 3.3% in May over the same month last year, which was up from a 2.9% drop in April. According to DANE, the current push behind industrial production is the result of heightened activity in the construction sector and increased external demand. In particular, the strong growth spurt in output of basic metals, chemicals and synthetic fibres is driving the industry’s current expansion.

Private consumption lags rest of economy
Private consumption, however, continues to suffer from the deterioration in real wages in the wake of the 20.0% currency depreciation last year and rising unemployment (16.9% in June). According to DANE, retail sales (excluding fuels) rose a modest 0.47% over the same month last year, which was down from 3.8% growth observed the previous month. Key behind the decline was a drop in food and non-alcoholic beverages and pharmaceutical product sales, which dropped 7.0% and 3.1% respectively over the same month last year. On the upside, consumers appear to be taking advantage of the low interest rate setting, as automobile and motorcycle sales were up 16.9% over the same month last year, while office equipment and furniture sales rose 12.6% for the same period.

Growth outlook positive amid improved prospects for domestic demand
Participants continue to be optimistic about growth prospects this year, as the exports should remain robust and firms are likely to continue to step up their investment activities to take advantage of the current low interest rate environment. Consumption, however, is anticipated to remain more subdued, amid government efforts to abide by strict fiscal discipline and consumers’ struggle with higher unemployment levels and deteriorating real wages. Nevertheless, the current Consensus figure of 2.5% for this year’s GDP growth is on the upper end of the government’s 2.0 to 2.5% projection range and is a 0.1 percentage point notch above last month’s figure. Domestic demand should pick up notably next year and help drive a more robust expansion, with the economy expected to grow 3.3%.

Government fiscal plan for 2004 banks on referendum and requests to increase IMF target
On 29 July, the Uribe administration presented its government spending plan for 2004. The 77.6 trillion peso (US$ 24.8 billion) budget for next year would generate a consolidated fiscal deficit of 2.5% of GDP, which would be above the 2.1% of GDP target agreed to with the International Monetary Fund (IMF) under the terms of the US$ 2.1 billion stand-by agreement approved on 15 January. The increased spending is attributed principally to a 14.6% nominal increase military spending and a 29.4% hike in pension outlays but is expected to receive approval by the IMF. Externally, the government expects to finance the budget with US$ 1.2 billion in sovereign bonds and US$ 1.2 billion in loans from multilateral lending institutions. The balance of 14.7 trillion pesos (US$ 4.7 billion) will be sought via domestic markets in the form of Treasury securities. The success of the government’s current fiscal agenda will depend heavily on the approval of a constitutional referendum on 25 October, which, among administrative reforms, will seek to set a maximum amount for public service pensions and freeze the government’s operational spending, social security and regional outlays as well as public enterprises for the next two years. The government estimates that the approval of the referendum will provide fiscal savings of 1.5 trillion pesos (US$ 530 million or 0.7% of GDP) this year and 3.0 trillion pesos (US$ 968 million or 1.2% of GDP) in 2004. Participants appear to be confident in the voter approval, as the fiscal deficit forecast for this year is on target with the government’s estimate and next year’s is just a 0.1 percentage point notch above the official target.