Colombia - Economic Briefing December 2003

Economy Rebounds But Legislative Resistance On Reform Looms (continued)

Inflation moderates as exchange rate stable
Consumer prices increased 0.35% in November, which was on target with market expectations but well above the 0.06% rate registered in October. The November figure brought down the annual inflation rate to 6.1% from 6.6% in October. Recreation and food prices experienced the strongest monthly increases, while education and health cost increases were subdued. The September result brought accumulated inflation for this year to 5.5%, which is above the 5% central inflation target agreed to with the IMF but remains within the +/- 2 percentage point target band. Subdued consumption is likely to avert a surge in consumer prices for the time being. In addition, the moderate appreciation of the currency (0.92% in nominal terms through November) is reducing inflationary expectations. Nevertheless, Consensus Forecast panellists anticipate that inflation will experience a year-end pickup, as the annual rate is seen reaching 6.5%, down a 0.1 percentage point from last month. The likelihood for a pickup in domestic demand, particularly consumption, next year will exert some upward pressure on consumer prices, as Consensus participants see the annual inflation rate at 5.8% by the end of 2004, which exceeds the Central Bank’s 5% to 6% target range revised on 28 November (previously 3.5% to 5.5%). Monetary authorities claim that the further pickup in economic activity next year, along with higher prices on some imported foods, is likely to put upward pressure on domestic prices next year. Nevertheless, for 2005, authorities see inflation decelerating again to a 3.5% to 5.5% range.

Monetary policy continues lax
Despite overshooting the inflation target the Central Bank remained reluctant to tighten monetary policy. The benchmark DTF rate has remained virtually unchanged throughout the year and the 8.0% at the end of November was just 25 basis points above the end of December 2002. According to the Consensus, the DTF rate will be raised very moderately to 8.1% by the end of this year, which is down a 0.1 percentage point from last month’s forecast. However, participants expect the Central Bank to hike interest rates next year, as economic activity picks up, with the DTF rate seen rising to 8.7%.

Government tax bill stalled in Congress
The government’s ‘Plan B’, which was intended to compensate for the revenue shortfall resulting from the lost 15 October nationwide referendum is encountering resistance from key allies and opposition parties. The government had hoped to pass a combination of public sector salary adjustments, spending freezes, income tax hikes and a generalization of the value-added-tax (for details see November 2003 Consensus Forecast) to enable compliance with this year’s fiscal deficit target of 2.8% of GDP agreed to with the International Monetary Fund (IMF). In addition, the measure sought to provide a more solid footing for next year’s fiscal balance, reducing the deficit to 2.5% of GDP. Given the current legislative recalcitrance to the government’s plan, officials are now considering a ‘Plan C’, which would declare an economic emergency and further cut public investment next year. In addition, the government is likely to pursue the less orthodox measures of using the Central Bank’s international reserves to retire short-term public debt. Consensus Forecast participants expect the official target for this year to be exceeded, with the fiscal deficit reaching 3.1% of GDP instead. Similarly, at 3.0% of GDP, next year’s figure is also well above the government’s target.