Colombia - Economic Briefing February 2004

Domestic Demand Resurfacing but Stronger Currency Raises Concerns (continued)

Exchange rate strengthening prompts Central Bank intervention
The exchange rate continued on its appreciation trend in January.  The currency closed at 2,721 pesos to the US$ at the end of the month, which represented a 2.1% appreciation versus the US$ in nominal terms.  The January strengthening in the currency was the fourth consecutive monthly appreciation and followed a 2.2% appreciation in December.  A combination of heightened interest by international investors for emerging market assets, improved confidence levels in the Colombian economy and remittances from Colombians living abroad were accountable for the recent exchange rate rally.  However, even though the government’s debt servicing costs benefit from the current currency movements, officials are concerned that a persistence of peso appreciation could serve to undermine the competitiveness of the export sector – a key driver behind the current economic rebound.  Aside from intervening directly with US$ purchases in the foreign exchange market, the Central Bank adopted several measures in January to help curb the peso strengthening.  Financial institutions have been directed to hold US$ positions equivalent to their external liabilities.  In addition, the Finance Ministry plans to purchase US$ 2.2 billion in the spot market during this year to provide for future service of external debt and intends not to convert US$ proceeds from external debt issuance into pesos.  Finally, the administration is evaluating the adoption of a "market mechanism" to compensate exporters for the peso appreciation.  Consensus Forecast panellists do not anticipate the current appreciation to endure and expect the currency to weaken to 2,954 pesos to the US$ by the end of 2004 - a 6.0% nominal depreciation compared to 2003.  

Inflation subdued but concerns on horizon
Consumer prices rose 0.89% in January, which was up from the 0.61% increase observed in the previous month but remained below market expectations.  Culture and recreation costs along with food prices experienced the strongest monthly increase, while education and clothing costs saw very modest hikes in prices.  As a result of the January figure, annual inflation dropped from 6.5% in December to 6.2%.  The current recovery in the domestic economy, particularly consumption, is likely to exert upward pressure on consumer prices in the coming months.  Consensus participants see the annual inflation rate at 5.7% by the end of this year, which is within monetary authorities’ 5% to 6% target range.  Authorities anticipate that inflation will drop further to a 3.5% to 5.5% range in 2005.  The Consensus Forecast of 5.3% for this month is on the higher end of the range of the official target but has been revised downward a 0.1 percentage point notch from last month.  

Fiscal deficit target surpassed but barely
The government narrowly exceeded the 2.8% of GDP fiscal deficit target for last year agreed to with the International Monetary Fund (IMF) under the terms of the US$ 2.1 billion stand-by agreement.  According to the DNP, the fiscal deficit reached 2.9% of GDP, which was well below market expectations that had seen the figure at 3.2% of GDP.  Following the failure of the government referendum in October, which had sought public approval of wide ranging fiscal reforms, the government budget deficit was anticipated to deteriorate, particularly given the inability of officials to adopt the necessary fiscal adjustments in the short time left for the year.  Tax increases adopted last year and the acceleration of economic activity in the second half of the year are likely to have bolstered the government’s coffers.  This year, officials expect the fiscal deficit to decline to 2.5% of GDP amid continued healthy growth.  Consensus Forecast participants appear to confide in the Uribe administration’s commitment to fiscal discipline but see the fiscal deficit above the official figure at 3.1% of GDP.