Colombia - Economic Briefing May 2004

Growth Benefits from Increased Domestic Demand and Strong External Sector  (continued)

Currency appreciation persists despite US Fed talk
In April, the currency appreciated 1.2% in nominal terms versus the US$ to reach 2,647 pesos to the US$.  The April appreciation represented the seventh consecutive month of currency strengthening and was up from the 0.3% appreciation observed the previous month.  As a result of the currency’s successive appreciation in the first four months of the year the peso is now 5.0% stronger than at the end of last year.  The combination of increased international investor appetite for emerging market assets and improved confidence in the Colombian economy specifically account for the recent exchange rate rally.  The April rally was partly influenced by the tax season, which has companies and individuals selling US$ holdings to make tax payments.  The government is benefiting from the currency movements since debt servicing costs have been lowered.  Nevertheless, officials are eager to avert more pronounced appreciation with the Finance Ministry asserting that a trading range of 2,800 to 2,900 pesos to the US$ would be preferred for this year.  The government is concerned that the current rebound in the export sector, driven by healthy global demand and high commodity prices, could be curtailed.  Therefore, the Finance Ministry is implementing a plan to purchase US$ 2.2 billion in the spot market to provide for future debt servicing without converting the proceeds into domestic currency.  Furthermore, the Central Bank has been actively intervening in the foreign exchange market to help curb further peso strengthening.  Monetary authorities auctioned US$ 250 million in US$ put options on 30 April as part of a plan to sell a total of US$ 700 million from April through July to stabilize the currency.  Consensus Forecast participants anticipate that the current exchange rate strengthening trend will reverse throughout the year with the currency depreciating 5.9% from the April levels to reach 2,812 pesos to the US$ by year-end.  Next year, the currency weakening trend is expected to persist with the exchange rate closing at 3,042 pesos to the US$ - a 7.5% annual nominal depreciation.  

Inflation drops to lowest rate in almost 40 years
In April, consumer prices rose 0.46%, which was above market expectations of 0.73% but less than half the 0.98% increase observed the previous month.  Strong health and housing price increases were the key drivers behind the April increase, as increases in most other price categories remained subdued.  As a result of the moderate April reading, the annual inflation rate dropped from 6.2% in March to 5.5% - the lowest rate since 1965. 

The exchange rate appreciation observed at the beginning of this year is likely to keep inflationary pressure at bay for the time being but an anticipated currency weakening and heightened economic activity is likely to put upward pressure on consumer prices throughout the year.  As a result, Consensus Forecast participants see the annual inflation rising to 5.8% by the end of the year.  The Consensus figure is within the Central Bank’s inflation target of 5% to 6% for this year.  Next year, Consensus Forecast participants anticipate a moderation in inflation, which is seen decelerating to 5.4% - on the upper end of monetary authorities’ official target range of 3.5% to 5.5% set for 2005.  

Economic reforms take backseat in President Uribe’s re-election drive
The government has introduced a bill to Congress to allow President Uribe to run for re-election in 2006.  Re-election is only possible if the legislature approves a constitutional reform, which is a lengthy process involving several votes during two successive congressional sessions.  Under the current constitution re-election is prohibited even for non-consecutive terms.  The need for a majority vote in Congress will demand significant legislative efforts from the government and is likely to undermine expedient passage of current economic reforms related to the budget, pensions and taxes.  Furthermore, the government’s re-election drive is likely to come at a significant cost in terms of political capital and will require making concessions to legislators that could undermine compliance with fiscal discipline agreed to under the terms of the US$ 2.2 billion stand-by agreement with the International Monetary Fund (IMF).