Colombia - Economic Briefing June 2004

Economic Growth Moderates but Remains Healthy (continued)

Currency depreciates amid prospects for a US Federal Reserve rate hike
In May, the currency depreciated 2.9% in nominal terms versus the US$ to close at 2,724 pesos to the US$.  The May weakening in the exchange rate was the first depreciation observed since September last year and was attributed principally to investor concerns about a possible interest rate hike by the US Federal Reserve.  Similar to other countries in the region, Colombian assets experienced a substantial sell-off in May.  The IGBC stock index dropped 12.1% over the prior month, which represented a notable deterioration compared to the prior month’s 1.6% advance and represented the strongest decline observed since October 2001.  Furthermore, the benchmark sovereign bond J.P. Morgan EMBI+ spread widened by 80 basis points in May to close the month at 523 basis points to the comparable US Treasury bond.  Despite the May deterioration in the exchange rate, the currency still remained 2.0% stronger than at the end of last year.  Given the sustained appreciation observed since September last year and the government’s expressed desire to foster a more competitive exchange rate to bolster exports, authorities are unlikely to adopt any measures to avert additional depreciation for the time being.  In fact, the Finance Ministry has expressed its intention to strive for an exchange rate within a trading range of 2,800 to 2,900 pesos to the US$.  This gives the currency room for an additional 2.7% to 6.0% depreciation this year.  Therefore, Consensus Forecast panellists expect the currency to depreciate further throughout the year and to close at 2,816 pesos to the US$ - a 1.4% annual nominal depreciation.  Next year, the currency depreciation is anticipated to accelerate to a 7.4% pace with the exchange rate reaching 3,040 pesos to the US$ by year-end.

Inflation remains subdued despite surge in economic activity
In May, consumer prices rose 0.38%, which was down from the 0.46% increase observed the prior month but right on target with the Consensus Forecast figure of last month.  The most pronounced monthly increases were observed in health (+0.65%), food (+0.57%) and housing (+0.51%), while in all other major categories price increases remained subdued.  As a result of the moderate May increase, annual inflation dropped from 5.5% in April to 5.4%.  The current inflation rate remains on course with the 5% to 6% inflation target set by the Central Bank for this year.  Consensus Forecast participants, however, anticipate that the pick up in economic activity and efforts to weaken the currency are likely to translate into higher prices, as annual inflation is seen as accelerating to 5.8% by the end of this year.  Furthermore, the favourable growth trajectory and more accelerated currency depreciation next year are likely to curtail a pronounced deceleration in annual inflation, which is seen as reaching 5.4% by year-end – at the upper end of Central Bank officials’ official target range of 3.5% to 5.5% set for 2005.

Central Bank keeps interest rates low
The favourable inflation scenario is enabling monetary authorities to keep monetary reins loose.  In May, the benchmark DTF rate remained virtually unchanged, rising just 14 basis points to 7.9%.  The favourable interest rate setting is likely to foment the current economic rebound further.  However, Consensus Forecast panellists do not expect the current low interest rate environment endure this year, with the DTF rate expected to rise to 8.4% by the end of 2004.  Furthermore, monetary authorities are likely to tighten monetary policy further next year, as the benchmark interest rate is seen as rising to 9.0% by the end of 2005.