Colombia - Economic Briefing August 2004

Domestic Demand Robust but Export Growth Moderating  (continued)

Currency appreciates further
In July, the currency appreciated 3.1% to close at 2,620 pesos to the US$.  The July strengthening in the currency confirmed the resumption of the trend of continued nominal currency appreciation observed this year – interrupted only briefly in May by the concerns over a US Federal Reserve monetary tightening - and was well ahead of the 0.9% nominal appreciation observed in June.  As a result, the currency closed 6.1% stronger at the end of July than at the end of last year.  The current rebound reflects not only increased international investor appetite for emerging market assets but also Colombian assets in particular, given the improved economic picture and an easing of security concerns under the Uribe administration. 

Even though the government is profiting from the currency appreciation since it lowers debt service costs, officials remain concerned that the strong exchange rate could be detrimental to export growth, which is benefiting from the resurgence of global demand and high commodity prices.  The Finance Ministry has already stated that a trading range of 2,800 to 2,900 pesos to the US$ is preferable for this year.  Therefore, officials are likely to attempt to actively avert a more pronounced exchange rate appreciation.  The Finance Ministry is currently implementing a plan to purchase US$ in the spot market for future debt servicing needs.  Moreover, the Central Bank is likely to continue to intervene in the foreign exchange market and to auction US$ put options to stabilize the currency.  Consensus Forecast participants have revised their forecasts for the currency this month, anticipating the peso to close at 2,795 to the US$ by the end of the year, which is 0.6% stronger than expected last month.

Congress resumes activities with reforms on plate
Legislators are expected to begin discussions on important reforms that will significantly shape the sustainability of the current recovery in economic growth.  In addition to the presidential re-election bill – likely to stall rapid progress on economic reforms – Congress will be starting discussions on social security reform, a new budget bill and tax reforms to finance rising pension costs.  The current economic reforms are considered crucial to set the framework for a more sustainable fiscal policy environment, which is currently overshadowed by rising costs of the social security system.