Colombia - Economic Briefing October 2004

 Domestic Demand Complements External Sector Expansion (continued)

Currency appreciation persists unabated
In September, the currency appreciated 4.0% nominally, which was up from the 2.7% nominal appreciation in the prior month and represented the strongest appreciation observed since the beginning of the year.  As a result, the currency closed at 2,595 pesos to the US$.  Given the strong September appreciation, the currency was 7.0% stronger than at the end of last year.  The combination of strong international investor interest in emerging market assets and higher confidence in the Colombian economy in particular are key drivers behind the exchange rate rally.  The government is reaping the benefits of the currency movements, as debt servicing costs have dropped.  However, officials hope to avert further appreciation, since the government is concerned that the current rebound in the export sector, which has been driven by robust global demand and high commodity prices, could be curtailed.  The Finance Ministry remains confident that the currency could fall back to a trading range of 2,800 to 2,900 pesos to the US$.  However, policy measures taken by both the government and the Central Bank throughout the year have been insufficient to stem the currency appreciation.  On 17 September, monetary officials announced their intention to continue to intervene in the exchange rate market for the remainder of the year by buying up to US$ 1 billion either via auctions or discretionary buying.  Consensus Forecast panellists expect the currency to depreciate further throughout the year and to close at 2,713 pesos to the US$ - a 4.3% nominal depreciation from current levels.  Next year, the currency depreciation is anticipated to decelerate to a 5.9% pace with the exchange rate reaching 2,883 pesos to the US$ by year-end.

Inflation remains contained amid higher economic activity
In September, consumer prices rose 0.30%, which was below market expectations of 0.46% but well ahead of the two prior months’ virtually unchanged price levels.  Strong transport, education and housing price increases were the key drivers behind the September rise, as increases in most other price categories remained modest.  As a result of the September reading, the annual inflation rate rose from 5.9% in August to 6.0%.  The currency strengthening observed throughout this year is likely to help keep inflationary pressure induced by higher economic activity at bay.  As a result, Consensus Forecast participants see the annual inflation remaining virtually unchanged in the final three months of the year to close at 5.9% by year-end.  This puts the Consensus figure on the upper end of the Central Bank’s inflation target of 5% to 6% for this year.  Next year, Consensus Forecast participants expect consumer price pressures to moderate with the annual inflation rate decelerating to 5.5% - on the top end of monetary authorities’ official target range of 3.5% to 5.5% set for 2005.

Government on target with fiscal performance
The consolidated public sector deficit reached 2.5% of GDP in the first half of the year, which was below the 2.9% of GDP deficit observed for the same period last year but above the fiscal deficit target agreed to with the International Monetary Fund (IMF) under the terms of the US$ 2.2 billion stand-by agreement.  Revenues rose 16.8% nominally over the same period last year due to healthier growth, tax increases and a widening in the tax base.  Expenditures increased at a more moderate 10.3% in nominal terms.  The government plans to meet a 2.5% of GDP fiscal deficit figure this year.  Consensus Forecast participants are less optimistic, however, and expect the government to overshoot the target with a fiscal deficit of 2.8% of GDP for this year.  Next year, the deficit is anticipated to remain unchanged.