Cycle Balance

What were the milestones for Banco de la República over 2012?

The primary objective of monetary policy in Colombia is to maintain price stability. The operational target of monetary policy is an annual consumer price inflation of 3%. At the same time, monetary policy is intended to keep economic growth on a sustainable path. In order to achieve these objectives, Colombia applies a countercyclical monetary policy, whereby the interest rate is raised whenever economic growth exceeds its potential or either the inflation forecast or expectations for it surpass the target. Interest rate reductions are made when the opposite conditions prevail. This helps to prevent inflationary pressures at the peak of the cycle and to avoid an excessive redundancy of resources at the bottom of it. By the beginning of 2012, a positive output gap had been identified. Moreover, different types of credit—particularly consumer credit—were growing at a high rate. There was a risk that this situation would intensify if left unchecked and pose a risk to the achievement of the inflation target. Accordingly, during the first two months of this year, the Board of Directors of the Banco de la República continued raising the policy interest rate until it attained a peak of 5.25%. This tightening started in February 2011 when the projections for both inflation and GDP growth as well as the behavior of domestic demand and consumer credit led the Board to conclude that the Colombian economy no longer needed the support of a 3% interest rate, which had been provided in the context of the international crisis of 2008-09. During the second half of 2012, economic activity started to show clear symptoms of deceleration. The latest information shows that GDP growth in the third quarter (on an annual basis) was 2.1%, well below the economic performance observed during the first six months. Although some slowing down of the economy was expected given the previous tightening of monetary policy and the effects of the European crisis, this weakening turned out to be worse than expected. To some extent external factors, such as weaker demand and lower prices for our commodities exports, explain this result. However, domestic factors also played an important role, with the shrinkage of public investment and private construction. Following its inherent countercyclical role, monetary policy reacted by reducing the policy interest rate to a level of 4.25% by year-end. This lower rate is expected to eventually provide a renewed stimulus to economic activity during 2013. The inflation rate has continued falling so that, by the end of November, the annual inflation rate was 2.77%, which is below the long-term inflation target of 3%. This absence of inflationary pressures allows the Central Bank to provide monetary stimulus to the economy without risking the probability of reaching the inflation target. This, in fact, is reflected in inflation expectations that are firmly anchored around the long-term target of 3% in both the short term and medium term according to the latest surveys. It is also true of the break-even inflation derived from public bonds traded on the stock market.

What are your expectations in terms of the trade balance?

We are expecting a current account deficit of around 3% of GDP in both 2012 and 2013. This is mostly explained by the moderate dynamics of Colombian exports as a result of decreasing prices and quantities due to the weak growth of the US economy—our main trading partner—and the contraction in the eurozone. Since the 2004, the Colombian economy has received a substantial amount of FDI, which has increased at an average annual rate of 22% over the last six years and nowadays represents more than 4% of GDP. As a matter of fact, the strong increase in FDI is one of the main reasons behind the current account deficit in Colombia.

What are your plans for monetary and financial policies in 2013?

In the context of the flexible inflation targeting framework that Colombia has followed since 1999, the guidelines for monetary policy are well established and publicly known. As stated above, the Banco de la República is committed to price stability and, more precisely, to an inflation target of 3%, which the monetary authorities publicly reaffirmed for 2013. Monetary policy also seeks to maintain sustainable economic growth that is close to the potential productive capacity of the economy, which is estimated to be in a range of 4% to 5%. Accordingly, monetary policy will continue playing its key countercyclical role of avoiding situations of excess demand and providing timely support if the economy weakens. In a broader context, the recent experience of developed countries has shown that price stability is not a guarantee of financial stability. Therefore, in addition to its countercyclical role, the Banco de la República should emphasize macro-prudential issues aimed at preventing excessive risk taking by financial institutions. That is the reason the Banco de la República tries to prevent the interest rate from deviating from its “normal” level over significant and prolonged periods of time, so that it does not stimulate excessive risk taking or unsustainable increases in asset prices and in leverage. In addition, the Banco de la República is conscious that the presence of large currency mismatches in the financial sector is a source of financial vulnerability and limits the ability to float without significant restrictions. Such mismatches could also be a heavy constraint for allowing the degree of exchange rate flexibility considered necessary for maintaining monetary policy independence. Accordingly, foreign loans obtained by local financial intermediaries may only be used to fund assets denominated in the same currency and with a maturity that is less than or equal to that of the loans.

Despite international uncertainty, how do you reassure investors that Colombia is a prime investment destination?

During the recent worldwide financial crisis, the Colombian economy showed remarkable resilience. Colombia not only managed to grow 1.7% in 2009—while many emerging economies shrank—but also achieved a quick recovery in 2010 and 2011 by growing 4% and 5.9%, respectively. This satisfactory growth performance, despite the difficult external conditions, demonstrated that Colombia’s economic fundamentals were strong, and that the policy reaction to the crisis was timely and appropriate. As a result, foreign investor confidence in the Colombian economy increased and the main rating agencies declared Colombia investment grade country in early 2011. The role of monetary policy in attaining the results described above was crucial. By reducing the policy rate from 10% to 3% over a short period of time following the Lehman bankruptcy, together with the reduction in reserve requirements, the elimination of a temporary capital control (the unremunerated reserve requirement on foreign loans), and other supportive measures, monetary policy was able to provide a much needed stimulus at the right moment. Fiscal policy on its own also adopted a prudential countercyclical stance by avoiding expenditure cuts despite falling cyclical revenues and by shifting expenditures toward infrastructure investment in order to maximize their impact on domestic demand. Foreign investors can be assured that in case of necessity, monetary and fiscal policy will again react in coordination to preserve macroeconomic stability. In this context of a well-managed macroeconomic policy that guarantees economic stability, foreign investors can take advantage of the well-known government commitment to stable regulations regarding FDI, the existence of abundant natural resources such as oil, coal, and other minerals, significant progress in overcoming security challenges, and the well-trained labor force of the country that has given Colombian management a well-deserved reputation abroad.

What is your economic outlook for Colombia in 2013 and beyond?

For 2013, 3% inflation and economic growth of 4% or higher is expected. The latter would be the result of a moderate but sustained growth of external demand together with relatively stable commodity prices and conditions of ample liquidity at the international level. At a domestic level, the monetary policy stance, the stability of employment, and the favorable confidence level of households will support the dynamism of household consumption. It is expected that investment will be led by public works and the expansion of large projects in the energy sector. Investment will also have the support of the current relatively low level of interest rates. Of course, there is still considerable uncertainty in the world economy. Beyond 2013, we believe that inflation will be around 3%. We also think that Colombia has enormous potential to grow and to achieve medium-term growth that is somewhat higher than 4.5%, the average experienced over the last 10 years. So long as the country continues making progress on a series of structural reforms, we can grow sustainably at an even higher rate in the future.

© The Business Year – January 2013