Uber-bullish Colombia macro update from Credit Suisse, today:
| The slowdown of global growth does not seem to be affecting the Colombian economy significantly, at least for now. Coincident and leading indicators as well as anecdotal evidence suggest that economic activity remained relatively robust through early 2012. With domestic demand decelerating more gradually than what we had anticipated while exports are performing better than expected, we have raised our near-term GDP growth forecasts. We now project that real GDP growth will average 5.9% in 2011 and 5.2% in 2012 (up from 5.6% and 4%, respectively). |
Take that eurozone.
But the boom costs at a now all-too familiar cost:
| We think that it will be difficult for the government and the central bank to fight the appreciation of the Colombian peso as net dollar inflows in 2012 are likely to remain high. |
Thankfully, though, the composition of this inflow is predominately FDI rather than fickle capital flows:
| In our view, unless the price of oil falls sharply, the net dollar inflows in Colombia in 2012 will remain high, in line with the inflows observed in 2011. Specifically, we now think that FDI inflows, on a cash basis, could again reach $15bn (with the bulk of it going to the hydrocarbons sector) while FDI outflows are unlikely to increase significantly. In addition, we think that the state-owned company, Ecopetrol, will continue to repatriate profits to fund the bulk of its investment program, which is expected to reach $8.5bn in 2012, up from $7.2bn in 2011. |
In order to fight peso appreciation, FX intervention - i.e. dollar buying - will continue. But fraility thy name is capital controls, according to Credit Suisse:
| We do not rule out entirely that the central bank resorts again to capital controls although these would probably be a “last resort” measure and might not be very effective at containing the appreciation of the peso ... dollar inflows due to net foreign portfolio investment and net external borrowing by the private sector have not been very large in the last two years, when compared to the dollar flows related to FDI or Ecopetrol’s repatriation of profits. For this reason, capital controls – which would be imposed on foreign portfolio investment or external borrowing – are unlikely to be very effective tools to fight the peso appreciation. In addition, the central bank seems concerned about the distortions in the economy arising from the implementation of capital controls, which would result in lower growth rates of investment and GDP growth in the medium term. However, a large enough move of the USDCOP – bringing it close to the 1,700 level, which we think is the government’s “pain threshold” – may persuade the central bank to implement capital controls even if these may bring only temporary relief and despite the inefficiencies that it may create. |
In other words, the central bank might risk gambling on capital controls - should the peso appreciate to uncomforable levels -- as a desperate measure and amid political pressure. But, it will most likely fail - or if it brings relief, it will do so only temporarily or only at the margin.
Other tools?
As we wrote previously, market consensus is that the imposition of capital controls to stem currency strength will fail. That's why some research houses - Capital Economics, most recently - have argued that loose fiscal policy = high inflation = rate hikes = capital flows = currency strength. And, thus, a tighter fiscal policy - in Colombia and Brazil - would be one appropriate measure to aid currency competitiveness.
Conventional theory says a tighter fiscal policy now would be a good way of reducing the volatility of the macro-economic cycle in Colombia, given the susceptibility to terms of trade shocks. But it's not clear whether the policy, in isolation, would prove a net boost to currency competitiveness.
However, at least the policy challenge in Colombia seems to be less dramatic than in Brazil, which has opted for an interventionist approach to the FX challenge: Accusing the US of escalating a global currency 'war' while slapping taxes on imported cars.
Further reading:
EM FX fallout: cut spending or be damned - Emerging Markets