Colombia is battling the surge in the peso with a playbook that so far doesn’t include capital controls and appears inspired by a strong dose of market-friendly economics.
Faced with one the world’s strongest currency rallies so far this year, the government of President Juan Manuel Santos is moving to reduce the amount of dollars entering the country, without directly imposing controls on foreign investment.
The government last week, after repeated speculation that it would follow a move by Brazil and impose capital controls, shunned that option. Instead, it limited itself to eliminating a tax break on interest from short-term borrowing abroad by local firms.
The measure will likely discourage short-term foreign borrowing by local firms, easing demand for pesos in the currency market, but is well short of expectations.
Finance Minister Juan Carlos Echeverry, a U.S. trained academic who in the past has defined himself as a supply-side economist keen on reducing taxes, announced last week also that the government was slashing import tariffs on hundreds of capital goods from 12.2% to 8.2%. The decision, he says, will boost the competitiveness of the local industry amid the peso’s appreciation.
The government also said that it would keep $1.5 billion abroad this year and in the first months of 2011 without specifying where that money was expected to come from. The government will also reduce its financing plan from abroad for next year by $384 million and will buy as much as much as $3.7 billion in the forwards market.
“All these measures should contribute to lowering the supply of dollars in the exchange market and increase their demand,” said Salomon Kalmanovitz, an economist and former central bank director.
Colombian markets are closed Monday for a holiday. When investors return on Tuesday they will also have to weigh the central bank’s decision on Friday to extend its dollar purchases in the currency market at least until May 15. The central bank started buying $20 million daily in mid-September to rein in the peso’s surge. The central bank has so far purchased $580 million in the second half of the year.
Colombia appears to be shunning capital controls after they failed to curb a strong appreciation of the peso two years ago. The country went through a major currency surge from 2006 to 2008 despite the central bank attempting to restrain the currency’s climb with the imposition of capital controls.
At that time, the central bank imposed control rules trying to curb foreign investment in Colombian stocks and bonds. The measure failed to restrain the peso and the central bank lifted the controls in late 2008.
The use of capital controls may be ineffective because the peso’s appreciation is being driven by foreign direct investment, not inflows to local stocks and bonds, some economists note.
The “appreciation pressures are chiefly the result of the intersection of external forces and solid domestic fundamentals,” said Goldman Sachs economist Alberto Ramos in a research note. “Capital controls or other market unfriendly moves would likely be ineffective,” he added.
The government so far appears to agree with that assessment. Central bank chairman Jose Dario Uribe, meanwhile, has repeatedly said that capital controls aren’t currently justified as their costs outweigh their benefits. (Darcy Crowe / Dow Jones Newswires)