The Colombian peso is on a tear, continuing to appreciate against the dollar as authorities appear to have a limited arsenal at their disposal to stop the currency’s surge.
The peso’s rise is stoking fears that Colombia may be suffering the first symptoms of so-called “Dutch disease,” in which a boom in the commodities industries leads to an overvalued currency that hurts manufacturing and other exports.
The peso closed Wednesday at COP1,825 against the dollar, its strongest level in two years. In the last twelve months, the peso has gained 10.25% and ranks as one of the best performing currencies in Latin America.
Behind the currency’s strength is a set of structural factors that limit the reach of policymakers to curb the peso’s climb. The root causes of the peso’s appreciation may be one of the reasons why the central bank appears hesitant to step in. Colombia has become a magnet of foreign direct investment, with inflows expected to reach more than $10 billion this year thanks to a boom in oil and mining that the government hardly wants to stop.
And the economy, after growing a tepid 0.8% last year, is picking up pace and is expected to expand 4.5% this year, which is also boosting the peso.
The country recently went through a major appreciation of the currency, with the peso strengthening to COP1,657 in June 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 capital 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 situation now is similar because the peso’s strength is the result of foreign direct investment,” said Julian Cardenas, a currency analyst with local brokerage firm Corredores Asociados. “Foreign direct investment is going to oil and mining which are industries that the country needs to see grow,” he added.
The use of capital controls may be “ineffective” because the peso’s appreciation is being driven by foreign direct investment, not flows towards local stocks or bonds, said in a recent research note Bank of America Merrill Lynch.
The central bank halted June 30 its dollar purchases in the spot market after spending $1.6 billion in the first six months of the year buying dollars in a bid to tame the peso and build up the banks international reserves.
The central bank’s chairman, Jose Dario Uribe, has said that the central bank could resume the dollar purchases at any moment, but the peso has surged since the halt. And restarting the dollar purchases may only have limited success. “The central bank can slow the peso’s rise, but it can’t stop it,” Cardenas said.
The incoming government of President-elect Juan Manuel Santos, who is set to take office Aug. 7, meanwhile, appears to have ruled out capital controls as weapon to curb the peso’s rise.
JP Morgan said in a research note that Santos’ economic officials believe that a set of fiscal reforms that effectively put a leash on the deficit could limit the appreciation of the peso “by reducing the need to borrow abroad.”
The new economic team wants faster economic growth and knows that it “cannot afford to discourage capital inflows,” JP Morgan said in the research note. (Darcy Crowe / Dow Jones)