Much has been said recently about the rise in the value of the Colombian peso, which has gained roughly 13% this year. Indeed, many are warning of Dutch Disease as exporters begin to feel the effects of a stronger peso and plead with the government and Central Bank to take action.
The Central Bank announced in mid-September that it would begin dollar purchases to help stem the rise in the value of the peso, but so far the currency has remained strong, leading many Colombian firms to formally ask the government to take further measures to fight the peso’s appreciation.
On the international stage there are fears of a full-blown currency war. The U.S. is considering weakening the dollar further to boost exports in order to help the sluggish economic recovery, and other G-20 nations have considered doing the same with their currencies. For now a truce has been called, as G-20 finance ministers and central bankers met in South Korea last weekend and agreed not to devalue their currencies.
This theme of depreciating currencies is being seen not only in G-20 nations but in developing economies all over the world.
The question is, why? When has depreciating a currency ever been associated with a rise to super-power status? The dollar didn’t come to be the “world’s currency” through policies that purposefully devalued it, so why are so many nations going down that path?
The problem is that we live in an age where countries are more interdependent than ever and export-led growth policies are tempting because they are relatively easy to enact and they work – just devalue your currency, and consumers in other countries will buy your goods because they are cheap, and this will lead to economic growth.
China has followed this path for years, despite international reprimands, and because of this policy have become the “world’s factory.” Emerging economies in general have traditionally adopted export-led growth policies in order to boost domestic growth, and as long as there are rich superpowers that are willing to buy those goods this formula is a sure bet.
What’s different now is that today we are recovering from a global economic recession where rich superpowers were hit the hardest. Simply put, domestic consumers in rich countries don’t have the cash to buy all of those cheap goods anymore.
What is currently happening is that these rich nations who have always purchased the rest of the world’s cheap goods are now adopting these same strategies to bolster economic growth. In other words, they are intentionally depreciating their currencies to achieve an export-led recovery.
This works if the demand is there and other countries are buying the relatively cheaper goods. The problem is, when all of the rich countries try to depreciate their currencies at the same time so that other rich countries will buy their goods, you end up with a cluster of inflated currencies and nobody has relatively cheaper goods.
This leads to nations trying to undercut others, and is more commonly described as a “currency war.”
This is a very sticky situation to be in for any country, but especially for Colombia. As foreign capital continues to flow into the country and the peso strengthens, Colombian exporters are feeling the pain as their profit margins are slowly squeezed because their products are becoming more expensive.
Every day that the peso increases in value Colombian exporters are pushed a little bit closer to the edge of a financial cliff where falling could represent their commercial death. They are digging in their heels and pushing back with all their might but if the government doesn’t respond they might not be able to hold for very long.
So why is the government / Central Bank reluctant to take more aggressive action? In this situation many would say that the government must jump on the depreciation bandwagon in order to prevent a decline in competitiveness of Colombia’s manufacturing sector, but it’s not that straightforward.
When the global economy begins to show signs of full recuperation, all of the capital that has been flooding into emerging markets like Colombia might begin to flow right back out to safer, more developed markets. If this were to happen, a recession could occur and any measures taken by the Central Bank to weaken the peso could backfire, causing a rapid decline in the currency’s value.
This would be good for exporters and would certainly help to lessen the effects of a recession but it would be disastrous for imports which grew by 42% in August of 2010 compared to the same month in 2009, according to a DANE report.
With this rise in the value of the peso comes new purchasing power that Colombia hasn’t seen before. Colombian companies are now able to purchase foreign products that were once too expensive.
Industrial equipment such as boilers, machinery and parts made up the largest category of imports at roughly 15% from August 2009 – August 2010. This industrial machinery is important for economic growth so any loss in Colombian firms’ ability to buy these items could be a severe blow to the Colombian economy.
From January – August 2010, imports of fuel, mineral oil and its derivatives increased by 115% when compared to the same period in 2009. That means that Colombia bought more than twice the amount of fuel and mineral oil that it bought a year ago. Needless to say, these purchases are hugely important for the development of the economy.
26% of total imports came from the U.S. where Colombia is enjoying an unprecedented dollar-peso exchange rate. A weaker peso would mean that Colombia couldn’t afford to buy as many products from its favorite supplier.
Thus, manipulating your currency is a double-edged sword. A weaker peso is good for exports but bad for imports. Finding the right balance is a difficult, delicate task that is tremendously important to the economic future of Colombia.
My opinion: Colombia shouldn’t let its manufacturing sector die out completely but it should not necessarily see a strong peso as a bad thing.
It should use its newfound popularity among international investors to improve its infrastructure and to invest in education so that future generations will be more competitive in other industries outside of manufacturing.
There is nothing glamorous about being the world’s factory. Sure, economic growth is good but do you really want your citizens to work 12 hour days in a factory performing mundane, often back-breaking tasks?
As the peso strengthens, manufacturers will hurt and many will go out of business. But instead of fighting this natural economic evolution by devaluing the currency, it makes much more sense to invest in education and to offer assistance and new training programs to those workers who lose their jobs due to declines in manufacturing.
Colombia should embrace new foreign investment and it should take advantage of this opportunity while it is here.
As always, much will depend on the policies of the current and future administrations. If they are wise, they will invest in a better future for Colombia so that when the coal and oil runs out, they will have a well-educated, competitive work force that is service-oriented instead of a work force that might only know how to tighten bolts, operate heavy machinery and work assembly lines.
Author Matthew Helm is an American who moved to Colombia where he started the website relocationcolombia.com, specialized in information for potential expats and investors.