Colombia's inflation has stayed well above target range of 3% plus or minus 1%, which has kept the central bank on a tightening cycle.
Implications | At its July meeting, the Central Bank of Colombia (BANREP) decided to increase its policy interest rate to 7.75% from 7.50%. |
Outlook | Inflation is projected to begin relenting in the coming months; however, if prices continue to rise, IHS Markit expects the policy rate to continue moving upward as the central bank has shown a strong commitment to price stability. We believe 2016 year-end inflation will be between 5.2% and 5.8%. |
The Central Bank of Colombia (BANREP) has decided to increase its policy interest rate from 7.50% to 7.75%, maintaining a tighter stance. The decision took into consideration the fact that inflation has steadily been well above its 2–4% target and reached 8.6% in June.
The current high levels of inflation are mainly explained through a less dynamic food supply, due to the weather phenomenon of El Niño and a lingering effect from exchange-rate pass-through to imported goods. Monetary authorities are expecting that the convergence to the target range of 3% plus or minus 1% will not occur in the short term, and may take well into 2017 to achieve. The exchange rate has experienced improvement in recent months, after an extreme bout of depreciation caused the Colombian pesos' value to slide to its weakest value ever at COP3,435:USD1 on 12 February 2016. Currently, the exchange rate is approximately COP3,080:USD1.
As inflation has steadily risen so far in 2016, despite numerous policy rate increases, IHS Markit expects further inflationary pressures to be met with increasing interest rates. The central bank has shown a strong commitment to price stability, and we therefore are confident this relationship will reliably hold; inflation now stands at over twice the upper limit of the target range, and further interest rate hikes could become more aggressive than the 25-basis-point hike undertaken this round. Overall, in the coming months we expect inflation to begin to relent and therefore we believe the tightening cycle will begin to show the desired results. By year-end 2016, we believe inflation will be between 5.2% and 5.8%.
Outlook and implications
IHS Markit forecasts that the Colombian economy will decelerate but will still achieve a moderate growth rate in 2016. Economic growth will be led by domestic demand, most heavily by fixed investment. Credit activity will moderate as the financial sector absorbs the losses from the slowdown in the cycle. This will further slow down private consumption and help reduce external imbalances through a lower import bill. Credit will be reallocated towards infrastructure, helping for a gradual rebound from 2017 onwards.
Regarding consumer spending, we project it will moderate due to tighter credit conditions with the marginally higher interest rates. Monetary policy has been tightening and will remain tight to bring prices back towards the target range of 3% plus or minus 1%. Similarly, the restrictive monetary policy is helping to curb the extreme currency depreciation the Colombian peso has experienced in 2016, hitting its weakest value ever in February. IHS Markit projects non-traditional exports, mainly manufacturing and agriculture, to show positive growth rates boosted by gains in competitiveness due to a depreciated peso.
Unusually strong international uncertainty drives a variety of risks for our outlook. These risks stem mainly from deterioration in market sentiment, which could slow or reverse capital inflows and further weaken Colombia's external position. Factors that may lead to deterioration in market sentiment are a weaker-than-expected growth in advanced economies, uncertainties regarding the US Federal Reserve's next steps, as well as a harder-than-expected slowdown in China which could further weaken commodity prices. Our forecast for China is now 6.5% for 2016 and 6.4% for 2017.
On the upside, a successful completion of the peace process negotiations could improve business confidence and would encourage more capital inflow. On 23 June, the government and the Fuerzas Armadas Revolucionarias de Colombia (FARC) signed an agreement for a definitive bilateral ceasefire and the framework for the insurgent group's demobilisation once a final peace agreement has been signed. Partial agreements already exist on the issue of drug trafficking, land reform, political participation, and transitional justice, but must be finalised. June's agreement will reinforce the significant reduction in attacks on state security forces and hydrocarbon and energy infrastructure since July 2015. A referendum will also be held to approve the agreement, possibly in September or October. Demobilising the FARC's 7,000+ fighters to 23 pre-designated concentration zones would begin the day after the final agreement is signed. Disarmament is to be concluded within 180 days, via United Nations observers.
Our current forecast holds that economic activity will decelerate but remain at subdued levels throughout year-end 2016. Our year-end GDP forecast calls for 2.5% growth.