Highlights of “A Report on the Colombian Economy and Rendering of Accounts for 2006”: A Presentation by Mr. José Darío Uribe, Governor of Banco de la República

Publication Date:
13:45

1. Important Developments in 2006

Mr. José Darío Uribe highlighted three important developments with respect to the Colombian economy during 2006:

  • Annual consumer inflation was 4.48% at December, which is on target with the objective set by the Board of Directors of Banco de la República.

 

  • GDP growth in the first three quarters of 2006 (6.4%) surpassed all expectations.

 

  • The Board of Directors reduce the monetary stimulus by raising intervention interest rates in April, June, August, September, October and December 2006 and in January 2007.  On each occasion, the increase was 25 bp.  As a result of the latest hike, the repo auction base rate was 7.75%.

 

2.  Questions and Answers

Why raise interest rates?  The answer rests with the recent, anticipated trend in output and inflation.  The increase in economic growth was concentrated in private GDP, which rose by 8.7%. The growth in domestic demand (9.7%) was fueled mainly by the acceleration in household consumption and the continued healthy increase in investments, particularly in machinery and equipment, and construction and buildings. Total exports also continued to perform well and accelerated in real terms. The coming quarters are expected to see no significant slowdown in the growth in aggregate demand, and GDP growth in the 4.4%-to-6.6% range is forecast for 2007.

The reduction witnessed at the end of the third quarter of 2006 with respect to non-tradable inflation, excluding food items and regulated prices, did an about-face and ended the year at  4.75%, which is more than in 2005 (4.57%). Also, the average for the core inflation indicators rose from 4.25% in September to 4.51% in December.

According to the Governor, the economy no longer needs the monetary stimulus implicit in historically low interest rates.  The idea behind the interest rate hikes is to achieve maximum growth consistent with inflation that is converging toward the long-term target (between 2% and 4%).

Why the rate hikes as of April 2006? They were necessary because it takes considerable time for a change in interest rates to affect demand in the economy (12 to 24 months). Decisions on whether or not to modify interest rates must be based on how inflationary pressures will develop one or two years in the future.  

If interest rates are not raised in advance, and inflation accelerates, the Central Bank will be obliged to sharply increase rates later.  However, by raising them ahead of time, the overall increase will tend to be less and the economy will be more stable.

 

3. The Announcement in January

At a meeting on January 26, 2007, the Board of Directors of Banco de la República announced a 25 basis point increase in intervention interest rates and large-scale intervention in the foreign exchange market “to curb the temporary pressure derived from the sale of assets in the public sector”.

Are these measures contradictory? The answer is no, because monetary expansion created by the purchase of dollars is offset to keep short-term interest rates at a level that is compatible with the inflation target. Moreover, the concentration of monetization is a temporary and identifiable phenomenon. Once it occurs, both the exchange rate and expectations about its future performance should return to normal.

The decision to continue the monetary normalization process ratifies the Board’s commitment to adopt the measures that are necessary to ensure convergence toward the long-term target for inflation.  This gradual elimination of monetary stimulus does not affect the Colombian economy’s capacity for growth in terms of its potential.  In fact, it contributes to the continuity and stability of that growth.