Bogotá — The first quarter drew to a close in Colombia with a 50-basis point interest rate reduction from Banco de la República, the country’s central bank, leaving the benchmark at 12.25%. That level of borrowing costs had not been seen since December of 2022, causing the Colombian peso (COP) to rally to COP3,700 per greenback.
In the midst of such changes in the Colombian credit landscape, Bloomberg Línea spoke exclusively with Leonardo Villar, governor of the Banco de la República, who also touched on the crisis in the health sector and President Gustavo Petro’s proposal to hold a Constituent Assembly to eventually be able to alter monetary policy.
This interview has been translated from Spanish, and has been edited for clarity.
BL. President Gustavo Petro has spoken of the need for a Constituent Assembly to ensure, among other things, that monetary policy prioritises employment and production. What do you think about this?
Leonardo Villar: Economic growth is a consideration that the Governing Board of the Banco de la República takes very seriously in its decisions. This consideration is explicitly and clearly included in the inflation targeting strategy pursued by the issuer, which aims to achieve the inflation target on a permanent basis, but to minimise deviations in growth from the potential growth of the economy, which depends on non-monetary factors.
BL. When Gustavo Petro came to power, the dollar reached COP5,000. Over time, the exchange rate has dropped, although the president has continued to make announcements. Is the market no longer reacting to the president’s objectives?
L.V. What I would say is that the market sees the way in which the main macroeconomic variables are evolving, i.e. those that fundamentally affect portfolio investors and international direct investment. What they see is an important process of adjustment in the economy, variables that are behaving in a way that is appropriate for Colombian circumstances, with inflation falling, with interest rates that are likely to fall as inflation consolidates its convergence to the target, and with a fiscal deficit that is in line with the rule established by the institutions.
BL. The healthcare system in Colombia is going through a crisis: two EPSs (insurance companies) have been intervened and another has filed for voluntary liquidation. Do you think this situation will eventually have an impact on the market?
L.V. There is a very complex sectoral problem that I do not want to comment on because it is outside the scope of the Banco de la República, but the problems there do not prevent us from pointing out that the macroeconomic situation in the country is improving. Confidence in this improvement is reflected in the appreciation of the peso, in the reduction of the risk margins of Colombia’s public debt, in the reduction of inflation and in the very fact that the Central Bank has been able to initiate a process of lowering interest rates, which will certainly contribute to the recovery of economic activity in the future.
BL. If you talk to Colombian business leaders, they are uncertain about the country’s economic situation and the guarantees they have, for example, to invest. What’s your view on their prospects?
L.V. The Colombian economy is in a complex situation because we are at a critical point in an adjustment process that has been painful and has implied a very strong slowdown in the growth rate of the economy. This has been essential to reduce inflation and a significant external imbalance that we had, with a balance of payments deficit that represented 6.2% of GDP in 2022, which fortunately has already been significantly reduced to 2.7% of GDP in 2023, making the situation much more sustainable.
The slowdown has been costly for businesses and is creating unease. The slowdown in credit has implied a deterioration in the portfolio, which is obviously painful for the financial system and even more painful for people who have not been able to pay their obligations, but this is part of an adjustment process that can, in principle, contribute to lower interest rates in the future, to a return to growth with controlled inflation. The projections of the Bank’s technical team point to growth of more than 3% in 2025, with inflation already normalised around the target, but there are obviously uncertainties on several sectoral fronts that are causing anxiety and concern.
BL. The Colombian peso has strengthened and is now trading around COP 3,700. One of the reasons is the interest rate spread with other countries in the region and the US. If the Bank of Japan accelerates its rate cuts, this differential will narrow and the peso will become less attractive. Are you worried about the peso weakening again?
L.V. The appreciation we have seen in recent days has been widespread in several economies in the region and has been particularly strong in countries such as Colombia, where oil exports are important. One could conclude that the fact that the oil price has risen above US$90 a barrel is related to this recent appreciation.
In any case, it is important to note that the appreciation has been seen in many other economies, including some that already have a much lower interest rate than Colombia, such as Chile. And it cannot therefore be attributed to an interest rate that in Colombia has already been reduced by 50 basis points in the last month.
As far as the exchange rate policy is concerned, I can repeat that the exchange rate is floating freely. The policy is to allow the exchange rate to be a first adjustment mechanism, and that is what has happened in the recent period. The depreciation of the peso was atypically strong in 2021 and 2022, and since the end of 2022 there has been a correction that has taken us towards an exchange rate with a behaviour more similar to that of other comparable Latin American countries.
From this point of view, the behaviour of the exchange rate is an important source of information for the Bank’s decision-making, but the issuer does not have specific targets for where it should be.
BL. Unemployment rose in February and the indicator is not expected to improve this year. What is your analysis of the labour market?
L.V. The labour market is in a paradoxical situation. On the one hand, after a macroeconomic adjustment of the magnitude we have experienced, with such a strong slowdown, it is remarkable that the unemployment rate is lower today than it was a year ago. However, we have to recognise that if you look at the evolution of the labour indicators month by month and adjust for seasonal factors, there is a deterioration in the margin of the labour market, in the unemployment rate and in the employment rate, which could deepen in the course of this year.
The Bank’s technical team has said that the expected unemployment rate this year could be higher than last year. This is a worrying factor which we hope will not materialise. And if it does, hopefully it can be reversed relatively quickly with the higher growth we expect in 2025.
BL. What about foreign direct investment?
L.V. Foreign direct investment has remained quite positive. On the other hand, portfolio Investment, both in Colombia and in the rest of Latin America, fell significantly in 2023, but in it has shown somewhat of a recovery recently. This is not a cause for concern. The sharp reduction in Colombia’s current account deficit makes the country much less vulnerable and less dependent on what happens to international resource flows, which is good news.
BL. The co-director of Emisor, Olga Lucía Acosta, recently said on a panel that if you want to reduce inequality, you have to pay more taxes, do you agree with this statement?
L.V.: I think the context in which she raised it was medium and long term. Colombia is increasing its spending levels - which were previously below comparable countries in the region - and higher spending levels require more taxation. This is something that many analysts agree on. I do not think they were predicting tax reforms in the near future, but rather that Colombia needs to have higher tax revenues than in the past in order to maintain the level of spending it already has. This is what the two recent tax reforms are doing.
BL. Is the government’s hike in public spending excessive?
L.V. What is absolutely fundamental is that the country’s decision on the level of spending must be accompanied by the fact that this level of spending must be adequately financed. For the macroeconomic balances that influence the decisions of the Banco de la República, it is important that spending is not financed with excessive debt. This is the purpose of the fiscal rule, and to the extent that the fiscal rule is complied with, the level of debt will be under control.
Indeed, the level of government debt as a percentage of GDP fell significantly last year. This year there may be an increase, but the important thing is that, as long as the rule continues to be observed, both this year and in the following years, the level of public debt as a percentage of GDP will remain balanced and this will create the right conditions for monetary management.
BL. Inflation forecasts are easing downward for 2024. Are you concerned about the impact of the El Niño phenomenon or what other risk factors do you see?
L.V. This is a forecast that is subject to risks, both downward and upward, but it is important to stress that the technical team’s forecast is in line with that of most market analysts.
Fortunately, the El Niño phenomenon does not appear to be having a serious impact on food prices. There are still some concerns about the impact on dams, and therefore on electricity prices and other utilities. However, it is important to recognise that the risks associated with these impacts are now lower than they were at the beginning of the year.
There are other important risk factors, some of which have to do with the international financial situation and the prospect of easy conditions that will help us in the process of lowering interest rates. Many expect the Federal Reserve to cut interest rates three times this year, by 25 basis points each time. This would obviously help to maintain an international environment conducive to interest rate cuts in our countries, but uncertainty remains. Obviously, we will have to pay close attention to how this global financial panorama unfolds.