Exchange rate policy and inflation targeting in colombia Jorge Toro Head of Economic Studies Department Banco de la República, Colombia ECB, Frankfurt 1,2 March 2007
Appreciation OF THE EXCHANGE RATE Steady appreciation since the beginning of 2003 3.200,00 3.000,00 2.800,00 Representative Exchange Rate (Pesos for Dollar) Temporary reversal in Q II 2006 2.600,00 2.400,00 2.200,00 2.000,00 05-Nov-05 27-Dic-05 17-Feb-06 10-Abr-06 01-Jun-06 23-Jul-06 13-Sep-06 04-Nov-06 26-Dic-06 01-Ene-02 22-Feb-02 15-Abr-02 06-Jun-02 28-Jul-02 18-Sep-02 09-Nov-02 31-Dic-02 21-Feb-03 14-Abr-03 05-Jun-03 27-Jul-03 17-Sep-03 08-Nov-03 30-Dic-03 20-Feb-04 12-Abr-04 03-Jun-04 25-Jul-04 15-Sep-04 06-Nov-04 28-Dic-04 18-Feb-05 11-Abr-05 02-Jun-05 24-Jul-05 14-Sep-05
Annual nominal change shows the extent of appreciation Exchange Rate -Annual Percentage Variation- 40,00% 30,00% 20,00% 10,00% 0,00% -10,00% -20,00% 01/01/2002 01/04/2002 01/07/2002 01/10/2002 01/01/2003 01/04/2003 01/07/2003 01/10/2003 01/01/2004 01/04/2004 01/07/2004 01/10/2004 01/01/2005 01/04/2005 01/07/2005 01/10/2005 01/01/2006 01/04/2006 01/07/2006 01/10/2006 01/01/2007 Percentage
Appreciation is also real, affecting competitiveness Real Exchange Rate Index (1994 = 100) 140 130 120 110 100 90 80 Feb-87 Feb-89 Feb-91 Feb-93 Feb-95 Feb-97 Feb-99 Feb-01 Feb-03 Feb-05 Feb-07 PPI CPI
Appreciation has also affected other Latin countries Nominal Exchange Rate (Index) (January 2003=100) 105 95 85 75 65 55 Ene-03 May-03 Sep-03 Ene-04 May-04 Sep-04 Ene-05 May-05 Sep-05 Ene-06 May-06 Sep-06 Ene-07 COLOMBIA BRASIL CHILE PERU
Main factors behind appreciation I. Trade
Steady increase of commodity prices excluding oil. Commodity price index without Crude Oil (WCF) 150 130 110 90 70 Dic-95 Dic-96 Dic-97 Dic-98 Dic-99 Dic-00 Dic-01 Dic-02 Dic-03 Dic-04 Dic-05 Dic-06 Fuente: The Economist Intelligence Unit
In particular, the price a of the main Colombian export products increased continuously since 2003 Description Average Forecast 1/ 2004 2005 2006 2007 2008 Coffee ($ / lb) 0.8 1.2 1.2 1.2 1.2 Crude Oil ( $ / bbl) 37.3 49.8 56.3 48.9 51.9 Coal ($ / mt) 36.1 47.8 47.8 46.1 42.1 Ferronickel ($ / lb) 2.3 2.4 3.1 2.6 2.1 Gold ($ / toz) 409.3 445.0 610.2 670.3 705.3 1/ Balance of Payments forecast International Prices
Which significantly improved terms of trade Terms of Trade geometric mean 1994=100 140 130 120 110 100 90 80 Ene-90 Ene-91 Ene-92 Ene-93 Ene-94 Ene-95 Ene-96 Ene-97 Ene-98 Ene-99 Ene-00 Ene-01 Ene-02 Ene-03 Ene-04 Ene-05 Ene-06 Ene-07
Both traditional and non-traditional exports positively reacted to price incentives and sustained world demand US$ Mill 12200 11200 10200 9200 8200 7200 6200 5200 4200 Exports Growth Traditional Exports (Last 12 Months) Annual Growth 50% 40% 30% 20% 10% 0% -10% -20% -30% US$ Mill 13200 12200 11200 10200 9200 8200 7200 6200 5200 4200 Non-Traditional Exports (Last 12 Months) Exports Growth Annual Growth 40% 35% 30% 25% 20% 15% 10% 5% 0% -5% -10% -15% Dec-00 Mar-01 Jun-01 Sep-01 Dec-01 Mar-02 Jun-02 Sep-02 Dec-02 Mar-03 Jun-03 Sep-03 Dec-03 Mar-04 Jun-04 Sep-04 Dec-04 Mar-05 Jun-05 Sep-05 Dec-05 Mar-06 Jun-06 Sep-06 Dec-06 Dec-00 Mar-01 Jun-01 Sep-01 Dec-01 Mar-02 Jun-02 Sep-02 Dec-02 Mar-03 Jun-03 Sep-03 Dec-03 Mar-04 Jun-04 Sep-04 Dec-04 Mar-05 Jun-05 Sep-05 Dec-05 Mar-06 Jun-06 Sep-06 Dec-06 Source. DANE Source. DANE
Main factors behind appreciation II. Capital
Capital inflows encouraged by a sharp fall in EMBI Nominal Exchange Rate, Embi+ and Embi+ Colombia Embi+ NER 1300 1100 3000 900 2750 700 500 300 2500 2250 100 2000 Feb-02 Jun-02 Oct-02 Feb-03 Jun-03 Oct-03 Feb-04 Jun-04 Oct-04 Feb-05 Jun-05 Oct-05 Feb-06 Jun-06 Oct-06 Feb-07 NER Colombia Embi+
Capital also attracted by high confidence levels Confidence Index for manufacturing sector (Tendencial Component) Consusmer's Confidence Index 40 25 30 20 15 20 10 5 10 0 0-5 -10-15 -10-20 -20-30 Aug-05 Dec-01 Mar-02 Jun-02 Sep-02 Dec-02 Mar-03 Jun-03 Sep-03 Dec-03 Mar-04 Jun-04 Sep-04 Dec-04 Mar-05 Jun-05 Sep-05 Dec-05 Mar-06 Jun-06 Sep-06 Dec-06 Nov-01 Feb-02 May-02 Aug-02 Nov-02 Feb-03 May-03 Aug-03 Nov-03 Feb-04 May-04 Aug-04 Nov-04 Feb-05 May-05 Nov-05 Feb-06 May-06 Aug-06 Nov-06 (Index) Fuente: Fedesarrollo y Banco de la República Source: Fedesarrollo
Capital inflows mostly invested in treasury bills, thus reducing TB interest rates Exchange rate and Treasury bonds interest rate (2020) 12 2.700,00 11 2.600,00 2.500,00 10 9 8 2.400,00 2.300,00 2.200,00 7 6 2.000,00 10-Ago-05 05-Sep-05 28-Sep-05 24-Oct-05 18-Nov-05 14-Dic-05 11-Ene-06 06-Feb-06 01-Mar-06 27-Mar-06 24-Abr-06 18-May-06 15-Jun-06 14-Jul-06 11-Ago-06 06-Sep-06 29-Sep-06 25-Oct-06 21-Nov-06 15-Dic-06 15-Ene-07 07-Feb-07 Treasuries Exchnage rate (col$/us$) 2.100,00 TES JUL/20 TRM
CAPITAL INFLOWS HAVE ALSO BEEN INVESTED IN DOMESTIC SHARES Exchange Rate (TRM) and Stock Index (IGBC) 14000 2700 12000 2600 10000 2500 8000 6000 2400 2300 4000 IGBC 2000 TRM 2100 01-Sep-05 03-Oct-05 03-Nov-05 07-Dic-05 11-Ene-06 10-Feb-06 14-Mar-06 18-Abr-06 19-May-06 22-Jun-06 27-Jul-06 30-Ago-06 29-Sep-06 01-Nov-06 05-Dic-06 11-Ene-07 IGBC TRM 2200 0 2000
Capital inflows partly originated in FDI, mainly into the mining (oil; coal) and manufacturing sectors 8,00 Colombia - Net foreign Direct Investment 6,00 4,00 2,00 0,00-2,00-4,00 I - 2000 III - 2000 I - 2001 III - 2001 I - 2002 III - 2002 I - 2003 III - 2003 I - 2004 III - 2004 I - 2005 III - 2005 I - 2006 III - 2006 (Percentage of G DP)
Growing remittances have significantly contributed to capital inflows Migration Flow and Remmitances Thousand of Persons 2.000 1.500 1.000 565 790 1.072 1.355 1.490 1.607 1.765 1.905 2.084 4.500 4.000 3.500 3.000 2.500 2.000 1.500 Million of Dollars 500 184 184 221 406 160 225 282 282 136 116 158 141 178 1.000 500 0 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 0 Net Migration Flow Cumulated Migration Remmitances
FX Intervention by the Banco de la República
FX interventions aiming at Accumulating international reserves, Reducing exchange-rate volatility, Moderating unsustainable appreciations or excessive devaluations likely to affect inflation behavior. Modalities of FX interventions: Put (call) options for accumulating (decreasing) international reserves Put (call) options for controlling volatility of the exchange rate Discretionary Intervention
Fluctuating conditions in the foreign-exchange market have led to the use of the Bank s different intervention-policy instruments Purchases and Sales of Foreign Exchange by the Banco de la República (Millons de Dollars) 1999* 2000 2001 2002 2003 2004 2005 2006 2007 (January) Purchases 200,0 318,6 629,2 251,5 106,2 2.904,9 4.658,4 1.780,5 1.001,6 Put Options 200,0 318,6 629,2 251,5 106,2 1.579,6 0,0 583,8 0,0 For Accumulation of International Reserves 200,0 318,6 629,2 251,5 106,2 1.399,7 0,0 0,0 0,0 For Volatility Control 0,0 0,0 0,0 0,0 0,0 179,9 0,0 583,8 0,0 Discretional Intervention 0,0 0,0 0,0 0,0 0,0 1.325,3 4.658,4 1.196,7 1.001,6 Sales 0,0 0,0 0,0 414,0 344,5 500,0 3.250,0 1.944,3 0,0 Call Options 0,0 0,0 0,0 414,0 344,5 0,0 0,0 944,3 0,0 For Decreasing of International Reserves 0,0 0,0 0,0 0,0 344,5 0,0 0,0 0,0 0,0 For Volatility Control 0,0 0,0 0,0 414,0 0,0 0,0 0,0 944,3 0,0 National Government 0,0 0,0 0,0 0,0 500,0 3.250,0 1.000,0 0,0 Net Purchases 200,0 318,6 629,2-162,5-238,3 2.404,9 1.408,4-163,8 1.001,6
Discretionary intervention widely employed, except during Quarters II; III, and IV of 2006, when appreciation pressures temporary ceased Discretionary Intervention in the FX Market (Million of Dollars) 1.000 800 600 400 200 0 Sep-04 Nov-04 Ene-05 Mar-05 May-05 Jul-05 Sep-05 Nov-05 Ene-06 Mar-06 May-06 Jul-06 Sep-06 Nov-06 Ene-07
In addition, volatility options, both put and call, have been frequently activated over the last three years Volatility Control Options (excercised) (Million de US$) 500 300 100-100 -300-500 -700 Ene-04 Mar-04 May-04 Jul-04 Sep-04 Nov-04 Ene-05 Mar-05 May-05 Jul-05 Sep-05 Nov-05 Ene-06 Mar-06 May-06 Jul-06 Sep-06 Nov-06 Ene-07
Effectiveness of FX Intervention
FX Intervention has been an effective instrument to raise international reserves to adequate levels Net International Reserves 18000 16000 14000 Million of Dollars 12000 10000 8000 6000 4000 2000 0 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 (j) As end of
Which helped to improve key indicators of international liquidity 1,40 International Reserves / (Foreign Debt Payments in the next 12 months + Projected Current Account deficit in present year) 1,30 1,20 1,10 1,00 0,90 2000 2001 2002 2003 2004 2005 2006 proj International Reserves / (Foreign Debt Payments in the next 12 months) 1,15 1,10 1,05 1,00 International Reserves / (Foreign Debt Payments in the next 12 months + Projected Current Account deficit in the next year) 1,65 0,95 1,55 1,45 1,35 1,25 0,90 0,85 2000 2001 2002 2003 2004 2005 2006 proj 1,15 1,05 0,95 2000 2001 2002 2003 2004 2005 2006 proj
In addition, as it was clear in 2005, FX intervention moderated exchange rate appreciation in the face of transitory shocks Exchange Rate (pesos for Dollar) 3000,0 2900,0 2800,0 2700,0 2600,0 2500,0 2400,0 2300,0 2200,0 2100,0 2000,0 1900,0 1800,0 Jan-03 Feb-03 Mar-03 Apr-03 May-03 Jul-03 Aug-03 Sep-03 Oct-03 Nov-03 Dec-03 Feb-04 Mar-04 Apr-04 May-04 Jun-04 Jul-04 Sep-04 Oct-04 Nov-04 Dec-04 Jan-05 Mar-05 Apr-05 May-05 Jun-05 Jul-05 Aug-05 Oct-05 Nov-05 Dec-05 Jan-06 Feb-06 Apr-06 May-06 Jun-06 Jul-06 Aug-06 Oct-06 Nov-06 Dec-06 Jan-07
3,5% 3,0% 2,5% 2,0% 1,5% 1,0% Options for controlling volatility have had a rather poor performance for achieving its purpose. Exchange rate deviation from its 20-days moving average Exchange rate deviation from its 20-days moving average 6,0% 5,0% 4,0% 3,0% 2,0% 1,0% Call volatilility auction US$ 180 m, April 10 0,0% -1,0% -2,0% 06-Abr-06 07-Abr-06 08-Abr-06 09-Abr-06 10-Abr-06 11-Abr-06 12-Abr-06 13-Abr-06 14-Abr-06 15-Abr-06 16-Abr-06 17-Abr-06 18-Abr-06 19-Abr-06 20-Abr-06 21-Abr-06 22-Abr-06 23-Abr-06 24-Abr-06 11-May-06 13-May-06 15-May-06 17-May-06 19-May-06 21-May-06 23-May-06 25-May-06 27-May-06 29-May-06 31-May-06 02-Jun-06 04-Jun-06 06-Jun-06 4,0% 3,5% 3,0% 2,5% 2,0% 1,5% 1,0% 0,5% 0,0% Call volatilility auctions US$180 m each. May 16,18,23,25 Exchange rate deviation from its 20-days moving average Exchange rate deviation from its 20-days moving average 1,0% 0,5% 0,0% -0,5% Put volatilility auction US$180 m July 11-1,0% Call volatilility auction $US180 m June 27-1,5% -2,0% -2,5% -3,0% -3,5% 21-Jun-06 23-Jun-06 25-Jun-06 27-Jun-06 29-Jun-06 01-Jul-06 03-Jul-06 05-Jul-06 07-Jul-06 06-Jul-06 08-Jul-06 10-Jul-06 12-Jul-06 14-Jul-06 16-Jul-06 18-Jul-06 20-Jul-06
Consistency between Inflation Targeting and FX Intervention
Intervention in the FX market has not prevented to continue the disinflation process and to achieve inflation targets with remarkably precision, particularly for the last three years Thus, on an ex-post basis, it can be said that FX intervention has been consistent with inflation targeting (IT). P e r cen t 6,50 6,00 5,50 5,00 4,50 4,00 3,50 Total CPI Inflation and Inflation Targets Jan-04 M a r-0 4 M a y -0 4 Jul-04 Sep-04 Nov-04 Jan-05 M a r-0 5 M a y -0 5 Jul-05 Sep-05 Nov-05 Jan-06 M a r-0 6 M a y -0 6 Jul-06 Sep-06 Nov-06 Jan-07
In part, ex-post consistency has been possible due to the existence of a negative output gap that has permitted to combine a loose monetary policy with FX intervention. 3,0% 2,0% 1,0% 0,0% -1,0% -2,0% -3,0% -4,0% -5,0% -6,0% -7,0% 1990 1991 1992 1993 Output Gap 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 (py)
Policy coordination with the Treasury: another key element for maintaining consistency The Government has reduced its FX exposure Part of the reserves purchased in the market by the Bank were sold to the Treasury to shift the composition of public debt. The Treasury has kept all its excess liquidity in deposits at the Central Bank (Fiscal restraint helps in this sense).
Thus, coordination with the Government has been an effective sterilization device SOURCES OF GROWTH OF THE MONETARY BASE Miles of millions $ 2000 2001 2002 2003 2004 2005 2006 I. Net purchases of international reserves 675 1.445-517 -703 7.446 10.758 1.785 II. Treasury 432 1.310 1.296 914-1.488-10.156-300 Trasfers of Central Bank Profits 516 1.226 1.226 830 803 0 793 Deposits -84 84 70 83-1.038-2.637 1.175 Sales of international reserves 0 0 0 0-1.252-7.519-2.268 II. Public bonds held by the Central Bank 190-954 150 568-2.524 897-327 IV. REPOS -755-730 1.128 1.492-1.058 1.539 2.586 V. Others 429-135 399 239 270 506 483 VI. Change of Monetary Base 971 937 2.457 2.510 2.647 3.543 4.227
Consistency has also been possible as a result of the significant increase of money demand that has allowed the Central Bank to purchase international reserves as a way to meet the increasing demand for money at the policy interest rates 7,5% 7,0% 6,5% 6,0% 5,5% 5,0% 4,5% 4,0% Monetary Base as Percentage of GDP Dic-94 Jun-95 Dic-95 Jun-96 Dic-96 Jun-97 Dic-97 Jun-98 Dic-98 Jun-99 Dic-99 Jun-00 Dic-00 Jun-01 Dic-01 Jun-02 Dic-02 Jun-03 Dic-03 Jun-04 Dic-04 Jun-05 Dic-05 Jun-06
Consistency is reflected in that purchases of reserves have been made in a context of decreasing or constant interest rates (2004-April 2006). However, most recently, as the output gap is becoming positive, and the central bank is progressively increasing its interest rate, consistency between intervention and monetary policy is vanishing US $ m illion 1200 700 200-300 -800-1300 Forex Intervention, Policy Interes Rate and Interbank Interest Rate Feb-00 Jun-00 Oct-00 Feb-01 Jun-01 Oct-01 Feb-02 Jun-02 Oct-02 Feb-03 Jun-03 Oct-03 Feb-04 Jun-04 Oct-04 Feb-05 Jun-05 Oct-05 Feb-06 Jun-06 Oct-06 FX Intervention (Mil US$) Interbank Interest Rate (monthly average) Policy Interes Rate 13,0 12,0 11,0 10,0 9,0 8,0 7,0 6,0 5,0 Percent
In fact, as inflation is accelerating, monetary authorities will have to continue increasing interest rates. In these conditions, inconsistency between IT and FX intervention will exacerbate Period Target Inflation Active Forecast Transmission Mechanism Model Output Gap Interbank (average) Term Dep (average) Exch. rate Annual Depreciación (avg) Mar-06 4,88 4,16 0,29 5,93 5,92 2.264-9,44 Jun-06 4,75 3,97 0,80 6,15 5,85 2.431-5,28 Sep-06 4,63 4,54 0,47 6,65 6,31 2.434-1,04 Dic-06 4,50 4,47 1,00 7,21 6,47 2.304 1,57 Mar-07 4,37 4,61 1,20 8,22 7,44 2.231 2,21 Jun-07 4,25 4,75 1,26 8,90 8,54 2.229-0,95 Sep-07 4,12 4,03 1,12 9,21 9,31 2.233-4,41 Dic-07 4,00 3,98 0,88 9,37 9,80 2.231-5,39 Mar-08 3,87 4,23 0,54 9,40 10,09 2.317-4,14 Jun-08 3,75 3,98 0,24 9,33 10,23 2.329-0,96 Sep-08 3,62 3,92-0,03 9,12 10,21 2.342 2,46 Dic-08 3,50 3,84-0,30 8,80 10,05 2.356 4,70
An active sterilization policy, by using all available mechanisms will need to be implemented in order to prevent inflationary effects of FX intervention. Nonetheless, Sterilization, even if effective, does not solve the problem of inconsistency, and actually could aggravate it In such circumstances FX intervention does not seem to be feasible for too long. What to do? Pure floating is not a feasible option in face enormous interests at stake A decisive countercyclical fiscal policy could help, but it does not seem to be a practical option at least in the short-term