Monetary and Exchange Rate Policy Responses to the Global Financial Crisis: The Case of Colombia Hernando Vargas Banco de la República Colombia March, 2009
Contents I. The state of the Colombian economy at the time of the crisis A. The macroeconomic situation B. Financial stability II. The effects of the international crisis III. Monetary policy responses IV. Exchange rate policy responses
I. The State of the Colombian Economy at the Time of the Crisis
A. The Macroeconomic Situation
Three years of strong aggregate demand and output growth driven by favorable external and domestic conditions GDP and Domestic Absorption (% annual growth) 12 10 8 6 4 2 0 Mar-00 Jun-00 Sep-00 Dic-00 Mar-01 Jun-01 Sep-01 Dic-01 Mar-02 Jun-02 Sep-02 Dic-02 Mar-03 Jun-03 Sep-03 Dic-03 Mar-04 Jun-04 Sep-04 Dic-04 Mar-05 Jun-05 Sep-05 Dic-05 Mar-06 Jun-06 Sep-06 Dic-06 Mar-07 Jun-07 Sep-07 Dic-07-2 GDP Domestic Absorption Improvements in security, fiscal consolidation, favorable TOT, expanding external demand, remittances, large FDI flows, abundant external liquidity
An increasingly positive output gap Output Gap 2000-2007 3% 2% 1% 0% -1% -2% -3% -4% -5% -6% Mar-00 Jun-00 Sep-00 Dic-00 Mar-01 Jun-01 Sep-01 Dic-01 Mar-02 Jun-02 Sep-02 Dic-02 Mar-03 Jun-03 Sep-03 Dic-03 Mar-04 Jun-04 Sep-04 Dic-04 Mar-05 Jun-05 Sep-05 Dic-05 Mar-06 Jun-06 Sep-06 Dic-06 Mar-07 Jun-07 Sep-07 Dic-07-7%
And a moderate current account deficit 1,0 Current Account Deficit (% of GDP) 0,0-1,0-2,0-3,0-4,0 2000 2001 2002 2003 2004 2005 2006 2007 2008 pre
That came along with a real appreciation of the currency 140 Real Exchange Rate Index (1994 =100) 130 120 110 100 90 80 Ene-00 Ene-01 Ene-02 Ene-03 Ene-04 Ene-05 Ene-06 Ene-07 Ene-08 Ene-09
The economy was hit by a variety of supply shocks in 2007-2008: International energy/food prices Climate-related food price shocks With clear effects on prices and output 16 CPI Annual Inflation (%) 14% Non-Labor Costs Index (change YoY) 14 12% 12 10% 10 8% 8 6 4 6% 4% 2% 0% 2 Feb- 06 May- 06 Ago- 06 Nov- 06 Feb- 07 May- 07 Ago- 07 Nov- 07 Feb- 08 May- 08 Ago- 08 Nov- 08 Feb- 09-2% Feb-06 Abr-06 Jun-06 Ago-06 Oct-06 Dic-06 Feb-07 Abr-07 Jun-07 Ago-07 Oct-07 Dic-07 Feb-08 Abr-08 Jun-08 Ago-08 Oct-08 Dic-08 Feb-09 Headline CPI Food & Regulated
In this context, monetary policy was tightened: To curb increase in inflation derived from the expanding aggregate demand (2006-2007) To control inflation expectations after the supply shocks (2008) Central Bank Policy Rate 10,0% 9,0% 8,0% 7,0% 6,0% 5,0% 11-ene-06 11-mar-06 11-may-06 11-jul-06 11-sep-06 11-nov-06 11-ene-07 11-mar-07 11-may-07 11-jul-07 11-sep-07 11-nov-07 11-ene-08 11-mar-08 11-may-08 11-jul-08 11-sep-08 11-nov-08 11-ene-09 11-mar-09
Results: Inflation rose and the targets were missed However, core inflation remained stable (some measures) and expectations increased less than headline (partial anchoring) CPI Inflation and Targets CPI Inflation and Expectations (%) 8,0 8,0 7,0 7,0 6,0 6,0 % 5,0 5,0 4,0 4,0 3,0 3,0 Feb-06 Ago-06 Feb-07 Ago-07 Feb-08 Ago-08 Feb-09 Feb-06 Abr-06 Jun-06 Ago-06 Oct-06 Dic-06 Feb-07 Abr-07 Jun-07 Ago-07 Oct-07 Dic-07 Feb-08 Abr-08 Jun-08 Ago-08 Oct-08 Dic-08 Feb-09 CPI ex Food & Regulated 12 m Ahead Expectations Headline
Results: Slowdown in 2008: Response to monetary policy tightening Effects of the supply shocks (real disposable income of households, firms costs) Trade restrictions imposed in Venezuela 12 GDP and Domestic Absorption (% annual change ) 3,0% 2,5% Output Gap 2006-2009 10 2,0% 8 1,5% 6 4 1,0% 0,5% 0,0% 2-0,5% 0-1,0% Mar-06 Jun-06 Sep-06 Dic-06 Mar-07 GDP Jun-07 Sep-07 Dic-07 Domestic Absorption Mar-08 Jun-08 Sep-08 Dic-08-1,5% -2,0% Mar-06 Jun-06 Sep-06 Dic-06 Mar-07 Jun-07 Sep-07 Dic-07 Mar-08 Jun-08 Sep-08 Dic-08 Mar-09
B. Financial Stability
50% 40% 30% 20% 10% 0% Strong credit growth in 2006-2007 (especially consumer credit) Financial System Credit and Consumer Credit Real Annual Growth (CPI ex Food) dic-04 mar-05 jun-05 sep-05 dic-05 mar-06 jun-06 sep-06 dic-06 mar-07 jun-07 sep-07 dic-07 mar-08 jun-08 sep-08 dic-08 Total Consumer Credit
Despite exchange rate flexibility: Monetary policy regime stabilizes short term interest rate Money supply follows money demand + Large increases in domestic asset demand during the appreciation period Nominal Exchange Rate (COP/USD) 2700 2500 2300 2100 1900 1700 1500 01-Ene-05 01-Feb-05 01-Mar-05 01-Abr-05 01-May-05 01-Jun-05 01-Jul-05 01-Ago-05 01-Sep-05 01-Oct-05 01-Nov-05 01-Dic-05 01-Ene-06 01-Feb-06 01-Mar-06 01-Abr-06 01-May-06 01-Jun-06 01-Jul-06 01-Ago-06 01-Sep-06 01-Oct-06 01-Nov-06 01-Dic-06 01-Ene-07 01-Feb-07 01-Mar-07 01-Abr-07 01-May-07 01-Jun-07 01-Jul-07 01-Ago-07 01-Sep-07 01-Oct-07 01-Nov-07 01-Dic-07 01-Ene-08 01-Feb-08 01-Mar-08 01-Abr-08 01-May-08 01-Jun-08
Policy makers concern not only for inflation and current account deficit sustainability, but also for financial stability (bitter memories of the nineties) Macro-prudential measures: Reserve requirements (rapid credit growth and slow transmission of policy rate hikes) Capital controls (appreciation, control of leverage) Increased provisioning requirements (rapid credit growth and exposure of banks to household sector) Counterparty risk limits in FX markets International reserves purchases (appreciation, perception of temporary favorable external conditions)
This in addition to: Permanent regulation on FX and FX maturity mismatches of banks (no domestic FX interbank loan market) Flexible exchange FX risk contains excessive foreign indebtedness
Results: Low corporate sector leverage Low currency mismatches Control on household indebtedness Solid banks Low probability of FX liquidity problems Corporate Sector Total Liabilities/Total assets 17,0% Financial System Risk-weighted Assets/Net Worth 39,0% 38,0% 37,0% 36,0% 35,0% 34,0% 33,0% 32,0% 31,0% 2004 2005 2006 2007 Total Tradables Non-Tradables 16,0% 15,0% 14,0% 13,0% 12,0% 11,0% 10,0% 9,0% 8,0% Ene-04 Abr-04 Jul-04 Oct-04 Ene-05 Abr-05 Jul-05 Oct-05 Financial system Ene-06 Abr-06 Jul-06 Oct-06 Ene-07 Abr-07 Jul-07 Oct-07 Ene-08 Abr-08 Jul-08 Oct-08 Minimum requirement
In sum, when the crisis hit, the Colombian economy was characterized by: A slowdown of output growth as a result of monetary policy tightening and the supply shocks An increase in inflation, with the targets being missed, as a consequence of the supply shocks A slowdown of credit expansion as a result of monetary policy tightening and other measures to control credit growth Healthy financial positions of firms, households and banks thanks to contained credit expansion and small mismatches in balance sheets
II. The Effects of the International Crisis
170 160 150 140 130 120 110 100 TOT deterioration Terms of Trade Index* 1994=100 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 Jun-07 Oct-07 Feb-08 Jun-08 Oct-08 Feb-09 * Based on PPI
Export growth decline 25 Total Exports (% Change YoY) 50 40 Non Traditional Exports (Change YoY) 45 20 15 10 5 0-5 -10 40 30 20 10 0-10 30 20 10 0-10 -20-30 -40-50 40 35 30 25 20 15 10 5 0-5 -10 Mar-05 Jun-05 Sep-05 Dic-05 Mar-06 Jun-06 Sep-06 Dic-06 Mar-07 Jun-07 Sep-07 Dic-07 Mar-08 Jun-08 Sep-08 Dic-08 Mar-05 Jun-05 Sep-05 Dic-05 Mar-06 Jun-06 Sep-06 Dic-06 Mar-07 Jun-07 Sep-07 Dic-07 Mar-08 Jun-08 Sep-08 Dic-08 Real (COP) Nominal (USD) Tons Nominal (USD) Vulnerability: Main trading partners: The US, EU, Venezuela, Ecuador Nontraditional Exports to the US very weak already Ecuador imposed trade restrictions / Venezuela becoming more fragile
Drop of remittances from Colombian workers abroad Monthly Workers Remittances Annual growth (USD) 50 40 30 20 10 - -10-20 -30-40 Ene-07 Feb-07 Mar-07 Abr-07 May-07 Jun-07 Jul-07 Ago-07 Sep-07 Oct-07 Nov-07 Dic-07 Ene-08 Feb-08 Mar-08 Abr-08 May-08 Jun-08 Jul-08 Ago-08 Sep-08 Oct-08 Nov-08 Dic-08 Ene-09 Feb-09 %
900 800 700 600 500 400 300 200 100 Increases in risk premia EMBI+ and EMBI+ Colombia 700 10 Year Credit Default Swaps (CDS) in Latinoamérica* 600 500 400 300 200 100 0-100 Ene-08 Feb-08 Mar-08 Abr-08 May-08 Jun-08 Jul-08 Ago-08 Sep-08 Oct-08 Nov-08 Dic-08 Ene-09 Feb-09 Mar-09 Ene-08 Feb-08 Mar-08 Abr-08 May-08 Jun-08 Jul-08 Ago-08 Sep-08 Oct-08 Nov-08 Dic-08 Ene-09 Feb-09 Mar-09 EMBI+ Colombia EMBI+ Brasil Chile Colombia México Perú * Chile and Perú: 7 year CDS
FDI expected to fall 10.000 Net FDI (USD Million) 8.000 6.000 4.000 2.000 0 2000 2001 2002 2003 2004 2005 2006 2007 2008 pre 2009 proy pre: Preliminar. proy: BR BoP Forecast
Assessment: Strong shocks to the Current Account External financing dearer but available Worsening expectations at home (consumers and businesses) and abroad (outlook for trading partners, TOT)
Results: Negative shock to national income and expenditure on top of ongoing slowdown Real and nominal depreciation But: Real depreciation (partially) compensates impacts on current account items No strong restriction on foreign financing No domestic credit crunch (credit annual growth rate still greater than GDP growth) No dramatic adjustment of Domestic Absorption
In sum: Negative shock to income and expenditure + No abrupt adjustment of Domestic Absorption + Reversion of supply shocks + Pick up in public investment (regional electoral cycle) = Sharp decline in growth, but not a disaster like 1999 (Recession + Financial Crisis)
On Inflation: Reversion of supply shocks Widening of the output gap Expectations partially anchored (Reacted less than one for one to supply shocks and converged rapidly to target with reversion of headline inflation) Moderate wage adjustments Margin for inflation to fall
III. Monetary Policy Responses
Countercyclical so far: The inflation target was increased from 3.5%- 4.5% in 2008 to 4.5%-5.5% in 2009 Idea: Gradual reversion of inflation after supply shock Avoid large volatility of interest rates and output in the face of worsening external conditions Path of convergence to long run target was announced to ensure that the signal was one of a temporary adjustment in the target: 4% midpoint for 2010 and 3%±1% for 2011
Countercyclical so far: Reserve requirements were reduced in November 2008 by 1% (on average) to provide liquidity in a moment of market nervousness and to start relaxing the stance of monetary policy Capital controls were partially lifted in October 2008: Depreciation + Slowdown in credit Policy rate has been decreased by 200 bps. since December 2008 (smaller drop in ex-post real interest rates)
This has been possible because: Policy was countercyclical in the expansion phase of the cycle: No large imbalances were allowed, so core inflation was contained Inflation expectations were partially anchored There have been no serious trouble so far with the depreciation: Relatively low pass-through + Sustained depreciation not expected The external shock caused a depreciation, but at the same time impacted negatively aggregate demand Low currency mismatches Moderate CA deficits before (no large imbalances were allowed)
The transmission mechanism seems to be working: Active credit channel Policy rates reduction has been transmitted to other rates (less clear for consumer loans) 12,0% Nominal Interest Rates 17,00% 16,50% 16,00% 15,50% 10,0% 15,00% 14,50% 14,00% 13,50% 8,0% 13,00% 31-dic-07 31-ene-08 29-feb-08 31-mar-08 30-abr-08 31-may-08 30-jun-08 31-jul-08 31-ago-08 30-sep-08 31-oct-08 30-nov-08 31-dic-08 31-ene-09 28-feb-09 90 day CD rates Policy Rate Commercial Loan Rates Thanks to a still healthy financial system
Risks: Size of the external shocks In particular, serious restriction of foreign financing: Strong depreciation with imperfectly credible monetary policy Still plenty of rigidities (e.g. labor markets) Abrupt CA deficit correction will cause a contraction of domestic absorption
IV. Exchange Rate Policy Responses
Floating Exchange Rate: International Reserves accumulation while the exchange rate appreciated in 2008: Auction of put options (US$ 450 million, April- June 2008) US$20 million daily direct purchases (auctions) (June-October 2008) No discretionary intervention No exchange rate target
2700 2500 2300 2100 1900 1700 1500 Nominal Exchange Rate (COP/USD) Ene2008 - Mar 2009 18-Nov-08 02-Dic-08 16-Dic-08 30-Dic-08 13-Ene-09 27-Ene-09 10-Feb-09 24-Feb-09 10-Mar-09 01-Ene-08 15-Ene-08 29-Ene-08 12-Feb-08 26-Feb-08 11-Mar-08 25-Mar-08 08-Abr-08 22-Abr-08 06-May-08 20-May-08 03-Jun-08 17-Jun-08 01-Jul-08 15-Jul-08 29-Jul-08 12-Ago-08 26-Ago-08 09-Sep-08 23-Sep-08 07-Oct-08 21-Oct-08 04-Nov-08
FX Intervention by Banco de la República (USD Million) Accumulation Volatility Volatility Direct Total Put Put Call Auctions 2008 January 0,00 February 232,7 232,65 March 38,0 38,00 April 150,0 62,5 212,50 May 150,0 150,00 June 150,0 180,0 71,6 401,60 July 444,3 444,30 August 380,0 380,00 September 440,0 440,00 October -234,55 79,9-154,65 November 0,00 December 2,3 2,30 Total 450,0 515,5-234,55 1415,8 2146,7 2009 January -175,0-175,0 February -193,5-193,5 March 0,0 Total 0,0 0,0-368,50 0,0-368,5
Floating Exchange Rate: Appreciation trend was reversed in June 2008 and depreciation accelerated in August 2008 Reserve accumulation program based on daily interventions in the FX market was stopped in October 2008 Capital controls were lifted in October 2008 As the international context was rapidly changing, floating was considered convenient Intervention restricted to automatic auctions of Volatility call options Even this mechanism was altered to allow for greater flexibility (trigger was increased from 2% to 5% of exchange rate 20 day moving average) and was eventually suspended between July and October 2008
Floating Exchange Rate: The liquidity squeeze that hit other FX markets in the region did not happen in Colombia Regulation inhibits domestic USD interbank loan market Regulation limited FX counterparty risk The COP was relatively stable between November 2008 and January 2009, while other currencies in the region depreciated rapidly
150,00 140,00 130,00 120,00 110,00 100,00 90,00 80,00 Nominal Exchange Rate Indeces January 2008 = 100 02-Ene-08 23-Ene-08 13-Feb-08 05-Mar-08 26-Mar-08 16-Abr-08 07-May-08 28-May-08 18-Jun-08 09-Jul-08 30-Jul-08 20-Ago-08 10-Sep-08 01-Oct-08 22-Oct-08 12-Nov-08 03-Dic-08 24-Dic-08 14-Ene-09 04-Feb-09 25-Feb-09 Colombia México Brasil Perú Chile
Floating Exchange Rate: However, the COP caught up abruptly with other currencies in February 2009 Large forward purchases by off-shores and pension funds Again, only automatic Volatility call options have been used
Floating Exchange Rate: Rationale: Healthy effects of exchange rate flexibility (shock absorber, countercyclical monetary policy, currency risk) Given inflation outlook and low currency mismatches, the only reason to intervene is to avoid disorderly behavior in currency and other asset markets Automatic Volatility call options instrument useful so far No clear evidence of persistent exchange rate misalignment Desirable to avoid contradictory signals of FX policy and monetary policy Do not want to invite speculative behavior against the central bank + Use of international reserves deemed more valuable under worse external or FX market conditions
"Band Chart" for the Equilibrium RER 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 Band chart built on the basis of 4 equilibrium RER models: PPP, SVEC, Smoothing CA Deficit and a Balassa-Samuelson based model. Weight depends on Variability of equilibrium RER estimate. Probability distribution depends on the weighted standard errors of the models 160 150 140 130 120 110 100 90 80 70 60
Monetary and Exchange Rate Policy Responses to the Global Financial Crisis: The Case of Colombia Hernando Vargas Banco de la República Colombia March, 2009