Highlights of “The Current Situation and Outlook for the Colombian Economy”: A Presentation by Mr. José Darío Uribe, Governor of Banco de la República

Inflation

The Governor of Banco de la República, Mr. José Darío Uribe, indicated the recent increase in inflation (6.26% at April 2007) is the result of factors associated with both supply and demand. The supply factors refer to the effects of El Niño weather on food production and the increase in prices for certain regulated goods and services.  The demand factors are associated with the sharp rise in domestic spending, the demand for Colombian products in Venezuela, and increased world demand for agricultural products that can be used to produce alternative sources of energy as a substitute for oil.

The inflationary pressures brought to bear on food prices as a result of El Niño weather are temporary and should disappear during the second half of the year.  However, inflationary pressure associated with international prices for oil and bio-fuels, and the pressure originating with exports to Venezuela, are likely to continue throughout the year.  Inflation in regulated goods is expected to decline during the second half of 2007.


Growth

On the supply side, growth during 2006 (6.8%) originated in numerous sectors of the economy, particularly industry, construction commerce and transport.  Investment and household consumption were the major components of demand. These aspects of economic growth allow for optimism about its continuation, given the broad production basis where it originates and the increase in the economy’s potential for output.

In fact, domestic demand was up by 9.9% in 2006, fueled largely by investment in machinery and equipment.  The growth in household consumption accelerated from 5.5 to 8.0% during the second half of the year, while the GDP growth forecasts for 2007 are between 5% and 6.5%, with an increase in domestic demand of nearly 8%.


Interest Rates

Given the acceleration in aggregate demand and credit, the Board of Directors has raised Banco de la República’s intervention interest rates ten times between April 2006 and April 2007, by 25 basis points on each occasion.  The most recent hike, on April 30, placed the base rate for repo auctions at 8.50%. This policy helps to ensure compliance with the target for inflation in 2007 and convergence towards the long-term target, which is in the 2%-to-4% range.  This elimination of the monetary stimulus does not affect the Colombian economy’s potential for growth. Rather, it contributes to the continuity and sustainability of that growth.


The Exchange Rate

At the start of the year, the Board of Directors of Banco de la República voiced its commitment to exchange market intervention aimed at contributing to macroeconomic stability and ensuring a certain balance in GDP growth between the sectors producing tradable and non-tradable goods and services. In pursuit of this policy, the Bank purchased US$ 4,527.4 million on the foreign exchange market during the first four months of the year.

The monetary effects of this intervention are being offset by the Bank, so as not to jeopardize the inflation target.


Recent Measures

The Board of Directors adopted a series of measures on May 6, 2007 that reflect its commitment to making sure inflation targets are met.   For example, it imposed a marginal reserve ratio on the amount of Colombian currency deposited by financial institutions. The idea is to reduce growth in the consumer loan portfolio in the financial sector.  The Board also decided to require an external debt deposit equal to 40% of the disbursement value at six months, so as to even up domestic and foreign interest rates on short-term external credit arrangements. Finally, a limit equal to 500% of technical capital was placed on the leveraged portion of derivative operations by exchange market intermediaries. In this case, the idea is to reign in the risk associated with those operations.