While you take over as Governor of the Central Bank, what positive aspects could you emphasise about your predecessors’ legacy? What are the most important challenges that the Colombian economy will face?
The decisions reached by the Board of Directors of Banco de la República tried to achieve the simultaneous goals of keeping inflation low and stable, contributing to long-term growth, and smoothing the economic cycle. My predecessors were very successful in bringing inflation down from levels of 30% at beginning of the 1990s to 3% in 2014. The challenges for monetary policy are different now.
Unfortunately, the Colombian economy faced at least four different economic shocks in the past two years. The most important one was the fall in the price of oil, which implied a permanent decrease in the country´s income that was reflected in an acute devaluation of our currency. This shock coincided with the fall in the price of other main exports, such as coffee and coal. Together with the fall in the price of oil, this constituted the greatest terms-of-trade loss in Latin America. The shock of the oil price also affected the performance of the economies of our most important trading partners - Ecuador and Venezuela.
At the same time, domestically, we had climate problems (El Niño) which affected many crops and increased their prices. The Colombian economy is still adjusting to all these events, and we estimate that it will finally come out of the dark later this year. Due to the fact that all these shocks were inflationary, we did not achieve our inflation target in the past two years, but this year inflation will be within the target range.
Are you worried about the negative impact of increasing private debt? What can the Government and the Central Bank do to maintain “healthy growth,” especially after the erratic behaviour of the markets last year?
We are not worried about the country´s level of indebtedness as long as there is full compliance of the fiscal rule. In this sense, we have celebrated the recent approval and implementation of the Tax Reform by the Government and the Congress. We are sure that the fiscal situation will be clear in the short and medium terms with these reforms.
This tax reform will also bring more certainty to the markets that were volatile, partly because the fiscal situation was uncertain. It will also alleviate Banco de la República’s work to keep inflation low and stable. The Board will continue to carefully watch the evolution of the economy and will react to new shocks that may appear on the horizon.
Given the low probability that interest rates be reduced in the coming 12 months, how is the banking sector likely to adjust?
According to the recent behaviour of the economy and the inflation rate, there is relative consensus on the Board that we are following a path that will enable us to reduce interest rates. However, there are differences within the Board regarding the speed of the reduction.
The environment in which these decisions have to be made is changing every day, and uncertainty has gained more ground. In the next few months, the Board will probably disagree as to the pace of the interest-rate reductions.
What impacts could Basel III regulations have on the behaviour of Colombian banks? What is the liquidity forecast for the sector in the coming year? What can banks do to increase their capital?
The requirements of Basel III are not expected to have a significant impact on the financial system and the credit conditions of the economy. In 2012, the National Government issued a decree whose purpose was not only to increase the strength of the financial system, but also to soften the process of adjustment to this regulatory framework. Although Colombian regulations fully comply with international standards in some aspects, local regulations are still more caustic on some considerations, for instance in the management of banking reserves and weighted assets, while being more lenient in others, like in the treatment of trade credit.
In terms of liquidity regulation, the requirement of the Liquidity Risk Indicator covers some aspects of the Liquidity Coverage Ratio. However, it still does not involve aspects such as differentiation per type of depositor, which would affect the liquidity position of institutions facing an eventual migration to international practices.
Liquidity risk is not a current concern, and the Central Bank will provide the necessary liquidity for the normal operation of the economy. Finally, a deceleration of credit growth and the existence of new conditions for the placement of subordinated debt by financial intermediaries will facilitate increasing the banks’ solvency.
How do you see the recent peace agreement with FARC affecting the economy?
The peace agreements will be positive for the Colombian economy. International evidence suggests that growth in countries at peace is two points above than in countries at war. What does this imply for Colombia? If the economy grew at a historical rate of 4%, it could now grow at 6%. I believe that there will be an important dividend from peace, although it is very difficult to estimate its magnitude. Colombia has a non-conventional war in that is not open and has been circumscribed to specific territories. The peace dividend will come from the fact that we will be able to reallocate resources which are currently dedicated to war instead of other activities, such as education and health. Investors will be more confident to invest in Colombia. Some sectors will benefit immediately if we do this well: rural areas, tourism, and foreign investment.
From the Central Bank’s standpoint, how will rising US interest and the “Trump effect” impact the monetary policy?
Colombia has a flexible exchange-rate which implies that interest-rate decisions made by the monetary authorities in the United States have little impact on what Colombia does about its monetary policy.
On the other hand, the Trump effect may or may not impact Colombia. We still don´t know for sure what his policies will be like. We only know for certain that there will be higher volatility and uncertainty in the world economy. This imposes more challenges on Banco de la República’s policy because we will have to react to any inflationary pressures independently from where they come from.
Colombia has a free-trade agreement in place not only with the United States, but also with Europe, Japan and Korea. In my view, these agreements will protect us from arbitrary measures abroad. It is ironic that 10 years ago, many people in Colombia opposed these agreements. Opponents thought they will be harmful to our country because domestic production and employment could be displaced by imports. Advocates of free-trade used to justify them by saying that they would be useful in case protectionism surged in developed economies, although this seemed a very improbable scenario. Unfortunately, protectionism has arrived, and although these agreements are not going to insulate us completely, we would be worse off not having them.
Overall, it is very worrying for those like me who consider globalization and free international trade beneficial forces that contribute positively to the growth of our countries. In my view, trade globalization is a healthy phenomenon, difficult to contain, and many clouds may emerge along the way.
What other global challenges do you anticipate for the following months?
The great challenge for the country in the coming months is to keep adjusting to the huge shock to the terms of trade. I am sure we will be coming out of the dark in 2017. Inflation has been descending since July 2016, and it is likely to reach the upper limit of the target range (2-4%) by the end of the year.
There is good news on the growth front. A recent increase in the price of oil due to the agreement reached among OPEC members and some other oil-producing countries to reduce world production and regulate high levels of inventories is positive. Simultaneously, the Government plans to continue investing in infrastructure, which is also very supportive of growth.
However, our projections rely on not encountering any big surprises on other fronts, particularly in the international environment. If new protectionist measures affect Colombia directly, or if the interest rates in the US increase more than expected, the situation could change dramatically for the Colombian economy.