Juan José Echavarría, governor of Colombia’s central bank, talks to Jacopo Dettoni about the impact of recent financial reforms and how the country is getting to grips with increasing inflation.

Juan Jose Echavarria

Q: Colombia's central bank repeatedly cut interest rates in 2017. Are you comfortable with the current levels of inflation?

A: We are still in a restrictive monetary policy phase, but we are going through a smoother phase now. Inflation spiked [close to] 9% in mid-2016, way higher than our 3% target, and the central bank tightened up interest rates. We inverted that trend in December as inflationary pressures started cooling off. As long as inflation is coming down, we have space to cut interest rates to support economic growth. However, we are still facing the dilemma of a supply shock, which is causing hard times with decreasing but still high inflation rates, and growth well below our long-term potential.

Q: How are you going to address that challenge?

A: We started announcing interest rates cuts in December, and we will likely cut them by another 80 basis points to 100 basis points in the rest of 2017, although it will depend on the news [on inflation] in the months to come. We are expecting inflation to come down to above 4% in 2017, and 3.5% in 2018. The question is how fast we can get inflation within our long-term target of 3%. All in all, it’s a matter of credibility, because the central bank hasn’t got full credibility yet. Credibility makes inflation shocks temporary, but it’s not easy to achieve.

Colombia suffered from 25% inflation rates for 20 years [which took in the whole of] the 1990s. Prices began to grow again more recently. There is a lot of inertia in the economy, many services are indexed to inflation, and expectations easily get out of control. The central bank missed its inflation targets in the past two years because it didn’t want to stifle the economy [with high interest rates]. Now we are back on track to bring inflation down to 3%, which is the most important thing.

Q: The Colombian peso quickly depreciated in the currency market, pushing up the imports bill. What are the other factors that are increasing inflation pressures?

A: It was largely due to rough weather conditions, which hit the supply of basic foods such as rice, potatoes and tomatoes in 2016, combined with the isolation of the Colombian economy: there is little food importation in Colombia. The peso’s depreciation obviously played a role too. The central bank allowed a 90% depreciation of the peso [to absorb the shock from reduced oil exports], which increased sharply the cost of any imports and triggered a hike in interest rates to contain inflation. [The peso reached a historic low in February 2016 but has since recovered.]

Q: Where do you see sources of growth as the oil sector deals with continued low prices?

A: As highlighted by the International Monetary Fund in its Article IV consultation, Colombia’s current economic potential is no longer at 4.5% [growth], but between 3% and 3.5%. With reforms it can get to between 4% and 4.2%. Where is this growth going to come from? Productivity in Colombia has not grown much over the years. That’s part of the problem. At the same time, there is a big push to develop the country’s road network, which is among the poorest in the whole of Latin America.

Another source of growth comes from the peace dividend [thanks to the historical accord with the leftist rebel group Farc], which can be broken down in terms of more tourism, foreign direct investment and also the development of rural areas. There will be room for development in areas previously affected by the conflict, if [the authorities] manage to handle the peace process successfully.

Q: Are they going to be successful in that?

A: Let’s wait and see. What happened in Colombia is a paradox. Any country would have rejoiced in a peace agreement, but Colombian society is very polarised. [The country rejected the deal in last October’s referendum; a revised version of the agreement was then approved by congress in December without being put to a public vote.] It’s important that the next president endorses or discards altogether the assumptions of the ongoing peace process [to give a clear signal to the market]. My hope is for the former option. It would be very difficult to get rid of all the recent achievements in terms of peace.

Q: What is your assessment of 2016’s fiscal reform?

In Colombia, the informal economy makes up 50% of the gross domestic product, and that makes any fiscal reform even more complicated. The reform is going to help, although we are not seeing any positive effect yet on the fiscal deficit side. In fact, we are observing negative impact on consumption from higher VAT rates, which grew to 19% from 16%. Overall the central bank is expecting economic growth at 1.8% in 2017, which stands at the lower range of market expectations. I personally believe we can do a bit better.

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