Oil, cocaine and Rock & Roll ?
In our trip around the world during the present holidays, we decided to take a small stop in Santa Fé De Bogota : Columbia es pasion ! Indeed, the tourist guide of Colombia will overwhelm you with the following nice features : mother nature's most beautiful spot in South America (true), amazing rich coffee, amazing soccer players, Luis Herrera and Fabio Parra writing Tour de France history mid-eighties, and last but not least, Shakira, their recent most famous export product and having a kind of select fanclub in Borgerhout as well. But Colombia is also economics. And next to coffee, we have soft commodities such as bananas, hard commodities with a growing oil & gas industry and special commodities with drugs & the Medellin cartel. And related to this we have politics and corruption (ranked 80 in the 182 transparency international index) and a little civil war going on with FARC.
So it's a rich mixed blend with various ingredients. Now despite some major obstacles in terms of risk factors related to this blend, this country has been a high flyer since the financial crisis broke out. It has been upgraded to investment grade BBB status and a 5y Credit Default Swap premium matching some AAA countries such as Denmark and the Netherlands, approx 120 bp or 1,2% risk premium. Note that the safest havens today such as Norway, Switzerland and the US hover around 50 bp with Germany now @90 bp (Belgium 200bp). This is quite remarkable in view of the rather unstable political situation where the FARC rebels are still very active and a wildcard in the region. And From FARC we move on to oil.
Oil has been a major revenue bonanza over the past couple of years. It accounted for almost 50% of export revenue in 2011, up from 24% in 2007. But lately it has also been some kind of curse. FARC has been targeting the oil sector from out of financial and political motives. First of all, the "clear and present danger" or the war on drugs has been generating some successes over the years, diminishing FARC's sources of revenue. Now they are hitting the oil sector by ways of extortion & dead squads to raise the revenue and to hit the growth engine of President Santos : stepping up attacks on pipelines, murdering workers in the oil business and tripling acts of sabotage (more than 30 incidents on average a month)
So life is not exactly easy - may be standard LatAm - but how does it translate itself into hard economic numbers on the scorecard ? Well, growth not too bad (but slowing down rapidly, unemployment moving up to 12%), a reasonable rate of inflation (3,5%) and an acceptable twin deficit of -2% on the budget and the current account. So we are doing fine. Well, not if we take a look at the following facts & figures which are quite amazing to say the least. In our Bloomberg ranking of currency gains against the EUR, we have the following results
Gains since June 2008 (hinge moment financial crisis)
1) JPY + 74%
2) Colombian Peso & Chilean Peso +39%
3) Swiss Franc + 34%
Gains since 30/12/2011 : Colombian Peso leading the world pack with a 16% gain. But the quiz show becomes more interesting with the following question : what have Japanese sake, Colombian coffee, Swiss cheese and Danish cookies in common ? And the right answer is mass central bank currency intervention to stop the currency from rising (and Chile having already announced being ready, willing and able at any time). And again it seems they mean business because the Colombian government has taken measures of selling Pesos against $ at a rate of 20 mio$ on a daily basis to stem currency strength. Other measures include storing abroad the dividends from state-run oil company Ecopetrol. So the club of central banks / safe havens having to sell their currency - The Swiss, Danes and Japanese - are now joined by Colombia, in terms of composition a strange brew of 4 musketeers.
So is the currency strength justified and/or a problem ? One way of looking at this is to look at the evolution in the terms of trade or to take a look on how the real effective exchange rate evolved over the past couple of years. This exchange rate is adjusted to inflation differentials with respect to the main trade partners (if your inflation rate is moving slower than your average main trade partner, an appreciation isn't so dramatic and justified). And here, we see that indeed the exchange rate has moved up and is potentially making life troublesome, not as such for the oil sector but for others :
So from an index level of 90 in 2003 it constantly moved up to the present level of 130. And coincidentally or not,the pattern is similar to the Swiss real effective exchange rate before Zurich took measures mid last year. Note however that this is relatively speaking not dramatic yet because other currencies have witnessed upward evolutions outpacing this result. But the call from the coffee and banana farmers is heard : "Dutch disease", meaning the oil/gas bonanza generating too much currency strength and hurting others in the economy.
What do policy makers intend to do about this ? Well first of all, probably reducing the attractiveness of some assets and reducing carry trade opportunities further (yields are now around 6-6,5%). And because growth is slowing down, public stimulus is most likely on the menu as well. In fact, Santos recently gave expression of his admiration towards FD Roosevelt. In the meantime, he is preparing for the 2014 election and the day-to-day political business in Colombia. Last month, the judicial system was "reformed", basically making it harder to prosecute politicians with alleged links towards organized crime : sadly enough, bunga-bunga still seems to be alive and kicking in some emerging markets.