Colombian Economic Outlook: A Conversation on Recovery, Rates, and Blockchain with Central Bank Head Juan José Echavarría

This article was originally published by Bonds & Loans. It has been reprinted with permission.

Colombia’s central bank Governor Juan José Echavarría speaks with Bonds & Loans about the economy, interest rates, and blockchain in this exclusive interview.

The Colombian economy slowed more than expected in 2017 to growth rates not seen in a decade. What were some of the main drivers in play? And are you seeing more opportunities for a rebound in 2018? What are the biggest economic risks to Colombia in 2018?

“Future decisions on the benchmark interest rate will depend on the analysis of the risk balance between the expected recovery of the economy, along with the high levels of excess capacity, and the pace of convergence of inflation to its target.” – Juan José Echavarría, head of the Banco de la República

The Colombian economy grew 1.8% in 2017, slightly below the growth figure for 2016, or 2.0%. This digit was close to the one forecasted by the central bank’s technical staff months ago, 1.6%, and to the expectations by the majority of market analysts.

The fall in the terms of trade since mid-2014 and the sharp slowdown or even contraction of the country’s main trading partners in the region have been the most important reasons behind the slower growth of the economy in the last few years, including 2017. Additionally, the Colombian economy continued to face some adverse transitory supply shocks.

In 2017, the process of adjustment of expenditure continued after the huge negative shock to national income due to the fall of the international price of oil and other commodities exported by the country. While an increase in the terms of trade was reported in the same year, their levels remained significantly lower than those observed before 2014.

Similarly, the adjustment of both public and private expenditure has taken place gradually in a less favorable external context. However, there has been a significant advance in this process, as suggested by the reduction of the external imbalance.

Juan José Echavarría, governor of the Colombian central bank, Banco de la República. (Credit: Banco de la República)

For 2018, the external and internal conditions are more favorable than in previous years, which allows to trust in an acceleration of growth. In its most recent projection, the technical staff of the central bank forecasts a growth figure of 2.7%, and considers that, within a stable international economic context, it may continue to improve and converge towards potential growth in coming years. On the one hand, the average of international oil prices would increase again compared to the previous year, even after considering any foreseeable correction on its level in the coming months.

“The board considered that by reducing the benchmark interest rate to 4.5%, the cycle of rate reductions initiated in December 2016 had been completed.” – Juan José Echavarría

Additionally, the economies of the region begin to show signs of recovery, and advanced economies are at their best moment in the last ten years, which suggests that sectors such as non-traditional exports and services may gain momentum and help consolidate long-term growth. On the domestic front, the decline of inflation and the expansionary monetary policy should help to stimulate demand in the coming months. In addition, investment in civil works announced by the government will continue to contribute significantly to growth, as happened in 2017.

However, the possibility of a strong decline of oil prices by an excessive supply that may be deemed to be permanent may require greater and more prolonged adjustments in domestic spending besides those already foreseen. Likewise, the decisions on monetary, fiscal and trade policies that are being made in advanced economies must be considered.

Particularly, those related to unforeseen changes in the U.S. Fed’s benchmark interest rate could cause increases in the volatility of financial markets as well as in the risk perception of the economies of the region, increasing the costs of the sources of funding.

Bonds & Loans: Commercial lending looks set to rise by more than triple the rate seen the previous year, according to Asobancaria’s estimates. How do you see this impacting banking sector liquidity and entities’ reliance on the capital markets?

Juan José Echavarría: Given that the observed nominal annual growth rate of the stock of commercial loans in 2017 was 3.3%, Asobancaria’s estimate for 2018, somewhere slightly below 10%, is still relatively low compared to the average of the last five years, 11.7%. As a consequence, an expansion of commercial credit of such magnitude should not have significant effects on the liquidity of banks, considering that the banking sector has enough liquid assets to finance this growth.

This is supported by the analysis (presented in Box 2) of the September 2017 “Financial Stability Report of the Central Bank of Colombia,” where it is shown that banks have enough capital and liquidity to support a greater growth of the total loan portfolio.

Regarding the reliance of financial entities on capital markets, Colombian banks traditionally have shown a relatively low dependence on this type of funding. As such, the impact of higher credit growth on capital markets should be small.

Bonds & Loans: In January the central bank cut its benchmark rate in a narrow decision but called an end to its easing cycle, which lasted over a year, and has held rates steady since. Where do you anticipate rates heading in the medium term given the Bank’s outlook on the economy?

“Cryptocurrencies are not an asset equivalent to legal currency, neither recognized as foreign currency by the exchange rate regime.” – Juan José Echavarría

Juan José Echavarría: The latest press release after the monetary policy meeting of the board of directors of the central bank announced that, facing the macroeconomic scenario under analysis and with the information available at the time, the board considered that by reducing the benchmark interest rate to 4.5%, the cycle of rate reductions initiated in December 2016 had been completed.

Thus, future decisions on the benchmark interest rate will depend on the analysis of the risk balance between the expected recovery of the economy, along with the high levels of excess capacity, and the pace of convergence of inflation to its target. Should this balance not differ much from expectations, the rates would remain at their current level until new information indicates something different.

Bonds & Loans: Blockchain is becoming increasingly popular with banks and financial institutions, not only to support process efficiency but to also bolster transparency and data integrity, helping them meet evolving regulatory requirements. Do you see a role for blockchain among the country’s financial institutions? What is the Colombian central bank doing in this area?

Juan José Echavarría: Cryptocurrencies, or virtual coins, are a digital asset whose value is highly volatile; therefore, it can generate huge profits or losses to its holders. This is why it is important for them to adequately understand the risks they face. Virtual currencies are not backed by physical assets nor by any central bank, so their exchange value could be drastically reduced in a short period of time.

The use of blockchain as a means of payment may generate some kind of disruption in the way financial services are provided. These risks can be heightened given the fragility in the value of cryptocurrencies, which could induce collapses of the prices of these assets.

READ MORE: Colombian Central Bank Projects GDP to Grow by 2.7% in 2018

At the same time, there could be new risks and legal implications should they be allowed to operate together with the rest of the financial system. Particularly, they could induce greater instability in times of financial crisis by facilitating bank runs. Therefore, the regulation should look at competition issues, interoperability with intermediaries, and infrastructure of the financial system.

In Colombia, cryptocurrencies are not recognized as currency, and, therefore, they are not legal tender. Thus, it is not mandatory to receive it as a means to fulfill obligations. In other words, cryptocurrencies are not an asset equivalent to legal currency, neither recognized as foreign currency by the exchange rate regime. Consequently, they cannot be used in foreign exchange operations.