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Tuesday, May 29, 2007
Perspectives

Colombia: Bad Policy Decisions

Colombia is one of the few emerging market countries that is not taking advantage of the commodity boom.
Colombia should focus more on commodity exports instead of capital controls, the author argues. Here President Alvaro Uribe with his economic team and members of Colombia's Central Bank on Sunday. (photo: Miguel Angel Solano/SNE).

BY WALTER T. MOLANO

The Colombian government’s decision to introduce additional capital controls reflects a flawed economic model and bad policy-making.

Last week, the economic authorities expanded the capital controls that were introduced on May 6, which forced corporates and banks to deposit loans taken abroad at the central bank for a period of six months. The new measures expanded the compulsory deposit requirements to the investor community.

The capital controls were implemented in order to stem the appreciation of the Colombian peso (COP), which gained 30 percent over the course of the past year. Although most emerging market currencies are appreciating, the drivers behind the Colombian peso are very different.
 
MISSING COMMODITY BOOM
 
Colombia is one of the few emerging market countries that is not taking advantage of the commodity boom. Instead of focusing on its vast natural resource base, Colombia is exploiting the special relationship it enjoys with the U.S. to secure quotas and preferential tariff for light manufacturers—particularly textiles and clothing.

As a result, Colombian firms carved out a space in the U.S. market, competing against Asian behemoths. Nevertheless, the Colombian goods are still sensitive to price changes, and a 30 percent appreciation of the peso is eroding their competitiveness and profit margins. Many of these firms are located in Medellin, President Uribe’s political power base. Therefore, he has been sensitive to movements in the currency.

However, the benefits created by these light industries are limited. They employ a relatively small percentage of the population and most of the economic benefits are realized by a few urban centers. Therefore, the country does not generate sufficient export earnings to cover the costs of its imports, and it constantly reports a trade deficit. Colombia, for example, posted a trade deficit of $272 million in March; meanwhile, most of its peers were reporting huge trade surpluses. 
 
Hence, the Colombian authorities countered the short fall in the trade account by attracting capital inflows and remittances. However, this is an inexact science. The government has been privatizing assets. Colombian firms have been raising capital, and the improved security resulted in higher remittances. Yet, there were more inflows than the government expected and the currency appreciated—which was the reason why it was forced to act.

ASIAN COMPETITION

Colombia would not be in this situation if it relied on commodity exports. Today, commodity producers are price setters. The demand for their exports is so high and the supply is so limited, that producers are impervious to price. However, manufacturers, particularly light manufacturers, are price takers. There is so much competition from Asia in light manufacturing that the slightest change in price could leave someone out of the marketplace. 
 
Colombia has no reason to focus on light manufacturing. Its comparative advantage is not in abundantly cheap skilled labor. It is not a capital intensive nation. However, it is brimming with natural resources. A refocus on the commodity sector would widen the employment base, reduce poverty and improve security.

Colombia is making itself susceptible to sudden stops by relying on capital flows to solve its balance of payment needs. It will have to reverse these measures the moment there is an increase in risk aversion and the money flows in the other direction.

Last of all, there is no reason why the Colombian government should take steps to keep its population of 44 million citizens artificially impoverished in order to help a handful of light manufacturers in Medellin.

Walter Molano is head of research at BCP Securities.
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