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Liberalising an energy economy’s currency
In a report last month, launched at Lloyds of London during the visit of the Colombian President Juan Manuel Santos, the Oxford Business Group opined that Colombia only stands to benefit from further internationalising its currency as it attempts to diversify its sources of foreign exchange.
An open and expanding economy with large exposure to commodity trade, Colombia stands to benefit from further internationalisation of its currency in a gradual manner that enhances access to liquidity and reduces the cost of capital while preventing inflows of “hot money.”
As an emerging market, Colombia must support its macroeconomic and financial stability to protect its economy from external shocks as a first-order priority. In that regard the concern that open and unregulated access to peso liquidity could attract financial speculators has some merit.
However, in this policy discussion paper we shall argue that there are various options available to policymakers that would achieve meaningful currency internationalisation without sacrificing financial stability or inviting currency speculation.
Implemented gradually, the sovereign, which is committed to maintaining its own currency and independence, can send a powerful signal to investors that Colombia is a well-structured and liberal economy that is open to foreign participation.
Examples from other countries that have adopted this approach, such as Mexico, proves it could help differentiate Colombia from other emerging economies, placing it in a lower-risk category because of the ease of moving capital and improved access to local liquidity.
When combined with sound macroeconomic policies, currency liberalisation benefits the real sector by lowering the cost of borrowing across the economy, from benchmark sovereign bonds and interbank rates to the cost for domestic businesses of borrowing from local banks.
A gradual increase in trade booked in pesos in the medium and long term would further benefit exporters and domestic banks by reducing foreign exchange (FX) imbalances and making large-scale, long-term peso lending more competitive with dollar lending.
• Publicly communicate that it is the long-term goal of the Colombian government and the central bank (Banco de la República de Colombia, BRC) that the Colombian peso be a fully convertible and deliverable currency in every sense of those terms;
• As an interim step towards that goal, permit trading in the peso in foreign jurisdictions, subject to limits to shield the economy from excessive inflows and outflows of hot money;
• For that purpose, allow select international banks located in major global currency-trading centres to offer peso accounts to their clients, subject to limits;
• Promote Colombia as a foreign direct investment (FDI)-friendly destination to maximise the quality of investment inflows;
• Engage with key stakeholders to achieve buy-in and smooth roll-out of a more liberal currency trading system;
• Promote and facilitate further development of the domestic foreign exchange market to improve liquidity and pricing transparency; and
• Make use of best international practice and know-how available in advanced financial centres such as London and New York.
The Colombian economy appears to be at a turning point after a challenging period in 2013-15, during which dollar financing became less accessible, growth in China slowed, and oil prices collapsed. Much of the pain of adjustment lies ahead, and the course of near-term global growth is still uncertain.
But in 2016 Colombian—and most other Latin American—asset markets have rallied in anticipation of stabilisation and recovery.
Looking beyond the near term, a single, crucial secular change in global conditions is likely to stand out in importance over cyclical factors.
There is a growing consensus that international prices for oil, Colombia’s dominant export product, are most likely to stabilise for the foreseeable future around their recent range of US$40-50 per barrel, or perhaps recover to a level around US$60 per barrel.
We know of no foreseeable trends that could bring oil prices back to the $100 per barrel range that prevailed until 2014, as the development of new technologies and opening up of new sources has fundamentally changed the global oil supply and demand outlook. Colombia’s recovery ahead will therefore be unlike recent recoveries.
The economic paths of commodity-exporting economies since the mid-1990s have been a lot like a roller-coaster ride. Those conditions naturally led to a desire to build brakes and better control the economy’s speed. But if, as expected, we are entering a new era of relatively stable oil prices, the Colombian economy will be moving on a different kind of track with milder dips and rises.
Focus will naturally shift to the power of the economy’s own locomotion.
It is in that context that we offer this study of the potential for liberalising foreign exchange and internationalising the Colombian peso.
The current FX regime prevents most offshore uses of the Colombian peso, including offshore FX transactions and payments in pesos to or from foreign jurisdictions. This regime exists for mainly macroprudential reasons. It allows brakes to be applied to inward flows of short-term foreign investment during “hot” phases of the economic cycle, and thus can also reduce the scale of outflows during subsequent “cold” phases.
The logic of liberalisation is to lighten or remove those brakes in order to facilitate greater foreign investment and lower the costs of finance and trade. There are clear trade-offs involved. Besides those already mentioned, a larger, more international market in Colombian pesos would increase the power of market discipline over fiscal and monetary authorities. That would help maximise the benefits of good policies, but in case of missteps might also amplify any problems.
The aim of this study is to examine potential paths to liberalisation and present a realistic assessment of their benefits and risks.
For the sake of discussion, we simplify the options into three scenarios that Colombia could follow over the next five years.
The Colombian government and the BRC could commit to lifting all restrictions on legitimate movements of and transactions in the peso, enabling unlimited amounts of pesos to be held and traded outside Colombia.
The Colombian government and the BRC could develop and implement a plan to allow limited volumes of Colombian pesos to be held and traded offshore.
No internationalisation, but other liberalisation:
The restrictions on foreign ownership and transactions in pesos could be retained, but efforts could be made to improve the functioning and liquidity of the domestic FX market. We shall demonstrate that each scenario presents different mixes of opportunities and risks, protections, and opportunity costs over the short, medium and long term.
In the long run, full internationalisation is preferable, however, in the short to medium term only partial internationalisation is likely to be acceptable given the risk of increased currency volatility.
Oxford Business Group
The logic of liberalisation is to facilitate greater
foreign investment and lower the costs of ﬁnance and trade