Colombia's inflation rate is one of the highest in the region, reaching YoY 6.86% in July. In comparison, Brazil has experienced a price increase of YoY 4,5%, while Mexico's is at YoY 5,57%. However, recent data indicates that prices in the South America country are gradually converging toward the target of 3%, a result of the restrictive monetary policy that has been in place since late 2021.
A potential interest rate cut by the Federal Reserve in September could widen the interest rate differential between Colombia and U.S., potentially strengthening the Colombian Peso in the short term. This appreciation could help mitigate inflationary pressures in the economy. Also, the dollar's weakening may potentially favor emerging markets' currencies as well as those of commodity-exporting nations like Colombia.
While recent monetary trends provided positive signals for authorities, the fiscal situation presents a different picture. As with other countries in the region, market has expressed concerns about the fiscal framework, particularly given lower-than-expected revenues and spending pressures.
Despite significant fiscal challenges, Colombia’s currency has performed better than some of its peers in 2024. Our econometric analysis, which decomposes volatility in emerging markets and commodity-exporting nations, enabled us to estimate a fair value for the Colombian peso by comparing it with countries that share similar characteristics. By comparing the current value of the currency with this fair value, we find that the Colombian peso is overvalued relative to the fundamentals observed in other countries.
However, it is important to note that the recent depreciation of the currency, driven mainly by the government's expansionary fiscal policies, may put additional pressure on the exchange rate in the 2H2024, even in a context of less restrictive monetary policy in the United States and Europe.
In this scenario, monetary policy fundamentals may support the currency in the short term. However, the trajectory of public debt and a high fiscal deficit will gradually increase market uncertainties, leading to depreciative pressures on the currency.
Source:
Hedgepoint, Refinitiv
Despite significant fiscal challenges, Colombia’s currency has performed better than some of its peers in 2024. Our econometric analysis, which decomposes volatility in emerging markets and commodity-exporting nations, enabled us to estimate a fair value for the Colombian peso by comparing it with countries that share similar characteristics. By comparing the current value of the currency with this fair value, we find that the Colombian peso is overvalued relative to the fundamentals observed in other countries.
However, it is important to note that the recent depreciation of the currency, driven mainly by the government's expansionary fiscal policies, may put additional pressure on the exchange rate in the 2H2024, even in a context of less restrictive monetary policy in the United States and Europe.
In this scenario, monetary policy fundamentals may support the currency in the short term. However, the trajectory of public debt and a high fiscal deficit will gradually increase market uncertainties, leading to depreciative pressures on the currency.
While Latin American countries like Mexico and Brazil face more pronounced depreciation of their currencies in 2024, the Colombian peso has outperformed.
This does not mean that domestic fundamentals are not concerning. The country's fiscal situation remains complex, and the drop in commodity prices, particularly oil, may pose additional challenges.
The interest rate cut in the US will provide relief to monetary authorities in various countries, including Colombia, where the interest rate differential is likely to strengthen the Colombian peso and help reduce inflation.
However, these gains may be outweighed by domestic factors that bring concern and may reduce the inflow of dollars into the country.
