The Board of Directors of Banco de la República Reports to Congress

Consumer inflation was 4.5% at the end of the year. This is the middle of the target range set by the Board of Directors and less than inflation in December 2005 (4.9%), rounding out three consecutive years of compliance with the inflation targets set by the Bank.

Lower inflation in 2006 was accompanied by a rapid increase in output.  The Colombian economy grew by 6.8% in 2006, a level not seen since 1978. It makes Colombia one of the fastest growing countries in Latin America.

The Board of Directors has raised interest rates gradually to reduce the monetary incentive, which the economy no longer requires.  In doing so, it hopes to guarantee maximum economic growth consistent with the targets for inflation. 

The favorable economic situation, marked by rapid growth and lower inflation, has been accompanied by steady appreciation of the peso, largely because foreign and national businessmen are more confident about investing in the country.  During the first quarter of 2007, with the peso under growing pressure to appreciate, the Bank intervened extensively in the exchange market, purchasing US$2,024.5 million in foreign currency between January and February.

Consumer inflation was 4.5% in December 2006. This is less than in 2005 (4.9%) and within the target range for the year, which the Board of Directors has set at 4% to 5%.  It also rounds out three consecutive years of strict compliance with the inflation targets. The first months of 2007 witnessed an upward trend in annual inflation to 5.25% in February.  This is explained, in part, by high food and regulated prices, which are expected to decline during the second half of the year.

In the case of non-tradables, the sharp increase in demand could spell a continuation of recent inflationary pressure. Tradables, however, are expected to be relatively stable, with 2.0% probable inflation.

The growth in supply witnessed during 2006 originated in a number of economic sectors, mainly industry, construction, commerce and transport.  The components that contributed the most to demand were investment and household consumption.  These aspects make the prospect of continued growth seem likely, given the broad productive base where it originates and the increase in potential economic output.  Moreover, the momentum in consumption reflects growing confidence, coupled with the expectation that this component of demand will continue to grow in the future.

With the acceleration in aggregate demand and the likelihood that it could outpace the economy’s production capacity, the Board of Directors raised the Bank’s intervention interest rates nine times between April 2006 and March 2007.  On each occasion, the hike was 25 basis points. With the latest increase, on March 23, the base rate for repo auctions went to 8.25%. This policy is aimed at keeping inflation on target for 2007 and continuing its convergence towards the long-term target, which is between 2% and 4%.

In addition to a favorable economic environment marked by fast growth and falling inflation, the country has seen the peso appreciate gradually.  This is partly the result of growing confidence among foreign and national businessmen with respect to investing in Colombia. High prices for the country’s leading exports, imbalances in the U.S. economy, and surplus liquidity on international markets are factors as well.  The Bank has used sterilized exchange market interventions to curb the trend towards appreciation.

Reducing the internal risks that can stem from excessive growth in demand with respect to the country’s production capacity is indispensable to sustained growth.  If this is not done in time, inflationary pressures can emerge, along with a current account deficit that could become unsustainable. The interest rate hikes ruled by the Board of Directors help to control this situation by slowing the growth in spending.  For the same reason, it is important to have a policy of fiscal restraint that is consistent with monetary policy, particularly fiscal restraint that lends stability to economic growth and reduces pressure on the peso to appreciate.

On the external front, the risks could come from negative shocks to terms of trade or capital markets. The  country has accumulated considerable reserves; these are a kind of insurance that protects the economy against the negative effects that could originate with such shocks.

In terms of its financial situation, Banco de la República reported Col$1,624 billion pesos (b) in profits for 2006, with Col$2,730 b in income and Col$1,106 b in outlays.  Profits were up by Col$1,299 b compared to 2005, thanks to an increase of Col $1,556 b in earnings.  Profits for 2007 are projected at Col$1,288 b. This is Col$335.9 b less than in 2006, primarily because of less income from returns on international reserves and more outlays to cover interest paid on the reserve ratio held in deposit accounts and on funds deposited by the national government.