Hot spots: Colombia.(hot spots)

The economy is continuing to make good progress for now, but the government is starting to lose vital U.S. support and, over time, this will leave its mark. Real GDP grew by as much as 7.98% in the first quarter of 2007, measured year-on-year, which was a full percentage point more than what most analysts had anticipated. Primarily responsible for the surprisingly good result was the effectiveness of President Alvaro Uribe's clampdown on violence generated by drug traffickers and the left-wing insurgent movements FARC and ELN as well as the (now almost totally demobilized) right-wing paramilitary group known as AUC. The improvement in security conditions across the nation boosted investor confidence and prompted Colombians of all walks to step up their spending.

Finance Minister Oscar Ivan Zuluaga and President Uribe both have been emphasizing, however, that they do not expect business activity to overheat and that they intend to stick to the present policy course, since the economy would not benefit from further limits on capital inflows or from the imposition of price controls. Colombia, they say, needs a high rate of growth over a sustained period since "this is the only way for us to overcome poverty, to create high-quality jobs." Annual inflation was at 6.23% in May, after 6.26% in April and, thus, far above the 3.5-4.5% range targeted by the Central Bank. In response to the accelerating monetary erosion, Banco Central raised its benchmark overnight interest rate 12 times in 15 months. While inflation is widely believed to have slowed to 6.10% in June, further increases in yields and borrowing costs are likely.

The relatively high interest rates and the good impression investors have been getting from the decline in violence have been giving the peso considerable upwind in the foreign exchange markets. Aware that the peso's rise against the U.S. dollar by more than one-third in the past 12 months has been crimping the profit margins of Colombian exporters who receive dollars for their goods, the Central Bank ordered in early May that Colombian companies and investors taking up loans abroad must deposit 40% of the proceeds in non-interest-bearing accounts for six months. It has also been offering direct subsidies and special low-cost loans to coffee growers and other exporters hurt by the peso's rally. But Minister Zuluaga then said that he hoped that these measures would be temporary and that the government could soon re-establish "the opening of our markets"

This now appears to be a fair assumption, since the pressures on the peso have lessened quite a bit. It is not easy to determine exactly what caused this change in trend, but it appears that a global shift toward increased risk aversion has played a role, prompting international investors and hedge fund managers to bail out of many emerging markets. The currency bazaars have also taken note of the problems President Uribe and his government have been having with U.S. legislators concerning the pending ratification of the trade pact that the Bush Administration has struck with Colombia.

Whatever the main reason may have been, the peso has been slipping as of late, so much so that the Central Bank stepped in as a seller of dollar call options, as it does every time the COP's 20-day moving average changes by more than 2%. The ...