Strong Q2 GDP Reduces Likelihood Of Rate Cut And Gives Santos A Boost

BMI View: A stronger-than-expected real GDP expansion in Q2 13 has prompted us to revise up our Colombia growth forecast from 4.1% to 4.3% in 2013 and from 4.3% to 4.5% in 2014. Moreover, the economy' s robust performance in H113 significantly re duces the likelihood of additional monetary easing by the central bank this year and bolsters President Juan Manuel Santos's re-election bid , though we still beli eve he faces significant challenges to win next year's election.

Strong er -than-expected real GDP growth of 4.2% year-on-year (y-o-y) in Q213 has prompted us to make an upward revision to our Colombia growth forecast from 4.1% to 4.3% in 2013 and from 4.3% to 4.5% in 2014, compared to 4.2% in 2012. The main driver of such robust growth in the second quarter was a 4.4% y-o-y real expansion in private consumption, reaffirming our favourable long-term outlook for the Colombian consumer ( see 'Consumer Well Positioned For Multi-Year Acceleration', July 18 ). In addition , despite significant labour-related disruptions to key export-oriented sectors such as agriculture and mining, exports expanded by 7.6% y-o-y in real terms in Q2 . From a sectors perspective, agr iculture expanded the most , by 7.6% y-o-y, followed by construction (6.4% y-o-y), the latter reaffirming our favourable outlook towards Colombian materials, expressed in our Macro-Industry Strategy through a bullish view on Cementos Argos ( see 'Bullish Materials Stocks', July 2 ).

However, we now see significant risks to our forecast of an additional 25 basis point (bps) rate by the Banco Central de la República (BanRep) to bring the policy rate to 3.00% by year- end, as stronger-than-expected growth could prompt offi cials to put an end to their monetary easing cycle, which has seen 100 bps worth of cuts this year. In addition, a rapidly improving economy also provides a boost to President Juan Manuel Santos' recently deteriorating popularity, improving his chances of being re-elected in May 2014. That said, we believe Santos' electoral prospects will remain largely hinged on the evolution of the government's peace negotiations with the left-wing insurgent group, the Fuerzas Armadas Revolucionarias de Colombia (Farc) ( see ' Less Convinced About Santos' Re-Election', September 4, 2013 ) , and we remain sceptical that an agreement will be reached before the election.

Economic Recovery To Be Sustained
Colombia - Real GDP Growth

BMI View: A stronger-than-expected real GDP expansion in Q2 13 has prompted us to revise up our Colombia growth forecast from 4.1% to 4.3% in 2013 and from 4.3% to 4.5% in 2014. Moreover, the economy' s robust performance in H113 significantly re duces the likelihood of additional monetary easing by the central bank this year and bolsters President Juan Manuel Santos's re-election bid , though we still beli eve he faces significant challenges to win next year's election.

Strong er -than-expected real GDP growth of 4.2% year-on-year (y-o-y) in Q213 has prompted us to make an upward revision to our Colombia growth forecast from 4.1% to 4.3% in 2013 and from 4.3% to 4.5% in 2014, compared to 4.2% in 2012. The main driver of such robust growth in the second quarter was a 4.4% y-o-y real expansion in private consumption, reaffirming our favourable long-term outlook for the Colombian consumer ( see 'Consumer Well Positioned For Multi-Year Acceleration', July 18 ). In addition , despite significant labour-related disruptions to key export-oriented sectors such as agriculture and mining, exports expanded by 7.6% y-o-y in real terms in Q2 . From a sectors perspective, agr iculture expanded the most , by 7.6% y-o-y, followed by construction (6.4% y-o-y), the latter reaffirming our favourable outlook towards Colombian materials, expressed in our Macro-Industry Strategy through a bullish view on Cementos Argos ( see 'Bullish Materials Stocks', July 2 ).

However, we now see significant risks to our forecast of an additional 25 basis point (bps) rate by the Banco Central de la República (BanRep) to bring the policy rate to 3.00% by year- end, as stronger-than-expected growth could prompt offi cials to put an end to their monetary easing cycle, which has seen 100 bps worth of cuts this year. In addition, a rapidly improving economy also provides a boost to President Juan Manuel Santos' recently deteriorating popularity, improving his chances of being re-elected in May 2014. That said, we believe Santos' electoral prospects will remain largely hinged on the evolution of the government's peace negotiations with the left-wing insurgent group, the Fuerzas Armadas Revolucionarias de Colombia (Farc) ( see ' Less Convinced About Santos' Re-Election', September 4, 2013 ) , and we remain sceptical that an agreement will be reached before the election.

Economic Recovery To Be Sustained
Colombia - Real GDP Growth

Some Downside Risks In Q313, Yet Growth Acceleration To Remain Broadly On Track

While we maintain our conviction that the economy will continue to accelerate over the coming months and into 2014, we believe that several factors could see real GDP growth disappoint in Q313 . The first downside risk to growth in the third qua rter stems from labour disruptions to exports, particularly a 53-day strike , which ended mid-September, by workers at the Cerrejón mine. Indeed, the mine, operated by Drummond , produces about one third of Colombia's coal output , and coal accounted for 12.9% of total exports in 2012. The second downside risk to growth in Q313 is related to a significant decline in the consumer confidence index from 25.1 in July to 13.4 in August, its lowest level this year, which suggests household spending could have weakened around that period. That said, we believe much of the deterioration in consumer confiden ce is owed to countrywide labour-strikes, which have l argely dissipated in recent weeks . Stronger consumer confidence levels , combined with loose monetary policy and fiscal stimulus ( see 'Additional Stimulus To Widen Deficit In 2014', September 11 ), will drive stronger household spending and real GDP growth through the end of 2013 and into 2014.

Consumer Confidence To Pick Up In The Coming Months
Colombia - Consumer Confidence Index, Retail Sales, And Consumer Credit

Rate Cut Looking Less Likely

The strong Q2 13 GDP print challenges our expectations for additional monetary easing in Colombia this year ( see 'Fragile Recovery And Low Inflation Underpin Rate Cut View', September 11 ) . However, for the time being we are leaving our monetary policy forecast unchanged for two reasons. First, despite recent signs that the economy is impr oving , several key officials have recently argued for one last rate cut to ensure that the economic recovery remains uninterrupted. Crucially, Finance Minister Mauricio Cárdenas voted for a rate cut at the August monetary policy meeting, when the policy rate was kept on hold at 3.25%, and President Santos has also publically expressed his preference for additional monetary easing. Second, the recent sharp appreciation of the peso, following the US Federal Reserve's decision to delay tapering of its current quantitative easing programme (QE3), if sustained, could still prompt BanRep officials to seek a rate cut in its September meeting. Indeed, a strong peso was a main reason behind the ongoing labour protests, as it decreased export competitiveness. However, over the coming weeks we will be monitoring the trajectory of peso, as well as QE3 tapering expectations, to reassess a potential adjustment to our BanRep policy rate forecast .

Room For Additional Easing But BanRep Turning Less Dovish
Colombia - Policy Rate And Consumer Price Inflation

Strong Growth Gives Santos A Boost But Far From Guaranteeing His Re-Election

While the significant improvement in the economy seen in recent months also bolsters President Santos' re-election bid, we believe that he still faces significant obstacles to winning the re-election next year. According to the latest Gallup poll, President Santos' approval rating collapsed to 21% in late-August from 46% in late-June, while his disapproval rating jumped from 36% to 72% over the same period. Admittedly, progress on labour negotiations with farmers and miners in recent weeks will help President Santos' recover some of his recently lost popularity over the coming months. However, we believe that his approval rating will continue to be weighed down by the ongoing peace negotiations with the Farc, which are unlikely to deliver an agreement before the May 2014 presidential election.

Santos Has A Lot Of Ground To Recover Before Election
Colombia - Gallup Poll Results Of Perceptions Towards President Santos And Peace Negotiations, %

Indeed, in nearly a year of negotiations, there has only been one preliminary agreement reached between the government and the Farc on land reform, out of a six-item agenda. Moreover, ongoing attacks despite peace negotiations reflect the deep distrust between both sides. The disapproval rating on the peace negotiations increased to 72% in August from 63% in June, and the main opposition to Santos' re-election, the Centro Democrático movement, led by former President Álvaro Uribe, who is a main critic of the peace talks, will likely take advantage of popular dissatisfaction through the campaigning process.

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Sector: Country Risk
Geography: Colombia
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