Over the last few years multinationals have been increasingly prioritizing Colombia within their LATAM portfolios, particularly as other major markets like Argentina, Brazil and Venezuela fall into recession. However, as regional CFOs revise their FX forecasts across the region many have been particularly surprised by the steep depreciation of the Colombian peso. Since July 2014, the peso has depreciated by 22.2 percent against the US dollar, from 1,845 COP/USD to 2,372. This has left multinationals vulnerable to falling margins and has forced many companies to increase prices, potentially imperiling their sales volumes.
The beginning of this rapid depreciation coincided with the fall in oil prices, and its end (so far) with the rebound of this commodity in mid-March. Since then, the Colombian peso has slowly appreciated again, triggering a new wave of optimism among multinationals and potential investors. However, companies should be mindful that the key drivers underpinning the fall in oil prices have not fundamentally changed and that there is an additional factor, namely the rise of US interest rates potentially in Q4 2015, that will keep pushing the Colombian peso towards depreciation.
While a weakened peso will likely lead to higher inflation in the short-run, potentially forcing Colombia’s central bank to raise interest rates, a context of depressed oil prices is creating additional problems for the economy beyond currency depreciation:
- The abrupt fall in oil prices is battering government’s finances: With oil accounting for 42 percent of Colombia’s exports and for 20 percent of total revenues, the steep fall in oil prices has translated into a contraction of US$ 7 billion in government revenues. For each dollar that oil prices fall, the Colombian government loses an average $120 million in revenue. To counter the impact of battered tax and royalty revenues, the Colombian government has decided to cut US$ 2.44 billion of its national budget, eliminating a significant driver of domestic demand.
- The oil and gas industry is no longer attracting significant FDI: Since 2014, oil companies have been progressively cutting investments, first due to persisting regulatory obstacles, and later because of the sharp drop in oil prices. For instance, oil companies drilled only 110 wells in 2014, versus the 207 that were supposed to be drilled. Also, only 54 percent of spending planned for exploration was actually executed. Given that the oil and gas sector currently accounts for more than half of Colombia’s foreign direct investment, falling foreign investment into this sector will undoubtedly have an impact on overall investment and the country’s economic performance.
- Consumer confidence and spending prospects are falling. With lower investment expected for the energy sector, companies have begun to shed employees. In Q1 2015, the oil industry saw almost a 10 percent drop in employment, which is negatively impacting consumer confidence. Overall consumer confidence fell 11.7 percentage points in March from February reaching its lowest level since 2009. Even more alarming is that consumer confidence in Bogota, the consumer spending engine of the Colombian economy, also fell by 20.4 percentage points in March, auguring poorly for consumption this year.
The Colombian economy is moving toward a slower growth phase, and multinationals will need to plan for significant headwinds that will impact both the exchange rate and the real economy in the short-to-medium run. If you would like to learn about how other multinationals have countered the impact of exchange rate volatility, please read our research reports on Currency Volatility Playbook and Pricing Tactics and Strategies for LATAM. Not a client? Contact us at email@example.com.