monetary policy challenges under tighter external ... · monetary policy challenges under tighter...

Monetary Policy Challenges under Tighter External Financial Conditions

“The Shadow of Neo-Protectionism and Coping with the Challenges of the Normalization Process” (Reinventing Bretton Woods Committee/Bank of Indonesia/UBS)

Gerardo HernándezBoard Member 1

These views are personal and do not represent those of the Central Bank or its Board of Directors

Policy challenges

• External Risks and Policy Challenges – First line of defense: Exchange rate flexibility but there are preconditions

• Limited currency mismatches

• A credible monetary regime

• Sound and robust financial sector

• Sound fiscal policy

– Second line of defense: External buffers

• Other Policy Challenges– Higher participation of foreign investors in local public debt market poses

other policy challenges.

– Higher debt2

Current policy challenges are linked to changes in external conditions

• Financial– Monetary policy normalization in advanced economies

– Increases in risk aversion

– USD appreciation

• Non-financial– Decrease in commodity prices

– Changes in international trade policies

3

Policy challenges








other policy challenges

– Higher debt4

• Financial exposure of households to exchange rate fluctuations is almost null.

Source: Banco de la República

5

Currently, debt denominated in foreign currency is not a source of concern. However, we continue monitoring the evolution of private sector indebtedness.

14,7% 15,1%17,4% 18,4% 19,1% 20,2%

23,3% 24,1% 25,3% 26,9% 25,3% 26,9% 27,3% 28,2%30,2% 31,6% 33,2% 32,8%

16,2% 15,4%

16,8% 13,6% 10,5% 9,7%8,0% 7,3%

7,9%6,8% 8,6%

9,8% 8,6%9,8%

12,1%

15,4%15,1% 14,9%

30,9% 30,5%

34,2%32,0%

29,6% 29,9%31,3% 31,4%

33,3% 33,7% 33,8%

36,7% 35,9%38,0%

42,3%

47,0%48,3% 47,7%

0%

5%

10%

15%

20%

25%

30%

35%

40%

45%

50%

2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017

Debt of the Non-Financial Corporate Sector by Currency (% of GDP)

Debt in Local Currency Debt in Foreign Currency


• A large proportion of the debt in foreign currency is either hedged or in hands of exporters, thus reducing the FX risks.


6

Unhedged corporate external debt represents a small fraction of private sector liabilities

33,0%

4,1%

1,7%

3,6%0,7%

0%

5%

10%

15%

20%

25%

30%

35%

40%

45%

2010 2011 2012 2013 2014 2015 2016

Debt of the Non-financial Corporate Sector (% of GDP)

Non-exporters debt (unhedged) Non-exporters debt with FDI (unhedged) Non-exporters debt (hedged) Exporters Debt Local Currency Debt

The exposure of financial intermediaries to exchange rate risk has kept low and relatively constant during last years.

*FX Market Intermediaries: Includes credit establishments and brokerage firms.

7Source: Banco de la República

-700,00

0,00

700,00

1.400,00

2.100,00

2.800,00

-5%

-2%

1%

4%

7%

10%

13%

16%

19%

22%

Jun-16 Dec-16 Jun-17 Dec-17 Jun-18

FX Proprietary Position (Assets minus liabilities in foreign currency) of the Financial Sector*

Proprietary Position (% Technical Capital)

Proprietary Position in Foreign Currency (RHS)

% o

f Te

chn

ical

Cap

ital

USD

Millio

n

Upper limit

Lower limit

The foreign currency debt remains in low levels as a percentage of the total public debt.


8

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

July-01 July-02 July-03 July-04 July-05 July-06 July-07 July-08 July-09 July-10 July-11 July-12 July-13 July-14 July-15 July-16 July-17 July-18

Public Debt Balance(local vs. foreign currency)

Local Currency Foreign Currency

Policy challenges









– Higher debt9

*The maximum value of the index is 15. The index is built using five categories: Political, economical, procedural, policy, operational. Each category has a value between zero and three.

Source : Dincer and Eichengreen (2014).

10

0

2

4

6

8

10

12

14

16

SWE CZE NZL USA GBR JAP AUS CAN NOR POL SWI BRA CHL PER COL MEX SGP ARG SLV GTM

Central Bank Transparency Index*

2014

1998

2008

A credible monetary regime is supported by high levels of transparency and an effective communication.Despite some enhancements, there is still a significant room for improvement.

Source: IMF (2018)

• Exchange rate works as an effective shock absorber if episodes of currency depreciations do not threat credibility on price stability objectives.

• The 2014-2015 episode showed a relatively small increase in the tradable CPI, despite the large currency depreciation

Source: DANE and Banco de la República

11

A credible monetary regime supports a low level of pass through from exchange rate to prices

90

110

130

150

170

190

sep.-10 sep.-11 sep.-12 sep.-13 sep.-14 sep.-15 sep.-16 sep.-17 sep.-18

Tradable CPI Excluding Food

Nominal Exchange Rate (Jan 2013=100)

85%Depreciation

• Exchange rate works as an effective shock absorber if episodes of currency depreciations do not threat credibility on price stability objectives.

• The 2014-2015 episode showed a relatively small increase in the tradable CPI, despite the large currency depreciation.

Source: DANE and Banco de la República

12

A credible monetary regime supports a low level of pass through from exchange rate to prices

-15%

-5%

5%

15%

25%

35%

45%

55%

65%

sep.-12 sep.-13 sep.-14 sep.-15 sep.-16 sep.-17 sep.-18

Tradables Inflation

Exchange Rate (% change YoY)

The low pass through could be partially accredited to the credibility of the inflation targeting regime. Therefore, improving communication and transparency is still one big challenge.

Source: Banco de la República – Monthly Survey of Economic Expectations 13

0%

1%

2%

3%

4%

5%

6%

7%

8%

9%

10%

Sep-10 Sep-11 Sep-12 Sep-13 Sep-14 Sep-15 Sep-16 Sep-17 Sep-18

Inflation Expectations

Median of 1-year Ahead Inflation Expectations

Median of 2-years Ahead Inflation Expectations

Inflation Target

Headline Inflation

Policy challenges









– Higher debt14

¹ 30-Day LCR is the ratio of high quality liquid assets to total net cash outflows over the next 30 calendar days.Source: Superintendencia Financiera de Colombia. Calculations by Banco de la República.

15

380,90%395,36%

80%

120%

160%

200%

240%

280%

320%

360%

400%

440%

May-13 Nov-13 May-14 Nov-14 May-15 Nov-15 May-16 Nov-16 May-17 Nov-17 May-18

30-Day Liquidity Coverate Ratio¹ (LCR)

Total Depository InstitutionsBanksMinimum Requirement

LCR= Liquid Assets / net cash outflows over the next 30 days

15,8%

16,4%

8%

10%

12%

14%

16%

18%

20%

Jun-12 Feb-13 Oct-13 Jun-14 Feb-15 Oct-15 Jun-16 Feb-17 Oct-17 Jun-18

Total Solvency Ratio (Tier II)

Banks

Total Depository Institutions

Minimum Requirement

Total Solvency Ratio = Technical capital / weighted assets + (11.11)*Market Risk

Local banks are resilient to tighter external conditions• Throughout the last few years, the Colombian banking system has kept solid liquidity and solvency indicators.• This has occurred despite the adjustment of the Colombian economy to negative external shocks. At the same

time, domestic regulation has contributed to building buffers for credit risk (e.g. dynamic provisioning) andliquidity risk.

Local banks are resilient to tighter external conditions II

• The latest stress test exercise simulates the effect of a full exit of foreign investors from domestic public/private debt markets together with a significant fall in GDP growth (1.3% for 2018).

• Under this extreme scenario the estimated cumulative losses would generate a reduction in Tier 1 Capital Ratio from 11,6% to 9,8% well above the regulatory minimum: 4,5%.

16

Policy challenges









– Higher debt17

31,5

43,4 43,4

30,9

25

27

29

31

33

35

37

39

41

43

45

2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2022 2023 2024 2025 2026 2027 2028

Public Debt (% of GDP)

Projected

Source: Ministry of Finance

Maintaining a sound and credible fiscal policy lowers the vulnerability to external shocks

18

-4,1

-3,9

-2,8

-2,3 -2,3

-2,4

-3

-4

-3,6

-3,1

-2,4

-2,2

-1,8

-1,4-1,3

-1,2-1,1 -1,1 -1,0

-2,3 -2,3

-2,3-2,2

-2,2

-1,9 -1,9-1,8

-…

-1,3

-1,0

Deficit Allowed by the Fiscal Rule (%GDP)

GovernmentBalance

Structural Balance

Start of the Fiscal Rule

Set by the Fiscal Rule Committee

Set by the Government

19

2,5

6,4

-5,6

5,3

1,4

2,1

-10

-5

0

5

10

15

20

Cumulative 2013 - 2017

12,5

0 0,20,5

1,10,7

1,7 1,5

1,7 0,60,9

-1,5 -1,4-1,1

-0,8 -0,7

0,7

2

3,4

-0,7

0,1

0,2

0,4

0,50,3

1,5

0,7

-0,4

0,4

-0,05

2,5

3,2

4,5

1,1

1,1

-2

-1

0

1

2

3

4

5

6

7

2013 2014 2015 2016 2017

Change in Gross Debt

Primary Deficit Real Interest Rate

GDP Growth Depreciation

Other Flows Residual

Change in Gross Debt

% o

f G

DP

• During the last years the interest rate and the devaluation of the exchange rate are the main factors that explain the growth of public debt.

Policy challenges









– Higher debt20

A sufficient level of external buffers provides another safeguard against external shocks. The Flexible Credit Line (FCL) by the IMF has complemented the accumulation of international reserves.

*A ratio between 1 and 1.5 is considered adequate

Source: IMF. 21

0% 100% 200% 300% 400% 500% 600% 700%

Argentina

Turkey

Malaysia

South Africa

Chile

Poland

Mexico

Colombia (without FCL)

India

Colombia (with FCL)

Indonesia

Brazil

China

Philippines

Peru

Korea

International Reserves to Short-term Debt and CurrentAccount Balance

0

0,5

1

1,5

2

2,5

3

3,5

2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019

Ratio of Reserves/ARA Metric*

Chile Colombia Mexico Peru

Policy challenges







• Other Policy Challenges– Higher participation of foreign investors in local public debt market

poses other policy challenges

– Higher debt22

Source: Banco de la República23

0%

5%

10%

15%

20%

25%

30%

jun.-13 jun.-14 jun.-15 jun.-16 jun.-17 jun.-18

% Offshore investors (UVR inflation linked bonds) / Total outstanding

% Offshore investors (TES) / Total outstanding

The development of the public debt market came hand on hand with an increased participation of foreign investors, particularly in recent years. This increase was mainly driven by the reduction of withholding tax for offshore investors (from 33% to 14% ) and the increase of Colombian debt weight in the JP Morgan’s GBI index since 2014.

The higher presence of offshore investors in Colombia goes in line with the experience of other emerging markets.

Source: IMF WP - Arslanalp and Tsuda (2017)24

0%

10%

20%

30%

40%

50%

60%

2004

2005

2006

2007

2008

2009

2010

2011

2012

2013

2014

2015

2016

2017

Brazil

Colombia

Mexico

Peru

0%

5%

10%

15%

20%

25%

30%

35%

40%

45%

2004

2005

2006

2007

2008

2009

2010

2011

2012

2013

2014

2015

2016

2017

China

India

Indonesia

Malaysia

Philippines

Thailand

0%

5%

10%

15%

20%

25%

30%

35%

40%

45%

50%

2004

2005

2006

2007

2008

2009

2010

2011

2012

2013

2014

2015

2016

2017

Hungary

Lithuania

Poland

Romania

0%

5%

10%

15%

20%

25%

30%

35%

40%

45%

2004

2005

2006

2007

2008

2009

2010

2011

2012

2013

2014

2015

2016

2017

Russia

South Africa

Turkey

Ukraine

Foreign Holdings of Local-Currency EM Government Debt Securities (% of total)

• The increase in offshore participation has been positive for diversifying the Government’s financing sources and has helped to finance the current account deficit facilitating the adjustment of the economy to external shocks. In addition, the currency risk is assumed partially by foreign investors.

BUT…

• Foreign investors’ decisions could affect interest rates along the curve offsetting in some cases the transmission of monetary policy to bonds with longer maturities.

• A sudden exit of foreign investors could create pressures on the exchange rate. A big reaction of these agents could amplify the effects of external shocks with possible implications on financial markets and financial stability.

25

A Higher Participation of Non-Resident Investors in the Local Public Debt Market is Welcomed but Creates Challenges

Policy challenges









– Higher debt26

Debt levels have increased but remain below critical levels.

*Annual Moving Average (30% is considered risky and 40% vulneragle)

Source: Banco de la República 27

17,4

14

15

16

17

18

19

20

ene-12 ene-13 ene-14 ene-15 ene-16 ene-17 ene-18

(%) Households’ Financial Burden(Interest and Capital payments / Income)*

Total Solvency Ratio = (Interest payments + capital payments) / Monthly Income

Source: Superintendencia Financiera. Calculations by Banco de la República

-5%

0%

5%

10%

15%

20%

25%

30%

0

50

100

150

200

250

ago-08 feb-10 ago-11 feb-13 ago-14 feb-16 ago-17

Composition and Real Annual Growth Rate of Households'

Indebtedness

Mortgages Consumption Indebtedness Real Annual Growth Rate (RHS)

Debt levels in Colombia have increased in last years but the size of the credit expansion is below international averages. Financial depth is still low relative other EME.

Source: Bank for International Settlements28

0%

20%

40%

60%

80%

100%

120%

140%

160%

180%

Jun-04 Jun-06 Jun-08 Jun-10 Jun-12 Jun-14 Jun-16 Jun-18

Total Credit to Non Financial Private Sector(Ratio to GDP)

Advanced economies (aggregate) Chile

Colombia Mexico

Malaysia Thailand

-20%

-15%

-10%

-5%

0%

5%

10%

15%

20%

25%

30%

Credit-to-GDP Gap(actual-trend)

Argentina Brazil Chile Colombia Mexico China

Thank you

29

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