OVERNIGHT NEWS
* Dollar bid on risk off/ new COVID variant, UST 10y -2bp, Brent crude -3%; GBP and NOK lead losses in G10; ZAR and RUB down most in EM
* US close to agreeing $900bn fiscal stimulus bill containing cheque of up to $300pp and unemployment benefits of $600/week, House to vote on legislation today, Senate to follow
* Brexit: no new progress, differences still significant over fisheries, ten days remain until the end of the transition period; London and SE England placed in tier 4 lockdown after virus cases surge
* CFTC positions: EUR net longs reduced to 21.6% of OI, JPY longs trimmed to 22.7%, GBP longs cut to 2.9%, AUD shorts increased to 7.3%, CAD shorts reduced to 8%, CHF longs steady at 20%
* Nikkei -0.18%, EUR 10y IRS -3bp at -0.29%, Brent crude -3% at $50.6, Gold +1.1% at $1,901
A stellar year for the SEK and CNY, a dreadful year for the BRL and TRY
· COP saw its central bank vote to keep the policy rate unchanged on a 5-2 decision. Citi Economics notes that, Mr. Echavarría’s comments and the fact that both analysts and staff expect inflation to rise towards the target next year, likely means that there is only a very brief window for a possible cut. While voting can remain split in following meetings, we stand by our expectation of stable rates next year.
It’s looking like a blue Christmas for the UK, with a new Covid-19 variant, lockdown measures, and no Brexit deal either. GBP has been dragged to 1.33 handle as a consequence, and there may be room to move lower, pending Brexit dynamics. The USD bid is broadly seen across our markets, with EURUSD trading around 1.22 and high yields like MXN and ZAR returning to familiar levels.
The US fiscal stimulus deal struck this weekend is somewhat overlooked, but should keep US assets supported. With little in way of catalysts today, headlines remain the main mover. PLN is in focus after central bank intervention on Friday, while RUB may be vulnerable to further correction.
Colombia: Fiscal proving ground in 2021
We expect Colombia’s central bank to keep the policy
rate unchanged for an extended period. Admittedly,
with inflation likely to end 2020 below BanRep’s 2-4%
tolerance range, some members of the Board could be
tempted to propose another 25bp cut. However, we
believe that fiscal and external vulnerabilities will force
BanRep to maintain a neutral stance. Moreover, with
Leonardo Villar, the new central bank Governor, taking
office in January, it would be reasonable for current
members not to make significant changes at the
December meeting.
While inflation surprised to the downside recently, it was
mostly due to one-off events. We think BanRep will factor
this in its analysis, together with the fact that the removal
of the relief measures that were introduced in response to
the pandemic will likely increase inflation at the beginning
of 2021. That said, we forecast inflation to return to the
3% target by end-2021.
Our base case is for monetary policy normalization to
start in Q4 2021, with two 25bp hikes. In its latest
monetary policy report, BanRep has hinted that the
projections from its technical staff are consistent with a
higher path of interest rates, although it acknowledged
the high level of uncertainty surrounding these forecasts.
With inflation expectations anchored, our view is that
BanRep will prefer to delay rate hikes until the end of the
year. Another round of strict lockdowns could pose
downside risks to our forecast, while failure to pass the
fiscal reform could imply that policy normalization would
need to start earlier.
Monetary policy guidelines from the new central bank
governor in January will probably provide a clearer
assessment of BanRep’s future stance. Our view is that
external and fiscal vulnerabilities justify a neutral stance
despite current subdued inflation.
However, the external imbalance is sustainable in the
short term, we think: Abundant liquidity and a weaker
dollar will likely support flows into emerging markets in
2021 (see Emerging Markets outlook 2021: Star
alignment, published on 24 November 2020). We expect
FDI to increase 0.7pp to 3% of GDP next year and cover
more than 75% of the current account deficit.
Still, the economy remains exposed to external
shocks: According to the IMF (2017), commodity price
shocks account for 15% of the variance of the current
account. Moreover, we estimate that a 10% negative
shock to terms of trade would increase the current
account deficit by 1.5% of GDP after a year (Figure 3).
This risk is partially mitigated by Colombia’s Flexible
Credit Line arrangement with the IMF (the remaining
amount available stands at USD12.2bn, or 4.5% of
GDP).
In our view, the weaker external sector requires a
stronger fiscal position: Given Colombia’s high
exposure to external factors and the sluggish recovery in
terms of trade, the misalignment between investment and
savings will likely require some fiscal consolidation to
increase national savings.
Authorities recently revised downwards their fiscal
balance projection for 2021 to a deficit of 7.6% of GDP, a
modest contraction from the 9% deficit expected for
2020. To meet the fiscal rule (suspended until 2022) and
ensure debt sustainability in the medium term, the
Ministry of Finance has indicated that Colombia needs a
tax reform that increases revenues by 2% of GDP. This
view is shared by rating agencies, which are likely to
downgrade Colombia below investment grade if the
government does not show commitment to fiscal
sustainability.
We expect the government to pass the reform, but
we think that it will raise revenues below its 2% of
GDP objective.
The good: Colombia has a long track record of
approving tax reforms (roughly one every two years
since 1990).
The bad: Reforms are often watered down in
Congress. Fedesarrollo, a local think tank, found that
reforms in Colombia have not been able to raise
revenues by more than 0.7% of GDP. Looming
legislative and presidential elections (scheduled for
March and May 2022, respectively) will probably not
make things easy for President Duque.
The ugly: The government’s proposal will likely
include unpopular measures. In fact, Finance Minister
Alberto Carrasquilla has hinted that the reform would
attempt to remove VAT exemptions, equivalent to 7%
of GDP in 2019. In a context of persistent levels of
inequality, significant informality and high
unemployment, a debate over this reform could give
rise to social unrest.
Despite falling short of the targeted 2% of GDP increase
in fiscal revenues, our base case scenario is that
Colombia will maintain its investment grade rating. In our
view, strong policy fundamentals will weigh more on the
decision than the difference in revenue enhancing
measures. If political or social tensions escalate to the
point where the government fails to pass the reform, we
would expect a downgrade in 2021.
KEY MESSAGES
Colombia’s fiscal front is likely to be a more pressing
issue than the current account deficit in 2021, we
believe. Failure to address it could amplify concerns
over the external imbalance.
We expect the government to pass another tax reform
in 2021. However, a weak position in Congress and
risks of social unrest will likely result in the proposal
falling short of the targeted 2% of GDP increase in
fiscal revenues.
We estimate Colombia’s current account deficit to be
wider than equilibrium by 1.5-2.0% of GDP. Yet, it
looks sustainable, given the favorable global financial
conditions and still adequate FDI financing.
External and fiscal vulnerabilities reduce degrees of
freedom to monetary policy, we think. We expect
stable rates until the end of Q3 2021