Colombia cenbank's Zarate sees gigantic risk in guaranteed peso level

BOGOTA Tue May 21, 2013 5:36pm EDT

BOGOTA (Reuters) - Colombia's central bank board member Juan Pablo Zarate on Tuesday warned of the "gigantic" risks of guaranteeing a level for the country's currency and highlighted the importance of a floating currency to cushion against volatile capital flows.

Colombia, which has a free-floating currency, has battled gains in the peso for years as exporters struggle with low dollar revenue and high peso costs and manufacturers face floods of cheap imports. The government has said it wants a peso devalued to about 1,900 per dollar from 1,847 today.

"The floating rate has been very important in preventing many risks in an environment of high and volatile capital flows," Zarate told the Reuters Latin America Investment Summit.

"The devaluation that we have today, I like, but I don't have a target."

Governments and central banks in advanced economies have resorted to unconventional policies to revive growth, cutting interest rates close to zero and injecting extra liquidity to boost their economies. That has led to a surge in capital flows into emerging economies, strengthening their currencies.

Latin American governments have tackled these inflows in a variety of ways. Brazil has applied strict controls on foreign capital inflows and its central bank has intervened in the local exchange market to tame the real, while Peru has opted for periodic currency-buying measures.

In Colombia, Finance Minister Mauricio Cardenas has rolled out a series of measures to help businesses cope with the "over-valued" currency, asking pension funds to diversify their portfolios overseas and buy as much as $5 billion in the foreign exchange market. The central bank has engaged in currency market intervention.

Japan's recent monetary easing may encourage some countries to step up efforts in a "currency war" to attract further investment.

"It's a big temptation that we should avoid," said Zarate, 42, a former deputy finance minister.

In the 1990's Colombia engaged in currency targeting, a policy that created an explosion in internal demand and a housing bubble, said Zarate. The peso began floating freely in 1999.

ADDITIONAL INTERVENTION?

Colombia has been the victim of its own success over the last decade, as improved security enabled foreign companies to build infrastructure and send workers to remote, once-off-limit areas.

Investment in capital markets has soared since a U.S.-backed offensive against Marxist rebels and paramilitary groups made it safer to do business in Colombia. Record foreign direct investment has flooded the economy, mostly in the oil and mining industries, and created structural flows of capital that are hard to prevent having an impact on the currency.

The peso has strengthened steadily over the last decade - with a respite in 2008 - from about 2,800 pesos per dollar at the end of 2003. Last year alone it gained 9 percent, but the potent dose of intervention has brought it down about 4 percent this year.

Zarate and his six colleagues on the bank's board will meet next week to decide whether to alter the benchmark lending rate from its current 3.25 percent. They also will be asked by Cardenas to extend its dollar purchase program from May 31 until the end of the year.

Cardenas, who represents the government on the board, will ask that policymakers continue to buy at least $30 million a day on the spot market in a bid to maintain pressure on the currency and prevent it strengthening further. The bank has bought roughly $3 billion on the spot market since February.

"I think that while we have excess installed capacity and have room to intervene in the currency we should, but without targets and without allowing it to dominate monetary policy," Zarate said.

He declined to be drawn on how he felt about Cardenas' intervention recommendation, and said any change in monetary policy or interest rate movements will depend on new economic data during the month.

"The speed depends on certain phenomena; if the recovery phenomenon is abrupt then we have to react more quickly, but with the actual data available I don't see a need to change in an accelerated way and start increasing the rate 50 basis points or 100."

"As far as today's data is concerned, if a normalization process takes place and if the second half is better we will see when we need to go for a more neutral rate, but today I don't see the need for a strong adjustment."

The central bank has cut 200 basis points from borrowing costs since July last year to help bolster economic growth.

Zarate said the biggest risk to emerging markets, including Colombia, over the medium term is developed nations like the United States shifting away from monetary easing.

Almost a quarter of those polled in a Reuters survey last month estimate the central bank will begin to increase interest rates before the end of the year to ward off future inflationary pressure.

(Reporting by Helen Murphy; Editing by Chris Reese)