Focus Report

Emerging markets are in for another turbulent year with the strong US dollar and US President Donald J Trump’s “America First” stance both challenging conventional wisdom in trade and macroeconomic policy.

Much to everyone’s surprise, investors have so far responded to the new reality by embracing hope over fear. Trump’s fiscal stimulus of the US economy, it is said, may well end up boosting global demand and growth.

Market reaction to Trump’s efforts to change global trade terms has been muted, as Trump will likely stop short of undermining the global trade order despite claiming to favour US businesses and inflammatory rhetoric.

How this will actually play out is unclear, with plenty of uncertainty over the next 12 months. What is certain though is that emerging market leaders are already facing a stark choice.

On the one hand, they can either follow the US by adopting their own version of economic nationalism, or, on the other, as Australia has been advocating, they can respond with a vigorous defence of international liberal order. Having witnessed the benefits of integration globally, I am inclined to advance the case for the latter.

Above all I am convinced that this is a moment for emerging markets to come into their own and assume leadership in global policy debate based on sound principles proven throughout many economic cycles.

Just like America once challenged the old European order, emerging markets have a case to make in favour of unshackled cross-border movement of capital, goods and services. History teaches us that protectionism tends to lead to stifled competition, stagnation and in the worst cases, outright conflict, even when it involves large and ostensibly self-sufficient countries such as the US.

In the short term, investors already reward countries that stay firm in the face of adversity and continue to display continuity and consistency in the field of macroeconomic policy.

In this regard OBG continues to recommend further internationalisation of the Colombian peso as a way to position the country as an open and attractive jurisdiction for foreign investors.

The main thrust of the report prepared by OBG and supported by the UK government in 2016 was that gradual internationalisation of any currency enhances liquidity and reduces the cost of capital.

The case in point is the Mexican peso, which has emerged as one of the world’s most traded currencies. This has made access to capital for Mexican companies much easier to obtain at significantly reduced risk premium.

OBG recognises that this process of currency liberalisation should be carefully managed to avoid hot money inflows and outright speculation on local currency. One downside of Mexico having such a popular currency is that, as any political or economic event in Latin America is usually traded through the Mexican peso, the country’s financial sector is thus exposed to increased volatility and external risk.

Foreign investors are fair-weather friends. They flock en masse when everything is going well and then are the first to exit when a situation becomes testy. We witnessed that most recently with a sharp sell-off of the Mexican peso after Trump surprised the markets by winning the US elections.

To address this specific issue our recommendation to the Central Bank of Colombia is to adopt limited deliverability of its currency after a careful consultation process with main stakeholders: domestic industry companies involved in exports, and domestic and foreign banks.

Our approach based on initial discussions would be to license a limited number of international banks to offer unlimited-purpose deposit accounts under Colombian law.

Such deposit accounts would be offered to clients by the international banking group’s branch or subsidiary in London or New York, which would be obliged to maintain a matching peso deposit at the same international banking group’s branch or subsidiary in Colombia.

During the early stages the amount of pesos in each such non-resident deposit account would be capped at some amount, which we suggest be initially COP15bn ($5m). The amount limits would be adjusted from time to time as the Banco de la Republica sees fit in accordance with its assessment.

The system should be easily scalable, allowing for a comfortably small-scale introduction that can be expanded in stages as the Colombian authorities deem appropriate and as circumstances change.

The rules should be as simple as possible, to avoid confusion, gaming of the system’s details and any other unintended results.

Essentially our proposed approach seeks to offer maximum protection against speculative behaviour and hot money inflows whilst maximising the benefits of holding pesos offshore for legitimate clients and business transactions.

Although we recognise that the practical steps need further finetuning and “buy in” from Colombia’s leading industries, it is our firm belief that incremental steps towards full liberalisation of the currency far outweigh the risks of inflows.

Such a policy move would help to send a powerful signal to investors seeking “smart emerging markets” with a positive attitude towards foreign investors. It would eventually bring significant macroeconomic benefits to the country and would help position Colombia as one of the most attractive investment destinations in Latin America. In my view this is a good way to respond to the wave of protectionism flowing from the US that threatens to undermine years of progress in global economic relations.

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