Fresh Bout of Petro Risk Sparks Rout in Colombia’s Currency

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(Bloomberg) -- For much of Gustavo Petro’s time in office, Colombia’s interest rates have been so high that foreign investors tolerated the sporadic bouts of political tumult that would have normally scared them off.

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The nation’s currency — the peso — strengthened against the dollar and local government bonds provided some of the best returns in Latin America in the two years since the leftist president took office. That’s partially because his repeated attempts to upend the nation’s conservative economic model were stymied. But also in large part thanks to rates that, at as high as 13.25%, were far above most of the developing world.

That investment thesis is now being put to the test. The nation’s central bank is set to cut rates on Monday, continuing what’s expected to be one of the world’s most-aggressive easing cycles. As the rates differential with the US and neighbors like Brazil shrinks, Colombian assets are becoming less attractive and political risks — particularly Petro’s budget maneuvers — are weighing on investor confidence.

“It’s just one thing after the other right now keeping the investor narrative a bit frail,” said Gilberto Hernandez-Gomez, a strategist at BBVA in New York, which is recommending clients short the peso against the dollar.

A representative for the Finance Ministry didn’t reply to messages seeking comment.

That drumbeat of headlines — from the global unwinding of the carry trade to a dispute between Petro and congress over the budget — is already taking a toll. The peso has dipped again this week against the dollar, adding to a dismal month in which it has been the worst performer among 31 major currencies tracked by Bloomberg. Now a growing chorus of big banks say it’s time to bet against it.

BNP Paribas and Morgan Stanley favor pitting the peso against the Brazilian real as policy makers there raise rates to combat inflation. And Deutsche Bank is playing the real against both the dollar and the peso “on the back of a divergent monetary policy story.”

Most analysts expect Colombia’s central bank will cut rates by half a percentage point on Monday, bringing the overnight lending rate to 10.25%, according to a Bloomberg survey. But traders are wagering the bank will bring them down to 7.25% in a year.

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That is leaving the currency exposed to underlying risks, including Petro’s attempts to force through an underfunded 2025 budget proposal. Depending on how much spending the government ends up cutting and whether efforts to boost tax collection pan out, the fiscal deficit could be anywhere from 4.7% to 7% of GDP, according to estimates by Felipe Hernandez, Latin America economist at Bloomberg Economics.

Petro and congress have until Oct. 20 to come to a consensus on his proposal, but his administration has already signaled it may enact it by decree. To finance part of the budget, he sent a tax bill to Congress, which also seeks to nix government spending limits to finance green projects.

Up until now, high rates have been “masking some other risks,” such as the political gridlock, according to Andres Pardo, a strategist at XP Investimentos. He’s betting the central bank will cut rates 75 basis points on Monday.

Petro has repeatedly bashed the monetary authority for its decision to keep borrowing costs high as economic growth slowed to 0.6% last year. He will name two more members to the bank’s seven-person board in February, bringing to four the number of voting representatives he’s appointed.

The new makeup may lead to a “more dovish equilibrium,” Bank of America economist Alexander Muller and strategist Christian Gonzalez Rojas wrote in a note, warning investors are overlooking this risk.

Without the appeal of high rates, the currency is likely to remain in the 4,100-4,200 pesos-per-dollar range by the end of the year, according to September’s central bank survey of analyst forecasts.

“The focus should turn more towards Colombia’s challenged fiscals and political stalemate, which should trigger more pronounced underperformance relative to peers,” Morgan Stanley strategist Ioana Zamfir wrote in a note.