November 9, 2018 / 4:23 PM / a month ago

Colombia tax reform may stoke inflation, hasten rate rise -analysts

BOGOTA, Nov 9 (Reuters) - A tax overhaul bill proposed by Colombia’s government could push up consumer prices, moving inflation above its target level and leading the central bank to raise interest rates sooner and more sharply than previously expected, analysts said on Friday.

The bill, presented to Congress last week, aims to raise 14 trillion pesos ($4.4 billion) to finance spending next year. It includes higher taxes on upper earners and lower duties on businesses.

But the most controversial part of the bill, which has divided lawmakers in President Ivan Duque’s party, is a plan to charge value-added tax on some food and other basics, many of which are currently exempt.

Fifteen analysts said new taxes on 40 products including meat, rice, eggs, fruit and beans would add a median of 245 basis points to inflation, sending the indicator to close to 4.8 percent next year, far from the central bank’s target rate of 3 percent.

Consumer prices rose 3.33 percent in the year to October.

Though the inflationary effect would likely last only through 2019 and would depend on what Congress approves, the increase is well beyond the 120- to 170-basis-point uptick predicted by the finance ministry.

“Inflation expectations could deteriorate, which would lead the central bank to act before it was expected to, or implement a longer rate-raising cycle,” said Daniel Velandia, chief economist for Colombia at Credicorp Capital brokerage.

The central bank board has held the benchmark interest rate at 4.25 percent since April, after a 350-basis-point rate-cutting cycle meant to boost economic growth.

After the bill was presented on Oct. 31, banking association Asobancaria changed its prediction for when the rate would next be raised to January from April. Others thought raises would still come in April, but with more pronounced increases.

“The bank could see a need to raise rates beyond what had been predicted,” said Banco de Bogota’s head of economic studies Camilo Perez. “It’s unlikely rates will move before April, when the bank will have more information about the impact of VAT.”

The analysts, surveyed by Reuters, raised their year-end interest rate estimates for 2019 to 5 percent on average from the 4.75 percent estimated before the tax bill’s proposal. The highest prediction was 6.25 percent.

The bill, seen as key to meeting the fiscal deficit target and avoiding a credit rating cut, has already had an impact on the bond market.

Inflation expectations incorporated into the yield curve of one-year local Treasury paper (TES) were up 50 basis points on Thursday compared to the day before the overhaul bill was presented, to 4.3 percent. Two-, three- and five-year debt was up an average of 40 basis points.

“Short-term bonds lost value on the expectation the central bank will have to react to higher inflation expectations and long-term ones were affected by possible impact on economic activity,” Corficolombiana’s Ana Vera said.

Several of the analysts expressed concern that VAT increases could hit economic expansion. The government estimates 2.7 percent growth this year and 3.5 percent next.

“We worry that it could have a negative impact on private consumption and on demand that puts a recovery at risk,” said Luis Fernando Mejia, director of think tank Fedesarrollo. (Reporting by Nelson Bocanegra Writing by Julia Symmes Cobb, editing by Dan Flynn and James Dalgleish)

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