Region - The combined currency/energy challenge
Declining currencies and gas price subsidies don’t mix.
I’m on vacation this week. The van transporting us from the airport in Santa Marta to the hotel outside of Tayrona National Park had to stop for gas. The price was 9,000 pesos per gallon. With Colombia’s peso hovering right near the 5,000 per dollar mark, that’s US$1.80 per gallon, less than half the price of the US average right now. The cheap gas comes at considerable cost to the national government, which subsidizes the gasoline prices.
One big problem for Colombia is that its peso floats based on market conditions but its gas prices don’t.
Nearly all emerging market currencies are down, but Colombia’s has dropped more than most others given a combination of President Gustavo Petro’s policies and investors’ fear of Petro’s policies (two different but related things). The situation is hitting one of those fear cycles where the peso is declining, so people are afraid it will decline further, causing it to decline further. The peso’s drop is probably far more steep than warranted by Petro’s actual policies (so far, not too radical and constrained by an even more moderate/conservative Congress), but that’s the market and the impact of psychology.
While the government did allow a small rise in gasoline prices, it’s far from market value and does not make up for the decline in the peso.
Political and economic constraints prevent the government from cutting those subsidies and raising prices much more. Energy price increases are one of those sparks that causes political discontent and protests. Colombia’s economy would also be hit hard by a major increase in fuel prices, even if it helped the government’s budget. Consider, for example, that van that transported us. The price would almost double if gasoline prices were near market levels and that wouldn’t be good for tourism or the local economy. While the government will almost certainly need to raise gas prices more in the coming months, it will need to be cautious and controlled. Even then, it may still cause political backlash.
Colombia’s challenge in this space is emblematic of the challenge that will face many governments in 2023. As I write in WPR this week, the IMF has shined a light on slowing growth, weak emerging market currencies, and limited fiscal space for subsidies and other social safety nets.
Specifically, the challenge that combines weak currencies and energy price subsidies will threaten governments throughout the region because there is no simple solution. Take any country where the local currency is declining relative to the US dollar and energy prices are limited or subsidized by the government, and it will be the source of potential blackouts, shortages, protests, and political fireworks.
And with that, back to vacation.