Colombian Government Faces New Pressures To Curb Peso's Surge

Federation of exporters wants limits on foreign investment

Peso has gained nearly 7% against dollar in January

Government has avoided placing limits on foreign investment

The Colombian government is facing renewed pressure to take forceful measures to curb the appreciation of the peso, which gained nearly 7% against the dollar in January.

Javier Diaz, the head of Analdex, Colombia's largest federation of exporters, said Tuesday the government needed to take action to counter the peso's surge, which is making Colombian products less competitive overseas and imports from abroad more affordable.

The peso closed Tuesday at COP1,814.00 to the dollar, nearly unchanged from a day earlier.

"The export sector is reeling from the strong peso and the government can't continue with its arms crossed," Diaz told Dow Jones Newswsires in an interview.

The peso's surge poses a major challenge for the administration of President Juan Manuel Santos. 

Colombia's economy, benefiting over the last few years from a boom in its oil and coal industries, is seeing a massive influx of foreign direct investment. 

But those same investment inflows are a key cause of the peso's strength.

The government has shown that it wants the boom in foreign investment to continue. 

The economy expanded 7.7% in the third quarter of last year and could grow as much as 6% for all of 2.011. 

That has triggered a drop in unemployment, one of Santo's main objectives, which stood at 9.2% at the national level in November from 10.8% a year earlier.

One idea proposed by Diaz and other business groups in Colombia is the use of capital controls, which limit foreign investment. 

Diaz said the government should impose regulations forcing foreign investors to keep their capital at least one year in Colombia, a measure that local regulators have used in the past.

The Santos administration, however, has opted to steer away from capital controls when it has faced a surge in the peso.

Diaz also said the central bank should keep its interest rate on hold at its current 4.75% level. 

"Foreign investors are taking advantage of the differential between interest rates here in Colombia and lower rates overseas, like in the US, to make an easy profit, and that's affecting the peso," he said.

This is not the first time that the Santos administration has to deal with dramatic gains by the peso. 

Last year, facing a similar situation, it steered away from capital controls and instead opted for dollar purchases in the spot market to curb the surge.

The central bank, however, changed that policy in November. Its strategy now consists of purchasing currency options to buy or sell dollars only when the peso rate fluctuates more than 5% from 20-day moving average.

Despite the peso's strong gains in January, the central bank has not yet been forced to step in.

Limiting the impact of the peso's surge on the economy is a persistent worry for Colombian officials. 

As exports of oil and other commodities are booming, some fret that Colombia may fall prey to so-called Dutch disease, which occurs when high natural resource revenues result in an appreciating currency, makes exports too expensive and damaging the local manufacturing sector.

Nader Nazmi, an economist with BNP Paribas, says the risk of Dutch disease striking Colombia "remains very real and the government is very aware of it."

Nonetheless, "Colombia has to learn to live with a strong peso," Nazmi said. "

It's a sign that the country is attractive to foreign investors and that it's economy is strong."

Rather than capital controls, Colombia can work to "increase productivity and boost its exports," Nazmi said. "Capital controls are not going to work in doing that."