APRIL 22 - MAY 6 2013NEWS 01

• As we have said in our previous reports, during this year the ER has gone through a trend reversal cycle:

i) ER (30 – day avg.) January 2 = $1,804.41ii) ER (30 – day avg.) February 7 = $1,772.74

(minimum)iii) ER (30 – day avg.) April 22 = $1,813.43iv) ER (30 – day avg.) May 6 = $1,826.45

• The driving force of such dynamics has been the Feb – May 3.5% depreciation (over 60 Colom-bian Pesos – COP – per $US):

i) ER January 31 = $1,773.24ii)ER May 6 = $1,835.88

• Now, the Feb – May depreciation has been partially a market response to the Central Bank’s (CB) loose policy stance (in response to output slow down).

• Recall that the CB has cut its interest rate in 100 basis points (bps) during 2013:

i) 25 bps on Jan 28.ii) 25 bps on Feb 22.iii) 50 bps on Mar 22.iv) 0 bps on Apr 26 (and the rate is currently

standing at 3.25%).

• Plus, the CB has adopted a more active interna-tional reserve accumulation policy: $US 30 million daily (or $US 3 billion between Feb and May), as opposed to the $US 20 million per day it had been purchasing before.

• However, local ER dynamics have been signifi-cantly influenced by exogenous factors.

• Indeed, uncertainty in Europe (Italy, Spain, Greece, and Cyprus), dismal corporate results in the U.S. (Yahoo Inc. Intel Corp. BoA, etc.) and the IMF’s cut in its global growth forecast have triggered risk aversion in international financial markets, thus inducing short term capitals to flee from emerging markets and into safe havens (like US T Bills).

• Thus, given that other currencies (Perú, Chile, Euro, etc.) have also depreciated significantly, exogenous (world market) factors are probably the main driving force behind local ER dynamics (and not the domestic monetary policy, nor the recent fiscal countercyclical fiscal policy also known as PIPE – see below –).

• In any case, there’s no evidence whatsoever of an inflection point in the 30 – day ER average so as to predict comfortably that the current level is a max and that it will converge back to the $1,800 threshold.

• On the contrary, if output slowdown (inducing more CB loosening), adverse shocks to business environment (see previous reports and below), and external shocks to the ER (uncertainty in world financial markets) continue to kick in, the COP might lose even more value.

• Hence, at this point we suggest caution before adopting a final stance on the future trend of the ER (which could be depreciation – like).

• If so, don’t forget that the systematic and steady depreciation of any currency is not a good symptom of confidence in the economy´s environment. On the contrary, it reflects a reduction in the demand for (or confidence in) its currency.

• Additionally, depreciation melts down the real (dollar) value of any foreign investor’s net worth.

• In terms of ER volatility, the cycle is as follows: skyrocketed during January, plummeted during February, picked up again during March, and converged back to below average levels during April and the first week of May:

i) St Dev. (45 – day avg.) January 2 = $16ii) St Dev. (45 – day avg.) January 23 = $23iii) St Dev. (45 – day avg.) February 25 = $11iv) St Dev. (45 – day avg.) March 8 = $17v) St Dev. (45 – day avg.) May 6 = < $13

• In sum, ER volatility seems to be converging back to its 10 – 11 peso minimum.

• Moreover, ER volatility is quite below its highest level. The max levels have been:

i) $23 during the first quarter of 2013 (Jan).ii) $27 during the second half of 2012.iii) $61 (!!!) during the first half of 2012.

• Hence, it is a good time for tradable sector compa-nies to purchase hedges against ER fluctuations.

• Remember: the higher the volatility, the more expensive the hedging. Don´t wait for volatility to pick up again.

EXCHANGE RATE:LEVEL & VOLATILITY

PESO – DOLLAR EXCHANGE RATE (ER)

ESCUELADE ECONOMÍA

VIGILANCIA AL CLIMA DE NEGOCIOS

• The Colombian stock market has exhibited a boom – deep bust cycle during 2013, with a bust almost twice as large as the boom.

• Indeed, $US 100 invested on Jan 02 have become $US 88 on May 3

• 30 – Day avg. gains (as measured by our index) peaked at 5% on Feb 15, but vanished completely after that, and prices (in dollar terms) are currently 6% to 7% below 2012 levels.

• This is a 12% to 13% average loss (in dollar terms) from peak to through.

• Note that after its Feb 5 max (15,195), the stock market’s main index (IGBC) plummeted system-atically:

i) IGBC February 5 = 15,195 (maximum)ii) IGBC March 1 = 14,786iii) IGBC April 1 = 14,043iv) IGBC May 3 = 13,491

• This is a more than 11% (COP) nominal drop.

• Hence, such a nominal stock price plunge, coupled with the 3.5% Feb – May depreciation (see above), has articulated a huge loss in real (dollar value) terms.

• This is why $US 100 invested on Feb 5 have become $US 86 on May 3.

• Reasons behind the plunge? We repeat our diagnosis from previous reports:

1. Traded volumes have been 20% below those of 2012.

2. Dismal corporate results: only 57% of those companies listed in the IGBC reported profit growth.

3. Disappointing data from oil and gas sector (O&G) companies: less than expected reserves, production and profits. O&G companies represent 23% of the COLCAP Index (capitalization weighted average index of companies with high liquidity levels).

4. GEA group announced more stocks to be issued for Cementos Argos and Bancolombia (price reduction due to expected increase in supply).

5. Uncertainty in international financial markets (Europe’s macro instability, U.S. corporate results, IMF cutting global growth forecast – see above –) has induced higher relative risk premiums in emerging markets’ currencies and stocks (capitals flee to safe havens, local currencies depreciate and domestic stock prices take a loss).

6. Consistently loose monetary policy (attributable to domestic output slowdown) depreciating the COP even more (see above).

7. Recent deterioration of business environment in Colombia (see below).

• We believe the market will remain bearish in the short – run.

• Implicit interest rates on the July 2020 TES bond (11% coupon, issued on July 24 2005, expire on July 24 2020) exhibited a systematic downward sloping trend until the first week of March (71 basis point drop and the corresponding bond price increase):

i) TES Rate January 3 = 5.39%ii) TES Rate March 7 = 4.68% (minimum)

• Afterwards and until the first week of April the rate increased again to levels not seen since the second half of January:

i) TES Rate March 27 = 4.90%ii) TES Rate April 5 = 5.03% • Since then (and until the first week of May), the

rate has fluctuated between 4.80% and 5% (avg. = 4.88%; TES Rate May 2 = 4.84%).

• Thus, in contrast to the stock price plunge, the T – bond price drop wasn´t as sharp and prolonged.

• In fact, note that the TES price drop lasted one – month (first week of Mar to first week of Apr), while the stock and forex price plunge has gone on for more than three months (Feb – May), with serious possibilities of deepening even more.

QUAESTOR’s $US Value of Domestic Stock Price Index

Treasury Bills (TES) Implicit Interest Rates

$US VALUE OFSTOCK PRICES

• On Saturday May 4 DANE (National Statistics Agency) published inflation data for April 2013: 0.25% (vs. 0.14% on Apr 2012).

• Hence:

i) Cumulated inflation (Jan – Apr) stands at 1.21% (compared to 1.62% during Jan – Apr 2012).

ii) Annual inflation (May/2012 – Apr/2013) is at 2.02% (compared to 3.43% during May/2011 – Apr/2012).

• As we have said over and over, consumer price data behavior reflects full stability and portrays sufficient macro/monetary stability for investment purposes.

• Yet, inflation data might also be revealing domes-tic economic deceleration and aggregate demand weakening.

• Recent relevant data:

i) Tuesday April 23 (Moody’s): The agency gave an OK to the recent PIPE program announced by the government.

Recall (see our previous report) that on April 15 the government revealed a $US 2.7 billion (1% of GDP) policy package (named PIPE) aimed at boosting tradable sector output (agriculture + manufacturing sectors) and consumption. The plan includes:

a) Government saving additional resources abroad.

b) Anticipation of the 2012 tax reform benefits for labor intensive sectors (like agriculture and manufacturing)1.

c) Tax withholdings reduction for the manufac-turing, agricultural and retail sales sectors2.

d) 50% time reduction for refunds of value added tax to the manufacturing sector.

e) 2 more years of zero - tariff on manufacturing inputs not produced domestically.

f) Waiting time reduction at port.

g) Energy cost reductions.

h) Custom reforms aimed at law enforcement against smuggling.

i) 2,500 additional policemen and soldiers.

j) Additional budget for public roads and highways.

k) Subsidies for mortgage rates in houses costing between $US 44k and $US 110k.

Inflation Rate

Output Performance

1 Meaning also anticipation of the tax reform’s additional burden on capital intensive sectors (like mining and O&G).2 To compensate, they are increased in the mining sector.3 Some of the current investors acquired participation in the building and the land in the early 1990’s (for example Corficolombiana – Hoteles Estelar from the Sarmiento Angulo Group with 50% of

shareholding).

l) Cheap 15 – year loans for agricultural infrastructure.

According to Moody’s, the PIPE program is OK because it won´t translate into additional public spending.

However (and unfortunately), even if the PIPE program demanded additional spending, Moody’s (and international markets) can be at ease because the government has shown an extremely poor capacity of executing and implementing effective counter cyclical fiscal policies to offset any further deceleration of the economy.

ii) Wednesday April 24 (Fedesarrollo): The Manufacturing Confidence Index plunged 12.3 percentage points during Mar 2013 (yoy), reaching – 6.2%. According to the think tank, the main reason behind the drop was the plunge in the volume of orders (38.6% fall in the corresponding metric). Additionally, the metric that estimates job creation expectations also plunged into negative terrain (-1.3%) for the first time since December 2009.

iii)Tuesday April 30 (DANE): The overall unemployment rate during March 2013 was 10.2%. This represents a yoy 20 basis point drop. However, there were 78k less jobs in relation to March 2012. Thus, the reason for the fall in the yoy unemployment rate was a signifi-cant reduction in the economically active population (people looking for jobs) during March 2013. In other words: less jobs + even less people looking for jobs = drop in the unemployment rate.

On the other hand, in the 13 major cities the unemployment rate during March 2013 was 11.6%. This represents a yoy 60 basis point increase. As in the overall datum, there was also an important reduction in the economically

active population (people looking for jobs) in the 13 major cities during March 2013. But note that such a reduction wasn’t enough to offset the job destruction number (-39k) and, as a result, the 13 – city unemployment rate had to go up.

Finally, the highest contribution to job destruc-tion came from the manufacturing, construction an agricultural sectors.

• As we have reported over and over, tradable sector output has stagnated in the Colombian economy.

• This time stagnation was reflected in unemploy-ment data and in manufacturing confidence.

• Monday April 22: The General Comptroller (GC) issued a report on Anglo Gold Ashanti (South African capital) in relation to the 2007 – 2011 time period.

According to the GC’s report, Anglo Gold, several regional administrations (states of Antioquia, Bolívar and Caldas) and some local offices of the National Mining Agency (Bogotá, Medellín, Cali, Bucaramanga and Ibagué) are accountable for $US 3.8 million of alleged fiscal losses attributable to unpaid obligations by the company. Specifically, the report mentions 39 findings/anomalies in relation to the company (one of them with penal consequences).

We don’t question the responsibility and authority of the GC in strictly safeguarding and protecting fiscal resources. However, given the recent GC’s fiascos in several major national investigations, and given the persecution from some public institutions against the company during the previous weeks/months, the GC’s findings in relation to Anglo Gold must be taken in with major skepticism (see our 08/04/2013 – 22/04/2013 and Quarter I/2013 reports).

As we have said over and over, official persecution against environmentally and fiscally responsible mining companies is the worst public policy whatsoever: it induces serious companies to flee, thus attracting illegal operators to mining areas. These operators use environmentally razing techniques and, obviously, pay zero taxes.

• Wednesday April 24: The Constitutional Court (CC) rejected the Minister of Mines’ Feb 21 request for an extension of the due date for Mine Code consultations with indigenous groups.Recall that two years ago the Mine Code was declared unconstitutional by the CC due to lack of such consultations. However, the CC granted

the government a 2 year grace period for consul-tations (in order to avoid the resurrection of the old Mine Code and the obvious legal instability/disruption of the mining industry).

Unfortunately time is up, the CC didn’t grant an extension of the due date and, as a result, the old Mine Code will resurrect during May. For sure, legal instability and business environment erosion will deepen in the mining industry. In addition to this major setback, other factors hurting business environment in mining are:

i) Enhanced animosity, contempt and fire from public opinion leaders and public officials against FDI in mining. Recall, for example, from our previous reports:

a. Outbursts and publicized decisiveness of the Minister of Environment, Attorney General, and General Comptroller against Drummond after the unfortunate coal ocean spill incident.

b. Systematic persecution from environmental authorities and local officials against Anglo Gold’s exploration activities (see also below).

ii) Systematic deterioration of physical security in the mining sector. See, for example, in our previous reports:

a. Multiple FARC attacks against Cerrejón’s infrastructure.

b. Multiple kidnappings of mining companies’ workers (Braeval, Grand Tierra Energy, etc.)

iii) Bigger state – take. Indeed, last year’s tax reform increases taxes (rates and withhold-ings) on capital intensive sectors like mining and O&G.

UNDER OUR WATCH:

3 Some of the current investors acquired participation in the building and the land in the early 1990’s (for example Corficolombiana – Hoteles Estelar from the Sarmiento Angulo Group with 50% of shareholding). But note that they are being penalized for seawall installation dating back to the late 1970’s, when investors were completely different and shareholding was controlled by public entities or corporations.

• Saturday April 27: The President of Cotelco (Colombian Hotels’ Association) warned against a possible witch hunt against some hotels in Cartagena. According to him, recent judicial rulings are altering the rules of the game for the hotel industry in Cartagena, thus affecting several hotel companies that create multiple jobs in the city.

Recall that on Thursday March 14 the Consejo de Estado (Supreme Court in administrative or public – private matters) issued a ruling against the current owners – investors of the land piece where Hilton Hotel operates in Cartagena. The ruling demands that:

i) The hotel´s beach area be recognized and formalized by authorities as public space (given that, originally, it was low sea water area and was turned into beach with seawalls during the late 1970’s).

ii) In compensation for having used the area for so many years, current land owners (not Hilton) must buy a piece of land close by (similar in area to the piece being restored as public space), develop a public park, and pay for its maintenance during 30 years.

With this ruling, current private investors are being sanctioned for public decisions made more than 30 years ago . Assuming the restoration of Hilton´s beach area as undisputable public space is fair and legal, the court’s penalty and compen-sation requirement on current investors is completely unfair, exotic and erodes business environment in the Cartagena hotel industry.

Additionally, the Constitutional Court issued a ruling against Torre de Mar Hotel declaring part of its beach area as public space. Here we have yet another setback for business environment in the Cartagena hotel industry.

Undoubtedly, Cotelco’s President cry is totally fair.

• Physical Security:

i) Monday April 22: FARC terrorists (belonging to the “Columna Móvil Alfonso Castellanos”) attacked the Police Station in the municipality of Tame (state of Arauca, frontier with Venezuela). One 26 year old policeman was killed.

ii) Monday April 22: FARC terrorists (belonging to the “Columna Móvil Antonia Santos”) ambushed with explosives an Army patrol in the Catatumbo region (state of Norte de Santander, frontier with Venezuela). As a result, one 24 year old soldier was assassi-nated.

iii) Monday April 22: Army personnel belong-ing to the 37th Mobile Brigade neutralized in the settlement of Chorrera Blanca (municipality of Morales, state of Cauca) a deposit full of explosives (115 kgs) that FARC was going to use in terrorist attacks all over the region.

Recall that during this year FARC terrorists have detonated three car – bombs in the state of Cauca (killing one civilian and injuring several soldiers).

iv) Sunday April 28: In the settlement of Puerto Jordán (municipality of Tame, state of Arauca, frontier with Venezuela) FARC terrorists (belonging to “Frente 10”) attacked with a grenade an Army unit belonging to Artillery Battalion No. 18 (18th Brigade). As a result, one 25 year old civilian peasant and his 3 year old son were killed. Nine other civilians (including one girl) and two soldiers were injured.

v) Sunday April 28: Amid “peace” talks with the government, FARC terrorists announced in Cuba that if they abandon the use of weapons, Colombia´s Military Forces must be restructured (meaning that its current 450k troop size must be cut down).

vi) Tuesday April 30: The Mayor of the munici-pality of El Tambo (state of Cauca) suffered a terrorist assault with explosive artifacts while heading to the state’s capital city (Popayán). Perpetrators almost surely belong to the FARC terrorist group.

vii) Wednesday May 1: A criminal group massacred four people in the municipality of San Roque (state of Antioquia).

viii)Thursday May 2: FARC terrorists (belonging to “Frente 6”) attacked the helicopter delivering cash to the public bank (Banco Agrario) of the municipality of Toribío (state of Cauca). Policemen escorting the personnel in charge of carrying the money into the bank were also attacked with assault rifles.

ix) Thursday May 2: Three soldiers belonging to the 27th Jungle Brigade stepped on FARC land mines in a rural area of the municipality of Ipiales (state of Nariño, frontier with Venezuela) while patrolling next to the border with the state of Putumayo. The soldiers were severely wounded (one of them lost part of both legs).

x) Thursday May 2: An explosive artifact was thrown at a small business in the municipal-ity of Pital (state of Huila). Perpetrators almost surely belong to the FARC terrorist group.

Our assessment: Physical security and personal (life and freedom) safety keep on deteriorating signifi-cantly, especially in frontier states, and in regions of interest to the O&G, Coal, Gold and Electrical Energy sectors.Escalation of terrorist acts in Colombia is not fortuitous. It’s the result of:

i) FARC’s evident strategy of enhancing people’s perception of its military capacity during peace talks with the government. FARC is trying to strengthen its stance (and hike up its price value) amid negotiations with President Santos.

ii) ELN’s attempt to induce the government into peace talks.

Keep an eye on peace talks in Cuba between the Santos administration and FARC. Apparently, both sides are close to a deal on the topic of rural development. Nothing good can come out of it for foreign or domestic investment.

On this issue FARC terrorists are insanely demanding:

i) Limiting (prohibiting?) private property in land.

ii) Expropriation of large estates.iii) Prohibiting FDI in land.

iv) Earmarking additional fiscal resources for the agricultural sector during a 10 year period.

We believe the Santos administration won’t concede private property or FDI. However, the final deal might include:

i) Increasing land taxes in order to induce a more efficient use of land.

ii) Strengthening the (already worrisome and dangerous) legal structure for land expropria-tion in order to nourish a land bank for poor peasants.

Unfortunately, this type of policies won’t help poor peasants. On the contrary, they will perpetuate rural poverty.

In fact, more land taxes curtail the feasibility of investment (and job creation) in rural areas.Additionally, peasants with land but lacking credit, technology, economies of scale and insurance (against exchange rate, climate, phitosanitary and international price risks) usually go bankrupt and abandon (once again) their land to find a job in the city.

At the end of the day this type of policies end up, on one hand, killing many job creating investment possibilities in rural areas and, on the other hand, driving out peasants from their land and back into the cities.