In an easy language, you can find here fellings basic definitions of some economic concepts.

Great part of these are summaries of economic dictionaries or of the book " Introduction to the economic analysis: the Colombian case " 2nd edition, edited in 1998 for the Banco de la Republica with the intention of spreading the economic topics of general interest.

¿What are the international reserves?  

International reserves are made up by external assets under the control of Banco de la República. These assets are of inmediate availability and can be used to finance payments abroad such as, for example, payments for imports. International reserves can also be used by Banco de la República to intervene in the foreign exchange market and defend the rate of exchange when necessary.

The accumulation of international reserves is the result of the transactions that a country carries out abroad. Transactions which produce foreign income include exports, loans from foreign banks, money transfers carried out by Colombians living abroad and foreign investment in the country. Those which generate expenditure of foreign exchange include among others imports, the payment of interests of loans incurred abroad and money transfers by Colombians within the country to residents abroad. When income is greater than expenditure international reserves are accumulated.

Banco de la República manages the country’s international reserves in such a way that they become available when they are necessary. Though it is sought that these reserves are profitable, the main criteria for their managment is the security of these investments and their liquidity.

The main component of the reserves corresponds to short term financial investments which are represented in deposits and securities abroad. Of these investments, 88.9% are made up of freely convertible currencies, of which 80% are dollars, 15% euros and 5% yens. The 8.1% which is deposited in the International Monetary Fund, corresponds to Special Drawing Rights (means of payments issued by the International Monetary Fund) and to the country’s positions of reserves in the IMF; 2.7% is invested in the Latinamerican Reserve Fund and a small percentage (1.1%) in Gold*.

IMF LRF GOLD Financial investments

*Data at the end of 1998.

¿What are OMOs?  

OMOs (Open Market Operations), are the main instrument the Bank has to increase or diminish the amount of money in the economy. When it becomes necessary to increase the liquidity, Banco de la República buys securities or financial bonds in the market, thus injecting money into the economy. On the contrary, when the Bank wants to diminish the liquidity, it sells securities and collects money from the market.

A. Expansion OMOs

The OMOs are thus called when the transaction is carried out to increase the amount of money. In these cases the bank intervenes buying securities to inject the amount of money necessary. There are two ways of carrying out this intervention:

Temporary OMOs (REPO)

So called REPO transactions are financial bonds bought temporarily.

This purchase is valid during a fixed period of time (one day, seven days, etc.). One talks of a temporary purchase with resale agreement because after the established period the Banco de la República must once again sell the bonds to the entities from which it bought them.

These transactions can be made in one of two ways: when the amount of money the Banco de la Repúblic wants to spend buying securities is limited, an auction takes place in which the available capacity is distributed among the entities which offer the best rates. When there is no limit to the amount the Bank wants to offer, it decides the rate at which it loans its resources.

Permanent OMOs

In these transactions the purchase of public debt securities is definitive and the liquidity remains in the public permanently.

B. Contraction OMOs

So called when transactions are made to diminish the amount of money. In these cases Banco de la República intervenes selling securities to reduce the amount of money necessary. There are two ways to carry out this intervention:

Temporary OMOs (Reverse REPO)

So called Reverse REPO transactions are transactions of temporary sale of financial bonds.

This sale is valid during a fixed period of time. One talks of a tempoary sale with rebuying agreement because after the established period of time, Banco de la República must once again buy the securities from the entities to which it sold them.

Permanent OMOs

These are transactions in which the sale of public debt securities is permanent.

¿What is interest rate?  

The interest rate is the price of money in the financial markets. As with the price of any other good, when there is more money the rate goes down and when there is shortage it goes up.

When the interest rate goes up, buyers will want to buy less, that is, they request fewer rsources on loan from financial intermediaries, while sellers seek to place more resources (in savings accounts, CDTs, etc.) The opposite occurs when the rate goes down: buyers in the financial markets request more loans and sellers withdraw their savings.

There are two types of interest rate: the passive or raising rate is the rate paid by financial intermediaries to those offering resources for the money raised; the active or placement rate is that which financial intermediaries receive from borrowers for loans granted. The latter is always greater because the difference with the passive rate is what allows the financial intermediary to cover its administrative costs, allowing aditionally a certain amount of profit. The difference between the active and passive rate is called net interest income.

In Colombia there are several reference interest rate used frequently:

DTF

This is the weighted average of passive real interest rates for 90 days (the rates of Fixed Term-90 days-Deposit Certificates) paid by banking establishments, financial corporations, trade financing companys and savings and housing corporations. This rate is calculated on a weekly basis by Banco de la República.

Monetary Correction

It is the rate used to update the value of the Constant Purchasing Power Unit (UPAC). Based on this rate are redefined the value of debts or savings based on UPAC units. It is calculated as a percentage of the DTF rate.

TBS (Basic rate of Superintendencia bancaria)

It is the average rate of CDAT and CDT for different periods at which financial intermediaries negotiate between themselves. This rate is calculated and certified by Superintendencia Bancaria.

TIB

It is the average passive rate at which financial intemediaries negotiate between themselves in the very short term liquidity market.

¿What is exchange rate?  

The exchange rate measures the amount in pesos that must be paid per unity of foreign currency. In our case the dollar is used as base because it is the currency used most in Colombia for transactions abroad. As with the price of any product, the exchange rate goes up or down depending on offer and demand. When the offer is greater than the demand, that is, when there is an abundance of dollars in the market and few buyers, the exchange rate drops, and when there is less offer than demand (there is a shortage of of dollars and many buyers), the exchange rate rises.

There are several types of exchange rate regimes:

Fix Exchange Rate Regime

In this regime, the Central Bank commits itself to mantaing a predetermined value for the exchange rate. Thus, when there is an excess demand for foreign currency, the Bank provides the market with the necessary amount of foreign currency to mantain the exchange rate at its prefixed value.

Flexible Exchange Rate Regime

In this regime the Central Bank abstains itself from intervening and the exchange rate is determined entirely by the offer and demand of foreign currency in the market.

The movements of the exchange rate downwards or upwards are called:

Devaluation

This is the name of any movement upwards of the exchange rate; that is, when one must pay more pesos for every dollar negotiated.

Revaluation

This is the name of any movement downwards of the rate of exchange; that is, when one must pay fewer pesos por every dollar negotiated.

It is important to know the difference between the nominal and real exchange rate. The nominal rate is the rate at which one buys and sells foreign currency. The real exchange rate reflects the real purchasing power of the national currency against one or several foreign currencies. This rate, besides considering the nominal rate of exchange, takes into account internal inflation and inflation in countries with which Colombia trades. The real exchange rate reflects the competitiveness of Colombian goods against those of other countries.

¿What is the exchange rate band?  

Since 1994 an exchange rate band regime was defined for Colombia, which represents an intermediate scheme between a fix rate of exchange regime and one which floats freely.

The exchange rate band is defined by the limits within which the rate of exchange can fluctuate.

Structure of the exchange rate band

Maximum rate (ceiling rate)

This is the maximum rate the Banco de la República is willing to allow in the interbanking dollar market. When the market takes the rate to this level, the Bank will sell as many dollars as are necessary to mantain the rate of exchange at that level. This rate changes every day according to the slope of the exchange rate band.

Minimum rate (floor rate)

This is the minimium rate the Banco de la República is willing to allow in the interbanking dollar market. When the rate reaches this level, the Bank buys foreign currency so that the exchange rate remains at that level. This rate changes every day according to the slope of the exchange rate band.

Slope of the exchange rate band

It is the anual percentage of devaluation that is applied to the floor rate and ceiling rate. Since June 1999, this variation is 10%.

Width of the exchange rate band

It is the distance that exists between the ceiling rate and floor rate. It is defined as a percentage (+-10%), measured from a middle point.

¿What is the inflation target for the year 2005?  

The Board of Directors of the Bank established the inflation rate for the year 2005 at between 4.5% and 5.5%.

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