Colombia Boosts Defense Spending, Raising Peso Program Concerns

–Colombia announces $838 million in new defense spending

–More defense outlays mean less cash to halt peso strength

BOGOTA (Dow Jones)–Colombia is planning a significant increase in defense spending due to a resurgence of guerrilla violence, a budget-bulging move that among other things could limit the government’s ability to keep the peso from getting too strong against a weak dollar.

During a swearing-in ceremony for new Defense Minister Juan Carlos Pinzon, President Juan Manuel Santos announced the government will add to its budget an additional 1.5 trillion pesos ($838 million) on defense. He urged Pinzon to use the funds to take a “decisive step” toward defeating terrorists “so the country can finally live in peace.”

Colombia has been in a bloody, drug-fueled war against leftist insurgents and others since the 1960s. A military offensive last decade weakened the insurgents’ capabilities, but this year the groups have reemerged, launching deadly attacks and kidnapping oil workers. Their resurgence led the previous defense minister, Rodrigo Rivera, to resign last week.

But while the new money for defense spending may aid the war effort by adding more ground troops, analysts warn it could reverse economic advances by hindering government attempts to maintain a stable currency and reduce a still-high fiscal deficit.

A statement sent Tuesday to Dow Jones Newswires by the Finance Ministry’s press office said the $838 million will come from better-than-expected collection on a wealth tax. “There are more resources due to increased collection,” the ministry said, adding it remains unclear what specific areas of defense the money will go toward.

The $838 million is a massive jump. Leading newspaper El Tiempo said it brings Santos’ four-year defense spending budget to $4 billion from $3.2 billion.

The extra tax revenue may seem like free money that might as well be used on defense, but officials have already said some of that revenue would go toward preventing excessive peso strength.

Colombia’s government collects seven times the amount of taxes it did a decade ago and during the first six months of 2011 collected COP47 trillion ($26 billion), a 33% year on year increase. The increased tax collection has been vital to the government’s efforts to contain the peso’s strengthening trend, which has come due to rising foreign investment and a globally weak dollar. Over the past two years the peso has gained 13% against the dollar, and closed Tuesday’s trading session at COP1,791 to the dollar.

For the past 12 months, however, the peso has only gained 2%, largely because the government, through the central bank, has used some of its increased tax revenue, which is received in local currency, to buy $20 million a day on the spot forex market.

Felipe Hernandez, an analyst at RBS Securities, said this planned increase in defense spending will, down the road, affect the government’s ability to buy dollars to limit peso strength. “If they are using the extra tax revenue for defense, they won’t have as much for buying dollars” in the forex market, he said.

Still, Hernandez said he doesn’t expect the announced increase in defense spending would limit the central bank’s current daily dollar-buying program, or a separate one by the government in which it said it would create this year an overseas fund with $1.2 billion bought in the local market.

The additional tax revenue was also expected to help the central government meet or even go below its fiscal deficit target of 4% of gross domestic product, and the plan for higher defense spending could derail that.

 By Dan Molinski 
   Of DOW JONES NEWSWIRES
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