By Nelson Bocanegra
BOGOTA (Reuters) - When Colombia's central bank chief, Juan Jose Echavarria, was asked what kept him up at night with inflation low and economic growth rebounding, his answer brought a stinging rebuke from the government and stirred a debate about the solidity of the country's recovery.
During the central bank's quarterly inflation presentation in late May, Echavarria said his biggest concern for South America’s third-largest economy, despite growth outpacing the regional average, was worsening political polarization.
"Consumers are scared. Investors are scared," said Echavarria, who has differed from his central bank predecessors in his two and a half years in office by his willingness to make public statements.
Finance Minister Alberto Carrasquilla shot back that Echavarria should keep such opinions private and stick to monetary policy. Echavarria's remarks led to weeks of testy exchanges with the center-right government, including President Ivan Duque himself.
The spat has raised questions over the sustainability of a rally in Colombian assets - with the peso currency rising in recent weeks and Bogota's COLCAP <.COLCAP> stock index up nearly 20 percent so far this year - as well as the longer-term growth prospects for the $300 billion economy.
Last month, Echavarria poured fuel on the flames when he said Colombia's economy had "stalled" in the first quarter - noting that performance was worse than expected, and compared with the previous quarter, gross domestic product actually fell by 0.01%.
He also pointed to a 9.6% drop in consumer confidence in April, the worst reading of the index in five months, as Colombians put off buying big-ticket items.
Carrasquilla and Duque responded by defending the government's management of Colombia’s oil-reliant economy, which grew at an annual clip of 2.8% in the first quarter.
"This is not a stalled economy. It's an economy that's recovering," Duque said at a recent financial conference, speaking directly to Echavarria, who sat in the audience. "Let's put things in a fair perspective."
Analysts say there are many reasons for optimism. Inflation is moderate, at 3.3% year-on-year in May. The price of oil, which accounts for nearly 5% of GDP, is stable. The peso, which has been volatile this year, strengthened 4.5% in June following the end of a foreign exchange accumulation program.
However, some prominent business leaders came to Echevarria’s defense, saying that consumers and investors were becoming spooked by the acrimonious political mood.
"It does have an impact," David Bojanini, head of Grupo Sura, the nation's biggest investment holding, said on RCN radio. "When the environment of the day is so convulsed, we get distracted and that generates consumer distrust and a decline in investment."
Indeed, stripping out the oil sector, foreign direct investment in Colombia tumbled by 16.2% from January to May, according to central bank figures.
PEACE LEFT DEEP DIVISIONS
Despite a 2016 peace deal between the government and the Marxist FARC rebels, Colombia remains politically and socially divided.
Duque and his Democratic Center Party made toughening the conditions of the peace deal a cornerstone of their 2018 election campaign. Most other parties, however, firmly backed the deal.
The dispute has left Congress deeply divided and has watered down Duque's legislative projects - like tax reform and a $355 billion national development plan - meaning the government must find alternative sources of funding to avoid a downgrade to Colombia's credit rating.
Moody's sovereign risk analyst Renzo Merino, who has a "Baa2" rating on Colombia with a stable outlook, said that while political noise is a regional phenomenon, in Colombia it is weakening confidence and hindering the reforms needed to improve the fiscal situation.
"We've seen that some of the measures that have been finally adopted in Congress have perhaps diminished the effectiveness of the original proposals of the government a little," he said.
Fitch Ratings warned that economic growth appeared unlikely to meet the government’s targets, which stand at 3.6% this year and 4% in 2020, and that any further deterioration in its fiscal credibility would have an impact on Colombia’s "BBB "sovereign credit rating, which it put on negative outlook in May.
“If the deterioration in credibility continues, we could lower its rating by one notch,” said Fitch’s director of sovereign ratings for Latin America, Richard Francis.
Some analysts point to the strength of Colombian bond prices and the peso and rule out polarization impacting Colombian capital markets because the economy enjoys better growth prospects and offers better returns than most countries in the region.
"It's already largely incorporated into prices and in large part Colombia is fairly priced," said Joel Virgen, chief economist for Colombia and Mexico at BNP Paribas.
Indeed, some analysts say that with Colombia’s current account deficit running at close to 4% of GDP, the strength in the peso may force the central bank to take action.
Barclays wrote in a recent research report that a re-opening of the foreign exchange program in the second half of the year could not be excluded if the peso remained strong.
However, for some investors in the real economy, there is concern for the political future.
Many analysts believe Duque, whose approval ratings in his first year are among the lowest of any president, may be unable to rally enough support at the end of his term to prevent a leftist administration taking office in 2022.
Gustavo Petro, a former member of the defunct M19 insurgent group, came the closest of any left-wing candidate in Colombia's history to winning the presidency against Duque last year. Center-left challenger Sergio Fajardo, who narrowly missed out on the second round, has already said he will run again in 2022.
Unemployment is stoking social pressures. Urban unemployment rebounded to 11.2 percent in May, which analysts and economists say could be the result of absorbing some of the 1.3 million Venezuelans who have migrated to Colombia.
"The future risk is that people postpone investments, not in portfolios, but real investment in the economy," which could undermine productivity and economic growth, said Sergio Olarte, chief Colombia economist for Scotiabank.
(Reporting by Nelson Bocanegra and Carlos Vargas; Writing by Helen Murphy; Editing by Daniel Flynn and Leslie Adler)