DBRS Upgrades Colombia to Investment Grade

DBRS has today upgraded the Long-Term Foreign Currency rating of the Republic of Colombia to BBB (low) from BB (high) and its Long-Term Local Currency rating to BBB from BBB (low); the trends on both ratings are now Stable.

“The upgrades underscore the steady improvements that Colombia has made in debt management, macroeconomic policy credibility and public security,” says Fergus McCormick, Senior Vice President, Sovereigns, at DBRS. “The upgrades also reflect the likelihood of policy continuity through the elections in 2010 and a more resilient balance of payments.” Evidence suggests that even if a global recovery is delayed, the Colombian economy will remain resilient.

“Together, these factors represent an improvement in credit quality and give us greater comfort in the government’s ability to service its debt payments over the coming years,” says Mr. McCormick.

Since DBRS changed the trend on Colombia’s ratings to Positive from Stable in August 2008, there have been four noteworthy signs of progress. First, public security continues to improve, creating the conditions for higher economic growth over the medium term. This is supported by high rates of investment, reaching 27.3% of gross domestic product (GDP) in 2008. Consensus expectations are that Colombia will enter a mild recession before resuming growth later this year.

Second, strong public support for the government’s security and economic policies all but guarantee these policies will continue beyond the elections, regardless of who is elected. Recognition of this fact appears to be reflected in the high foreign direct investment (FDI) inflows. At 3.5% of GDP, Colombia is one of the biggest recipients of FDI in Latin America, providing a stable source of current account financing.

Third, Colombia’s consistent and prudent fiscal policy over the last seven years has led to lower debt ratios and provided the finance ministry with space to stimulate short-term consumption and investment during the downturn, even at the expense of a slightly higher deficit. Of particular note is total external debt, which at 21% of GDP is one of the lowest in Latin America. Furthermore, the government completed its 2009 external financing needs in January and has pre-financed $1.0 billion of its 2010 needs. Domestic financing remains available and DBRS believes that the government is committed to its medium-term debt-reduction targets.

Fourth, the Central Bank (Banco de la República) has had the flexibility to lower interest rates by 500 basis points over the last five months to provide monetary stimulus. DBRS partly attributes this to lower inflation and inflation expectations as the economy has decelerated. However, the ability to provide stimulus quickly, without pass-through from exchange rate depreciation to domestic prices, suggests that the balance of payments is more resilient to shocks than in the past and that the credibility of the Central Bank has increased. The flexible exchange rate is behaving as a shock absorber, in a manner consistent with market forces. This contrasts sharply with past balance of payments crises when the Central Bank was compelled to raise interest rates to help stabilize a depreciating peso.

The current account deficit will widen slightly in 2009 as exports and workers’ remittances slow. However, even if oil prices decline, the global recession is prolonged and there are further balance of payments shocks, Colombia is well prepared, having accumulated $23.4 billion in international reserves and secured a $10.5 billion precautionary credit line from the International Monetary Fund. DBRS is further encouraged by Colombia’s financial system, which does not depend on external financing and continues to provide credit.

“However, a note of caution is also warranted,” says Mr. McCormick. “We do not want to understate the risks. Colombia has held up well, but it is not immune to a deeper recession, higher unemployment or tighter credit conditions. The real challenge for Colombia is addressing long-term structural imbalances in public finances.”

Specifically, high earmarked expenditures limit budgetary flexibility, with transfers and interest payments accounting for almost 90% of revenues. Furthermore, health-care costs will put increasing stress on public finances, underlining the need to expand the formal labor market, widen the tax base and increase the number of workers contributing to social security. Failure to address these imbalances could result in downward pressure on the ratings.

Notes:
All figures are in U.S. dollars unless otherwise noted.

The applicable methodology is Rating Sovereign Governments, which can be found on our website under Methodologies.

This is a Corporate (Public Finance) rating.