DBRS Confirms Colombia on Strong Growth Outlook

DBRS Inc. (DBRS) has confirmed the ratings on the Republic of Colombia’s long-term foreign currency debt at BBB (low) and long-term local currency debt at BBB. The trend on both ratings is Stable. The confirmation of the ratings reflects our view that Colombia’s sound policy framework and strong medium-term growth prospects bode well for fiscal consolidation and debt stabilization.

The Santos administration has presented an ambitious fiscal reform agenda to address structural weaknesses in public finances. Proposed legislation includes a central government fiscal rule, royalties reform and an amendment to enshrine fiscal sustainability in the constitution. If passed, the reforms would help save windfall commodity revenues and utilize royalties in a more efficient manner, thereby supporting fiscal consolidation and debt reduction over the medium term. While two of the proposed reforms are constitutional amendments and therefore require a more demanding approval process, the President’s coalition has a strong majority in Congress, raising the likelihood of a positive outcome.

Expectations of increased oil and mining production, in addition to higher levels of investment, buoy the medium-term growth outlook. The government estimates that Colombian oil production will increase 60% from 2010 to 2015, largely based on reserves and fields already discovered. This will have a positive effect on exports, fiscal revenues and overall economic activity. Moreover, security improvements and macroeconomic stability over the last decade have strengthened investor confidence and contributed to higher investment. From 2001 to 2009, gross fixed capital formation increased from 15% of GDP to 23% of GDP.

The ratings are underpinned by prudent macroeconomic policies, high foreign direct investment and low external debt ratios. Gross public debt declined from 59.1% of GDP in 2002 to 42.8% in 2008 due to cautious fiscal management and strong economic growth. Debt ratios increased moderately in 2009 and 2010 but are expected to stabilize over the next 1-2 years. In addition, a credible inflation-targeting regime and flexible exchange rate have enabled the Central Bank to support the domestic economy while remaining committed to price stability.

Higher levels of foreign direct investment provide Colombia with a stable source of external financing. From 2003 to September 2010, annual FDI inflows increased from $1.7 billion to $7.4 billion, attracted by the country’s abundant natural resources and improving security conditions. Low external debt, a healthy financial system and high international reserves further strengthen the resilience of the economy to adverse external shocks. At 21% of GDP, Colombia’s gross external debt is among the lowest in Latin America.

Despite these positive developments, mounting spending pressures and a distortionary tax structure present medium-term fiscal challenges. The rising cost of the public health system, in particular, will likely require additional fiscal resources over the medium term. On the revenue side, a narrow tax base, complex VAT structure with numerous exemptions and high payroll taxes contribute to an inefficient tax regime. Nevertheless, the Santos administration plans to implement several minor tax measures in the near term, which could lead to some improvement, and there is preliminary discussion of initiating a wider tax reform at a future date.

Furthermore, high unemployment and a large informal workforce reflect rigidities in the labor market. The urban unemployment rate was over 12% in 2010. The share of workers in the informal market is 61%. Both ratios are among the highest in Latin America. In December 2010 Congress passed legislation to provide some firms with temporary incentives to hire workers in the formal market. While this is a positive step, it falls short of addressing more fundamental problems of the labor market, including high non-wage labor costs and a high minimum wage relative to average salaries.

Effective implementation of fiscal reforms that strengthen the credibility of the fiscal framework and reduce public debt ratios could lead to an upgrade of the ratings over the medium term. Conversely, a sustained deterioration in debt dynamics – either due to weaker-than-expected economic growth or higher fiscal deficits – could put downward pressure on the ratings.

Notes:
All figures are in US Dollars unless otherwise noted.

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

The sources of information used for this rating include the Colombian Ministry of Finance and Public Credit, the Colombian Central Bank, the National Planning Department, the Ministry of Mines and Energy, the Financial Superintendent of Colombia, the National Hydrocarbon Agency, DANE, the US Energy Information Administration and the IMF. DBRS considers the information available to it for the purposes of providing this rating was of satisfactory quality.

This is an endorsed rating.

Lead Analyst: Michael Heydt
Rating Committee Chair: Alan G. Reid
Initial Rating Date: 11 December 2006
Most Recent Rating Update: 11 June 2009

For additional information on this rating, please refer to the linking document below.