DBRS Confirms Colombia at BBB (low), Trend Revised to Positive

DBRS, Inc. (DBRS) has today confirmed its ratings on the Republic of Colombia’s long-term foreign currency debt at BBB (low) and long-term local currency debt at BBB, and changed the trend on both ratings to Positive from Stable. The ratings are underpinned by Colombia’s sound macroeconomic management and demonstrated capacity to weather adverse shocks. The Positive trends reflect our assessment that Colombia’s strengthened budgetary framework and favorable medium-term growth outlook bode well for fiscal consolidation and debt sustainability.

Major structural reforms approved in 2011 reinforce the credibility of Colombia’s fiscal framework. The adoption of a structural fiscal rule and an overhaul of the royalties system will likely strengthen fiscal sustainability by gradually reducing the budgetary imbalances and facilitate counter-cyclical fiscal policy by saving windfall revenues when economic growth and commodity prices are above trend.

Sound macroeconomic policy frameworks, security improvements and abundant natural resources have spurred higher levels of investment and raised Colombia’s medium-term growth prospects. From 2001 to 2011, investment rose from 15% of GDP to 24% of GDP. Increasing oil and mining production, the approval of a free trade agreement with the United States, Colombia’s largest trading partner, and deepening commercial ties with Asia are likely to support higher investment and export growth. In 2011, GDP growth accelerated to an estimated 5.8% and the Ministry of Finance expects 5.0% growth in 2012. This positive economic performance has been supported by strong job creation, a rebound in credit growth and favorable terms of trade.

Reforms to the fiscal framework have been accompanied by an improving fiscal performance. The deficit narrowed from 3.1% of GDP in 2010 to 2.1% in 2011, significantly lower than the initial target of 3.5% of GDP. Underpinning this performance was a 25.4% increase in central government tax revenue. This was driven by strong economic growth, a 2010 tax reform that eliminated the fixed asset tax credit and improvements in tax collection. The government expects the deficit to narrow to 1.8% of GDP in 2012. Net public debt has also returned to a downward path, declining from 28.1% of GDP in 2010 to 27.3% of GDP in 2011. The Ministry of Finance expects it to decline to 25.9% of GDP in 2012. Consequently, DBRS believes that there is space to provide fiscal and monetary support if growth prospects deteriorate.

The presence of downside risks arising from continuing concerns over sovereign debt and bank balance sheets in some advanced economies – in particular, the Euro area – or a slowdown of growth in China, could have negative effects on Colombia’s economy through financial or terms of trade channels. However, a flexible exchange rate, sound banking system, high inflows of foreign direct investment and a sizable stock of international reserves enhance the resilience of the Colombian economy to adverse shocks. Colombian banks are profitable, highly capitalized and well-provisioned against losses. High foreign direct investment, largely driven by the oil and mining sectors, provides the economy with a stable source of external financing. Furthermore, with $32.5 billion (10% of GDP) in international reserves, Colombia has sufficient dollar liquidity to manage less favorable global financing conditions. This liquidity position is further buttressed by a $6.2 billion precautionary credit line with the IMF.

Despite these strengths, spending pressures and a distortionary tax structure could present medium-term fiscal challenges. The rising cost of the healthcare system, compensation for victims of Colombia’s internal conflict and infrastructure needs will likely demand additional fiscal resources over the medium term. On the revenue side, a narrow tax base, complex VAT structure and high payroll taxes contribute to an inefficient tax regime. However, the Santos administration is expected to present a tax reform in March 2012 that focuses on expanding the tax base. The President’s coalition has a large majority in congress, raising the likelihood that tax reform will be passed.

Furthermore, high structural unemployment and a large informal workforce reflect rigidities in the Colombian labor market. The urban unemployment rate was 11.4% in 2011, despite the strong economic performance, and over half of urban workers are in the informal market. Moreover, income distribution in Colombia is among the most unequal in the region. In December 2010, Congress passed legislation to provide some firms with temporary incentives to hire workers in the formal market. While this was a positive step, it falls short of addressing the fundamental problems of high structural unemployment and significant informality.

The Positive trends signal that an upgrade is likely if the 2011 budgetary reforms are implemented in a manner that enhances the credibility of the fiscal framework and firmly places public debt ratios on a downward path over the medium term. Conversely, a weakened political commitment to fiscal consolidation and debt reduction could lead to a revision of the trends to Stable.

Note:
All figures are in U.S 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 Central Bank of Colombia, Ministry of Finance and Public Credit, DANE, IMF, and Haver Analytics. DBRS considers the information available to it for the purposes of providing this rating was of satisfactory quality.

Lead Analyst: Michael Heydt
Rating Committee Chair: Roger Lister
Initial Rating Date: 11 December 2006
Most Recent Rating Update: 31 March 2011

For additional information on this rating, please refer to the linking document under Related Research.