DBRS Upgrades Colombia to BBB, Trend Revised to Stable

DBRS, Inc. (DBRS) has upgraded the Republic of Colombia’s long-term foreign currency issuer rating to BBB from BBB (low) and the long-term local currency issuer rating to BBB (high) from BBB. The trends on both long-term ratings have been revised to Stable from Positive. In addition, DBRS has upgraded the short-term foreign currency issuer rating to R-2 (high) and the short-term local currency issuer rating to R-1 (low). The trends on both short-term ratings have been revised to Stable from Positive.

The upgrade reflects DBRS’s assessment that Colombia’s strengthened budgetary framework and favorable growth outlook bode well for fiscal consolidation and public debt sustainability. Moreover, the ratings are underpinned by Colombia’s track record of sound macroeconomic management, which has supported strong and balanced economic growth. Although there are near-term risks to the outlook stemming from an uncertain global environment, the trends are Stable, reflecting DBRS’s view that Colombia’s growth prospects remain favorable and that the economy is well-positioned to weather adverse shocks.

Following a robust recovery in 2010 and 2011, the pace of economic growth moderated to 4.0% in 2012. Supply constraints in the mining sector, bottlenecks in construction and weak external demand contributed to the slowdown. Nevertheless, the economy continues to benefit from favorable terms of trade, large FDI inflows and healthy credit dynamics. Furthermore, resilient household consumption and higher public investment are expected to support a modest acceleration in 2013. The IMF forecasts GDP growth of 4.4%.

Security improvements, abundant natural resources and macroeconomic stability have spurred higher levels of investment and raised Colombia’s medium-term growth prospects. Investment rose from 15% of GDP in 2001 to 23% of GDP in 2012. Expectations of higher oil and mining production, the recent approval of free trade agreements with the United States and European Union, and strengthening commercial ties with Asia are also likely to support higher investment and export growth as Colombia increasingly integrates into the global economy.

Favorable growth prospects are complemented by major reforms that reinforce the credibility of the fiscal framework and support fiscal consolidation. In particular, the adoption of a structural fiscal rule and the overhaul of the royalties system will likely strengthen budgetary discipline and facilitate counter-cyclical policy by saving windfall revenues generated by the commodities boom. These reforms have been accompanied by better fiscal outcomes. The central government deficit narrowed from 3.9% of GDP in 2010 to 2.8% in 2011 and 2.4% in 2012. Underpinning this improvement was a large increase in tax revenue, driven by higher commodity-related receipts, a 2010 tax reform, and improvements in tax collection. Fiscal consolidation has helped put public debt ratios on a gradual downward path. Net public debt declined from 28.3% of GDP in 2010 to an estimated 26.4% in 2012.

Downside risks to the outlook largely stem from the external environment. An intensification of the euro area crisis or a sharp deceleration of growth in China could have negative effects on Colombia’s economy through financial and terms of trade channels. As a large commodity exporter, Colombia is exposed to the commodity price cycle. However, DBRS believes Colombia could provide fiscal and monetary support if growth weakens. Furthermore, a flexible exchange rate, low levels of external debt and a healthy banking system enhance the economy’s resilience to adverse shocks. Colombian banks, which are well-capitalized and profitable, have limited direct exposure to the European financial system. Large inflows of foreign direct investment provide the economy was a stable source of external financing. In addition, Colombia is well-positioned to manage less favorable global financing conditions. Reserves totaled $38.5 billion (11% of GDP) in February 2013. This liquidity position is further buttressed by a $5.8 billion precautionary credit line with the IMF.

Despite these strengths, spending pressures could present medium-term fiscal challenges. Rising healthcare costs, compensation for the victims of Colombia’s internal conflict, infrastructure spending and deep social development needs could demand additional fiscal resources. In order to comply with fiscal targets, revenue-enhancing measures will likely be required, particularly if the financial transaction tax and wealth tax are phased out in the coming years.

In addition, Colombia will likely need to address several structural challenges in order to boost productivity and sustain high rates of economic growth. In particular, high structural unemployment and widespread informality reflect rigidities in the Colombian labor market. The urban unemployment rate was over 11% in 2012, despite several years of strong economic growth, and more than half of workers are informal. This has negative implications for productivity, social security coverage and income inequality. The tax reform passed in December 2012, which increases incentives to generate formal employment, is a positive step. Nevertheless, additional measures will likely be needed to substantially improve labor market outcomes.

As Colombia takes advantage of its abundant natural resource wealth, sound macroeconomic management and structural reforms will be essential to boost national savings and develop the economy’s productive capacity. If the reformed budgetary framework sustains prudent fiscal policy and productivity-enhancing measures support strong and balanced economic growth, there could be upward pressure on the ratings over the medium term. On the other hand, weakened political commitment to fiscal discipline could lead to a revision of the trends to Negative from Stable.

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

The principal applicable methodology is Rating Sovereign Governments, which can be found on our website under Methodologies. The principal applicable rating policies are Commercial Paper and Short-Term Debt, and Short-Term and Long-Term Rating Relationships, which can be found on our website under Rating Scales.

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.

This rating is endorsed by DBRS Ratings Limited for use in the European Union.

Lead Analyst: Michael Heydt
Rating Committee Chair: Alan G. Reid
Initial Rating Date: 11 December 2006
Most Recent Rating Update: 17 December 2012

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