DBRS Confirms the Republic of Colombia at BBB, Stable Trend

DBRS, Inc. (DBRS) confirmed the Republic of Colombia’s long-term foreign currency issuer rating at BBB and long-term local currency issuer rating at BBB (high). The trend on both long-term ratings is Stable. DBRS has also confirmed the short-term foreign currency issuer rating at R-2 (high) and the short-term local currency issuer rating at R-1 (low). The trend on both short-term ratings is Stable.

The rating confirmation reflects DBRS’s assessment that Colombia’s strengthened budgetary framework and favorable growth outlook bode well for the sustainability of public finances. Sound macroeconomic management has helped foster a decade of strong and balanced economic growth. The outcome of the presidential election this year is unlikely to lead to major changes in macroeconomic policy. Despite some downside risks in the near term stemming from less favorable global financing conditions, the trends are Stable, reflecting DBRS’s view that the Colombian economy is well-positioned to weather adverse shocks.

Sound macroeconomic policy and structural reforms will be essential to boost national savings and develop the economy’s productive capacity as Colombia takes advantage of its wealth in non-renewable resources. If the reformed budgetary framework sustains prudent fiscal policy and productivity-enhancing measures foster balanced economic growth, the ratings could be upgraded over the medium term. On the other hand, weakened political commitment to fiscal discipline could put downward pressure on the existing ratings. The outcome of ongoing peace talks with the Revolutionary Armed Forces of Colombia (FARC) is not likely to have a direct effect on the ratings in the near term, although the long-term economic benefits of an accord could be substantial.

Colombia’s medium-term growth prospects are favorable. Abundant natural resources, improved security conditions and significant terms-of-trade gains have spurred higher levels of investment over the last decade, particularly in the oil and mining sectors. Plans to implement a $24 billion highway concession program will further boost investment over the next few years. This infrastructure program could have positive growth effects on the demand-side, by supporting economic activity in 2015 and 2016, and on the supply-side, by increasing the economy’s growth potential. Moreover, the implementation of free trade agreements with the United States and the European Union, the creation of the Pacific Alliance, and strengthening commercial ties with Asia are likely to foster investment and improve productivity as Colombia integrates into the global economy.

Favorable growth prospects are complemented by major reforms that reinforce the credibility of the fiscal framework and reduce the vulnerabilities to public finances. In particular, the adoption of a structural fiscal rule and the overhaul of the royalties system in 2012 will likely strengthen budgetary discipline and facilitate counter-cyclical policy by saving windfall revenues generated by the commodities boom. Reforms have been accompanied by better fiscal outcomes. The central government deficit narrowed from 3.9% of GDP in 2010 to 2.4% in 2013 even as public investment substantially increased. As a result of fiscal consolidation, public debt ratios are on a gradual downward path.

Colombia is in a strong position to weather increased market volatility stemming from the withdrawal of monetary stimulus by the U.S. Federal Reserve. Colombia runs a moderate current account deficit, but large inflows of foreign direct investment provide the economy with a stable source of external financing. Modest levels of external debt, a healthy banking system, substantial international reserves, and a flexible exchange rate further reduce risks associated with capital flow volatility. If the growth outlook weakens, Colombia also has space to provide fiscal and monetary policy support.

The first round of the presidential election is scheduled for May 25th, 2014. If President Santos wins re-election, as most polls suggest, he is expected to have the backing of a large majority in the Congress to advance peace talks with the FARC. A successful conclusion to the peace process could add to fiscal pressures in the near term, but the long-term economic benefits could be substantial. Regardless of who wins, DBRS expects the main pillars of macroeconomic policy to be sustained over the electoral cycle.

Notwithstanding these underlying strengths, spending pressures could present medium-term fiscal challenges. Rising healthcare costs, deep social development needs, and the potential for greater spending commitments related to the peace process, could all put pressure on public finances. In order to comply with the fiscal rule, revenue-raising measures will likely be required, particularly if the financial transaction tax and wealth tax are phased out in the coming years, as currently planned.

In order to sustain high rates of economic growth over the medium term, Colombia will likely need to address several structural challenges. In particular, the labor market is characterized by high structural unemployment and widespread informality. Reforms in 2010 and 2012 have fostered better outcomes. The unemployment rate has declined even as labor force participation has increased, highlighting the strong pace of job growth. Even more, there has been a clear trend in favor of formal employment creation. However, the urban unemployment rate still averaged over 10% in 2013, despite several years of strong economic growth, and nearly half of all workers remain informal. This has negative implications for productivity, social security coverage and income inequality.

In addition, the importance of the oil and mining sectors expose the economy to large changes in commodity prices. Oil alone accounts for over half of goods exports and roughly 17% of government revenues. Although Colombia’s policy framework is designed to dampen the effects of commodity-price volatility on the real economy, a permanent decline in commodity prices would have negative effects on Colombia’s growth and fiscal accounts.

Public security will remain a high priority for any incoming administration, even if peace talks conclude successfully. Over the last decade, the Colombian military drove insurgents into remote areas of the country, out of urban areas and away from transport and energy infrastructure. Nevertheless, the process of reintegrating thousands of former insurgents into society and tackling the criminal activity tied to narcotics trafficking is likely to remain a long-term challenge.

Notes:
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 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, Ministry of Mines and Energy, 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.

For further information on DBRS’ historic default rates published by the European Securities and Markets Administration (“ESMA”) in a central repository see http://cerep.esma.europa.eu/cerep-web/statistics/defaults.xhtml.

Generally, the conditions that lead to the assignment of a Negative or Positive Trend are resolved within a twelve month period while reviews are generally resolved within 90 days. DBRS’s trends and ratings are under constant surveillance.

Lead Analyst: Michael Heydt
Rating Committee Chair: Alan G. Reid
Initial Rating Date: 11 December 2006
Most Recent Rating Update: 28 March 2013

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