DBRS Confirms Republic of Colombia at BBB, Stable Trend

DBRS, Inc. has confirmed the Republic of Colombia’s long-term foreign currency issuer rating at BBB and long-term local currency issuer rating at BBB (high). 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 all ratings is Stable.

The rating confirmation reflects DBRS’s view that the Colombian economy is well-prepared to weather external shocks, including sharply lower oil prices and potential market volatility associated with rising interest rates in the United States. Colombia benefits from a sound macroeconomic policy framework, favorable medium-term growth prospects, and strong external resilience, all of which should facilitate the economy’s adjustment amidst a challenging global environment and support the sustainability of public finances. These underlying strengths are countered by several credit weaknesses, including medium-term fiscal pressures, high labor informality and public security challenges.

The Stable trends indicate that risks to the ratings are broadly balanced. If the government continues to adhere to the structural rule as an anchor for fiscal policy and supply-side reforms sustain strong rates of economic growth, the ratings could be upgraded. On the other hand, weakened political commitment to fiscal discipline could put downward pressure on the 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.

The sharp decline in oil prices is having an adverse impact on Colombia’s external accounts, public finances and economic growth. Petroleum products account for more than half of Colombia’s exports and roughly 17% of government revenues. The oil sector is also a major source of investment. Nevertheless, Colombia’s credible macroeconomic policy framework is helping to foster a smooth macroeconomic adjustment. An improved budgetary framework has strengthened fiscal accounts and reduced public debt ratios to a moderate level. The central bank, operating under a credible inflation-targeting regime, has anchored inflation expectations around the 3% target. Furthermore, a flexible exchange rate is dampening the effects of lower oil prices on the fiscal accounts while facilitating an external adjustment. Consequently, Colombia is still expected to grow 3.4% this year, markedly faster than the Latin American region as a whole, despite a large terms of trade shock.

Moreover, medium-term growth prospects remain favorable. Colombia has experienced rising investment and will benefit from the implementation of a $23 billion highway concession program over the next few years. Greater infrastructure spending could have positive growth effects on the demand-side, by boosting investment in 2016 and 2017, 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 further integrates into the global economy.

Colombia is relatively well-positioned to weather potential market volatility associated with the normalization of monetary policy in the United States. Although the current account deficit widened to 5.2% of GDP in 2014 and is expected to widen further this year, large net inflows of foreign direct investment provide the economy with a stable source of external financing. Low levels of external debt, a well-capitalized banking system that relies primarily on domestic deposit-based funding, substantial international reserves, and a flexible exchange rate further reduce risks associated with capital flow volatility. Moreover, Colombian exports stands to benefit directly from a strengthening economy in the United States.

However, these credit strengths are countered by several underlying weaknesses. Lower oil-related revenues and mounting spending pressures could present fiscal challenges over the medium term. Structural revenues face downside risks stemming from oil prices and volumes. On the spending side, rising healthcare costs and the potential for greater spending commitments related to the peace process, could also put pressure on public finances. In order to comply with the fiscal rule, revenue-raising measures will likely be required. The government has recently created a tax committee to provide recommendations on how to enhance the efficiency and competitiveness of the tax system while still achieving deficit targets. Its recommendations are expected later this year.

In addition, sustaining high rates of growth without the support of global tailwinds will likely require productivity-enhancing reforms. 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, the trend is clearly in favor of formal employment creation. However, despite five consecutive years of solid economic growth, the urban unemployment rate still averaged 10% in 2014 and nearly half of all workers are informal. This has negative implications for productivity, social security coverage and income inequality.

The economic benefits of a potential peace accord with the Revolutionary Armed Forces of Colombia (FARC) could be substantial over the long-term. However, even if peace talks conclude successfully, public security will remain a high priority for the government. The process of reintegrating thousands of former insurgents into society and tackling the criminal activity tied to narcotics trafficking is 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 Ministry of Finance and Public Credit, Central Bank of Colombia, DANE, IMF, the Conference Board Total Economy Database, 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: 30 April 2014

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