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). In addition, DBRS has 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 Colombia’s record of sound macroeconomic management and favorable medium-term growth prospects. The economy has adjusted to a series of external shocks in an orderly manner, supported by tight macroeconomic policy and currency depreciation. In 2016, external and domestic imbalances materially declined. The structural tax reform – passed in December 2016 – supports budget consolidation efforts and reinforces fiscal credibility. In addition, Colombia’s medium-term prospects are comparatively strong and could outperform expectations, particularly as the fourth generation (4G) infrastructure program advances. These positive factors are offset by several underlying credit challenges, including potential medium-term fiscal pressures, infrastructure bottlenecks, and high levels of labor informality.

Tight macroeconomic policy and exchange rate depreciation facilitated a large adjustment in the Colombian economy in 2016. GDP growth decelerated to 2.0% as domestic demand moderated. This helped narrow the current account deficit 2 percentage points to 4.4% of GDP in 2016. On the domestic front, inflation trended downward during the second half of the year. It is now approaching the upper band of the central bank’s target range. With the external and domestic adjustments well-advanced, a modest recovery is expected begin this year. The IMF projects GDP growth of 2.3% in 2017 and 3.0% in 2018. The pick-up will be supported by less restrictive monetary policy, increased infrastructure investment, and a rebound in oil prices.

Passage of the structural tax reform in December 2016 helps anchor fiscal sustainability and reinforce policy credibility. Taken as a whole, the reform improves tax efficiency, strengthens compliance, and raises sufficient revenue to achieve fiscal consolidation objectives over the next few years.

Colombia’s medium-term growth prospects are higher than most regional peers. The IMF expects Colombia to expand on average 3.6% per year from 2019-2022. Only Peru is expected to grow at a faster pace among Latin America’s largest economies. Despite cuts in commodity-related sectors, investment levels remain high. The 4G infrastructure program is expected to have positive growth effects on the demand side in the near term while increasing the economy’s growth potential. Moreover, the outward policy orientation through the expansion of free trade agreements and membership in the Pacific Alliance is likely to foster investment and improve productivity as Colombia more fully integrates into the global economy.

DBRS believes that the economic benefits of the peace accord could be substantial over the long term, as human and physical capital that were previously diverted by the conflict are reallocated toward more productive sectors of the economy. In DBRS’s view, however, the peace agreement is not likely to boost the economy in the near term. In large part, the Colombian economy is already benefiting from the security improvements achieved during the previous decade. Moreover, the government is unlikely to reduce or re-channel defense spending in the near term, particularly as other insurgent groups and organized crime networks continue to operate in Colombia.

Notwithstanding revenue-raising measures in the 2016 structural tax reform, DBRS believes medium-term fiscal pressures could reemerge. Spending pressures are likely to intensify due to post-conflict costs and social development commitments. At the same time, formalization and anti-tax evasion measures included in the 2016 reform could generate less revenue than anticipated. Consequently, complying with fiscal targets in the medium term could be challenging. Recognizing the need to contain spending, the government has put together a spending commission to rationalize expenditure and improve the delivery of social programs.

In addition, several underlying factors constrain Colombia’s productivity performance and economic diversification. Colombia’s large infrastructure gap is a major impediment to growth. Underdeveloped infrastructure increases transportation costs, limiting access within the domestic market and acting as an obstacle to international competitiveness. According to the 2016-2017 Global Competitiveness Report by the World Economic Forum, Colombia ranked 113th out of 138 countries in terms of the quality of overall infrastructure.

Colombia’s 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 and the trend has clearly been in favor of formal employment creation. However, the urban unemployment rate still averaged 10% in 2016 and approximately half of the workforce is informal. This has negative implications for productivity, social security coverage, and income inequality.

Public security remains a high priority of the government. While the peace accord could end a 52-year old armed conflict, the process of extending the state’s presence, reintegrating thousands of former combatants into society, and addressing criminal activity tied to narcotics trafficking remain long-term challenges.

RATING DRIVERS
The Stable trend reflects DBRS’s view that risks to the ratings are broadly balanced. If spending pressures intensify and weaken the outlook for fiscal sustainability, the rating could be downgraded. On the other hand, durable consolidation in the fiscal accounts, in line with the structural rule, combined with improvements in the supply-side of the economy could put upward pressure on the ratings over the medium term.

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. These can be found at http://www.dbrs.com/about/methodologies.

The sources of information used for this rating include Ministerio de Hacienda y Crédito Público, Banco de la República, Superintendencia Financiera de Colombia, DANE, IMF, UNDP, The Conference Board Total Economy Database November 2016, Banco Central do Brasil, Banco Central de Chile, Banco de México, Banco Central de Reserva del Perú, Banco Central del Uruguay, and Haver Analytics. DBRS considers the information available to it for the purposes of providing this rating was of satisfactory quality.

The rated entity or its related entities did participate in the rating process. DBRS did not have access to the accounts and other relevant internal documents of the rated entity or its related entities.

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, Vice President, Global Sovereign Ratings
Rating Committee Chair: Thomas R. Torgerson, Senior Vice President, Global Sovereign Ratings
Initial Rating Date: 11 December 2006
Last Rating Date: 29 April 2016

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