DBRS Confirms Republic of Colombia at BBB, Stable Trend

DBRS, Inc. confirmed the Republic of Colombia’s Long-Term Foreign and Local Currency – Issuer Ratings at BBB and Short-Term Foreign and Local Currency – Issuer Ratings at R-2 (high). The trend on all ratings is Stable.

KEY RATING CONSIDERATIONS

The rating confirmation reflects DBRS’s view that 1) the Colombian economy has adjusted well to a series of adverse shocks, and 2) sound macroeconomic policies will likely be sustained through the 2018 elections. Facing sharply lower oil prices and weak regional demand, the Colombian economy has rebalanced in an orderly manner. The current account deficit has narrowed to a moderate level. Inflation has converged to the central bank target. Moreover, a gradual economic recovery is expected to begin this year. DBRS expects continuity in economic policy following the presidential election. However, the next administration will inherit a challenging fiscal outlook. The trajectory of the ratings will depend in part on policymakers’ ability to ensure fiscal sustainability while allocating sufficient public resources to achieve the country’s growth and security objectives.

RATING DRIVERS

The Stable trend reflects DBRS’s view that upside and downside risks to the ratings are balanced. The ratings could experience upward pressure over the medium term if fiscal accounts consolidate in a durable manner and supply-side improvements in the economy raise economic growth prospects. Colombia’s ratings do not depend on achieving ambitious structural deficit targets as set out by the current fiscal rule. Nonetheless, the ratings could be lowered if the government fails to implement a credible medium-term fiscal strategy that ensures sustainable public finances.

RATING RATIONALE

External and Domestic Imbalances Have Materially Declined

Tight macroeconomic policy and currency depreciation facilitated Colombia’s adjustment to a large terms of trade shock. The current account deficit narrowed from 6.3% of GDP in 2015 to 3.4% in 2017. While import compression drove the adjustment in 2015 and 2016, strong export growth shouldered the bulk of the rebalancing in 2017. External financing is supported by a steady inflow of net foreign direct investment. In 2018, higher oil prices and stronger demand from regional trading partners will likely lead to a smaller current account deficit, thereby further reducing external vulnerabilities associated with capital flow volatility.

The inflation outlook has also improved. Inflation declined to 3.1% in March 2018 after reaching 9.0% in mid-2016. Price pressures moderated on account of subdued domestic demand and the unwinding of several transitory shocks. Given the more benign outlook, monetary policy has shifted to a more expansionary stance. The central bank has cut the policy rate 350 basis points over the last 18 months, which has fed through into lending rates, particularly for corporates. The banking system is profitable and adequately capitalized and, despite the recent deterioration in asset quality, appears well-positioned to support the economy as demand recovers.

Sound Macroeconomic Policy Framework is Unlikely to Change Following The Election

The presidential election is unlikely to lead to major changes in macroeconomic policy. Centrist and right-leaning parties, which broadly support policy continuity, won large majorities in both houses of congress in March 2018. Regardless of who wins the presidency, Congress is unlikely to back substantial changes in the policy framework. Moreover, the presidential election consists of two rounds. In DBRS’s view, this increases the likelihood of a centrist or right-of-center candidate winning the presidency. The first round is scheduled for May 27th. If no candidate wins a majority, a runoff election between the top two finishers will take place on June 17th.

Notwithstanding Colombia’s record of sound macroeconomic management, DBRS views the broader issue of institutional quality in Colombia as a credit challenge. According to the World Bank Governance Indicators, Colombia compares unfavorably to most similarly rated countries in the area of rule of law. While the peace accord with the FARC could end a 54-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.

Fiscal Accounts Are Adjusting But Additional Effort is Likely Needed to Ensure Sustainable Public Finances

Colombia has tightened fiscal policy in response to the 2014 oil price shock. The government applied a series of tax increases and spending cuts over the last three years, including a major tax reform in December 2016. These measures facilitated the economy’s rebalancing and helped maintain fiscal credibility. Moreover, the deficit-reduction plan is proceeding on schedule. The central government deficit is expected to narrow to 3.1% of GDP this year from 3.6% in 2017 on the back of spending cuts, higher oil revenues, and spillover benefits stemming from arbitration fees paid last year.

However, the scale and pace of the additional consolidation outlined in the fiscal rule looks difficult to achieve without raising additional revenue or modifying the rule. The government is expecting significant revenue gains from formalization and the implementation of anti-tax evasion measures. While possible, DBRS views these projected revenues as highly uncertain. At the same time, corporate tax rates are set to decline through 2019 and rigidity in the spending profile could constrain the government’s ability to reduce expenditures without excessively relying on cuts to public investment, which could weaken medium-term growth.

All of this leaves the next administration with limited room to maneuver. Public debt ratios have stabilized but remain substantially above the levels achieved prior to the terms of trade shock. Depending on the yield of the anti-tax evasion measures, further consolidation efforts will be needed to put public debt ratios on a clear downward path.

Colombia’s Growth Prospects Are Moderate – Constrained by Structural Factors

Colombia’s growth prospects are higher than most regional peers. The IMF expects the Colombian economy to expand on average by 3.5% per year from 2019-2023. Only Peru is expected to grow at a faster pace among Latin America’s largest economies. However, with an aging population and investment already at a high level, Colombia’s growth outlook will depend on productivity.

In that regard, the economy is constrained by several factors. Colombia’s large infrastructure gap is a major impediment to growth. Underdeveloped infrastructure increases transportation costs, thereby limiting access within the domestic market and acting as an obstacle to international competitiveness. In addition, Colombia’s labor market is characterized by high structural unemployment and widespread informality. Finally, the economy is relatively closed and, therefore, does not fully benefit from the potential efficiency gains derived from greater integration into global markets. Consequently, growth prospects will depend in part on the next administration’s ability to advance a comprehensive agenda that addresses these interlinking constraints.

RATING COMMITTEE SUMMARY

The DBRS Sovereign Scorecard generates a result in the A (low) to BBB range. The main points discussed during the Rating Committee include: 1) the fiscal outlook, 2) congressional and presidential elections, and 3) growth outlook.

KEY INDICATORS

Fiscal Balance (% GDP): -3.1% (2017); -2.7% (2018F); -1.9% (2019F)
Gross Debt (% GDP): 49.4% (2017); 49.3% (2018F); 48.2% (2019F)
Nominal GDP (USD billions): 309.2 (2017); 328.0 (2018F); 347.0 (2019F)
GDP per capita (USD thousands): 6.3 (2017); 6.6 (2018F); 6.9 (2019F)
Real GDP growth (%): 1.8% (2017); 2.7% (2018F); 3.3% (2019F)
Consumer Price Inflation (%, eop): 4.1% (2017); 3.4% (2018F); 3.0% (2019F)
Domestic credit (% GDP): 46.9% (2016); 48.9% (2017)
Current Account (% GDP): -3.4% (2017); -2.6% (2018F); -2.6% (2019F)
International Investment Position (% GDP): -48.3% (2016); -48.0% (2017)
Gross External Debt (% GDP): 40.2% (2017); 39.5% (Jan-2018)
Foreign Exchange Reserves (% short-term external debt + current account deficit): 186.9% (2016); 185.1% (2017)
Governance Indicator (percentile rank): 48.5 (2016)
Human Development Index: 0.727 (2015)

Notes:

All figures are in U.S. dollars unless otherwise noted. Public finance statistics reported on a general government basis unless specified. Governance indicator represents an average percentile rank (0-100) from Rule of Law, Voice and Accountability and Government Effectiveness indicators (all World Bank). Human Development Index (UNDP) ranges from 0-1, with 1 representing a very high level of human development.

The principal applicable methodology is Rating Sovereign Governments, which can be found on the DBRS website www.dbrs.com at http://www.dbrs.com/about/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 at http://www.dbrs.com/ratingPolicies/list/name/rating+scales.

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, Tullet Prebon Information, World Bank, NRGI, Brookings, BIS, World Federation of Exchanges, and Haver Analytics. DBRS considers the information available to it for the purposes of providing this rating to be of satisfactory quality.

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

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, Co-Head of Sovereign Ratings
Initial Rating Date: 11 December 2006
Last Rating Date: 28 November 2017

Information regarding DBRS ratings, including definitions, policies and methodologies, is available on www.dbrs.com.