DBRS, Inc. (DBRS Morningstar) downgraded the Republic of Colombia’s Long-Term Foreign and Local Currency – Issuer Ratings to BBB (low) from BBB. At the same time, DBRS Morningstar downgraded the Short-term Foreign and Local Currency – Issuer Ratings to R-2 (middle) from R-2 (high). The trend on all ratings has been changed to Stable from Negative.
KEY RATING CONSIDERATIONS
The downgrade is driven by the deterioration in Colombia’s public finances since the outbreak of the pandemic and the high likelihood, in DBRS Morningstar’s view, that the fiscal consolidation going forward will be slower than previously assumed. Gross general government debt increased by 15 percentage points of GDP in 2020 and we expect it to continue rising by about 2 percentage points in 2021 and in 2022. On a consolidated basis, general government debt increased by 14 percentage points of GDP in 2020. The Duque administration presented a fiscal reform in April that would have helped put public finances on a sustainable path, but withdrew the proposal in early May amid widespread protests and congressional pushback. The administration hopes to build consensus around an alternative reform in the coming months, but given the difficult political environment we expect the pace of fiscal consolidation to be gradual. The downgrade reflects deterioration in the “Fiscal Management & Policy” and “Debt & Liquidity” building block assessments.
The Stable trend reflects our expectation that moderate growth prospects, combined with a gradual fiscal adjustment, will stabilize gross general government debt slightly above 70% of GDP over the next 5 years. This is in line with general government debt stabilizing at around 63% of GDP on a consolidated basis. The reopening of the economy, combined with accommodative macroeconomic policies, higher oil prices, and strengthening global demand, should underpin a robust recovery in 2021 and 2022, although the protests and surge of COVID-19 cases pose risks to the near-term outlook. The Stable trend assumes that Colombia’s political institutions will respond to citizens’ demands over time and in a manner that preserves the country’s political and economic stability.
The BBB (low) ratings balance Colombia’s fiscal and governance challenges with the country’s sound macroeconomic policy framework and moderate growth prospects. Colombia benefits from a credible inflation-targeting regime, exchange rate flexibility, and sound financial sector regulation. Due to its strong policy framework, Colombia has been able to implement expansionary macroeconomic policies and credit-supporting prudential measures, thereby mitigating the impact of the pandemic on the economy. At the same time, infrastructure development and the integration of Venezuelan migrants into the economy should support the country’s growth prospects.
Colombia’s ratings could be upgraded if fiscal reforms narrow the structural deficit and reduce the public debt burden. The reinstatement of a credible fiscal rule that provides a sustainable anchor for fiscal policy would also be credit positive. In addition, the ratings could be upgraded if medium-term growth prospects strengthen on the back of supply-side improvements in the economy.
The ratings could be downgraded if 1) the fiscal adjustment is slower in pace or smaller in scale than current assumptions, thereby leading to a higher public debt burden, or 2) medium-term growth prospects materially underperform expectations, thereby complicating efforts to put public finances on a sustainable path.
The Duque administration presented a fiscal reform to Congress on April 15. We stated in our previous rating review (published April 6, 2021) that passage of the reform was critical to maintaining the BBB ratings. In our view, the reform would have limited the deterioration in public finance metrics, helped anchor market confidence, and enabled authorities to rebuild fiscal space over time. However, in early May the Duque administration withdrew the reform following widespread protests and pushback in Congress. The administration is now trying to build support across society and in congress on an alternative strategy that would include a more gradual consolidation of the fiscal accounts.
The COVID-19 shock and the fiscal response has led to a material deterioration in Colombia’s public debt metrics. Gross general government debt (unconsolidated) increased from 52% of GDP in 2019 to 67% in 2020. The 15 percentage point of GDP increase was due to the sharp contraction in GDP, the large fiscal deficit, and peso depreciation. The debt-to-GDP ratio is expected to rise above 70% in 2022 and then stabilize as the fiscal deficit gradually narrows. On a consolidated basis, general government debt increased from 45% of GDP in 2019 to 58% in 2020. The consolidated debt ratio is expected to increase to 63% in 2023. The deterioration in the debt metrics relative to April 2021 assumptions account for the negative adjustment to the “Debt and Liquidity” building block.
The Colombia economy was rapidly recovering in early 2021 but the protests and the surge in COVID-19 cases may have weakened growth momentum over the last 2-3 months. GDP expanded at an annualized pace of 11.9% in the first quarter, driven by a rebound in private consumption and investment. Based on the carryover from the first quarter, GDP growth would be 8.0% in 2021 even if quarterly growth were to stall the rest of the year. The recent wave of the pandemic, which began in March 2021, is having a severe impact on health outcomes in the country, with new cases and deaths reaching its highest level last week. The economic effect of the outbreak, combined with the protests, could lead to a contraction in output in the second quarter relative to the previous period. Nevertheless, the economy still looks set to outperform the IMF’s April forecast for GDP growth of 5.2% in 2021.
Colombia’s medium-term growth prospects are good compared to regional peers. The IMF expects output to be 14% above 2019 levels by 2025, the best forecast among Latin America’s largest economies. Although this does not imply a strong cumulative growth performance from 2019 to 2025, it highlights Colombia’s resilience compared to others in the region. This economic resilience accounts for the one category uplift in our assessment of the Economic Structure and Performance building block.
Colombia will hold congressional elections in March 2022 and the first round of the presidential election will be held two months later. The BBB (low) ratings assume that the broad pillars of macroeconomic policy will be maintained through the electoral cycle. Potential presidential candidates span the ideological spectrum. In the center and on the right, there are many potential candidates but no clear frontrunner. On the left, Gustavo Petro, the former mayor of Bogota, stands out. A lack of clarity around the direction of economic policy in the run-up to the election or in its aftermath could lead to market volatility.
Resource & Energy Management (E), Human Capital & Human Rights (S), Bribery, Corruption & Political Risks (G), Institutional Strength, Governance & Transparency (G), and Peace & Security (G) were among key drivers behind this rating action. The economy is vulnerable to oil price shocks, with petroleum products constituting roughly 1/3 of Colombia’s exports, 20% of foreign direct investment inflows, and 5-10% of government fiscal revenues. Similar to other emerging market economies and many of its regional peers, Colombia’s GDP per capita is relatively low at US$5.3k (US$14.3k on a PPP basis). This largely reflects the low level of labor productivity. In addition, organized criminal gangs continue to commit human rights abuses, especially against journalists, community leaders, and human rights activists. According to World Bank Governance Indicators, Colombia ranks in the 49th percentile for Control of Corruption, the 56th percentile for Voice & Accountability, and the 56th percentile for Government Effectiveness. While Colombia has made significant progress in reducing violence through a peace deal with the FARC, the country still ranks very low (16th percentile) on Political Stability and the Absence of Violence/Terrorism, and ranks in the 39th percentile for Rule of Law. These considerations have been taken into account within the following Building Blocks: Fiscal Management and Policy, Economic Structure and Performance, Balance of Payments, and Political Environment.
A description of how DBRS Morningstar considers ESG factors within the DBRS Morningstar analytical framework can be found in the DBRS Morningstar Criteria: Approach to Environmental, Social, and Governance Risk Factors in Credit Ratings at https://www.dbrsmorningstar.com/research/373262.
For more information on the Rating Committee decision, please see the Scorecard Indicators and Building Block Assessments: https://www.dbrsmorningstar.com/research/380543.
For more information regarding rating methodologies and Coronavirus Disease (COVID-19), please see the following DBRS Morningstar press release: https://www.dbrsmorningstar.com/research/357883
All figures are in U.S. dollars unless otherwise noted. Public finance statistics reported on a general government basis unless specified.
The principal methodology is the Global Methodology for Rating Sovereign Governments https://www.dbrsmorningstar.com/research/364527/global-methodology-for-rating-sovereign-governments (July 27, 2020). Other applicable methodologies include the DBRS Morningstar Criteria: Approach to Environmental, Social, and Governance Risk Factors in Credit Ratings https://www.dbrsmorningstar.com/research/373262/dbrs-morningstarcriteria-approach-to-environmental-social-and-governance-risk-factors-in-credit-ratings (February 3, 2021).
Generally, the conditions that lead to the assignment of a Negative or Positive trend are generally resolved within a 12-month period. DBRS Morningstar’s outlooks and ratings are monitored.
The primary sources of information used for this rating include the 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 Morningstar 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 for this rating action. DBRS Morningstar 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.
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