Last year, Colombia suspended its fiscal rule, in place since 2011, until 2022 to allow an increase in spending and new debt issuance to finance direct transfers to households and spending in social care and healthcare. As a result, the fiscal deficit almost tripled to nearly 7% of GDP in 2020 and is expected to reach 9% in 2021, according to the Colombian Ministry of Finance. The IMF estimates Colombia’s gross debt has increased from 52% of GDP in 2019 to 63% in 2020. The decline in activity in 2020 helped reducing the current account deficit to 3.3% of GDP as a result of higher net borrowing, a reduction in remittances abroad from the corporate sector and a smaller trade deficit.
Investment Insights
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A political crisis threatens Colombia’s recovery in 2021
One challenge governments will face in the aftermath of the Covid-19 pandemic is to return the economies to a sustainable growth path. In the case of Colombia, real GDP grew by 1.1% in Q1-2021 in comparison with the same quarter last year, representing a considerable recovery from a decline of almost 4% in Q4-2020. However, weakening public finances, social protests and a political crisis could undermine GDP growth in 2021. In this Macro Flash Note, Joaquin Thul looks at the recent events.
Chart 1. Colombia’s fiscal balance and current account balance (% of GDP)
Source: Refinitiv, Ministerio de Hacienda y Crédito Publico and EFGAM
Chart 2. Colombia’s government gross debt (% of GDP)
Source: Refinitiv, Ministerio de Hacienda y Crédito Publico and EFGAM
On April 15th, as part of the efforts to strengthen public finances, President Ivan Duque sent a tax reform bill to Congress. The reform intended to increase revenue by 2% of GDP over the next 10 years by removing some VAT exemptions, lowering the income tax threshold and increasing taxes on pensions. Colombia’s finance minister Alberto Carrasquilla added the reform would allow government to increase spending on social programs and reduce extreme poverty, which increased from 9.6% to 12.8% of the population in 2020.1
The bill was criticized by Colombians, who considered the tax increases were inappropriate after unemployment increased from 10% to 21% in 2020 and economic conditions had worsened because of one of the stricter lockdowns in the region. In May 2021, the discontent over the bill and questions of President Duque’s inability to tackle the effects of the pandemic led to protests in Cali, Medellin and Bogota, followed by a national strike. These protests turned violent after the army’s intervention, ending with at least 24 people dead. These incidents prompted Duque to withdraw the bill and the resignation of Finance Minister Carrasquilla.
Jose Manuel Restrepo was appointed as the new Finance Minister with a mandate to draft a new reform bill. Three alternatives are being considered: The first is to pass a new version of a tax reform that helps to raise revenue. However, given recent events the new reform will probably focus on increasing the corporate tax rate, currently at 33%, rather than VAT. Risks are that in order to appeal to all political sectors the new reform raises too little revenue to stabilize the debt dynamics, requiring additional measures.
The second option would be the privatization of government-controlled companies such as Interconexion electrica (ISA), an electricity company, or Ecopetrol, the state-owned oil firm. Colombian authorities have considered selling their 51% stake in ISA, but no decision has been made yet. Although the sale of some of these assets would help public finances, past experiences show that privatizations are often slow due to political red tape. This might not be a quick solution.
The third option is to seek external funding from multilateral organizations. Colombia is among the few developing economies with access to the IMF’s Flexible Credit Line (FCL).2 In December 2020, the government drew USD 5.4 billion from the USD 17.6 billion available under the FCL, which helped the government meet some short-term financing needs. Colombia still has USD 12.2 billion available under this credit line. Although this might be the quickest alternative, it does not address the long-term sustainability issues.
Overall, the economic situation in Colombia has worsened over the last year, in line with other economies in the region because of the Covid-19 pandemic. As the country tries to control the third wave of Coronavirus cases, markets have reacted negatively to the rise in political uncertainty. Yields on Colombia’s 10-year government bonds increased from 5% in February to close to 7.5% in May and the Colombian peso has depreciated by 8.5% against the US dollar in 2021, more than most other currencies in the region.
Chart 3. Depreciation of Latin American currencies vs USD in 2021
Source: Refinitiv and EFGAM
Chart 4. Government bond yield (%)
Source: Refinitiv and EFGAM
Despite the suspension of the fiscal rule, Colombia is struggling to find alternatives to finance an increase in public spending. The failed attempt to pass a tax reform was the catalyst for a political and social crisis which could undermine Colombia’s hard-earned credibility over the last 10 years. Both S&P and Fitch rating agencies rate Colombia as BBB-, just one notch above high yield, with a negative outlook which will be reviewed before the next Presidential election in 2022. After three weeks of protests, the government needs to find a solution to the social crisis before it can plan a reopening of the economy. However, without a clear solution in sight for the social crisis, the economic and political conditions will remain volatile in the coming months.
1 Departamento Administrativo Nacional de Estadística, DANE, Colombia, April 2021.
2 The FCL was designed to meet the demands for crisis prevention and mitigation by lending to countries with strong policy frameworks and track records. Up to date only Chile, Colombia, Mexico, Peru and Poland can apply for FCL funds.