On behalf of the authorities, I want to express our gratitude to the Board for the FCLs obtained by Colombia, and to staff and management for their continued support. Colombia belongs to a group of countries for which special swap lines are not available and regional liquidity arrangements do not provide adequate coverage. Consequently, the FCLs have been instrumental to cope with heightened external risks in recent years, and have suited well the country’s need for liquidity risk coverage in a highly uncertain environment.
Indeed, the FCLs have been an important complement to the authorities’ wide policy response to the global crisis, which has involved exchange rate flexibility, countercyclical fiscal and monetary policies, securing precautionary external funding, and ensuring a cushion of international liquidity for the country. In addition, the availability of the instrument has provided space to strengthen the policy framework and to build policy buffers, while sending a positive signal to international financial markets on the strength of the economy.
Also, the FCLs have enhanced the economy’s resilience in the face of adverse external shocks, as reflected in the market assessment of Colombia’s credit risk. A study by the central bank (Banco de la Republica)1 found that access to the FCL reduced the sovereign risk premium (EMBI) for Colombia and México by 10 and 15 bps., respectively, after controlling for the movement of the EMBI for a group of similar countries. The FCLs had also a statistically significant positive impact on the Consumer Confidence Index in Colombia. Moreover, when these effects were included in a DSGE model for the Colombian economy, the FCL was found to have an important positive influence on growth. Consistently, an IMF exercise found that the FCL reduced the EMBI spreads for Colombia and México by 51 bps., after controlling for domestic macroeconomic variables and the VIX2.
The access level of the FCL approved by the Board in June 2013 was 500 percent of the quota (SDR 3.87 billion). The authorities perceive that the current international risk measures are higher than or equal to those prevailing when the line was requested, and there is no market evidence of a generally less risky international environment. This is consistent with the risk assessments in the April 2014 World Economic Outlook and the Global Financial Stability Report, particularly with regard to emerging markets (EMs).
As other EMs, Colombia is subject to a variety of shocks. The fallout of the protracted global financial crisis is still being felt, this time in the form of an uncertain and potentially disruptive normalization of the monetary policy pursued in the U.S. After the “tapering” announcement by the U.S. Federal Reserve, some local asset markets recorded high volatility, as illustrated in the staff report. Although this volatility was reasonably absorbed by the economy, it served as an indication of the type of turbulence that may appear in the future. The next step that involves raising policy interest rates could be more disruptive, as some past episodes suggest. Although these changes would come as a result of a stronger U.S. economy and higher external demand for EMs, adverse shocks through world financial markets could overwhelm any positive effect stemming from real channels. Indeed, the April 2014 WEO pointed out that “unexpectedly rapid normalization of U.S. monetary policy or renewed bouts of high risk aversion on the part of investors could result in further financial turmoil. This would lead to difficult adjustments in some emerging market economies, with a risk of contagion and broad-based financial stress, and thus lower growth.”
In addition, the uncertain situation of the financial system in China and, more generally, of growth perspectives entail serious risks for several commodity exporting EMs. The impact of an abrupt Chinese slowdown on the prices and quantities exported by these economies could be substantial. The same shocks may also curtail global growth and indirectly affect individual countries. For instance, Colombia could be affected not only directly, through decreases in the prices and quantities of commodity exports, but also indirectly, through a declining export demand from regional markets that depend significantly on exports to China (e.g. Ecuador, Peru, Chile etc.)3.
In summary, the disruptions caused by unexpectedly turbulent adjustments in the U.S. and China may affect directly the Colombian economy through their impact on export revenues, capital flows and asset price changes. They could also trigger adverse reactions in other EMs and impact the economy via financial contagion.
It is worth noting that the increased participation of foreigners in the local asset markets (public bonds and equity) may exacerbate the response of these markets to a shock. Recently, the weight of Colombian local public bonds in the benchmark portfolios of some investors was substantially augmented. As a result, there have been additional portfolio investment inflows and a large drop in long-term interest rates. While this phenomenon is partly due to the resilience of the economy and the robustness of its macroeconomic policy framework, there could be also reasons related to the weakness and riskiness of other EMs. Should the state of the latter change, a (partial) reversal of capital inflows and a local asset appreciation may ensue. This potential volatility adds to the above-mentioned risks.
Lines of defense against external risks
A Strong Policy Framework. For the Colombian authorities it is clear that a first line of defense against the outcomes of these shocks is a strong macroeconomic policy framework that provides the country with resilience and with the ability to pursue countercyclical policy responses. This framework rests on three pillars, namely (i) sustainable fiscal policy; (ii) an inflation targeting regime with exchange rate flexibility and (iii) a strong financial system.
(i) A sustainable fiscal policy reduces the probability of an abrupt cut in external funding for the economy. It is also a pre-condition for a counter-cyclical fiscal policy response to an exogenous macroeconomic shock. Colombia has a Fiscal Rule and a Constitutional Royalties Regime that facilitate saving temporary public revenue windfalls. This ensures a sustainable path for the public debt in the context of a Medium Term Fiscal Framework.
(ii) A strong financial system involves not only solvent and liquid financial intermediaries, but also the absence of large currency or term mismatches in the real and financial
sectors. In these circumstances, an external shock will not significantly cut domestic credit supply, severely undermine the payment system or suddenly compromise fiscal sustainability (through large financial bankruptcies).
(iii) A flexible exchange rate regime allows the exchange rate to work as a shock absorber and permits monetary policy to respond counter-cyclically to shocks. A credible long- term inflation target, a subdued exchange rate pass-through, and low currency and FX term mismatches are both consequences and conditions for the successful operation of the monetary and FX policy strategy.
This policy framework served well Colombia during the global financial crisis, being one of the few countries that did not experience a recession in its aftermath. Since then, the framework and fundamentals have remained strong, as stated in detail in the Article IV consultation report of May 2014 (IMF Country Report No. 14/141).
The fiscal deficit and the public debt as a percentage of GDP have declined. In 2013, the fiscal target dictated by the fiscal rule for the central government of 2.4 percent of GDP was met (0.9 percent for the combined public sector). The consolidation will continue gradually in the next years in order to reach a structural deficit of the central government of 1.9 percent of GDP in 2018 and levels below 1 percent in 2022 onwards—which in turn will bring down public debt to 26 percent of GDP.
Inflation has remained within the 2–4 percent long-term target range and international reserves have been accumulated to maintain reserve indicators at adequate levels. It is worth noting, however, that although the pursued level of international reserves is considered adequate for precautionary purposes, it would be insufficient to cope with tail risks. The exchange rate has been the main shock absorber; after the announcement of the tapering by the U.S. Federal Reserve, the currency depreciated significantly with no negative consequences for the economy or inflation.
The external position continues to be strong. In 2013 the current account deficit stood at 3.4 percent of GDP, similar to that of 2012, comfortably financed with capital inflows (5.3 percent of GDP) of which FDI constitutes the largest fraction.
The financial sector remains sound, with healthy corporate and households balance sheets, strong credit quality and profitability. The solvency ratio of close to 15 percent is well above the regulatory minimum (9 percent) and, since August 2013, it complies with the capital quality required by Basel III. Colombian credit institutions hold ample liquidity and are required to satisfy a liquidity indicator in line with the Liquidity Coverage Ratio of Basel III. Currency and maturity mismatches of financial intermediaries are closely monitored and regulated.
Self-Insurance and the Global Financial Safety Network. Despite its strengths, the macroeconomic policy framework may not be sufficient to face a large external shock or a combination of external shocks without heavy costs on domestic economic activity and welfare. This is a situation shared by other economies with similar sizes and exposures, for which the Global Financial Safety Network does not offer an alternative to cope with large or multiple external shocks. On the one hand, Colombia’s economy may not be considered as a “systemically important”; hence, the possibility of bilateral swap lines or other similar mechanisms is not available. Even if Colombia were eligible, these instruments have a short maturity and have been available only during systemic stress periods as stated by the IMF4. On the other hand, regional international liquidity facilities like the Latin-American Reserves Fund (LARF) cannot provide enough funds as potentially needed.
Thus, in the absence of mechanisms such as the FCL, countries like Colombia have only the option to self-insure by accumulating international reserves. The latter, however, is inefficient both from the point of view of the individual country and of the world as a whole. The country is forced to maintain a costly stock of reserves to mitigate the effects of low- probability adverse events, while the international system may be confronted with excessive reserve accumulation, with undesirable consequences on global imbalances and risk-taking.
In that sense, products like the FCL help “complete the markets”, by providing more efficient protection instruments5. This is entirely compatible with the Fund’s objective to contribute to a robust Global Financial Safety Net, in which well-behaved “innocent bystanders” could be protected from the fallout of large or multiple external shocks.
In this context, the Fund (and the Board) should focus on removing the obstacles that are preventing the demand for precautionary instruments, and have a more proactive and extensive outreach to communicate their effectiveness in contributing to the stability of countries that have requested them as well as their significant positive externalities to the international system. Imposing new costs or constraints to these instruments may have undesired effects; for example, the requirement for a concrete ex-ante exit strategy may discourage the demand from new users. This trade-off needs to be taken into consideration when addressing the concerns about continued use of precautionary instruments.
The Colombian authorities are fully aware that the FCL is a temporary facility and are increasingly monitoring external risks. The access requested since 2009 has changed along the fluctuations in the riskiness of the external environment, as well as the authorities’ assessment of future risks. They remain committed to continue strengthening the policy framework and to treat the FCL as a precautionary facility.
“Impacto macroeconómico de la línea de crédito flexible con el Fondo Monetario Internacional”. Mimeo. Departamento de Modelos Macroeconómicos, Banco de la República. March 2011.
“Review of the Flexible Credit Line, the Precautionary and Liquidity Line, and the Rapid Financing Instrument”. IMF. January 2014. P. 43.
Colombian exports to China accounted for roughly 9 percent of total exports in 2013, and 24 percent of total exports were sold in 2013 to countries with significant trade links with China (excluding the US).
“The Fund’s Mandate-Future Financing Role.” IMF. March 2010.
This does not mean that the FCL is a substitute for international reserves accumulation, but rather a complement.