This 1999 Article IV Consultation highlights that the recession in Colombia intensified in 1999. The unemployment rate rose to a record 20 percent in September, while inflation fell to 9½ percent and the current account deficit came down sharply. The fiscal position deteriorated markedly during the first half of 1999, largely as a result of weak tax collections and higher outlays on interests, wages, and pensions. As market sentiment toward Colombia remained unfavorable, the peso came under repeated pressure, and on September 27, 1999, the central bank allowed the currency to float.


This 1999 Article IV Consultation highlights that the recession in Colombia intensified in 1999. The unemployment rate rose to a record 20 percent in September, while inflation fell to 9½ percent and the current account deficit came down sharply. The fiscal position deteriorated markedly during the first half of 1999, largely as a result of weak tax collections and higher outlays on interests, wages, and pensions. As market sentiment toward Colombia remained unfavorable, the peso came under repeated pressure, and on September 27, 1999, the central bank allowed the currency to float.

I. Introduction

1. The discussions for the 1999 Article IV consultation and use of Fund resources under the Extended Fund Facility (EFF) were held at headquarters during three periods from August 15 to October 27.1 In a letter to the Managing Director dated December 3, 1999 and its attached memorandum of economic policies, the authorities describe the policies they intend to pursue during the period through 2002 and request a three-year extended arrangement in an amount equivalent to SDR 1.957 billion, equal to 84 percent of quota on an annual basis (Appendix I). Colombia has not accepted the obligations under Article VIII, Sections 2, 3, and 4, and maintains multiple currency practices that are subject to Fund approval (Colombia’s relations with the Fund are set out in Appendix II).

2. At the conclusion of the last consultation with Colombia on December 8, 1998 (EBM/98/124), Directors stressed the need for rapid action to reduce the imbalances in the economy, address the structural weaknesses in the fiscal area, and deal with emerging problems in the financial system. They noted that the tightening of monetary policy in response to the turmoil in the international financial markets had been appropriate, and expressed support for the decision to adjust the exchange rate band in September 1998. Directors welcomed the achievement of the inflation target in 1998 and underscored the importance of attaining the target on a consistent basis.

II. Background and Recent Developments

3. For several decades, Colombia achieved significant economic progress, with steady and strong economic growth and good balance in its external accounts. In recent years this record has given way to slow growth, rising unemployment, and widening external current account deficits, while inflation remained around 20 percent. In the first half of the 1990s Colombia’s fiscal position began to deteriorate, mainly owing to the introduction of expenditure programs that were not accommodated by appropriate adjustments in revenue or other expenditures, and fiscal management was made difficult by a revenue sharing system that required the central government to transfer an increasing part of its revenue to territorial governments. This put a disproportionate burden on monetary policy, with high interest rates and a real appreciation of the peso contributing to a slowdown in economic activity and the emergence of financial sector distress toward the end of the decade, while the external imbalances continued to widen.

4. Since the early 1990s Colombia has implemented important reformsto liberalize its external trade and financial sectors; it has advanced on reducing the public sector’s role in key sectors of the economy through significant privatizations, concessions, and private sector participation in the construction and operation of infrastructure facilities; and it has sought to decentralize the public sector by increasing the autonomy of territorial governments.

5. Supported by the introduction of structural reforms, output grew by 5 percent a year during 1992-95, but it slowed subsequently as the emergence of political uncertainties, further fiscal drift, and the onset of the Asian crisis affected Colombia’s economic performance. Faced with a weakening of economic activity, policies were relaxed in 1997, but the recovery was short lived after pressures against the peso started to build toward the end of the year.

6. Colombia’s economy continued to deteriorate in 1998 and real GDP contracted in the second half of the year. To a large extent, the deterioration was the result of external shocks; the effect of the fiscal imbalances; and a further weakening of confidence related to stepped-up activity by insurgent groups. The turmoil in international financial markets and growing concerns about the sustainability of Colombia’s large fiscal and external deficits led to repeated episodes of pressure against the peso despite a tightening of monetary policy that resulted in record-high real interest rates, and in September 1998 the trading band for the peso vis-à-vis the U.S. dollar was depreciated by 9 percent (Figures 1, 2, and 3).

Figure 1.
Figure 1.

Colombia: Selected Economic Indicators, 1995-2002

Citation: IMF Staff Country Reports 1999, 149; 10.5089/9781451808797.002.A001

Source: Banco de la Republica
Figure 1.
Figure 1.

Colombia: Selected Economic Indicators, 1995-2002

Citation: IMF Staff Country Reports 1999, 149; 10.5089/9781451808797.002.A001

Sources: Colombian authorities; and Fund staff estimates.
Figure 2.
Figure 2.

Colombia: Exchange Rate Developments, 1982-99

Citation: IMF Staff Country Reports 1999, 149; 10.5089/9781451808797.002.A001

Sources: IMF Information Notice System; and Banco de la Republica.1/ Nominal exchange rate through November 12, 1999; real effective exchange rate to August 1999.2/ IMF trade-weighted index of nominal exchange rates deflated by seasonally adjusted relative consumer prices; increase means appreciation.
Figure 3.
Figure 3.

Colombia: Interest Rates, 1993-October 1999

(In percent per annum)

Citation: IMF Staff Country Reports 1999, 149; 10.5089/9781451808797.002.A001

Source: Banco de la Republica1/ Effective rate (monthly average).2/ Based on the change in the consumer price index over the preceding twelve months.

7. The recession intensified in the first half of 1999 and real GDP is projected to fall by 3.5 percent for the year as a whole(Table 1). Weak aggregate demand helped reduce the external current account deficit significantly and 12-month inflation has been in single digits since mid-1999, while unemployment rose to a record 20 percent in September from 15 percent a year earlier. Following a decline in real GDP of 6.7 percent (year-on-year) in the first half of 1999, there are signs that the export sector may have begun to recover, helped by the 24 percent real depreciation of the peso during the 12 months to August 1999 (see Figure 2). Agriculture also continues to rebound from the effects of the El Nino weather phenomenon in 1998, and the decline in manufacturing output has slowed.

Table 1.

Colombia: Selected Economic and Financial Indicators

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Sources: Colombian authorities; and Fund staff estimates and projections.

End of period.

Based on the Information Notice System.

All annual changes in foreign currency stocks valued at constant exchange rate.

Excluding privatization proceeds.

Includes the balance of the quasi-fiscal operations of Banco de la Republica.

Includes residual differences between items above and below the line, as well as sales of assets and extension of phone licenses.

Includes short-term debt.

Short-term debt is defined by its remaining maturity from 1999 onwards.

8. The fiscal position deteriorated markedly during the first half of 1999, and the nonfinancial public sector (NFPS) deficit is projected to rise to 6.3 percent of GDP for the year, from 3.9 percent in 1998, due to higher interest payments, large salary increases (awarded when inflation was expected to be much higher than at present), higher pension payments (linked to wages), lower tax collections, and increased capital outlays in response to the earthquake in January 1999 (Table 2). The projected widening of the deficit also reflects revenue sharing arrangements that prevent a timely reduction of government transfers when revenue falls below budgeted amounts (Table 3 and Box 1).

Table 2.

Colombia: Operations of the Combined Public Sector

(In percent of GDP)

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Sources: Ministry of Finance and Public Credit; Banco de la Republica; and Fund staff estimates.

Excludes proceeds of financial transaction tax in 1999 from revenue and expenditure.

Includes local fees, penalties, and oil stabilization fund.

Includes expenditure on an accrual basis not included in other outlays.

Transfer to Caja Agraria in 1999, interest payments on public banks restructuring bonds and mortgage debt relief related costs.

Includes residual differences between items above and below the line.

Includes nonrecurrent fees from telecommunications licensing.

Includes army and police wages and purchases of goods and services.

General government expenditure less transfers to households and interest payments, plus investment by public enterprises.

National definition for the nonfinancial public sector. Includes transfers of central bank profits from previous years, proceeds from long term licenses, future oil sales, and Fogafin resources maintained in central government. Excludes unrecorded local government expenditure, increase in floating debt expenditure and net lending.

Table 3.

Colombia: Operations of the Central Administration

(In percent of GDP)

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Source: Ministry of Finance and Public Credit.

Excludes proceeds of financial transaction tax in 1999 from revenue and expenditure.

Expenditure on an accrual basis not included in other outlays.

Includes interest payments to the rest of the nonfinancial public sector.

9. At the beginning of 1999, the government introduced measures to help deal with the difficult outlook for revenue induced by the weakening of the economy. These included a widening of the base for the value-added tax (VAT), higher fuel taxes, and programs to strengthen tax enforcement.2 Despite these measures, tax revenue of the NFPS is projected to fall by 0.8 percentage points of GDP in 1999 due to the impact of the recession on tax collections and social security contributions (see Table 2). Nevertheless, the overall revenue position of the NFPS is projected to improve, mainly because of a notable increase in the operating surplus of the state oil company (ECOPETROL), and improvements in the financial positions of the oil stabilization fund and local telephone and water supply (aqueduct) companies.

10. As inflation fell faster than expected during the first three quarters of 1999, interest rates were reduced(Table 4 and see Figure 3). Nevertheless, financial sector credit to the private sector fell by 2.5 percent (year-on-year) in September 1999 owing to the recession and the difficulties facing the financial sector. The reduction in interest rates contributed to renewed pressures on the currency, and on June 27 the exchange rate band was again depreciated by 9 percent and widened from 7 to 10 percentage points on each side of the midpoint. Nevertheless, the exchange market remained unsettled as market sentiment continued to be unfavorable in light of uncertainties about the direction of economic policies and the reduction in August/September of Colombia’s sovereign debt to below investment grade by two major rating agencies. By mid-September the peso had come under renewed pressure and on September 27 the central bank allowed the peso to float. In the preceding 21 months the central bank’s net international reserves (NIR) had fallen by US$2.1 billion, to US$7.6 billion. From the time it was floated until end-November, the peso appreciated by nearly 5 percent against the U.S. dollar.

Table 4.

Colombia: Summary Accounts of the Financial System

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Sources: Banco de la Republica; and Fund staff estimates.

All annual changes in foreign currency stocks valued at a constant exchange rate.

Changes in relation to private sector liabilities at the beginning of the period. Rates of growth of money and quasi-money are with respect to themselves.

Changes in relation to monetary base at the beginning of period.

Corresponds mainly to the sum of the stock of open market bills and exchange certificate

The NIR are equal to the BoP concept of NIR excluding causaciones (accrued, but unpaid, interest on reserve assets).

Includes M3 plus bonds issued by financial institutions.

End of period annual rates. The 1999 interest rates correspond to September

11. The Colombian financial system was showing clear signs of distress by late 1998, exacerbated by the turnaround in the economic and financial environment. The difficulties have been manifested by a rise in nonperforming loans (to 13.2 percent of total loans in September 1999 from 9.0 percent a year earlier), large losses, and a significant deterioration in solvency.3 Recent MAE missions found that the health of the system is worse than reported by the official statistics owing to underprovisioning of nonperforming assets, misclassification of loans, and overvaluation of repossessed assets (see Section III C below). Moreover, only a small number of institutions appear to satisfy the minimum capital adequacy requirements when adjustment is made to reflect the fact that a share of fully performing loans may be rolled over systematically without clear repayment perspectives. Most of the state banks have been undercapitalized or outright insolvent, with a nonperforming loan ratio of 24.0 percent in September 1999, compared with 13.2 percent one year earlier. Credit institutions are generally well hedged against direct foreign exchange risk and have only limited foreign currency denominated liabilities. Nevertheless, they are indirectly exposed to exchange rate risk, as Colombian corporations have large debts denominated in foreign currency.4

12. To head off a system-wide crisis, the government introduced several measures in late 1998 and early 1999, including programs to assist savings and loan institutions, financial cooperatives, and mortgage holders, financed by a new tax of 0.2 percent on financial transactions (excluding interbank transactions). Subsequently, programs were put in place to help recapitalize viable private banks, deal with the problems of the public banks, and, in October, the authorities proposed additional relief for mortgage holders who remain current on their obligations at the end of 1999. Under the recapitalization plan for private banks, the government, through FOGAFIN (the Colombian insurance fund and bank resolution agency), extends credit lines to the shareholders of troubled institutions. These lines, which are given in the form of FOGAFIN bonds, are used by the shareholders to recapitalize the financial institutions. The largest public bank (Caja Agraria) is in the process of liquidation and has been replaced with a smaller agricultural bank, and a resolution strategy has been adopted for the six remaining state-owned banks (including three that have been taken over by the authorities) based on audits, recapitalization, and subsequent divestment. A financial sector reform law was enacted in June 1999 which, inter alia, strengthens the power of the authorities to deal with troubled banks in a timely manner. The recent proposal submitted to congress provides for the additional mortgage relief to be financed by forced investments in government bonds at below market rates by the financial and the financial services sectors.5 6 The cost of the restructuring program for the financial sector (including the mortgage relief programs) is currently estimated at about 5 percent of GDP in net present value terms.

III. The Program Discussions

13. To deal with the deteriorating economic and financial situation, the Colombian authorities have formulated an economic program for the period through 2002 that calls for a major policy correction in a medium-term context.

14. The program seeks to restore conditions for the resumption of economic growth, the further reduction of inflation, and the achievement of a sustainable external position. Specifically, it aims at reducing inflation from 10 percent in 2000 to 6 percent in 2002, while real GDP growth is projected to accelerate to 3 percent in 2000 and near 5 percent by 2002. The external current account deficit would widen somewhat to 2.4 percent of GDP in 2000, and then stabilize at around 3 percent of GDP in 2001 and 2002 (Table 5 and see Figure 1).

Table 5.

Colombia: Summary Balance of Payments

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Sources: Banco de la Republica; and Fund staff estimates and projections.

Net of capital remittance of the oil sector. In 1999, this includes USS-475 million as a result of the decapitalization of EEB.

Consists of movements in deposits held abroad in response to privatization receipts.

Includes trade credits, short-term borrowing, and deposits held by the Colombian residents in current account abroad net of interest payments of deposits held by nonresidents in Colombia.

15. In the first part of the program period, mainly in 2000, privatization proceeds and increased borrowing from multilateral institutions will contribute a major share of the financing for the external current account deficit. Subsequently, it is expected that foreign direct investment will rebound to historical levels and that the share of traditional market borrowing will increase.7 The net international reserves would increase in each year of the program after 1999, with gross reserves remaining at the equivalent of nearly six months of imports of goods and services, one and a half times the level of short-term external debt (by remaining maturity), and about 30 percent of broad money (Table 6 and see Table 5). Under the program, Colombia’s external debt would stabilize at 43-44 percent of GDP.

Table 6.

Colombia: Indicators of External Vulnerability

(In percent of GDP, unless otherwise indicated)

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Sources: Ministry of Finance and Public Credit; Banco de la Republica; and Fund staff estimates and projections.

The increase shown for September 1998 reflects a reporting change that takes account of operations with a foreign financial institution. The net international reserves remain unaffected.

Short-term debt is defined by its remaining maturity from 1999 onwards.

There is a data break in 1996 which includes data on the private sector financial debt stock previously not available.

Source: INS. For 1999, the reference month is August.

Standard & Poors.

Consists of spread on US$750 million global ten-year note issued in February 1997 at a spread of 130 basis points.

16. Achievement of the program objectives will be sought through fiscal consolidation; structural reforms; financial sector restructuring; and exchange rate flexibility, and would be supported by the depreciation of the peso that has taken place over the past year and a half (to a level in real effective terms similar to that of the early 1990s when Colombia’s external current account was near balance, prior to the onset of petroleum exports on a large scale). These policies also should ease the pressure on interest rates and lend support to the growth and inflation objectives of the program.

A. Fiscal Policy

17. The fiscal program for 2000 calls for a sharp reduction in theNFPS deficit to 3.6 percent of GDP, and further to2.5 percent in 2001 and 1.5 percent in 2002 (see Table 2). The deficit of the combined public sector is projected at 3.5 percent of GDP in 2000 (a performance criterion), 2.4 percent of GDP in 2001, and 1.3 percent of GDP in 2002.8

18. The reduction in the NFPS deficit in 2000 is crucially dependent on a tight wage policy; economic recovery; improved control of resources under the fiscal decentralization system; and continued success of the tax enforcement program. The further reduction in the NFPS deficit beyond 2000 is predicated on a further widening of the tax base, both at the national and territorial level; continued strict control of non-interest spending; the implementation of structural reforms in the fiscal area; and a sustained recovery in economic activity.

19. Central to the achievement of the medium-term fiscal objectivesare plans to build up funds to support the pension liabilities of territorial governments, streamline the special pension schemes for teachers and oil workers, and introduce pension reform under the social security system. Also important is a plan to freeze in real terms the amount of revenue transferred to territorial governments (see Box 1). These reforms are being presented to the congress in its July-December 1999 session together with initiatives to restrict the creation of new municipalities and limit the territorial governments’ current spending.

20. The program to strengthen tax administration and tax enforcement will support the fiscal effort. To this end, the tax administration (DIAN) has been invested with additional powers and authorized to hire 1,000 additional inspectors/agents under a program aimed to reduce collection lags, identify delinquent accounts, collect arrears, and reduce contraband. The program has been successful to date in terms of its collection goals.

Changes in Transfers to Territorial Governments

Fiscal decentralization in Colombia has been mainly financed by constitutionally mandated revenue sharing arrangements, under which 44.5 percent of the central government’s current revenue is presently transferred to territorial governments, up from 36.5 percent in 1993. These transfers have been the largest source of increase in central government outlays during the 1990s.

The Situado fiscal and the Participation municipal are the main transfer mechanisms of the revenue sharing system. Under the Situado, the central government provides transfers to regional governments for education and health, while the Participation transfers funds to municipal governments for education, health, and water supply. The 1991 constitution stipulates that neither the Situado nor the Participation can diminish as a share of central government current revenue from one year to the next, mandating that their combined share be increased to 46.5 percent by 2001. Moreover, in the event of a shortfall in current revenue from budgeted amounts, the transfers cannot be reduced in the same proportion, thus complicating fiscal management. To increase budgetary flexibility, a constitutional amendment was presented to congress in September 1999 aimed at freezing in real terms the transfers under the Situado from 2001 and under the Participation from 2002, once they reach the maximum rate of 24.5 percent and 22 percent of current government revenue, respectively. This reform requires approval by two successive sessions of congress and could provide fiscal savings of 0.4 percent of GDP in 2001, increasing to 0.8 percent of GDP in 2002.

Mineral royalties, collected mainly from oil and coal production, are distributed two-thirds to the producing regions and the remainder to the National Royalties Fund (NRF). The NRF’s resources are earmarked to more than 40 specific sectors and projects. To help strengthen the finances of the territorial governments, the authorities are proposing to channel 10 percent of the NRF to territorial government pension funds.

An important change in the transfer system was the phasing out of the cofinancing funds in 1999; these funds (not mandated by law) provided matching grants for territorial government investment projects. The government also allocates resources to regional universities and provides a supplementary education fund to territorial governments. In all, of the central government’s current spending of 13.6 percent of GDP in 1998, all but 3.6 percent of GDP was allocated to wages, pensions, interest payments, and the constitutionally mandated revenue sharing arrangements.

21. A major part of the sharp fiscal adjustment planned for 2000 reflects a reduction in non-interest current spending of the NFPS by 1.7 percent of GDP. To achieve this, 70 percent of government employees will receive no wage increase, and the rest, including the lowest paid and those with rights to automatic annual adjustments, will receive an average of 4-5 percent. Combined with some staffing reductions, this would reduce the wage bill of the NFPS from 7.5 percent of GDP in 1999 to 7.0 percent of GDP in 2000 (Table 7 and see Table 2). To alleviate the impact of the recession on the most vulnerable groups, the budget also includes additional social safety net programs for 0.3 percent of GDP that will be continued over the next three years, and will help ensure that the gains in social spending over the past several years will be preserved (Table 8).9 The new programs include training for youths, additional daycare centers; school lunch programs; and increased enrollment of the elderly in the health insurance system. In addition, there will be a reduction in capital outlays in 2000, by 0.7 percent of GDP, reflecting lower investment by the central government and the state oil company, ECOPETROL (see Tables 2 and 3).10 At the same time, investment by territorial governments will increase somewhat; in particular, the city of Bogota is using the proceeds from last year’s divestment of its electricity company to fund a major public works program.

Table 7.

Colombia: Impact of Selected Fiscal Measures

(In percent of GDP)

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Sources: Ministry of Finance; and Fund staff estimates.
Table 8.

Colombia: Social Spending

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Includes transfers (pensions, severance payments, contributions to health funds and subsidies) and investments.

Includes expenditures funded by constitutionally mandated transfers from the central government (Sitwdo Fiscal for departments and Participation Municipal for municipalities)

Includes transfers (pensions, severance payments, contribution to education funds and subsidies to public universities), goods and services and investments.

Welfare services agency.

Includes transfers and investments related to maintenance of the agency.

Provides training for youth entering the labor force and unemployed workers.

Including direct expenditures by the central government and constitutionally mandated transfers.