Colombia
2010 Article IV Consultation: Staff Report; Public Information Notice on the Executive Board Discussion; and Statement by the Authorities of Colombia
Author: International Monetary Fund
Publication Date:
03 May 2010
eISBN:
9781455202645
ISBN:
9781455202645
Language:
English
Keywords:
ISCR; CR; GDP; inflation expectation; Colombia; deficit; monetary policy; current account; output gap; interest rate; GDP deflator; fiscal policy; Fiscal stance; Global; stabilization fund
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The key findings of Colombia’s 2010 Article IV Consultation on economic developments and policies are presented. The Colombian economy had begun to slow down in early 2008, as policies had been tightened to address overheating, but the global crisis caused private investment to collapse in the last quarter of 2008. The largely domestically owned and locally financed financial system did not experience major strains from the global crisis. Colombian banks did not have complex off-balance sheet financial instruments, and had limited cross-border linkages.

Abstract

The key findings of Colombia’s 2010 Article IV Consultation on economic developments and policies are presented. The Colombian economy had begun to slow down in early 2008, as policies had been tightened to address overheating, but the global crisis caused private investment to collapse in the last quarter of 2008. The largely domestically owned and locally financed financial system did not experience major strains from the global crisis. Colombian banks did not have complex off-balance sheet financial instruments, and had limited cross-border linkages.

I. Recent Economic Developments

1. Colombia was not affected too severely by the global crisis. The economy had begun to slow down in early 2008, as policies had been tightened to address overheating, but the global crisis caused private investment to collapse in the last quarter of 2008 (Figure 1). Domestic demand began recovering in the second quarter of 2009, led by public investment and consumption. For the year as a whole, real GDP growth was about zero. With near zero food price inflation and an output gap of about 2 percent at end-2009, end-year inflation fell to 2 percent from 7.7 percent at end-2008, well below the official inflation target range of 4½–5½ percent.

Figure 1.
Figure 1.

Colombia: Recent Economic Developments

Citation: IMF Staff Country Reports 2010, 105; 10.5089/9781455202645.002.A001

Sources: IFS, Haver, Datastream, and Fund staff estimates.Note: LAC5 represents the average of Chile, Colombia, Brazil, Mexico, and Peru. Fiscal expenditures adjust for the timing of fuel subsidies granted in 2007-08 but recorded in the 2007-09 budgets.
uA01fig01

Contribution to output growth (SAAR)

(Percent)

Citation: IMF Staff Country Reports 2010, 105; 10.5089/9781455202645.002.A001

uA01fig001

Contribution to output growth (SAAR)

(Percent)

Citation: IMF Staff Country Reports 2010, 105; 10.5089/9781455202645.002.A001

2. The overall reserves position remained broadly stable during 2009. The peso depreciated sharply in the first quarter of 2009 but recovered fairly quickly and, by mid-June, was above pre-Lehman levels. With only moderate intervention, central bank net international reserves (excluding the SDR allocation) remained broadly constant at the end-2008 level of US$24 billion.1 Weak exports and workers’ remittances were more than offset by a fall in imports and, as a result, the external current account deficit narrowed to 1.8 percent of GDP (from 2.9 percent the previous year). The capital account surplus declined only moderately, as a sharp increase in public inflows (up by US$8.4 billion) compensated for lower private inflows. Rollover rates of private external debt only declined moderately and the US$10.9 billion in contingent reserves from the FCL approved in May 2009 were not used.

Figure 2.
Figure 2.

Colombia: Impact of the Global Financial Crisis

Citation: IMF Staff Country Reports 2010, 105; 10.5089/9781455202645.002.A001

Sources: IFS, Haver, Datastream, and Fund staff estimates.Note: LAC5 represents the average of Chile, Colombia, Brazil, Mexico, and Peru. The trade index is the sum of exports and imports of goods (in U.S. dollars).

3. Monetary policy responded swiftly. Since late 2008 the policy rate was lowered by 650 basis points (to 3½ percent). Bank lending rates fell, but credit to the private sector decelerated sharply (to about 1 percent growth at end-2009). Corporates took advantage of the low interest rate environment by making sizable placements of domestic bonds in 2009 (US$11 billion, twice the level of 2008).

uA01fig02

Monetary transmission

(banking channel)

Citation: IMF Staff Country Reports 2010, 105; 10.5089/9781455202645.002.A001

4. Fiscal policy also contributed to support demand. The overall fiscal deficit rose from broad balance in 2008 to 2.8 percent of GDP in 2009, providing more stimulus than the one anticipated in the budget (mainly due to lower-than-budgeted tax revenues).2 The structural deficit3 deteriorated from 1.2 percent of GDP in 2008 to 2.2 percent of GDP in 2009, imparting a fiscal impulse of about 1 percent of GDP. Total revenues remained broadly constant in real terms, as oil revenues (based on 2008 profits) compensated for weak proceeds from the VAT and international trade.4 Meanwhile, total spending (adjusting for fuel subsidies) grew by 7 percent in real terms, with capital expenditure—which has important multiplier effects—increasing by 25 percent in real terms, as regional governments made up for budget under-spending in 2008.

Colombia: Combined Public Sector Balance

(Percent of GDP)

article image

Payments for fuel subsidies granted in 2007-08 were recorded in the budgets for 2007-2009.

Fuel subsidies are included in the year in which they were granted to the public, instead of the year in which they were recorded.

Adjusts for the output gap, oil price expectations, and fuel subsidies, and one-off pension related revenues in 2009.

5. Government foreign borrowing increased preemptively. With sound fundamentals, supported by the FCL, Colombia had uninterrupted access to capital markets at favorable rates, and considerable space for countercyclical policies. Gross official external borrowing exceeded US$6 billion in 2009 (compared with US$3.2 billion in 2008) with sovereign bond placements totaling US$3.5 billion. In net terms, official external borrowing rose to 2 percent of GDP, and the government was able to increase its deposits abroad by about 1.4 percent of GDP.

Colombia: Financing of the Fiscal Deficit

(In percent of GDP)

article image

Includes privatization of electricity companies projected for 2010.

6. Financial soundness indicators remained solid, despite the global shocks and the downturn in activity. The largely domestically-owned and locally-financed financial system did not experience major strains from the global crisis. Colombian banks did not have complex off-balance sheet financial instruments, and had limited cross-border linkages. Liquidity indicators improved as credit demand slowed and banks increased their holdings of government securities (the ratio of liquid to total assets increased by about 3¾ percentage points). Capital adequacy remained strong, and valuation gains helped maintain profits high (Figure 3). NPL indicators reached 4½ percent in mid-2009 but declined to 4.1 percent by the end of the year, backed by high provisions. The corporate sector’s strong balance sheets and the moderate levels of household debt also helped avoid financial distress.

Figure 3.
Figure 3.

Financial Soundness Indicators: Colombia and Other Emerging Markets

Citation: IMF Staff Country Reports 2010, 105; 10.5089/9781455202645.002.A001

Source: GFSR. December data for 2007, latest available for 2009 (December in the case of Colombia).

7. Measures taken since late 2008 also contributed to financial sector resilience. At end-2008, banks reached agreement with the superintendent to retain a portion of their 2008 profits, increasing their capital adequacy ratio from 13.4 to around 15 percent. In early 2009, the authorities raised the effective coverage of the deposit insurance, improved risk-based deposit insurance premia, and introduced a new liquidity risk management system. In July 2009, Congress approved a financial sector law increasing flexibility in pension funds’ investment portfolios (with effect in September 2010) and enhancing consumer protection and financial education. In September 2009, it was decided that countercyclical provisioning would be more rules-based and bank-specific starting in April 2010.

II. Macroeconomic Outlook

8. The electoral calendar of 2010 is not expected to weaken Colombia’s solid policy framework. Congressional elections were held in March, and presidential elections are scheduled for May with a second round, if necessary, for June. The new government will take office in August. Colombia’s strong institutions and broad domestic consensus for economic stability bodes well for the continuation of sound policies under the next government.

9. The outlook for 2010 and the medium term is generally positive.

  • Economic growth is expected to pick up gradually. Real GDP growth in 2010 is projected at about 2¼ percent, reflecting the upturn in the world economy and the impact of the expansionary policies of 2009. The full-year effect of lower exports to Venezuela (which staff estimates will lower 2010 growth by ¾ percentage points) will dampen the recovery.5 Over the medium-term, real GDP growth is expected to rise to 5 percent until the output gap is closed, and thereafter settle at 4½ percent.

  • Inflation is likely to remain within the central bank target range. Inflation expectations indicators in early 2010 suggest that end-year inflation may be around 3.8 percent, near the top of the target range. However, the effects of El Nino on food inflation are likely to be offset by the output gap and peso appreciation. Over the medium-term, inflation is expected to remain well within the target range of 2–4 percent.

  • The external current account deficit is expected to narrow over the medium term. The combination of lower exports to Venezuela and an envisaged increase in oil investment-related imports are projected to widen the external current account deficit to 3.1 percent of GDP in 2010. The bulk of the deficit would be financed by FDI, with other private flows also expected to recover. Over the medium term, the current account deficit is expected to decline to about 1 percent of GDP, driven by higher exports (including from the expected increase in oil production), improvements in commodity prices, and a gradual recovery in trade with Venezuela.6

uA01fig03

Output gap

In percent of potential GDP

Citation: IMF Staff Country Reports 2010, 105; 10.5089/9781455202645.002.A001

Colombia: Medium-Term Outlook

(Percent of GDP, unless otherwise indicated)

article image
Sources: Fund staff estimates.

10. The overall fiscal deficit would continue rising in 2010, but start declining in 2011. Staff updated the authorities’ medium-term fiscal framework (MTFF), published in mid-2009, with the revised 2010 budget, the latest WEO assumptions, an improved outlook for oil production, and higher spending in roads and health care. The updated projection shows a combined public sector deficit of 3.5 percent of GDP in 2010, and a gradual decline thereafter to levels around 1½ percent of GDP.7 This fiscal consolidation would bring the public debt to GDP ratio to about 32 percent by 2014-15 (similar to the end-2008 level).

Colombia: Combined Public Sector Structural Balances

(Percent of GDP)

article image

Include adjustments for the output gap, oil price expectations, fuel subsidies, and one-off pension-related revenues in 2009.

11. Risks to the growth outlook are broadly balanced. While the baseline scenario assumes an important increase in oil production over the medium term, there is significant upside potential in the oil sector. This could result in significant higher oil production, and overall output, over the medium to long term. Key downside risks to growth include the uncertainty surrounding the strength of the global recovery, and increased political tensions with Venezuela, which could have a larger and more protracted adverse impact on activity.

III. Policy Discussions

12. Discussions centered on the appropriate policy stance during 2010 and possible improvements to the policy framework. In particular, the discussions covered (a) the policy mix to protect the nascent economic recovery; and (b) measures to further strengthen the medium term policy framework, including through the adoption of a structural fiscal rule, and other policies to contain downside fiscal risks. Discussions also assessed the strength of the financial sector following the global crisis.

Near term policy stance

13. There was agreement that macroeconomic policies should remain supportive until there is firm evidence that the recovery is self-sustained. Avoiding an early withdrawal of stimulus would be especially important in light of the dampening effect on 2010 growth of the trade disruptions with Venezuela.

14. Staff agreed that the current stance of monetary policy remained appropriate, and that a premature tightening cycle ought to be avoided. Staff noted that the significant easing of monetary conditions in 2009 had supported domestic demand without endangering the inflation objective, and that monetary policy lags would continue providing support during 2010. In addition, it noted that the rise in inflation in 2010 would be driven by supply factors and should not call for an immediate policy response. There was agreement, however, that with short and medium term inflation expectations near the top of the target range, the central bank should remain vigilant and stand ready to tighten at the first signs of domestic demand pressures. In this regard, staff noted that it would be important to monitor closely the effects of higher food prices on inflation expectations.

15. The fiscal stance envisaged for 2010 strikes a reasonable balance between supporting domestic demand and safeguarding medium term sustainability. Given weaknesses on the revenue side, linked both to cyclical and noncyclical factors, staff welcomed the spending cuts of 0.7 percent of GDP adopted in early 2010 to prevent a further widening of the deficit. With these measures, the structural fiscal balance would remain broadly at the same level as in 2009.

16. It would be advisable to consider possible responses to a surge in private capital inflows. The authorities’ baseline scenario assumes that non-FDI outflows in 2010 would be only slightly lower than those observed in 2009, although they acknowledge that improved domestic investment opportunities and low global interest rates could induce larger gross inflows. They considered that, in such a scenario, exchange rate flexibility would continue to be the first line of defense, possibly supported by rules-based intervention to smooth volatility. The authorities agreed that macroeconomic policies could play an important role in moderating capital inflows, including through some fiscal tightening once the recovery is on more solid footing. While not contemplating capital controls at the time, the authorities indicated that they could be an option if warranted by the type and size of foreign inflows. Staff noted that, in general, the effectiveness of controls is rather limited as a permanent measure, although they could be useful to manage a temporary surge in capital flows.8

Strengthening the policy framework

17. Although the medium term outlook was seen as positive, there was agreement that policies should aim at reducing downside risks. Prudent macroeconomic policies, a sound financial system, and limited vulnerabilities bode well for the economy. However, there are important risks stemming from external conditions (including the strength of the global recovery and relations with Venezuela) and domestic uncertainties, particularly on the fiscal side.

Fiscal Policy

18. Staff discussed the implications of the updated global outlook for the authorities’ medium-term fiscal framework. Although the authorities had not formally revised their medium term fiscal framework, they recognized that external conditions had significantly improved since the publication of the current framework in June 2009. In particular, fiscal revenues are now expected to benefit from sizable increases in oil production. At the same time, however, key expenditure risks have materialized, particularly on health as a result of court-mandated decisions. It was agreed that these factors would likely result in higher fiscal deficits and public debt levels than those envisaged during the 2008 Article IV consultation.

19. More ambitious medium term fiscal targets would be beneficial. Although oil-related revenues will be higher than previously envisaged, public debt is projected to be 8 percentage points of GDP above the medium term level suggested as a target during the 2008 Article IV consultation. Staff argued that, while the overall debt level remains moderate, lower medium term debt levels were feasible and would create fiscal space to absorb fiscal risks if these were to materialize. In addition, they would likely improve the prospects for an upgrade from credit rating agencies (Box 1). The authorities agreed that the country would benefit from lower debt levels, but stressed that the envisaged fiscal stance ensures debt sustainability.

20. Staff supported the authorities’ plans to adopt a fiscal rule. It noted that Colombia is a good candidate for adopting a fiscal rule owing to its moderate public debt and strong fiscal institutions, including an effective fiscal responsibility law, a medium term fiscal framework, and budget rules for regional governments. A fiscal rule would help signal more firmly the commitment to fiscal consolidation, and facilitate the use of countercyclical policies to limit the impact of exogenous shocks on the economy. In addition, a rule could be useful to shield the economy from the volatility in oil receipts. Staff stressed, however, that a fiscal rule would not be effective to prevent an equilibrium exchange rate appreciation.

21. Staff recommended that Colombia’s fiscal rule:

  • Targets a broad structural fiscal balance (including the central and subnational governments). Staff noted that such a target would provide a clear link to overall public debt and ensure consistency between the fiscal stances of the central and subnational governments. While recognizing the advantages of a broad aggregate, the authorities indicated that that they are currently considering all options, including a central government target that would be easier to control.

  • Aims at a significant decline in public debt. Staff argued that adopting a formal framework to reduce the public debt ratio in a five-year period to the level reached prior to the global crisis (32 percent of GDP) may represent somewhat of a missed opportunity. It noted that a more ambitious target9 would send a powerful signal of Colombia’s commitment to fiscal prudence and debt sustainability. The authorities agreed that the fiscal rule ought to be consistent with an ambitious decline in public debt levels.

22. Staff acknowledged that an ambitious medium term debt target may require a phased adoption of the fiscal rule. A rule that targets a zero structural balance for the combined public sector starting in, say, 2011 would require a fiscal adjustment of about 2 percent of GDP in the first year of operation. Staff recognized that an upfront adjustment of this magnitude may not be warranted, and would entail risks for aggregate demand. Considering this, it was agreed that a phased implementation of the fiscal rule could be based on a less ambitious target for a transitional period (e.g., a structural deficit of about ¾-1 percent of GDP for two to three years) while announcing that a more ambitious target would be adopted at a specific date (e.g. zero structural overall balance by 2013).

Debt Levels and Sovereign Debt Ratings

Colombia’s sovereign debt had an investment grade rating from international rating agencies during 1995–98. Its downgrade to below-investment status was one of the fallouts from the 1998–99 financial crisis. Fiscal consolidation efforts during the 2000s have lowered Colombia’s public debt from 50 percent of GDP at end-2002 to 32 percent of GDP at end-2008. Notwithstanding increased government borrowing during 2009, Colombia’s current public debt to GDP ratio is broadly similar to those of emerging markets whose sovereign debt is rated as investment grade (see chart).

uA01fig04

Gross Public Debt, 2009

(Percent of GDP)

Citation: IMF Staff Country Reports 2010, 105; 10.5089/9781455202645.002.A001

The level of public debt, however, is only one of several indicators used by rating agencies to assess country risk. An analysis of panel data from 48 emerging markets made by staff finds that, in addition to public debt levels, rating agencies attach significant weight to three other factors when assessing country risk: the size of the export sector, the depth of the financial system, and political risk.

These findings suggest that Colombia’s efforts toward regaining investment grade status should focus on reducing further its public debt level. A significant decline in public debt rates could allow Colombia to compensate for its relative disadvantages (compared to other emerging economies) in the other, more “structural” factors considered by rating agencies in their assessments.

Prospects for a future reduction in Colombia’s debt levels are favorable. Results from a debt simulation model suggest that there is a fifty percent probability that, by 2015, Colombia’s public debt to GDP ratio will be below the level it had prior to the global crisis in 2008 (32 percent of GDP); and only a 25 percent probability that it will exceed 40 percent of GDP. The likely adoption of an explicit fiscal rule, and the overall debt targets associated with it, also bodes well for progress in fiscal consolidation and public debt reduction in the coming years.

uA01fig05

Public Debt to GDP

Citation: IMF Staff Country Reports 2010, 105; 10.5089/9781455202645.002.A001

Alternative Fiscal Rules for Colombia

Staff analyzed the implications of several types of fiscal rules on debt levels, the scope for countercyclical policies, and the expenditure path. As point of reference, staff used the authorities’ 2009 medium term fiscal framework with updated assumptions (see paragraph 10). In all scenarios, except where noted otherwise, the structural fiscal balance includes adjustments for the output gap, future oil prices, the timing of fuel subsidies, and one-off pension-related revenues in 2009. The scenarios assumed that the fiscal rule would be in place starting in 2011. The main results of three scenarios are summarized below:

  • A zero overall balance for the combined public sector. Adoption of this rule would lower the debt ratio to about 22 percent of GDP by 2015, almost 10 percent of GDP below the baseline scenario. To achieve this target, however, measures equivalent to about 2 percent of GDP would need to be adopted in the first year (2011). If this adjustment were achieved only through expenditure cuts, it would imply a reduction in real government spending of about 2.6 percent in 2011, which would be followed by 6 percent real growth in 2012. A zero balance rule would be easy to communicate, and ensure consistency between the regional and central governments.

  • A nonoil deficit for the combined public sector of 3.5 percent of GDP. Under this rule, debt would decline to about 25 percent of GDP by 2015, significantly lower than in the baseline. With no revenue measures, this rule would entail a reduction in expenditure of about 1.3 percent of GDP in 2011 with respect to the baseline. However, if oil prices and production were lower than in the baseline, overall deficits and debt would rise.

  • Primary surplus for the central government of 1 percent of GDP. This rule would also reduce public sector debt to 25 percent of GDP. Upfront measures of about 1.6 percent of GDP would be needed to reach the target in 2011. Compared to rules applicable to a broader fiscal aggregate, this one would be more directly under the control of the government. However, under this rule local governments could adopt a stance that undermines the intended effect of fiscal policy on domestic demand and overall public debt.

A transition period for the fiscal rule based on a two-step approach would avoid a sharp upfront adjustment. If the rule of a zero overall balance for the combined public sector were implemented fully after a three year transition period with a deficit of 1 percent of GDP, the implied adjustment for 2011 would be 1 percentage point of GDP and the debt would decline to 25 percent of GDP by 2015. A similar transition period could be adopted for the central government structural primary surplus rule. In that case, a three year period with a primary surplus target of 0.5 percent of GDP would require an adjustment of 1 percent of GDP, and would lower public debt to 27 percent of GDP by 2015.

23. Staff encouraged the authorities to address two major sources of medium term fiscal vulnerabilities.

  • Risks arising from special regimes and tax incentives for investment.10 Staff cautioned that continued increases in the number of beneficiaries of special tax regimes would lead to a significant erosion of the tax base. The authorities were of the view that the positive impact of the incentives on new investment had so far outweighed their costs, but reiterated their readiness to reconsider the need for and scope of these incentives. For example, they noted that the tax reform approved at end-2009 had helped limit tax benefits by reducing the income tax deduction of fixed-asset investments from 40 percent to 30 percent, and eliminating the possibility of combining the income tax deduction with the special free trade zone regime.

  • Risk from social security expenditure, in particular higher health care costs. Staff welcomed the decision to incorporate explicit assumptions of higher health care costs (estimated at 0.9 percent of GDP, starting in 2011), but argued that these fiscal contingencies remained large and uncertain. The authorities noted their commitment to continue to work to reduce the impact of these outlays on the deficit, as evidenced by recent steps taken in January 2010 to set up a comprehensive framework to restrain the increase in health costs, identify new revenues (0.2 percent of GDP), and reallocate existing resources (0.2 percent of GDP).

24. A more systematic approach to detect and respond to fiscal contingencies would be advisable. Concretely, staff recommended giving a more forward looking orientation to the assessment of contingences in the medium term fiscal framework. For example, the analysis could be expanded from the current assessment of the costs of tax exemptions for the year in question, to a multi-year assessment of potential costs. Staff also stressed the need to identify contingency measures that would be adopted if those risks materialized.

25. There remains scope for improving the efficiency of the tax system and reducing expenditure rigidities. In line with previous Fund recommendations, staff suggested simplifying the tax system (by broadening the VAT base and reducing the number of rates), and phasing out the financial transaction tax. It argued that a more efficient tax system would facilitate compliance with the targets set under a fiscal rule. Staff noted that expenditure rigidities remain high and constrain the country’s ability to prioritize high impact spending, especially under a fiscal rule. The authorities agreed that a tax reform would be beneficial and noted that spending rigidities are expected to decline gradually as a result of previous reforms.

Monetary policy framework

26. The recent adoption of an inflation target range for 2010, in line with the long term objective of 2–4 percent is welcome. This measure will help lock in the gains of the sharp drop in inflation in 2009 and strengthen the inflation targeting framework. Staff encouraged the authorities to discontinue making reference to annual and medium-term targets for inflation in favor of a single, permanent target. The authorities saw merit in this proposal but noted that such change would require amending the central bank law, a step they are not considering at the moment. However, the authorities agreed to emphasize in their communication strategy that the near-term and long-term target ranges are expected to remain the same.

External sector

27. Colombia’s solid policy framework and reduced balance sheet risks helped mitigate the impact of the global crisis. The capital account shocks of the late 1990s had a severe impact on economic performance due to large unhedged exposures of the private sector and a rigid exchange rate regime. There was agreement that the strengthening of the policy framework over the last decade made those channels significantly less important.

uA01fig07

Impulse to Response of Colombia GDP to changes in the LATAM EMBI

Citation: IMF Staff Country Reports 2010, 105; 10.5089/9781455202645.002.A001

Selected Vulnerability Indicators, 2009 1/

(In percent of GDP, unless otherwise indicated)

article image
Source: Fund staff estimates.

End-year staff projections

Current account balance plus maturing external debt.

Debt in foreign currency or linked to the exchange rate, domestic and external.

Short-term debt and maturing medium- and long-term debt, domestic and external, excluding external debt to official creditors.

Latest available observation. In the case of Colombia, it refers to December 2009.

Figure 4.
Figure 4.

Emerging Markets: Gross International Reserves, 20091

Citation: IMF Staff Country Reports 2010, 105; 10.5089/9781455202645.002.A001

Source: Fund staff estimates.1/ End-year staff projections.

28. Higher reserve levels may help lessen remaining external vulnerabilities. The authorities considered that the current level of reserves is broadly adequate for “normal” times and that the FCL had served them well during the global crisis. They acknowledged, however, that higher reserve levels would be desirable as additional protection against large shocks. In this connection, staff noted that the authorities could take advantage of the projected strengthening of the balance of payments to gradually build reserves. The authorities agreed in principle, emphasizing that they would make sure that any intervention to build reserves is carried out transparently and is fully consistent with exchange rate flexibility and the monetary policy objectives.11

29. There was agreement that the real exchange rate was broadly in equilibrium. Staff’s updates of the macrobalance and external stability approaches point to a moderate undervaluation within the margin of error. These results are in line with a gradual strengthening of the external current account balance expected over the medium term as a result of higher oil production and exports, as well as stronger nontraditional exports.12 Moreover, given the large investments in exploration in recent years, there is further upside potential for oil production and exports that would tend to appreciate the equilibrium real exchange rate over the medium term.

Colombian peso: Equilibrium Assessments

article image
Source: Fund staff estimates

30. There have been no changes in Colombia’s exchange restrictions since the last Article IV consultation. Colombia maintains two exchange measures subject to Fund approval under Article VIII: (1) a multiple currency practice and an exchange restriction arising from a tax on outward remittances of nonresident profits earned before 2007 and that have been retained in the country for less than five years; and (2) an exchange restriction arising from the special regime for the hydrocarbon sector, in which branches of foreign corporations are required to either surrender their export proceeds or agree to a government limitation on their access to the foreign exchange market. Staff noted that it would recommend approval of the first measure (given that it is of a temporary nature, maintained for balance of payments reasons, and non-discriminatory in application), and encouraged the authorities to set a timetable for the removal of the second.

uA01fig08

Real Exchange Rate

Index (2008=100)

Citation: IMF Staff Country Reports 2010, 105; 10.5089/9781455202645.002.A001

Financial system

31. Colombia’s strong financial system will help sustain a rapid credit recovery. The system’s relative strength, particularly compared to other emerging markets, should allow banks to satisfy any prospective increase in credit demand, and bodes well for higher output growth (Figure 5). Stress tests conducted in late 2009 suggest that banks remain resilient and strengthened further following the crisis. NPLs increased modestly during 2009 but commercial loan portfolios need continued monitoring. Banks’ exposure to market risk also increased, owing to their increased holdings of government paper, which could affect profitability when the monetary tightening cycle starts.

Figure 5.
Figure 5.

Surge in Nonperforming Loans: Simulation Results

Citation: IMF Staff Country Reports 2010, 105; 10.5089/9781455202645.002.A001

Sources: BdR and staff calculations.

32. There has been further progress in capital market development, financial regulation and safety nets. A financial reform law approved on July 15, 2009, broadened the range of permissible assets in repo operations (to facilitate provision of liquidity support by the central bank), introduced greater investment strategy options for pension funds, and opened the doors for foreign issuers in the domestic stock exchange. There were also improvements in the OTC market infrastructure and in the regulation for collective investment vehicles. In addition, a new liquidity risk management system was adopted, the coverage of deposit insurance was broadened, and bank resolution procedures were improved.

33. Staff welcomed recent regulatory changes for banks’ provisions, though noted that shortcomings remain (Box 3). The new regulations introduced a rules-based determination of the phase of the cycle, on a bank-specific basis (taking into account delinquency rates and the financial strength of individual banks) rather than the system. Staff noted, however, that the regulation is complex compared to those adopted in other countries, and may not be too effective at reducing pro-cyclicality.

IV. STAFF APPRAISAL

34. With strong policy and institutional frameworks, the global crisis did not have too severe effects on Colombia’s economy. The slowdown in activity preceded the crisis as policies had been tightened in 2008 to correct an overheated economy. This, together with a solid policy framework, a sound financial system, and limited trade linkages mitigated the effect of the global crisis on output growth in 2009. The rebound in output in 2010 is not likely to be strong, however, in part due to the full-year effect of trade disruptions with Venezuela.

Reducing the Procyclicality of Prudential Regulations

The Colombian authorities have been ahead of most countries in implementing countercyclical prudential regulations, a pillar of the ongoing global financial reforms. In mid-2007, they adopted dynamic provisioning for commercial loans and, in mid-2008, they extended it to consumer loans. The new systems aimed at accumulating provisions during the upcycle, on the basis of through-the-cycle expected losses. Moreover, in late 2008, in agreement with the supervisory authorities, banks were encouraged to retain a large share of profits from 2008 (1.4 percent of risk-weighted assets) as an additional capital buffer to absorb potential losses related to the global slowdown.

In September 2009, the system of dynamic provisioning was strengthened. The system had been criticized for providing too much discretion to the supervisor in determining the cycle, and for not providing enough flexibility to the banks to reallocate provisions across loans. Countercyclical provisions—which are not taxed—had been designed to cover losses only of the loans against which they were accumulated, given that provisions accumulated for general loan loss coverage are taxed. The changes implemented (with effect as of April 2010) introduced a rules-based determination of the phase of the cycle, on a bank-specific basis—taking into account delinquency rates and the financial strength of individual banks—rather than the banking system. The changes provide the banks with a possibility to lower the countercyclical provisions in bad times by a proportion (40 percent) of the procyclical provisions.

Further enhancements should be considered. The recent changes strike a balance between reducing systemic credit risk and accommodating the use of provisions by financial institutions. Nonetheless, the countercyclical provisioning rules are still more complex than those adopted by other countries—such as Spain, often seen as a benchmark for countercyclical regulations. The countercyclical effect of the provisions is also dampened by the requirement to comply with a set of stringent indicators, as well as the fact that the accumulation of the procyclical component of provisions increases in bad times due to greater expected losses. Moving toward a countercyclical rule for provisions that could be reallocated freely across loans would be desirable, although such a step would require deciding the future treatment of the outstanding stock of countercyclical provisions, as well as the tax treatment of provisions.

35. The support provided by monetary policy was effective in limiting the impact of weaker external conditions. The tightening during 2008, declining food inflation, and well-anchored inflation expectations created room for letting the exchange rate absorb the brunt of the external shock, while easing monetary conditions. With expectations still inside the target range, the monetary stance during 2010 should remain accommodative until there is clear evidence of a sustained recovery. Close monitoring of forward looking indicators of activity and inflation will be critical to decide the timing of the change in stance. In particular, the authorities should prevent anticipated increases in food prices to affect long-term inflation expectations.

36. Fiscal policy was also supportive. The deterioration of the fiscal position in 2009, including through a modest fiscal stimulus, did not jeopardize medium-term sustainability. The fiscal stance envisaged for 2010 is also appropriate, with an additional deterioration explained mostly by transitory factors. Going forward, the fiscal deficit is expected to fall below 2 percent of GDP and public debt to resume a downward trend as the output gap is closed, growth returns to potential, government spending is kept in check, and oil-related revenues increase.

37. The response to a possible surge in capital inflows should be comprehensive and well-coordinated. Staff supports the authorities’ strategy of relying on the exchange rate as the first line of defense if large inflows materialize, but the response may have to involve other instruments. In particular, fiscal policy may need to be tightened. If the response were also to include some type of capital controls, these should be price-based and applied to a wide range of transactions.

38. The intention to adopt a fiscal rule is welcome. A rule would provide stronger assurances that the recent increase in public debt is temporary and greater clarity regarding fiscal policy going forward. In addition, the authorities’ recent efforts to contain health costs, and their intention to take compensatory measures if fiscal risks materialize, are also important. Staff underscores the need to develop a strategy to minimize medium-term fiscal risks, including those resulting from investment tax incentives and special tax regimes, and pension spending.

39. There is scope to strengthen further Colombia’s reserve position. Higher oil-related revenues over the medium term would provide the opportunity to gradually build up reserves and continue lowering external vulnerabilities. The mechanisms to build those reserves would have to continue being transparent and consistent with exchange rate flexibility and monetary policy objectives.

40. Recent further reforms to develop capital markets and improve financial regulation are welcome. Improvements in the OTC market infrastructure, new regulations on collective investment vehicles, and the broader investment strategy options for pension funds will contribute to financial deepening. At the same time, crisis preparedness will be enhanced by the new liquidity management system, the broader coverage of deposit insurance, and the tools to facilitate bank resolution. The recent regulatory changes on banks’ provisions are also an improvement, but the regulation is complex compared to that in other countries and has limited scope to reduce procyclicality.

41. There have been no changes in Colombia’s exchange restrictions since the last Article IV consultation. Staff recommends approval of the retention of the restriction and multiple currency practice arising from taxing remittances of nonresident profits earned prior to 2007, given that they are non-discriminatory in application, maintained for balance of payments reasons, and will have been fully phased out by January 1, 2012. Staff does not recommend approval of the retention of the restriction derived from the special regime in the hydrocarbons sector, since there is no timetable for its removal.

42. It is recommended that the next Article IV consultations be held on the 12-month cycle.

Table 1.

Colombia: Selected Economic and Financial Indicators

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Sources: Colombian authorities; UNDP Human Development Report 2007/08; World Development Indicators; and Fund staff estimates and projections.

Includes the quasi-fiscal balance of Banco de la Republica, sales of assets, phone licenses, and statistical discrepancy.

Table 2.

Colombia: Summary Balance of Payments

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

Includes movements of short-term assets owned by the public sector abroad.

Includes net portfolio investment.

Does not include valuation changes of reserves denominated in other currencies than U.S. dollars.

Figures for 2009 include SDR allocation to Colombia amounting to US$972 million.

Table 3.

Colombia: Operations of the Central Government 1/

(In percent of GDP)

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

Includes central administration only.

Payments for fuel subsidies granted in 2007-08 were distributed across the 2007-2009 budgets. A fuel price stabilization fund was created at end-2008 to eliminate fuel subsidies.

Includes income tax payments and dividends from Ecopetrol that correspond to earnings from the previous year.

Adjusts for the output gap, oil price expectations, and fuel subsidies.

Table 4.

Colombia: Operations of the Combined Public Sector 1/

(In percent of GDP)

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

Combined public sector includes the central, regional and local governments, social security, and public sector enterprises. Figures for 2008 and projections reflect exclusion of Ecopetrol operations and privatization of health care, which reduces revenue and spending by about 2 percent of GDP and 1.5 percent of GDP, respectively, in 2008.

Expenditure reported on commitments basis.

Payments for fuel subsidies granted in 2007-08 were distributed across the 2007-2009 budgets. At end-2008, a fuel price stabilization fund was created to eliminate fuel subsidies.

Includes adjustments to put spending on commitment basis and the change in unpaid bills of selected nonfinancial public enterprises.

Interest payments on public banks restructuring bonds and mortgage debt relief related costs.

Adjusts for the output gap, oil price expectations, fuel subsidies, and one-off additional pension-related revenues.

Includes income tax payments and dividends from Ecopetrol that correspond to earnings from the previous year, and royalties to local governments

Table 5.

Colombia: Monetary Indicators

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