Statement by Maria Angelica Arbelaez, Alternate Executive Director for Colombia, on the Request for a Successor Arrangement under Flexible Credit Line

Colombia’s strong institutional frameworks and sound policy management have underpinned a strong macroeconomic performance and contributed to reducing vulnerabilities. The Colombian economy exhibited great resilience during the global crisis, and the output recovery is well entrenched. The impact on fund finances, risks, and safeguards are discussed. The Colombian authorities viewed that the uncertainties surrounding the external environment remain elevated and that a successor flexible credit line (FCL) arrangement with a duration of two years would provide useful protection against continuing external risks.

Abstract

Colombia’s strong institutional frameworks and sound policy management have underpinned a strong macroeconomic performance and contributed to reducing vulnerabilities. The Colombian economy exhibited great resilience during the global crisis, and the output recovery is well entrenched. The impact on fund finances, risks, and safeguards are discussed. The Colombian authorities viewed that the uncertainties surrounding the external environment remain elevated and that a successor flexible credit line (FCL) arrangement with a duration of two years would provide useful protection against continuing external risks.

On behalf of my authorities, I thank staff and management for their positive response to our request for a new Flexible Credit Line (FCL). I also wish to express my authorities’ gratitude for the two FCLs received by Colombia in 2009 and 2010.

The FCLs have been an important support to the broad-based policy response to the global crisis, which involved exchange rate flexibility, countercyclical fiscal and monetary policies and ensuring a cushion of international liquidity for the country. An adequate stock of international reserves and the access to the FCLs were key components of this strategy. In addition, the FCLs signaled the strength of the Colombian economy and policy framework.

Economic conditions in Colombia have improved since the last Article IV Consultation. The Central Bank had expected economic growth to be around 3 percent in 2010, but instead growth was 4.3 percent. Inflation (year-on-year) was 3.1 percent in December, close to the midpoint of the long term target range (2–4 percent). Further, the current account deficit for the year was at a manageable level of close to 3 percent of GDP, financed mostly by FDI inflows, while the combined public sector deficit reached 3 percent of GDP.

For 2011, the Central Bank recently raised its growth forecast to between 4 and 6 percent-with the latest point projection at 5.5 percent—and expects the current negative output gap to close before the end of this year. As a consequence, macroeconomic policy strategy has moved to exit from fiscal stimulus, to rebuild fiscal buffers and to tighten monetary policy.

Monetary and exchange rate policies

The Colombian authorities remain committed to the inflation targeting regime adopted in the late 1990s, which has served the economy very well, as it has brought down inflation and has increased monetary policy credibility. In addition, it has given the authorities the flexibility and opportunity to react to changing circumstances.

Accommodative monetary policy started to reverse in the beginning of 2011, as inflation expectations have increased recently, credit growth has been strong (19 percent year on year in February) and aggregate private demand maintains a dynamic pace (the growth rate in 2010 was significantly higher than expected). For the third successive month through April 2011, the board of directors of the Central Bank raised the benchmark interest rate by 25 basis points to 3.75 percent, after a long period of historically low interest rates (3 percent in nominal terms). Inflation was 3.19 percent in March and is expected to be around 3 percent by the end the year.

Colombia is also fully committed to exchange rate flexibility. The authorities see the exchange rate as the most important shock absorber to mitigate the effects of the surge in capital inflows, and their strategy gives more weight to fiscal reforms and to the program of pre-announced daily purchase of foreign exchange (US$20 million per day). They have found that this transparent, small and predictable intervention is more effective than a large-scale and unpredictable accumulation of international reserves. Colombia has also in place prudential measures to minimize systemic risk. As highlighted in Chapter IV of last October in the IMF’s Western Hemisphere Regional Economic Outlook, the authorities have adopted a system of dynamic provisioning and bank-specific capital requirements, and the Central Bank relies on different tools—different limits on open foreign exchange positions—to minimize the emergence of vulnerabilities and mitigate potential adverse impacts of capital flows.

Fiscal policy

Colombia has put in place a solid and comprehensive fiscal institutional framework in order to anchor fiscal discipline and ensure debt sustainability, both at the central and regional levels. The Fiscal Responsibility and Transparency Law adopted in 2003, which includes a Medium-Term Fiscal Framework, sets the levels of fiscal deficit and financing. The Medium-Term Expenditure Framework establishes maximum levels of spending and priorities. These tools have been instrumental for fiscal consolidation.

Looking ahead, the government has submitted to Congress a Fiscal Rule, which not only limits the structural deficit of the Central Government to 2 percent of GDP from 2015 onwards, but also creates mechanisms to save the expected large increase of hydrocarbon revenues and develops rules to manage future countercyclical fiscal policy. The government has also presented to Congress a Constitutional Amendment to include fiscal sustainability as a general principle in the Constitution.

Fiscal buffers have allowed the Colombian authorities to adopt countercyclical measures to cope with the global crisis, but the authorities have started to shift towards a gradual consolidation. Although the adjustment is being delayed due to the severe flooding that the country is facing, the combined public sector deficit for 2011 is projected to be around 3.5 percent of GDP (slightly higher than that of 2010) and will decline further in 2012 to 1.7 percent of GDP. As a result, the public debt is projected to narrow to 35 percent of GDP in 2012. With the fiscal rule in place, a further gradual reduction of public debt is expected, reaching around 25 percent of GDP in 2020.

Request for the FCL

We want to convey to the Board the motivation behind the request for a new two-year FCL. As has been presented in the last issues of the Global Financial Stability Report (GFSR) and the World Economic Outlook (WEO), uncertainties and risks in the global economy remain. My authorities would like to have the FCL as an insurance against tail risks that, if realized, would involve a severe contraction of expenditure and production, even after a substantial reduction of international reserves. As shown in the staff document, assuming shocks in the stress scenario broadly similar in magnitude to those identified in the previous FCL, the resulting financing needs amount to US$5.6 billion.

With regard to risks to the outlook, an increase in the price of oil, as the one recently seen, is good for the Colombian economy in the short run, as this is one of the country’s main export products. In the long run, however, the increase might affect world economic growth that could translate into a highly uncertain outlook for Colombian terms of trade, external demand, workers’ remittances, risk aversion and capital flows.

Further, although the Central Bank acquired US$3 billion in 2010 through the program of daily purchases of international reserves currently in place, reserve indicators typically used to assess international liquidity remain similar to the levels seen in 2009. However, the authorities want to highlight that, as discussed in the last Article IV consultation, under low foreign currency and maturity mismatches, low pass-through and a credible macroeconomic policy framework, exchange rate flexibility will remain the main component of our response to an external shock.

As with the two previous FCLs, we intend to treat the new arrangement as precautionary. Support by the Fund for this request will send an important signal to markets about the Colombian authorities’ commitment to keep implementing sound economic policies and to further enhance strong policy frameworks.

Finally, based on the Colombian perspective, the authorities want to offer some thoughts on the FCL that may be helpful in the current and future discussions of this type of arrangements. An analysis carried-out by the Colombian Central Bank shows that the approval of the FCL in 2009 helped reduce the EMBI spread for Colombia and to increase the consumer confidence index1. This led to moderately higher GDP growth, lower depreciation of the peso and slightly lower inflation than what would have prevailed without the FCL.

1

Impacto macroeconómico de la línea de crédito flexible con el Fondo Monetario Internacional”, Banco de la República, March 11, 2011. This exercise was based on the dynamic stochastic general equilibrium model (DSGE) used at the Colombian Central Bank and on the application of econometric techniques to estimate the impact of the FCL on the EMBI and the consumer confidence index.

Colombia: Arrangement Under the Flexible Credit Line and Cancellation of the Current Arrangement: Staff Report; Staff Supplement; Press Release on the Executive Board Discussion; and Statement by the Alternate Executive Director for Colombia
Author: International Monetary Fund