IMF Executive Board Concludes 2011 Article IV Consultation with Colombia

The Colombian economy proved resilient to the global financial crisis, and a solid recovery is under way. The pace of monetary tightening envisaged strikes the right balance between restraining credit growth and mitigating incentives for further capital inflows. A sudden acceleration of domestic demand places an additional burden on monetary policy. Colombia’s financial sector oversight is solid, and plans to strengthen cross-border and consolidated supervision are commended. Steep taxation of labor and a relatively high minimum wage are significant hindrances to competitiveness. Colombia’s exchange restrictions remain unchanged.

Abstract

The Colombian economy proved resilient to the global financial crisis, and a solid recovery is under way. The pace of monetary tightening envisaged strikes the right balance between restraining credit growth and mitigating incentives for further capital inflows. A sudden acceleration of domestic demand places an additional burden on monetary policy. Colombia’s financial sector oversight is solid, and plans to strengthen cross-border and consolidated supervision are commended. Steep taxation of labor and a relatively high minimum wage are significant hindrances to competitiveness. Colombia’s exchange restrictions remain unchanged.

On July 20, 2011, the Executive Board of the International Monetary Fund (IMF) concluded the Article IV consultation with Colombia.1

Background

With strong policy and institutional frameworks, Colombia’s economy exhibited resilience during the global crisis, and the output recovery is well entrenched. Following a short-lived contraction, economic activity began to recover in the second half of 2009 supported by appropriate countercyclical fiscal and monetary policies, and a Flexible Credit Line arrangement, which helped keep real growth in positive territory (1.5 percent for the year as a whole). Activity gained further momentum in 2010 when real GDP grew by 4.3 percent (despite the adverse impact of severe flooding), inflation was near the mid-point of the official target range of 2–4 percent, commercial and consumer credit began to rebound strongly around midyear, and the external currency account deficit widened to 3.1 percent of GDP, reflecting a sharp pick up in imports.

Countercyclical macroeconomic policies in support of this performance included: the central bank lowering its policy rate by 650 basis points to a historic low of 3 percent between early 2009 and early 2011, an expansionary fiscal policy stance, with the combined public sector deficit widening to around 3 percent of GDP in 2009 and 2010 (compared with near balance in 2008). The financial system was little impacted by the global shocks and the downturn in activity as capital adequacy and profitability remained strong and non-performing loans increased only slightly.

In 2010, global liquidity conditions and favorable prospects for the Colombia economy resulted in renewed appreciation pressures on the peso. The bulk of the inflows were related to foreign direct investment, but portfolio and other investment inflows began accelerating toward the end of the year. In response to these pressures, the central bank purchased just over US$3 billion in the foreign exchange market through its pre-announced intervention program of purchasing at least US$20 million per day over a specified time horizon (most recently extended until September 30, 2011), and the peso appreciated by just 1 percent against the U.S. dollar through the remainder of the year since the program was initiated.

The outlook for 2011 is generally positive. Real GDP growth in 2011 is projected at about 5 percent, led by domestic demand and favorable terms of trade. Inflation is expected to remain within the central bank target range as the economy still operates with some slack (the output gap is projected to close in early 2012) and the impact of further anticipated peso appreciation. Inflation expectations are well anchored supported by the strong credibility of the central bank. In response to the cyclical recovery, the central bank has started to normalize monetary conditions (with the policy rate increased by 125 basis points so far during 2011). The external current account deficit is expected to narrow to 2.6 percent of GDP as a result of higher oil and other commodity prices. Strong private capital inflows (mainly foreign direct investment) are expected to result in an overall balance of payments surplus and continued appreciation pressures.

The government is taking important steps to strengthen the fiscal framework. The strategy comprises a structural fiscal rule for the central government, constitutional amendments that establish fiscal sustainability as a constitutional criterion and a more equitable distribution of royalties, and the creation of a national sovereign wealth fund.

Executive Board Assessment

Executive Directors commended the Colombian authorities for their sound macroeconomic policies and strong institutional frameworks. Economic recovery is well entrenched and the outlook is positive. Inflation pressures are contained, the financial sector is solid, and market sentiment is favorable. The main challenges ahead are to normalize the macropolicy mix to stave off overheating pressures, strengthen revenue collection, and reduce unemployment and labor market informality.

Directors generally agreed that a speedier exit from fiscal stimulus would be desirable in light of the closing output gap. A tighter fiscal stance would also help mitigate an unexpected surge in capital inflows and avoid overburdening monetary policy. Directors encouraged the authorities to save any overperformance in government revenues this year and restrain expenditure where feasible.

Directors welcomed the recent legislative reforms to strengthen further the medium-term fiscal framework, including the adoption of a fiscal rule for the central government. They noted that these reforms will bolster Colombia’s commitment to fiscal sustainability, and encouraged the authorities to make them operational in a timely manner. Directors supported the authorities’ plans to broaden the tax base and reduce distortions to spur formal sector activity. They welcomed the creation of a national Sovereign Wealth Fund to manage windfall fiscal gains. Directors stressed the importance of developing a strategy to address the large contingent liabilities in the pension and healthcare systems.

Directors noted that the inflation targeting framework has served Colombia well. They supported the gradual normalization of the monetary stance to mitigate inflation pressures without exacerbating capital inflows. Directors underscored that exchange rate flexibility, alongside limited intervention in the foreign exchange market, should remain the primary tool for absorbing capital inflows. Additional tools, including strengthened macroprudential regulation and capital flow management policies, can play a role in the event that capital inflows threaten financial stability. Most Directors supported the policy intention to further improve reserve coverage.

Directors noted that the financial system is sound. Credit and asset market developments however should be closely monitored for overheating risks. Directors welcomed improvements in financial supervision, particularly recent measures to improve the coordination of information exchange, bank resolution, and the design of macroprudential regulation. Directors encouraged the authorities to complete their analysis of the composition of bank capital and liquidity under Basel III.

Directors urged the authorities to build on recent labor market reforms to lower unemployment and labor market informality. They welcomed the authorities’ measures to improve incentives for firms to operate in the formal sector, but stressed the need to tackle remaining structural impediments including by broadening cuts in the still high labor taxation and addressing the binding minimum wage.

Public Information Notices (PINs) form part of the IMF’s efforts to promote transparency of the IMF’s views and analysis of economic developments and policies. With the consent of the country (or countries) concerned, PINs are issued after Executive Board discussions of Article IV consultations with member countries, of its surveillance of developments at the regional level, of post-program monitoring, and of ex post assessments of member countries with longer-term program engagements. PINs are also issued after Executive Board discussions of general policy matters, unless otherwise decided by the Executive Board in a particular case.

Colombia: Selected Economic Indicators

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

Includes Ecopetrol and Banco de la República’s outstanding external debt.

1

Under Article IV of the IMF’s Articles of Agreement, the IMF holds bilateral discussions with members, usually every year. A staff team visits the country, collects economic and financial information, and discusses with officials the country’s economic developments and policies. On return to headquarters, the staff prepares a report, which forms the basis for discussion by the Executive Board. At the conclusion of the discussion, the Managing Director, as Chairman of the Board, summarizes the views of Executive Directors, and this summary is transmitted to the country’s authorities. An explanation of any qualifiers used in summings up can be found here: http://www.imf.org/external/np/sec/misc/qualifiers.htm

Colombia: 2011 Article IV Consultation: Staff Report; Public Information Notice on the Executive Board Discussion; and Statement by the Executive Director for Colombia
Author: International Monetary Fund