Abstract
Colombia’s economy has been resilient to the adverse global shocks of recent years. Inflation has been subdued, credit growth has eased, and financial soundness indicators are strong. The strong balance of payments continues to put upward pressure on the Colombian peso. In 2013, growth is expected to rise and inflation to remain on target. Short-term risks to the outlook continue to be tilted to the downside. The central bank’s intervention policy is geared at containing exchange rate volatility and strengthening external buffers.
Article IV Consultation
The Colombian authorities thank the mission team for the constructive and open-minded discussions held in Bogota. They broadly agree with staff’s assessment and policy recommendations. The marginal differences in perception in some specific areas were adequately addressed in the staff report.
Economic outlook
After reaching a growth rate of 5.9 percent in 2011, the economy slowed down in 2012 with growth expected to be around 4 percent. The deceleration is partially explained by the tightening of monetary policy undertaken by the central bank (Banco de la República, BR) since the first quarter of 2011 in response to demand and credit pressures. However, other factors have accentuated the downward trend in the second semester, such as the decline in external demand, currency appreciation and supply difficulties that emerged in some sectors. Growth has been led mainly by domestic investment (25.5 percent of GDP), as well as by foreign investment (4.5 percent of GDP). It is expected that the economy will grow by around 4.5 percent in 2013, close to its potential.
Macroeconomic policies have continued to be prudent and well complemented by the FCL, and economic fundamentals remain strong. In 2012 inflation held at 2.4 percent; the consolidated fiscal deficit slowed to around 0.4 percent of GDP and the central government deficit to 2.4; the debt of Non Financial Public Sector declined to 26 percent of GDP (to 34 percent for the Central Government); the current account deficit remained around 3 percent of GDP financed mostly by FDI inflows; and the level of international reserves increased and remains adequate. Access to markets has continued to be comfortable and spreads have constantly narrowed. In September 2012, Colombia issued foreign sovereign debt denominated in Colombian pesos at the lowest rate in history (4.5 percent).
Looking ahead, while maintaining sound macroeconomic fundamentals, bringing down unemployment and informality, as well as closing the infrastructure gap, remain pressing challenges that the authorities have already been addressing. Although the authorities acknowledge that more efforts are needed, social indicators have improved and unemployment has declined.
Monetary policy and exchange rate
The inflation targeting regime has served the economy well and the BR benefits from great credibility. Inflation is below the 3 percent target, the interest rate is close to the neutral level and the output gap is close to zero. The authorities started tightening monetary policy in the first quarter of 2011 based on a forward-looking assessment of the economy, with the double objective of keeping inflation low and smoothing the business and credit cycles. However, owing to a reduction of inflation (below target) as well as a larger-than-expected deceleration of growth, the BR has adopted an accommodative monetary stance and the benchmark interest rate was reduced by 25 basis points in December 2012. The authorities concur with staff that, should the economy slows down further and forecast inflation remain on or below target, there is room for more monetary easing.
Exchange rate flexibility (de jure and de facto) has continued to be the main shock absorber. The BR renewed its pre-announced daily purchases in the FX market of 20 million USD until next March with the main objective of building up reserves and curbing the downward trend in some IR indicators, although it also helps mitigate exchange rate volatility.
The authorities consider that the current account deficit of around 3 percent of GDP is well financed by FDI and is consistent with the country’s position with regards to the oil sector. Colombia is still in a phase of high exploration and exploitation (which means sharp increases of FDI and imports) that partially offset income from oil exports. Therefore, higher oil prices are less reflected in an expansion of production (which would improve the current account), than rather in more exploration and exploitation.
Fiscal stance and policy
The solid institutional framework adopted in past years at the level of regional and the central governments (e.g. Fiscal Responsibility Law, Fiscal Rule, Lights Law) has allowed the fiscal stance to approach equilibrium. The authorities anticipate a lower-than-expected combined public sector deficit of around 0.4 percent of GDP in 2012 and 2.4 percent for the central government, which will be further reduced to attain the surplus goal of 0.2 percent in 2016 and a deficit of 1.7, respectively. The short-term fiscal policy, based on the Medium-Term Fiscal Framework that is updated and approved by Congress every year, is guided by the main objectives of debt sustainability and reduction, and increase in the primary balance in order to meet the fiscal rule which will enter into force in 2014. According to the rule, the structural deficit of the central government of around 2.4 percent of GDP in 2012 will decrease gradually to reach 1 percent in 2022, and the Non-Financial Public Sector debt will fall from 26 percent to 8.8 percent and that of the Central Government from 34 to 24.5.
With regard to revenues, an ambitious structural tax reform was recently passed in Congress which seeks to increase employment, reduce informality and inequality, enhance competitiveness, improve tax collection efficiency and administration and reduce evasion. Although the reform is considered revenue neutral in the sense that it does not raise tariffs, it will certainly increase structural revenues. Staff mentions in the report that a reduction in revenues is foreseeable in the next years (owing to the phase out of some taxes) and will be offset by capital expenditure cuts. In this regard, it has to be highlighted that the additional revenues stemming from the tax reform have not been considered yet in the projections; the authorities’ strategy is to wait for the proceeds of the tax reform and mobilize new revenues if needed to finance capital spending.
Revenues in 2012 behaved better than projected (reaching historical records) resulting in part from oil-related activity but also from improvements in tax collection. Some of these extra revenues were used to reduce the deficit, and some went to finance investment in infrastructure. Indeed, public investment played a critical role in supporting domestic demand in the third quarter of 2012 when signs of deceleration were more pronounced. The 2013 budget also includes a higher rate of capital spending relative to the current component.
The authorities concur with staff on the importance of strengthening savings. In fact, public and national savings have been increasing and will continue to do so as a consequence of the planned deficit reduction and, most importantly, of the royalty savings mandated by the fiscal rule and the royalty law recently approved.
Structural reforms
The promotion of sectors different from oil and minerals, with emphasis on agriculture and manufacturing (more labor intensive), is a priority for the government. Several reforms have been undertaken in agriculture as well as measures to enhance productivity and competitiveness. Among others, the tax reform will reduce labor costs significantly; the Ministry of Finance is working with the Energy Commission to reduce energy costs and an ambitious plan to enhance infrastructure and transportation is being adopted.
The authorities are preparing a structural Pension Reform to address the pressing issues of the system, which are low coverage, low progressivity and arbitrage between public and private systems, rather than unsustainability. To tackle the coverage issue, a mechanism to allow informal workers to attain a pension (Beneficio Económico Periódico, BEPS) was recently implemented. They are also designing a comprehensive health care reform aiming at correcting deficiencies of the system and containing costs.
Social Issues
Unemployment, inequality and informality remain the most urgent challenges. The authorities have adopted several measures to address them and some progress has been achieved. Although still high, unemployment fell to single digits and stands now at 9.2 percent. October’s unemployment rate of 8.9 percent was the lowest in 12 years of comparable data. In addition, the reduction in labor costs stemming from the tax reform is a critical step in the direction of bolstering formal employment. Inequality is being tackled not only through pension and tax reforms (through more progressivity), but also several targeted assistance programs to reduce social gaps and poverty have been put in place. Indeed, the poverty rate dropped 10 percent from 2006 to 2011.
Financial System Stability Assessment
In 2011, Colombia requested the IMF and the World Bank to conduct a comprehensive financial sector assessment, including the specific analysis of standards applicable to the banking, insurance, securities, payment systems, and financial infrastructure providers. The last FSAP was done in 2004, previous to the international financial crises and with a different institutional arrangement, insofar as there were two supervisory authorities (banking and securities) responsible for oversight of the entities within the financial sector. The authorities are grateful to the Fund for the opportunity to have an updated, deep and comprehensive assessment of the financial sector and particularly to the mission team for their dedication, skillful work, and useful discussions and recommendations.
The FSSA concludes that Colombia has a broad financial system, with complex financial conglomerates and with a variety of intermediaries. Credit institutions are sound, with healthy corporate and households balance sheets, strong credit quality and profitable banks. Nonbank financial intermediaries have been performing in a satisfactory fashion.
Most importantly, the stress tests conducted by the mission show that Colombian banks are resilient to a variety of shocks that included extreme scenarios of external crises and its effects on the quality of the loan portfolios. The authorities used in the past different macroprudential tools and policies that have proved to be beneficial for the financial system as a whole and are prepared to implement new ones, if necessary. Adequate coordination between the different institutions that are responsible for the Financial Safety Net (BR, Ministry of Finance, MHCP, Colombian Financial Superintendent, SFC, and FOGAFIN) has been crucial for adopting sound preventive policies.
The FSSA also concludes that Colombia has demonstrated considerable progress in implementing the standards and principles applicable to the regulation and supervision of banks, insurance companies, the securities market, and providers of financial infrastructure. The assessment recognizes that the SFC has improved its capacity to fulfill its responsibilities. In particular, the mission underscored the progress of the supervisory mechanism since the merger of the banking and securities in the SFC and the enactment of important laws (Law 964 of 2005 and Law 1328 of 2009). A single supervisory authority serves to cover all financial sectors and activities, ensuring transparency and efficiency in terms of regulatory enforcement and eliminating regulatory gaps and arbitrage that may arise when there is more than one supervisory authority. This is important in Colombia due to the existence of important financial conglomerates with activities in different financial services.
The authorities are aware that more work has to be done in order to improve regulation and supervision and will include in the pipeline of reforms some of those suggested in the FSSA. Nevertheless, we would like to highlight that the new capital adequacy regime, which was published in August 2012 and will take full effect on August 1, 2013, will address many of the shortcomings pointed out in the assessment. In the same token, regulation related to the adoption of International Financial Reporting Standards (IFRS) has been implemented. Financial institutions must issue IFRS financial statements starting in 2015, with a clear timetable established for that purpose. Additional reforms have been undertaken in other areas such as new reserves and solvency requirements for insurance companies.
On the issue of the independence of the SFC, we want to emphasize that, while Colombia’s legal and constitutional framework may make it difficult to establish de jure independence (an aspect that could be improved), the SFC has full de facto independence. It conducts supervision of the financial system without any political interference whatsoever, and works with the MHCP to develop regulations and other aspects of the legal framework without political influence.
On enhancing risk supervision, we would also like to feature the close collaboration of the SFC with the Toronto Center over the past few years, which has strengthened the capacity for risk-based supervision and improved the comprehensiveness of risk assessments conducted by the SFC as well as by the financial institutions themselves. We fully expect that this program of technical cooperation will continue to bear fruit in the next years and to strengthen supervision even further.
On the risks of credit growth, it is worth noting that the SFC established in June 2012 an additional provision applicable to banks that show a sustained increase in NPLs. In these cases banks are requested to raise each loan provisioning to a value between 0.2 percent and 0.5 percent over the corresponding balance loan. Based on figures as of November 2012, the additional provision represents an increase of 4.7 percent in the provisions of the consumer portfolio. In addition, a robust monitoring of the origination process was undertaken. Both measures proved to be effective in reducing the upward trend of consumption credit since 2009.
Strengthening the consolidated supervision is a key recommendation from staff. Indeed, the government is considering presenting a legal reform to include, under full supervision of the SFC, the holding companies of financial institutions.
On the stress testing methodologies, the BR continues to enhance its models and during the exercises conducted for FSAP new improvements were introduced and permanently adopted.
With regard to concentration of commercial loans, the authorities welcome FSSA recommendations and acknowledge that high levels of concentration increase risks and can harm the financial sector’s stability. We would like to offer some comments.
- Although 90 percent of commercial loans are concentrated in 7 percent of total debtors, this proportion corresponds to a significant amount of companies (28,101 firms). In addition, institutions diversify their portfolios in different economic activities that are not necessarily positively correlated. This is one among other tools adopted by them to mitigate the possible effects that concentration can have on their balance sheet in case of default.
- Concentration is a common phenomenon in emerging economies. Social and economic development requires that credit institutions finance important projects in areas such as the ones involved in mining, energy and infrastructure sectors. Due to their size and value, these projects need an important capital investment and are financed mainly by credit institutions.
- The SFC has several credit risk administration requirements to credit institutions, especially regarding loan origination and monitoring, which force the credit institutions to make proper risk evaluations from the moment the loan operation is done and periodic monitoring during its lifetime. Furthermore, taking into account that the aforementioned requirements are fully met by the credit institutions so they are able to respond appropriately should risk factors materialize, an instant and unexpected impairment of borrowers, including those who have important participations in the institution’s portfolio, is unlikely. Regulation establishes credit exposure limits, tolerated loss levels and methodologies for credit granting that allows monitoring of the credit exposure in the institution’s portfolios.
- The stress tests show that when a 1 or 2 notch downgrading is done to the system’s most significant borrowers, only one credit institution falls under a solvency level of 9 percent and only 3 institutions below the Tier 1/Risk Weighted Assets ratio of 4.5 percent. This exercise allows us to conclude that, given a sudden and unexpected impairment of systemic borrowers, credit institutions are able to respond properly due to their capacity to absorb losses that derivate from the significant increase in provision volume. Then, the risk associated to concentration is mitigated by the different mechanisms used by institutions (proper loan origination, permanent monitoring, provisions, countercyclical component and capital).
Finally, regarding coordination among entities, in October 2012 the SFC and Fogafín signed a MOU to improve coordination and resolution mechanisms. It was agreed that the SFC will inform Fogafín when an institution is at significant risk of being intervened and the SFC will support Fogafín in the process of collecting information about bank’s deposits directly from banks. For that purpose, it was decided that banks must submit this information directly to Fogafín beginning in 2014 and that banks and Fogafín shall work jointly during 2013 on the systems and coordination procedures required for this purpose.