Statement by Maria Angelica Arbelaez, Alternate Executive Director for Colombia, on the Arrangement under the Flexible Credit Line, June 24, 2013

This staff report on Colombia’s arrangement under the Flexible Credit Line highlights economic policies and development. Colombia’s economic performance in recent years has been very strong, underpinned by a very strong institutional framework and prudent macroeconomic management. Following a sharp slowdown in 2008–2009, output growth rebounded vigorously, and inflation stayed within the official target range. A very strong policy framework—comprising an inflation-targeting regime, a flexible exchange rate, effective financial sector supervisionand regulation, and a medium-term fiscal framework—provided policy space to undertake timely and effective countercyclical measures to mitigate the effects of the global financial crisis, and skillful policy management helped maintain strong growth with low inflation.

Abstract

This staff report on Colombia’s arrangement under the Flexible Credit Line highlights economic policies and development. Colombia’s economic performance in recent years has been very strong, underpinned by a very strong institutional framework and prudent macroeconomic management. Following a sharp slowdown in 2008–2009, output growth rebounded vigorously, and inflation stayed within the official target range. A very strong policy framework—comprising an inflation-targeting regime, a flexible exchange rate, effective financial sector supervisionand regulation, and a medium-term fiscal framework—provided policy space to undertake timely and effective countercyclical measures to mitigate the effects of the global financial crisis, and skillful policy management helped maintain strong growth with low inflation.

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

The FCLs have been an important support to the economy during the financial crisis and the prolonged global downturn, and have served as a complement to the wide range of countercyclical policy responses. In addition, they have provided space to strengthen the policy framework and to build policy buffers. Indeed, since the approval of the first FCL in 2009, and despite the challenging global economic climate, the government has adopted important structural reforms and kept strengthening the economy. The reform package included the Fiscal Rule, a comprehensive tax reform, an amendment to the Constitution to include fiscal sustainability as a general principle and a reform to mining and oil royalties to improve their distribution among regions and generate savings. A health reform now being discussed in Congress and a pension reform are underway.

Economic fundamentals have also strengthened. The fiscal stance has substantially improved and public debt decreased; inflation kept declining to low levels while expectations are well anchored; the current account deficit has remained low and comfortably financed by FDI; the external debt-to-GDP ratio near 20 percent is manageable and sustainable; international reserves have been continuously building up; and Colombia has had full access to international capital markets with improved funding conditions—in 2013 Colombia paid the lowest yields in history. As concluded in the recent FSSA, the financial supervisory and regulatory framework is strong and banks remain healthy, liquid and profitable. The ratio of capital to risk-weighted assets for the banking system is well above requirements and provisioning levels are high. The authorities are moving ahead with the FSSA recommendations.

The strength of the institutional framework, coupled with a countercyclical macroeconomic management and favorable commodity prices, has allowed the economy to become relatively resilient to the global downturn and steadily reduce unemployment. Nonetheless, growth slowed down from 6.6 percent in 2011 to 4 percent in 2012 well below expectations, to which lower external demand and in less degree currency appreciation—one of the highest in Latin America—have contributed. To reverse this downward path the authorities have implemented a policy mix grounded on monetary easing and a budget-neutral stimulus package recently launched aiming at boosting productivity and employment. The authorities expect that these measures will propel growth to near its potential.

Monetary and exchange rate policies

The monetary policy framework, based on a flexible inflation targeting regime and a flexible exchange rate, has helped attain the long-term inflation target (a range of 2–4 percent) and has contributed to smoothing out business cycles. Consistent with this commitment, the Banco de la República (BR) raised its policy rate from 3 percent in January 2011 to 5.25 percent in February 2012 to tame inflationary pressures that built up throughout that period. Recently, as those pressures eased, the monetary authorities relaxed the policy stance by reducing interest rates to 3.25 percent in March 2013 in order to provide the necessary stimulus under current circumstances. In April, the inflation rate of 2 percent fell below the long-term target of 3 percent, which gives the BR room for maneuver should domestic demand need further impulse.

Exchange rate flexibility (de jure and de facto) has continued to be the main shock absorber. International reserves have been rising in the past five years and coverage in terms of imports and short-term debt remains comfortable, although still below 2008 levels. The BR has put in place pre-announced daily purchases in the foreign exchange market, a mechanism that allows the authorities to keep accumulating reserves.

Fiscal Policy

Colombia has put in place a solid institutional framework in order to anchor fiscal discipline and ensure debt sustainability, at both the central and regional governments. The Fiscal Rule Law (FRL) sets a quantitative target for the structural balance of the central government of 1.0 percent or below from 2020 onward. The government must also attain a non-increasing path for the deficit along the transition to this long-run target. 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 reduction and sustainability, and improvement in the primary balance in order to meet the fiscal rule which will enter into force in 2014.

Fiscal performance has been remarkable since 2009. In 2012, the Combined Public Sector balance reached a surplus of 0.3 percent of GDP and the Central Government a deficit of 2.3 percent; the net debt of the Non-Financial Public Sector declined to 25.1 percent and is expected to hover around 15 percent by 2018 according to the FRL; and public savings increased to 6.2 percent of GDP. Such fiscal discipline and low levels of debt strengthen Colombia’s resilience to adverse economic shocks in the short, medium and long term.

Request for the FCL

Despite the progress made, the Colombian economy remains vulnerable to external shocks. In the authorities’ view, while prospects in advanced economies have somewhat improved, adverse risks stemming from the global economy still persist. Among the risks that would significantly impact both the current and the capital accounts, if materialized, are: a slowdown in economic growth in the US and in Europe (50 percent of exports) and deeper than expected in emerging markets such as China, India and Venezuela (15 percent of exports); a sharp decline in commodity prices—particularly oil—which would also impact FDI; and an increase in risk aversion and worsening of markets’ confidence which would lower external financing and provoke outflows by residents, as has been the case in previous crises.

The uncertainty associated with the exit of the accommodative monetary policy in the United States and the resulting increase in long-term interest rates have become issues of great concern. The motivation, timing and the way the exit will take place will determine the impact on the external adjustment of the Colombian economy. A bumpy exit might cause sudden reversal of capital flows, large fluctuations in the exchange rate and a sharp fall in the terms of trade. In such scenario, the protection provided by the FCL would be worthwhile.

Based on the above considerations, the authorities are requesting a two-year FCL arrangement in the amount of SDR 3.87 billion SDR (500 percent of quota). According to their estimations, the potential financing need would be even larger (in part due to the bigger size of the economy), but part of the shock could be absorbed through international reserves. However, although higher, the current level of reserves is not sufficient to offset most of the effects.

The authorities’ intention is to gradually lessen the economy’s dependency on contingent external financing should risks recede and resilience strengthens. Consistent with this strategy, the amounts requested relative to the scale of the economy have been declining since the first FCL in 2009. In the current request, although the amount is similar in magnitude to that of the 2011–13 FCL, the relative level of protection against tail risks provided by the arrangement is lower. Indeed, using the traditional metrics the amount of FCL, as a percentage of imports, fell from 3.5 percent in 2009 to 1.3 percent in 2011 and to 1 percent in the current request; similarly, in the same years the FCLs represented 0.12 percent of Broad Money, 0.05 percent and 0.04 percent, respectively; and finally, compared to the current account deficit plus external debt amortizations, the FCLs dropped from 0.64 percent to 0.22 percent and to 0.19 percent in the current request.

Looking ahead, the policy strategy consists in maintaining exchange rate flexibility as the main shock absorber, further strengthening fiscal buffers and savings, continuing to accumulate international reserves, and keeping inflation within the target range and expectations well anchored. These policies will help reduce vulnerabilities and build resilience to external shocks, which will allow the country to increase its self protection. In the meantime, the arrangement will continue to help reinforce market confidence that Colombia is in a position to withstand a wide range of adverse external shocks. The authorities are ready to review the access level during the first review should domestic and external conditions improve.

Finally, as with previous FCLs, the authorities intend to treat the new arrangement as precautionary.

Colombia: Arrangement Under the Flexible Credit Line—Staff Report; Staff Supplement; Press Release on the Executive Board Discussion; and Statement by the Executive Director for Colombia
Author: International Monetary Fund. Western Hemisphere Dept.