Colombia: Arrangement Under the Flexible Credit Line and Cancellation of the Current Arrangement
Author: International Monetary Fund. Western Hemisphere Dept.
Publication Date:
03 Aug 2015
eISBN:
9781513537054
Language:
English
Keywords:
ISCR; CR; successor FCL arrangement; regime; FCL facility; policy flexibility; FCL arrangement; balance of payments; oil price; private sector; interest rate; monetary policy; Oil prices; Global; commodity price
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EXECUTIVE SUMMARY Background: Colombia’s strong economic policy framework, comprising an inflation- targeting regime, a flexible exchange rate, effective financial sector supervision and regulation, and a fiscal policy guided by a structural balance rule, has underpinned strong economic performance in recent years. These policies and institutions also help smooth the large terms of trade shock the country is facing, allowing a gradual adjustment to a new equilibrium. Outlook: In the baseline scenario, growth is expected to decelerate to 3.4 percent in 2015 but gradually return toward potential (4¼ percent) over the medium term and inflation to remain at the midpoint of the central bank’s 2–4 percent target range. The current account deficit would gradually narrow in line with the expected mild rebound in oil prices and the sustained growth in Colombia’s trading partners, while net private capital inflows would remain strong. The authorities are firmly committed to maintaining their sound policy framework and strengthening policy buffers in the period covered by the proposed arrangement. Risks: Risks associated with emerging markets have increased since the 2014 Article IV consultation. Despite strong fundamentals, Colombia is facing a permanent adjustment to weaker external conditions while being vulnerable to tail risks, especially a surge in financial volatility, protracted growth slowdown in trading partners, and a further decline in oil prices. Flexible Credit Line (FCL): The authorities are requesting a successor two-year FCL arrangement for 500 percent of quota (SDR 3.87 billion), which they intend to treat as precautionary, and cancellation of the current arrangement which expires on June 23, 2015. The access requested would provide Colombia with reasonable cover in an adverse external scenario. The authorities consider access to the FCL to be temporary and have signaled their intention to phase out its use as external risks recede. Staff assesses that Colombia meets the qualification criteria for access to Fund resources under the FCL arrangement, and recommends its approval by the Executive Board. Fund liquidity: The proposed commitment of SDR 3.87 billion would have only a marginal impact on the Fund’s liquidity position. Process: An informal meeting to consult with the Executive Board on a possible FCL arrangement for Colombia was held on May 22, 2015.

Abstract

EXECUTIVE SUMMARY Background: Colombia’s strong economic policy framework, comprising an inflation- targeting regime, a flexible exchange rate, effective financial sector supervision and regulation, and a fiscal policy guided by a structural balance rule, has underpinned strong economic performance in recent years. These policies and institutions also help smooth the large terms of trade shock the country is facing, allowing a gradual adjustment to a new equilibrium. Outlook: In the baseline scenario, growth is expected to decelerate to 3.4 percent in 2015 but gradually return toward potential (4¼ percent) over the medium term and inflation to remain at the midpoint of the central bank’s 2–4 percent target range. The current account deficit would gradually narrow in line with the expected mild rebound in oil prices and the sustained growth in Colombia’s trading partners, while net private capital inflows would remain strong. The authorities are firmly committed to maintaining their sound policy framework and strengthening policy buffers in the period covered by the proposed arrangement. Risks: Risks associated with emerging markets have increased since the 2014 Article IV consultation. Despite strong fundamentals, Colombia is facing a permanent adjustment to weaker external conditions while being vulnerable to tail risks, especially a surge in financial volatility, protracted growth slowdown in trading partners, and a further decline in oil prices. Flexible Credit Line (FCL): The authorities are requesting a successor two-year FCL arrangement for 500 percent of quota (SDR 3.87 billion), which they intend to treat as precautionary, and cancellation of the current arrangement which expires on June 23, 2015. The access requested would provide Colombia with reasonable cover in an adverse external scenario. The authorities consider access to the FCL to be temporary and have signaled their intention to phase out its use as external risks recede. Staff assesses that Colombia meets the qualification criteria for access to Fund resources under the FCL arrangement, and recommends its approval by the Executive Board. Fund liquidity: The proposed commitment of SDR 3.87 billion would have only a marginal impact on the Fund’s liquidity position. Process: An informal meeting to consult with the Executive Board on a possible FCL arrangement for Colombia was held on May 22, 2015.

Background

1. A strong policy framework and prudent macroeconomic management have underpinned Colombia’s vigorous economic growth during the last several years. Colombia’s robust and broad-based growth in recent years has exceeded that of most Latin American peers and contributed to an improvement in social indicators. The inflation targeting framework has served to maintain low and stable inflation and anchor inflation expectations. The central bank has taken advantage of the abundant capital inflows, especially FDI, to rebuild net international reserves. Prudent financial supervision and regulation have supported financial deepening and macro-financial stability. Four successive FCL arrangements have supported the authorities’ policies by providing a significant buffer against global tail risks. During the Board discussion of the 2015 Article IV Consultation (concluded on May 18, 2015), Executive Directors commended the authorities for their prudent management and strong policy framework that have underpinned Colombia’s continued robust economic performance and financial stability (IMF Country Report No. 15/142).

2. Large adverse external risks threaten the outlook. The April 2015 WEO notes that global medium-term prospects have become less optimistic, especially for emerging markets, with risks to global growth tilted to the downside. The most salient risks are related to disruptive asset price shifts in financial markets, and—in advanced economies—stagnation and low inflation. Further, the April 2015 GFSR warns that continued financial risk taking by economic agents and structural changes in credit markets have shifted the locus of financial stability risks from advanced economies to emerging markets and from solvency to market and liquidity risks. The decline in structural liquidity in fixed-income markets in both the U.S. and other economies has amplified asset price responses to shocks, increasing potential spillovers. In this regard, a critical global risk stems from the expected normalization of U.S. monetary policy where a faster decompression of term premiums could lead to rapidly rising yields and substantially higher volatility, which coupled with further dollar appreciation and surging global risk aversion could have strong knock-on effects on emerging markets’ growth and commodity prices, including oil. Further, an intensification of sovereign distress in the Euro Area could generate a surge in bond yields, large movements in the value of major currencies, or an increase in global financial volatility. After a prolonged period of private capital inflows (as in Colombia over the last years), foreign investors could abruptly reduce their holdings of local currency debt, thereby increasing turbulence and undermining debt rollover. Lower global demand and idiosyncratic supply factors, such as reduced geopolitical tensions in Iran, could trigger further decline in commodity prices, including oil.

A01ufig1

Comparable GFSR Global Financial Stability Map

Citation: IMF Staff Country Reports 2015, 206; 10.5089/9781513537054.002.A001

Note: Away from center signifies higher risks, easier monetary and financial conditions, or higher risk appetite.

3. The authorities have continued to strengthen their policy framework and policy buffers, supported by previous FCL arrangements. A strengthened fiscal framework during the last few years and moderate levels of public debt have helped Colombia to absorb adverse external shocks. The flexible exchange rate regime, credible inflation targeting framework, and comfortable level of international reserves have provided the central bank with powerful tools to respond to shifts in cyclical economic and financial conditions. With inflation expectations well-anchored within the official target range, there has been ample policy space on the monetary front, which the central bank has used judiciously. Moreover, the authorities are making good progress in implementing FSAP recommendations to further strengthen the resilience of the financial system and address cross-border risks. They also continue to advance an agenda of fostering inclusive growth and boosting competitiveness, with measures set out in the recent development plan.

Recent Developments

4. Brisk growth continued in 2014, with mildly supportive macroeconomic policies. Despite strong headwinds from the external environment, real GDP increased by 4.6 percent in 2014, driven by domestic demand. Strong economic growth underpinned historically low unemployment rates and increased labor formality. As inflation returned quickly to the midpoint of the target band from a low level in 2013 and Q1 growth surged to 6.3 percent, the central bank normalized the monetary stance, increasing the policy rate by 125 bps between May and August, to 4.5 percent. However, real interest rates remained moderately supportive. The central government fiscal balance remained broadly unchanged from 2013, and met the structural balance target embedded in the fiscal rule. However, subnational governments posted strong expenditure growth, which drove a widening of the consolidated public sector deficit to 1.8 percent of GDP which, together with the effects of peso depreciation pushed public debt to 44 percent of GDP.

5. From position of strong growth, Colombia confronted a severe oil price shock in the second half of 2014. The economy was operating slightly above potential in mid-2014 and inflation expectations were anchored near the center of the central bank’s 2–4 percent target band. During the second half of 2014, oil prices plummeted by about 40 percent, leading to a moderation of portfolio inflows as well as a decline in asset prices. Reflecting some pass-through from a sharp peso depreciation (17 percent during Q4), and a weather-related agricultural output supply shock, inflation accelerated to 3.7 percent at end-December.

6. Despite a higher current account deficit, reserve buffers remained strong through 2014. The current account deficit widened to 5.2 percent of GDP, owing to strong import demand from buoyant economic activity, declining exports and the temporary shutdown of the Cartagena oil refinery. Partly due to its favorable economic conditions, Colombia experienced heightened portfolio inflows from the beginning of the year, triggered by an increase in Colombia’s weight in the J.P. Morgan’s Emerging Markets Bond Index. Despite some moderation in the last part of the year, portfolio inflows added to the ample inward foreign direct investment to more than finance the current account deficit, and consequently gross international reserves rose to US$46.8 billion at end-2014, representing 131 percent of the reserve adequacy metric augmented by the buffer for commodity exporters and 175 percent without augmentation. Using the augmented metric is appropriate in the case of Colombia given the country’s greater exposure to oil price volatility and other commodity related risks which warrant additional buffers, see Box 1.1 Total external debt remained low (29.3 percent of GDP). Reserve accumulation stopped in November 2014 and a moderate loss of reserves of around US$500 million, mainly due to valuation effects, accompanied the slowdown in exports and capital inflows until March 2015.

7. While portfolio inflows have strengthened over the past 5 years, the NIIP is mainly in the form of FDI, with net liabilities expected to increase over the medium term. Colombia’s NIIP reached about -30 percent of GDP at end 2014 and is projected to further decline to about -47 percent of GDP over the next five years. FDI liabilities—about 40 percent of GDP—are twice as large as portfolio liabilities. While the NIIP is sustainable, recent trends in portfolio investments could lead to heightened vulnerability to global financial volatility. Notably, portfolio liabilities increased on average by 26 percent in the past 5 years, twice as high as the average growth rate of FDI liabilities.

8. The banking system and corporate sector remained in good financial health. Financial soundness indicators remained strong. Following the implementation of new enhanced capital standards in August 2013, capital adequacy declined marginally but stayed well above the regulatory minimum. Growth in credit to the private sector was buoyant, and vulnerabilities stemming from the cyclical increases in house prices in recent years remained contained, and the mortgage subsidy on middle-income households was discontinued. Corporate profitability was strong, and liquidity remained adequate. Corporate debt increased to some 29 percent of GDP of which over ⅔ was due to domestic banks, but remained modest by international standards and total leverage was within historical norms.

Outlook and Policies

9. Economic growth is expected to decelerate in 2015 but gradually return toward potential. Real GDP growth is projected to slow to 3.4 percent in 2015 on account of a deceleration of private investment, especially in the oil sector, and a slowdown in private consumption, but gradually rise toward 4¼ percent by 2018, driven by a slight improvement in external demand and private investment associated with the authorities’ infrastructure program. With some pass-through from the exchange rate depreciation and food-related supply effects, inflation will likely increase temporarily in 2015, but is projected to remain at the midpoint of the central bank’s 2–4 percent target range over the medium term, with inflation expectations anchored. The current account deficit is projected to widen in 2015 due to the oil price decline, but would gradually narrow over the medium term in line with the expected mild rebound in oil prices and the sustained growth in Colombia’s trading partners, especially the U.S.

Reserve Adequacy for Commodity Exporters: the Case of Colombia

Commodity exporters, such as Colombia, are exposed to more volatile terms of trade and have greater difficulty in adjusting to commodity price shocks. As shown in IMF 2015,1 commodity intensive economies tend to face inelastic supply. They are therefore more strongly exposed to price shocks and tend to have a more limited ability to adjust to fluctuations in their terms of trade. In the case of Colombia, oil revenues amount to more than 50 percent of total exports. As experienced during the recent oil price shock, the country’s economy is vulnerable to oil price volatility, leading to significant exchange rate movements, widening of the current account and fall in FDI. While prices move quickly, non-commodity exports and investments only gradually respond to-partially-replace losses in oil export revenues and FDI.

Higher precautionary buffers may be needed to smooth commodity related shocks. These buffers could be met in various ways including through savings under a sovereign wealth fund, price hedging mechanisms, and longer term contracts. Another possibility is to hold additional international reserves as a buffer against this additional price risk. The Colombian authorities prefer to meet this additional buffer by holding additional reserves. IMF 2015 proposes to calculate the additional buffer using a forward-looking measure of price risk. In this case the buffer associated with commodity price risk is calculated by multiplying the gap between current oil prices and one year futures prices at the 68 percent confidence interval by the value of oil exports.

A01ufig2

Colombia: Reserve Adequacy, 2014

(In percent)

Citation: IMF Staff Country Reports 2015, 206; 10.5089/9781513537054.002.A001

Source: Fund staff estimates.

Taking into account both the general need for reserves (captured by the ARA metric), and the additional buffer, Colombia’s gross international reserves of US$46.8 billion in 2014 correspond to 131 percent of the ARA metric augmented by the buffer for commodity price risk. Reserves amount to 175 percent of the original ARA metric, which is calculated based on a weighted sum of four components reflecting potential drains on the balance of payments, including export income, broad money, short-term debt, and other liabilities, and depends on the weights used. Reserves are 5.1 times the estimated commodity price buffer. The metric is based on ARA data available March/April 2015 and the calculation of the augmentation follows the guidelines detailed in IMF 2015.

1 IMF, Assessing Reserve Adequacy—Specific Proposals, January 2015.

10. The macroeconomic framework provides flexibility to mitigate the impact of the sharp decline in world oil prices so far and smooth the adjustment to a lower level of national income.

  • Fiscal policy. The structural fiscal rule represents an important buffer against short-term fluctuations in oil prices and GDP and will also allow smoothing the adjustment of expenditure to a dimmer medium-term oil outlook. Public debt ratios remain moderate and sustainable, and after rising somewhat in 2014–15, would decline over the medium term in line with the planned fiscal consolidation.

  • Monetary policy. The monetary policy rate, at 4.5 percent, is currently near its neutral level. With a low exchange rate pass-through to prices, the projected decline in domestic energy prices, and unwinding temporary food-related supply effects, inflation pressures are expected to ease later this year, especially as the slowdown in domestic demand takes hold. If growth slows more than expected there would be scope for monetary policy easing as long as inflation expectations remain anchored near the mid-point of the target band.

  • Exchange rate and reserves. The flexible exchange rate regime continues to play an important role in helping the economy adapt to shifts in global economic and financial conditions. Colombia has an adequate international reserve level for normal times, though it might be insufficient to cope with tail risks. With the peso broadly aligned with fundamentals and already strong buffers, the pace of reserve accumulation will likely abate, partly as a result of lower oil prices, as reflected by the central bank’s decision to suspend foreign currency purchases since November 2014.

11. The authorities are implementing an ambitious structural reform package and further strengthening the macroeconomic and financial frameworks.2 The fourth generation infrastructure investment program of road concessions is expected to foster inclusive growth, by improving productivity and regional integration, and boost Colombia’s competitiveness and medium-term economic prospects. Efforts to foster innovation and economic diversification would reduce reliance on the oil sector and help improve growth prospects and external sustainability. The government is putting a high priority on mobilizing additional fiscal revenue, especially to offset the decline in oil-related revenue. They have established a tax commission to consider options for tax reform to ensure that the medium-term fiscal deficit targets can be achieved while also improving the progressivity and efficiency of the tax system and protecting key social and infrastructure spending in line with the priorities of the development plan. On the social inclusion front, the authorities are working on a pension reform to increase the coverage and progressivity of the system. They are also undertaking measures to improve labor market formalization, increase access to quality education, and strengthen the social safety net for the poor. Good progress is also being made in implementing FSAP recommendations to further strengthen the resilience of the financial system and address cross-border risks.

Role of the Flexible Credit Line Arrangement

A. Benefits of the FCL

12. The FCL has served Colombia well. The previous FCL arrangements have been instrumental to cope with heightened external risks in recent years, including after the 2008–09 global financial crisis and during the euro area crisis. Indeed, the FCLs have complemented the authorities’ policy response to the global crisis, including the flexible exchange rate and countercyclical fiscal and monetary policies. In addition, the instrument has ensured a cushion of international liquidity for the country, providing space to strengthen the policy framework and to rebuild policy buffers, while sending a positive signal to international financial markets on the strength of the economy.

13. The FCL has also enhanced the economy’s resilience to adverse external shocks. Empirical analysis conducted by the Colombian central bank found that access to the FCL reduced the sovereign risk premium (EMBI) for Colombia, and had an important positive impact on the consumer confidence index and growth.3 Consistently, staff’s econometric analysis suggests that exchange rate pressures eased more rapidly after the taper talk episode in mid-2013 for emerging markets with an FCL arrangement. Another IMF exercise found that the FCL mitigated the surge in sovereign yields for the three FCL countries after the taper talk and had been effective in bolstering confidence.4

14. The authorities are requesting a successor 2-year FCL arrangement for an amount equivalent to SDR 3.87 billion (about US$5.38 billion) or 500 percent of quota, which they intend to treat as precautionary, and the cancellation of the current arrangement which expires on June 23, 2015. They consider that the persistence of large global risks makes it premature to reduce their reliance on contingent external financing from the Fund. They further note that, notwithstanding their efforts to rebuild buffers, with ample international reserves amounting to 131 percent of the reserve adequacy metric augmented by the buffer for commodity exporters in 2014 (Figure 5), some reserves benchmarks are still below values prevailing before the global financial crisis (Table 2a). The authorities consider that the FCL provides useful temporary insurance that reinforces market confidence, providing the breathing space as they continue rebuilding policy buffers, helps smooth the adjustment to a lower level of national income, and provides policy flexibility in the face of heightened global and regional uncertainties.

Figure 1.
Figure 1.

Colombia: Recent Economic Developments

Citation: IMF Staff Country Reports 2015, 206; 10.5089/9781513537054.002.A001

Source: Banco de la República; DANE; Bloomberg; and Fund staff estimates.1/ Colombia mix follows closely Brent oil prices.
Figure 2.
Figure 2.

Colombia: Macroeconomic Policies

Citation: IMF Staff Country Reports 2015, 206; 10.5089/9781513537054.002.A001

Sources: Banco de la República; and Fund staff estimates.1/ Corresponds to the change in the structural primary deficit.
Figure 3.
Figure 3.

Colombia: Recent Macro-Financial Developments 1/

Citation: IMF Staff Country Reports 2015, 206; 10.5089/9781513537054.002.A001

Source: Banco de la República; DANE; Bloomberg; and Fund staff estimates.1/ LA4 corresponds to the average of Brazil, Colombia, Peru and Mexico.2/ Spreads are calculated using yields on 2024 soveing bonds in USD and 2023 bonds for oil companies.3/Data for 2014 refers to June 2014.
Figure 5.
Figure 5.

Colombia: Reserve Coverage in an International Perspective

Citation: IMF Staff Country Reports 2015, 206; 10.5089/9781513537054.002.A001

Sources: World Economic Outlook ; IFS; and Fund staff estimates.1/ The current account is set to zero if it is in surplus.2/ The blue lines denote the 100–150 percent range of reserve coverage regarded as adequate for a typical country under this metric. COL1 displays the reserve ratio using the original ARA metric. COL2 reflects the ARA metric for Colombia augmented by the buffer for commodity exporters.
Table 1.

Colombia: Selected Economic and Financial Indicators

article image
Sources: Colombian authorities; UNDP Human Development Report; World Development Indicators; and Fund staff estimates.

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

Does not include Banco de la República’s outstanding external debt.

GIR refers to Gross International Reserves.

Excludes Colombia’s contribution to FLAR and includes valuation changes of reserves denominated in currencies other than U.S. dollars.

Table 2a.

Colombia: Summary of Balance of Payments

article image
Sources: Banco de la República and Fund staff estimates and projections.

Deposit flows of public sector entities abroad.

Includes net portfolio investment.

FLAR is Fondo Latinoamericano de Reservas.

IMF definition that excludes Colombia’s contribution to Fondo Latinoamericano de Reservas (FLAR) and includes valuation changes of reserves denominated in other currencies than U.S. dollars.

Original maturity of less than 1 year. Stock at the end of the previous period.

Table 2b.

Colombia: Summary Balance of Payments

(In percent of GDP)

article image
Sources: Banco de la República and Fund staff estimates and projections.

Deposit flows of public sector entities abroad.

Includes net portfolio investment.

FLAR is Fondo Latinoamericano de Reservas.

B. Evolution of Risks

15. Adverse external risks pose strong headwinds to Colombia’s economic outlook. Colombia faced a massive oil price shock in 2014 and risks associated with emerging markets have increased since the 2014 Article IV consultation. Given the country’s high exposure to commodities and increasing reliance on portfolio flows for the public as well as the private sector, these elevated downside risks are particularly challenging for Colombia and, if they materialize, could weaken Colombia’s external position.

16. A surge in global risk aversion would adversely affect Colombia through financial market and trade linkages. The expected asymmetric exit from unconventional monetary policy in the U.S. and faster than expected decompression of U.S. term premia could generate a surge in bond yields or an increase in global financial volatility, which coupled with further dollar appreciation and surging global risk aversion could have strong knock-on effects on emerging markets’ growth and commodity prices, including oil. In the context of Colombia’s greater economic vulnerability after the oil price decline, including a stronger reliance on portfolio inflows, it could lead to sharp repricing of Colombian assets and exchange rate, as well as spillovers to export revenue, FDI, and growth. Further, the decline capital inflows could lead to lower investment, tightening liquidity conditions, and rising bond yields.

17. Negative growth shocks in key trading partners could slow Colombia’s growth and capital inflows and weaken world oil prices further. Potential growth has been repeatedly revised down in advanced and emerging countries, pointing to a latent protracted period of slower growth, including in China. Given Colombia’s strong trade links with the U.S., Europe, and China, slower growth in trading partners could lessen Colombia’s exports receipts, FDI inflows, and further weaken oil prices.

18. Colombia would be particularly affected by further declines in commodity prices, especially oil. In 2014, commodity exports accounted for about 72 percent of total export revenues. The outlook for oil prices is uncertain and will remain exposed to bouts of volatility. In addition, given the large share of FDI inflows channeled to commodity-related projects, oil companies’ cutbacks in investment associated with the cash flow constraints after the fall in prices will likely limit the growth of the sector over the medium term. Further oil price declines due to weak external demand or positive supply shocks, such as easing tensions in the Middle East and technological improvements in oil production, would therefore notably weaken Colombia’s balance of payments and increase its external financing needs.

19. Regional risks have risen significantly. Growth in neighboring countries is projected to decline, thereby undermining Colombia’s potential export boost from the peso depreciation. The recent fall in oil prices is likely to dampen growth in Ecuador (which has also recently raised import tariffs), and to exacerbate the economic distress in Venezuela, both of which remain key destinations for Colombia’s nontraditional exports. Potential civil unrest in Venezuela could also spillover to Colombia’s border areas, where unemployment could increase due to migration. In addition, economic distress in Central America could adversely affect the subsidiaries of Colombian banks that have expanded into the region.

20. Domestic risks could also weaken medium-term growth prospects. While the authorities are optimistic about a full implementation of the infrastructure investment program of road concessions, delays in project execution could put a drag on raising potential growth, boosting competitiveness, and fostering social inclusion.

21. The external economic stress index remains elevated for Colombia and would worsen under the downside scenario (Box 2). Colombia has seen a strong deterioration in the external environment throughout 2014 until the first quarter of 2015, mainly driven by the sharp fall in oil prices. With energy prices increasing somewhat and U.S. growth picking up in Q2 under the baseline, the index would stabilize but remain in negative territory as the overall level of oil price projections is significantly lower than prices observed in the past decade. In the downside scenario however, the downward trend would continue for another quarter due to a faster-than-expected increase in U.S. interest rates and heightened volatility in EMs.

External Economic Stress Index

The External Economic Stress Index for Colombia is calculated according to the methodology outlined in “Review of the Flexible Credit Line, the Precautionary and Liquidity Line, and the Rapid Financing Instrument—Specific Proposals.”

The index is based on four major variables which capture external risks for Colombia. The external risk variables include: the level of the oil price, a proxy for oil exports as well as oil-related FDI; U.S. growth, a proxy for exports, remittances and other inward FDI; the emerging market volatility index (VXEEM); and the change in the 10 year U.S. government bond yield, proxies for risks to equity and debt portfolio flows. The index is then calculated as a weighted sum of standardized deviations of the above variables from their means. The weights are estimated using balance of payments and international investment position data, all expressed as shares of GDP. The weight on oil prices (0.32) corresponds to the sum of oil and coal exports and oil-related FDI. The weight on U.S. growth (0.24) corresponds to exports to the U.S. The weight on the VXEEM (-0.04) comes from the equity portfolio investment stock and the weight on the U.S. government bond (-0.40) from the debt portfolio investment stock.

The calculation of the downside scenario reflects external risks stemming from potential heightened financial volatility following the lift-off of U.S. federal funds rate. A stronger or earlier than expected increase in U.S. interest rates for other reasons than a positive U.S. growth shock would trigger financial volatility and tightening financial conditions, notably in EMs. Moreover, a stronger U.S. dollar would put further strains on the EM growth outlook and slow down the recovery of commodity prices. The assumptions underlying the scenario are as follows:

  • Similar to the 2014 Spillover report, long-term U.S. interest rates increase by 100 basis points relative to the baseline, spread over the next four quarters.

  • U.S. growth by 0.5 percent lower than in the baseline, spread over the next four quarters.

  • Stress in financial markets leads to an increase in the VXEEM by two standard deviations which remains at this level over the next two quarters, falling to 1.5 standard deviation in 2015Q4 and to 1 standard deviation in 2016Q1.

  • With a stronger dollar, oil prices decline slightly relative to their 2015Q1 value (by about 12 percent by end 2015), as opposed to a slight improvement from Q2 onwards as under the baseline.

A01ufig3

Colombia: External Economic Stress Index

(Negative values indicate above average stress)

Citation: IMF Staff Country Reports 2015, 206; 10.5089/9781513537054.002.A001

Source: IMF staff calculations.

C. Access Considerations under an Adverse Scenario

22. Staff considers that the level of access of 500 percent of quota requested by Colombia would provide reasonable coverage against the balance of payments needs arising from the materialization of global risks. While the 2015 baseline already incorporates the realization of the 2014 oil price shock—a price decline of 40 percent—and the subsequent decline in mainly oil-related FDI of around 25 percent, an illustrative adverse scenario (Box 3) applies additional elements of external stress which could materialize in the coming two years. The main source of risks for the Colombian economy stems from an increase in U.S. interest rates leading to rising yields and substantially higher volatility in international capital markets, which coupled with higher global risk aversion could put further downward pressure on growth in emerging markets, including China. Further oil price declines stemming from weaker global demand would lessen Colombia’s exports receipts and FDI inflows even more. With oil prices falling further to close to production costs, the impact could be magnified by insolvencies in the oil sector and closing of oil fields, implying lower production going forward.5 According to the adverse scenario, if this shock were to materialize over the next two years, Colombia’s balance of payments would deteriorate by about US$5.5 billion (520–525 percent of quota) relative to the baseline projection for 2015 and 2016 (Table 3).

Table 3.

Colombia: External Financing Requirements and Sources

(In millions of U.S. dollars)

article image
Sources: Banco de la República and Fund staff estimates.

Including financial public sector.

Original maturity of less than 1 year. Stock at the end of the previous period.

IMF definition that excludes Colombia’s contribution to Fondo Latinoamericano de Reservas (FLAR) and includes valuation changes of reserves denominated in other currencies than U.S. dollars.

Assumes build-up of Ecopetrol dividends as a safeguard against long-term fiscal liabilities.

Original maturity of less than 1 year. Stock at the end of the current period.

Includes all other net financial flows (i.e. pension funds, other portfolio flows), Colombia’s contribution to FLAR, and errors and

23. Given the current external environment, assumptions on the components of the adverse scenario have been adjusted relative to previous FCL arrangements. The changes include (i) a smaller decline in oil prices (and no decline in remittances); (ii) slightly lower rollover rates for portfolio flows, which is consistent with the recent increase in portfolio inflows and market expectations of U.S. interest rate increases; (iii) a stronger decline in FDI and longer term capital flows; and (iv) a drawdown of reserves. On this final point, the scenario assumes that in the event of external stress the authorities use some of Colombia’s international reserves (about US$4.1–4.6 billion) to help cover the estimated potential financing needs, bringing end-2016 reserves to around 110 percent of the IMF’s Assessing Reserves Adequacy (ARA) metric augmented by the buffer for commodity exporters.

Illustrative Adverse Scenario

An illustrative adverse scenario suggests that the requested access level of SDR 3.87 billion (about US$5.8 billion) is justified. The proposed access level, combined with a drawdown of reserves of about US$4.1–4.6 billion, would help fill the estimated potential financing needs of US$5.5 billion in 2015 and US$5.6 billion in 2016.

Assumptions underlying the adverse scenario for 2015 and 2016 are as follows:

  • Rollover rates decrease to around 90 percent for short-term debt. Given strong portfolio inflows in 2014 as well as signs of foreign investor sell-offs in early 2015, a reduction in rollover rates seems justified in light of an expected asymmetric monetary exit in advanced markets and Colombia’s exposure to U.S. financial markets. Short-term rollover rates are lower than in all but one FCL request for Colombia, but comparable to Mexico, for instance.

  • Longer term public debt inflows are 25 percent lower than under the baseline but still reach a rollover rate of around 150 percent.

  • Longer term private inflows decrease by 20 percent for non-financial flows and 25 percent for financial flows.

  • World oil prices decline by 15 percent relative to the baseline and commodity prices by 10 percent. Under the adverse scenario, APSP oil prices would be about US$49.5 per barrel on average in 2015. The price shock is significantly smaller than the one experienced in the previous months and above the price of the GRAM’s medium (<30 percent) downside scenario.

  • FDI declines by 20 percent relative to the baseline. The decline is comparable to the first three FCL requests and smaller than the decline expected in the 2015 baseline.

  • Reserves are drawn down by US$4.6 billion in 2015 and US$4.1 billion in 2016.

D. Exit Strategy

24. The authorities consider access to the FCL to be temporary and dependent on external conditions. Indeed, they have demonstrated their commitment to an exit strategy by reducing access when risks attenuated. In particular, Colombia’s first FCL arrangement was approved in May 2009 in the amount of 900 percent of quota, but successor FCL arrangements starting in mid-2011 have been only 500 percent of quota reflecting the authorities’ assessment that risks related to the global financial crisis had receded.

25. The authorities consider it premature to scale back access further in the current global environment. They note that global risks remain elevated, particularly risks of a potential surge in financial market volatility associated with the expected U.S. monetary policy normalization. In this context, access to the FCL is important to ensure a smooth adjustment of the Colombian economy to the sharp and persistent decline in oil prices.

26. The authorities have outlined conditions that would facilitate exit. They expect that as U.S. monetary policy normalizes, any associated global financial market volatility will recede. In addition, the Colombian economy will adjust over time to the much lower oil prices. As these adjustments take place, with substantial reduction of global risks affecting Colombia, the authorities would intend to phase out Colombia’s use of the facility.

E. Review of Qualifications

27. Staff’s assessment is that Colombia continues to meet the qualification criteria identified in paragraph 2 of the FCL decision (Figure 4) on access to Fund resources under an FCL arrangement. Colombia has very strong economic fundamentals and institutional policy frameworks,6 with an inflation targeting framework and a flexible exchange regime, a fiscal policy framework anchored by a structural balance rule, and financial system oversight based on a sound regulatory and supervisory framework. Colombia has a sustained track record of implementation of very strong policies and the authorities are firmly committed to maintaining such policies going forward.7 Staff’s assessment of Colombia’s qualification is based, in particular, on the following criteria:

  • Sustainable external position. Colombia’s external debt is low, at an estimated 29.3 percent of GDP at end-2014. Staff’s updated external debt sustainability analysis shows that external debt ratios would decline further over the medium term and remain manageable even under large negative shocks. Based on the latest WEO projections for commodity prices, the external current account deficit is projected to widen to 5.9 percent of GDP this year, but would gradually narrow to about 3.7 percent by 2020. The real effective exchange rate was broadly in line with fundamentals by the end of 2014.

  • Capital account position dominated by private flows. Capital account flows in Colombia are predominantly private, mostly in the form of net flows of foreign direct investment (estimated at US$12.2 billion or 3.2 percent of GDP in 2014). The reliance on portfolio inflows is projected to remain stable before gradually declining over the medium term. FDI inflows are expected to moderate from recent high levels, but will finance about 80 percent of the current account deficit over the medium-term. As a result, the current account deficit will continue to be financed largely through stable funding sources, as in the past.

  • Track-record of steady sovereign access to international capital markets at favorable terms. Colombia has had uninterrupted access to international capital markets at favorable terms since the early 2000s. All major credit rating agencies upgraded Colombia’s sovereign rating to investment grade level in recent years. While both sovereign spreads (about 210 basis points) and CDS spreads (at around 150 basis points) have increased somewhat since the time of the last FCL arrangement (from about 140 and 90 basis points, respectively) they are broadly at par with other highly rated emerging sovereigns.

  • International reserve position remains relatively comfortable. Gross international reserves increased during the current FCL arrangement and reached US$46.8 billion as of December 2014. This is broadly equivalent to coverage of 8.7 months of imports and over 100 percent of the sum of short term external debt at remaining maturity plus the projected current account deficit, which is relatively comfortable.

  • Sound public finances, including a sustainable public debt position. The authorities are committed to fiscal sustainability by adhering to their structural balance rule. Strengthened fiscal framework and moderate levels of public debt helped Colombia to absorb the recent oil price shock. While public debt (44.3 percent of GDP at end-2014) is now 6.5 percentage points higher than in 2013—due in part to the cyclical widening of the public sector deficit and the valuation effects of the peso depreciation—it will gradually decline over time and remain sustainable, and in line with other investment-grade countries.

  • Low and stable inflation, in the context of a sound monetary and exchange rate policy. The recent hike in inflation (4.6 percent y/y in April 2015) above the upper bound of the target range was mainly due to temporary supply effects which are expected to unwind later this year, especially as the disinflationary impact of the slowdown in domestic demand takes hold. Medium-term inflation expectations remain anchored at close to mid-target range of 2–4 percent. The authorities remain committed to their inflation targeting framework and flexible exchange rate.

  • Sound financial system and the absence of solvency problems that may threaten systemic stability. Financial indicators are strong, and, according to a central bank stress test conducted in June 2014, the banking sector would remain solvent even under an extreme macroeconomic shock. Banks’ exposure to companies in the oil sector is extremely low, mitigating the risk from the oil shock to direct lending portfolios.

  • Effective financial sector supervision. The authorities made good progress in implementing FSAP recommendations, and are continuing their efforts to help address cross-border risks. The financial sector supervisor (Superintendencia Financiera de Colombia (SFC)) continues to move ahead with risk-based supervision. The Ministry of Finance is working on proposals to implement the Basel III capital adequacy measure, Basel II (Pillar 2) buffers, conservation capital buffers, and capital surcharges for domestic systemically important banks to increase loss absorbency against cross-border and domestic risks. The authorities have also put a draft law before Congress which will strengthen independence of the SFC by requiring a clear fixed-term appointment and reasons for removal. SFC staff will be provided legal assistance and protection from lawsuits when acting in good faith. The SFC will also be given supervisory and regulatory powers over the holding company of a financial conglomerate and will be able to obtain information from domestic and foreign entities currently not subject to supervision. The SFC does not have, however, any enforcement powers over non-financial institutions that form part of mixed conglomerates.

  • Data transparency and integrity. Colombia’s macroeconomic data continues to meet the high standards found during the 2006 data ROSC. Colombia remains in observance of the Special Data Dissemination Standards (SDDS), and the authorities provide all relevant data to the public on a timely basis.

Figure 4.
Figure 4.

Colombia: FCL Qualification Criteria

Citation: IMF Staff Country Reports 2015, 206; 10.5089/9781513537054.002.A001

Sources: Banco de la República; Ministerio de Hacienda y Crédito Público; Datastream; Haver; and Fund staff estimations.1/ Combined permanent 1/4 standard deviation shocks applied to interest rate; growth; and non-interest current account balance.2/ Data for 2015 corresponds to issuance up to March 2015.3/ Combined 2 year shock to primary balance (1/2 standard deviation) and growth (1 standard deviation) shocks to primary balance; permanent shock to interest rate (to historical maximum) and exchange rate (30 percent nominal).4/ One-time increase in non-interest expenditures equivalent to 10 percent of banking sector assets leads to a real GDP growth shock (see above): growth is reduced by 1 standard deviation for 2 consecutive years; interest rate increases as a function of the widening of the primary deficit5/ 30 percent permanent nominal depreciation in 2016.

28. International indicators of institutional quality show that Colombia has strong and improving government effectiveness. Colombia has sharply improved its ranking in the World Bank’s indicators of the ease of doing business, rising 19 places over the past year to a ranking of 34, the best in Latin America. Furthermore, reflecting the authorities’ continuing efforts to further strengthen the already sound institutions and policy frameworks, Colombia compares favorably with other regional peers and emerging markets on a number of institutional quality indicators, including government effectiveness (Figure 7).

Figure 6.
Figure 6.

Colombia and Selected Countries: Comparing Adverse Scenarios 1/

Citation: IMF Staff Country Reports 2015, 206; 10.5089/9781513537054.002.A001

Source: Fund staff calculations.1/ The empirical distributions are based on countries’ actual experiences during the crisis year (for all four types of debt rollover rates), or countries’ experiences during the crisis year relative to proceeding 3-year average (for FDI). For the presented FCL/PLL country cases, shocks are defined according to the adverse scenario (with the exception of the 2015 fuel price growth rate labeled COL 5 baseline) and placed on the kernel curve.
Figure 7.
Figure 7.

Colombia: Indicators of Doing Business and Institutional Quality

Citation: IMF Staff Country Reports 2015, 206; 10.5089/9781513537054.002.A001

Sources: World Bank and Fund staff estimates.

F. Impact on Fund Finances, Risks, and Safeguards

29. Access under the proposed two-year FCL arrangement (SDR 3.87 billion or 500 percent of quota) would have only marginal effect on Fund’s liquidity. The Fund’s liquidity is expected to remain adequate after the approval of the proposed FCL arrangement for Colombia, and will be further discussed in the supplement assessing the impact on the Fund’s finances and liquidity position if Board approval for the proposed FCL arrangements is requested. In particular, the reduction in the Forward Commitment Capacity arising from the new arrangement would be small, partially offset by the expiration of Colombia’s existing FCL arrangement (Table 12).

Table 4a.

Colombia: Operations of the Central Government 1/

(In percent of GDP, unless otherwise indicated)

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

Includes central administration only.

The increase in tax revenue in 2012 reflects the elimination of the fixed asset tax credit, which was part of the end-2010 tax reform.

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

In percent of potential GDP. Adjusts non-commodity revenues for the output gap and commodity revenues for differentials between estimated equilibrium oil price and production levels. Adjustments are made to account for fuel subsidy expenditures and the accrual of Ecopetrol dividends.

Excludes private pension transfers from revenues.

Table 4b.

Colombia: Operations of the Central Government 1/

(In trillion of Col$)

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

Includes central administration only.

The increase in tax revenue in 2012 reflects the elimination of the fixed asset tax credit, which was part of the end-2010 tax reform.

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

Adjusts non-commodity revenues for the output gap and commodity revenues for differentials between estimated equilibrium oil price and production levels. Adjustments are made to account for fuel subsidy expenditures and the accrual of Ecopetrol dividends.

Excludes private pension transfers from revenues.

Table 5a.

Colombia: Operations of the Combined Public Sector 1/

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

The combined public sector includes the central, regional and local governments, social security, and public sector enterprises. Excludes Ecopetrol.

Includes royalties, dividends and social security contributions.

Expenditure reported on commitments basis.

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

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

Adjusts non-commodity revenues for the output gap and commodity revenues for differentials between estimated equilibrium oil price and production levels. Adjustments are made to account for fuel subsidy expenditures and the accrual of Ecopetrol dividends. Excludes private pension transfers from revenues.

Includes statistical discrepancy.

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

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