Colombia: Review under the Flexible Credit Line Arrangement
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Review Under the Flexible Credit Line Arrangement-Press Release and Staff Report

Abstract

Review Under the Flexible Credit Line Arrangement-Press Release and Staff Report

Context and Recent Developments

1. Colombia is adapting smoothly to the large terms of trade shock experienced since 2014. Growth moderated to 2 percent in 2016 due in part to the cumulative effects of a 50 percent decline in oil prices since June 2014 and slowing trading partner growth. Inflation started declining in August 2016 but remained above the target band due to the lagged impact of the large depreciation that accompanied the fall in oil prices and weather-related shocks. Inflation expectations converged to the target band guided by monetary policy tightening. Strong import compression narrowed the current account deficit to 4.4 percent of GDP in 2016, from 6.4 percent of GDP a year earlier. The fiscal deficit widened to 4 percent of GDP as oil revenue declined but the structural fiscal balance improved. The financial system remained well capitalized and liquid but corporate balance sheets worsened somewhat.

A01ufig1

Nominal Exchange Rate

(Pesos per U.S. dollar)

Citation: IMF Staff Country Reports 2017, 149; 10.5089/9781484303320.002.A001

Source: Banrep.

2. The timely policy adjustment to lower oil prices underscores the strength of Colombia’s policy framework and fundamentals. The decisive monetary policy response to the spike in inflation helped anchor inflation expectations and narrow external imbalances. The central bank started a gradual easing cycle in December as inflationary pressures started to abate and the current account deficit fell more than expected. The exchange rate continued to float and was effective in dealing with the oil price shock given limited balance-sheet mismatches. Fiscal policy tightened as prescribed by the fiscal rule, while protecting essential social and infrastructure spending. A structural tax reform closely aligned with past Fund advice was approved in December 2016. The reform increased the VAT rate by 3 percentage points, simplified the tax code comprehensively, reduced the high corporate tax burden, and included measures to improve formalization and tax administration.

3. Colombia’s FCL arrangement provided support to pursue policy adjustments against a background of global and regional uncertainties, and signaled policy strength. Colombia made a very significant adjustment effort in a complex external environment, while maintaining relatively strong growth, and reducing poverty and inequality. Strong buffers, including the FCL arrangement, complemented the adjustment effort and insulated Colombia well from external shocks. The U.S. presidential elections resulted in short-lived volatility in Colombian financial markets. The External Stress Index also worsened significantly in this episode (see Box 1). Recent episodes of falling oil prices (13.4 percent in October–November, 2016, and 10.8 percent in February–March, 2017) were associated with currency depreciations but had limited impact on other Colombian markets, as shown by steadily declining sovereign spreads. Regional uncertainties, especially in Venezuela, persisted and were a headwind to Colombia’s efforts to increase non-commodity exports.

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Colombia—Financial Markets

Citation: IMF Staff Country Reports 2017, 149; 10.5089/9781484303320.002.A001

4. The peace agreement with the FARC and the structural reform agenda set the foundations for medium-term inclusive growth. The peace agreement signed in December 2016 was a historic milestone that put 50 years of armed conflict to an end and included plans to reduce infrastructure and social gaps across the regions most affected by the conflicts. The construction phase of a large wave of infrastructure projects has begun, setting the stage for increasing potential growth in the medium term. Many export barriers were removed and pilot projects on innovation and managerial skills are helping diversify exports. During the Board discussion of the 2017 Article IV Consultation, Directors commended the strong performance of the Colombian economy and the encouraging prospects of the peace agreement for inclusive growth.

Outlook and Risks

5. The outlook is for a gradual increase in growth. Staff projects growth to increase to 2.3 percent in 2017, as policies ease somewhat and the economy diversifies away from commodities. After a worse-than-expected outturn in 2016, the growth outlook in key regional markets for Colombia’s non-commodity exports remains subdued, partly due to the deep economic crisis in Venezuela. Infrastructure spending, the positive effects of the tax reform on investment, and improved confidence from the peace agreement with the FARC are expected to lift growth to 3.5 percent in the medium term.

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Nontraditional Exports-Trading Partner Growth

(Percent)

Citation: IMF Staff Country Reports 2017, 149; 10.5089/9781484303320.002.A001

Source: IMF WEO.

6. Inflation is projected to converge to the target band in early 2018. Inflation is on a declining path but the effects of the VAT increase and indexation will delay convergence to the target band to early 2018. The improved outlook for inflation will allow the central bank to continue the easing cycle started in December, at a pace contingent on preserving well-anchored inflation expectations.

7. Tight policies will help narrow the current account deficit further to 3.8 percent of GDP in 2017. Additional import compression due to sluggish domestic demand, improved tourism receipts, and growing non-commodity exports will contribute to a reduction in the current account deficit of 0.6 percentage points of GDP. Gross external financing needs will decline to about 12 percent of GDP in 2017 and remain around 10 percent of GDP in the medium term. Net capital inflows, including portfolio flows, are expected to decline as the current account deficit narrows. FDI saw a significant increase in 2016 due to the sale of a state-owned company but is expected to return to 2015 levels, as low oil prices continue to depress investment in the oil sector.

A01ufig4

Gross External Financing Needs

(In percent of GDP)

Citation: IMF Staff Country Reports 2017, 149; 10.5089/9781484303320.002.A001

Sources: National authorities and Fund staff estimates and projections.

8. Fiscal sustainability will remain a key criterion in the implementation of the peace agreement. Colombia has some fiscal space for additional peace expenditure, while placing public debt firmly on a downward path and protecting the credibility of the fiscal rule.

9. As noted in the WEO and GFSR, the global environment has improved somewhat since June 2016 but global risks have evolved and remain tilted to the downside.

  • Global economic activity is picking up and higher commodity prices have provided some relief to commodity exporters. Financial markets are buoyant and expect continued policy support in China. Certain tail risks identified at the time of the current FCL arrangement such as oil below US$30/barrel are less severe now.

  • But notwithstanding these positive developments, the risks that remains tilted to the downside. As noted in the flagships, global policy uncertainty and protectionism are new risks that could affect global growth and generate spillovers to emerging markets. Uncertainty about U.S. policy actions and their effects could lead to tighter-than-expected financial conditions and a rise in volatility and risk aversion. A faster-than-expected pace of interest rate hikes in the U.S. could tighten financial conditions elsewhere. A global shift toward protectionism could adversely affect trade and global growth. In such a scenario, emerging markets open to trade would face rising risk premiums amid declining global trade and commodity prices.

  • Emerging market economies continued to enhance their resilience, but higher inflation volatility in some countries and rising financial vulnerabilities in China left emerging market risks elevated and unchanged.

  • The updated External Stress Index shows that the baseline external conditions Colombia faces going forward are better than at the time of the FCL approval but would worsen significantly in the adverse scenarios described above (Box 1).

10. The regional outlook has improved slightly but risks persist. Spreads in two of Colombia’s main regional trading partners—Brazil and Ecuador—have fallen, suggesting risks have diminished somewhat. The growth outlook in Brazil is slightly more positive than at the time of Colombia’s FCL request but the LAC growth projection for 2017 was downgraded. Venezuela continues to be the regional outlier and remains mired in a deep economic crisis with a very uncertain outlook. Spillovers from a potential humanitarian crisis in Venezuela are difficult to estimate but could be disruptive for Colombia.

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Colombia—Global and Regional Risks Remain High

Citation: IMF Staff Country Reports 2017, 149; 10.5089/9781484303320.002.A001

Sources: IMF WEO and GFSR.

11. Colombia’s vulnerability to capital account shocks has increased as foreign participation in the local government debt market reached an all-time high. Nonresident holdings of local-currency government bonds increased 39 percent to US$21 billion since the FCL request and account for 25 percent of total domestic public debt. Moreover, nonresidents hold about 50 percent of the outstanding 10-year benchmark bonds. Purchases were driven by Colombia’s strong policies and performance relative to the region, and robust investor demand for EM debt.1 Strong policies make debt outflows less likely but large global shocks could still trigger a sell-off in local-currency bond markets.

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Colombia—Higher Vulnerability to Capital Account Shocks

Citation: IMF Staff Country Reports 2017, 149; 10.5089/9781484303320.002.A001

Sources: EPFR Global; IMF WEO; Ministry of Finance.

12. The authorities reiterated their intention to continue treating the FCL arrangement as precautionary and to reduce access to Fund resources as risks to the global outlook recede. The FCL arrangement has supported the authorities’ efforts to adjust to a large terms-of-trade shock in an orderly fashion. The FCL arrangement has boosted confidence in Colombia’s very strong policy frameworks in an uncertain global environment. The authorities consider that, while policy adjustments have reduced Colombia’s vulnerability to current account shocks, inflows to the local-currency bond market have increased, amplifying the potential effects of still large external risks, including from a faster-than-expected pace of interest rate hikes in the U.S. They are committed to continue enhancing Colombia’s resilience to external shocks by completing the gradual adjustment to lower oil prices. The authorities have retained the exit strategy presented at the time of the FCL approval in June 2016. With a substantial reduction of some of the global risks affecting Colombia, including those listed in the FCL arrangement (¶23 of IMF Country Report No. 16/154) and other policy uncertainties, the authorities would intend to reduce access to Fund resources in any subsequent FCL arrangements and to phase out Colombia’s use of the facility. Successful and complete adjustment to permanently lower oil prices and the ongoing productive transformation of the economy should also build resilience and reduce future access to Fund resources.

Review of Qualification

13. Staff assesses that Colombia continues to meet the qualification criteria for an arrangement under the FCL.2 Colombia still has very strong economic fundamentals and institutional policy frameworks, anchored by an inflation-targeting regime, a flexible exchange rate, a fiscal rule, and effective financial supervision and regulation. The authorities took timely and decisive policy actions to respond to the term-of-trade shock and remain committed to maintaining their very strong policy framework going forward. Staff’s assessment of Colombia’s continued qualification is based, in particular, on the following criteria:

  • Sustainable external position. Colombia’s external debt is sustainable and relatively low, at 49 percent of GDP at end-2016. Methodological changes and the large depreciation contributed to the recent increase in external debt. The increase since 2015 was lower than projected at the time of the FCL approval, and was partly due to the need to smooth the impact of the oil price decline and a decision to pre-finance 2017 borrowing needs. External debt is projected to decline slightly to 46 percent of GDP in 2022 and would remain manageable under negative shocks (Table 11). The current account deficit narrowed substantially in 2016 and is projected to decline further to 3.8 percent of GDP in 2017, down from a peak of 6.4 percent of GDP in 2015. The external position is moderately weaker than implied by fundamentals but the large real depreciation, tight policies, and structural policies to foster diversification will help narrow the gap in the medium term. Gross external financing needs declined but remain sizeable at 12 percent of GDP.

  • Capital account position dominated by private flows. Capital account flows in Colombia are predominantly private, mostly in the form of FDI and portfolio investment. FDI inflows in 2016 were lower than projected at the time of the FCL approval. The reliance on portfolio inflows is projected to decline substantially in the medium-term as the current account deficit narrows and interest rates converge to neutral levels. FDI inflows are projected to remain around 3.4 percent of GDP in the next five years, although foreign investment in the non-oil sector was revised down. As a result, the current account deficit will continue to be financed largely through stable funding sources.

  • 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 rate Colombia at investment grade level. Sovereign bond and CDS spreads (202 and 133 basis points) have declined significantly since June 2016. The authorities pre-financed 2017 borrowing needs for about 1 percent of GDP taking advantage of favorable market conditions.

  • A reserve position that is relatively comfortable. Gross international reserves have been roughly stable since the approval of the current FCL arrangement. They stood at US$46.9 billion as of April 2017. This is equivalent to 140 percent of the ARA metric and 127 percent of the sum of short-term external debt at remaining maturity and the projected current account deficit, which is relatively comfortable.3

  • Sound public finances, including a sustainable public debt position. The authorities are committed to fiscal sustainability by adhering to their structural balance rule. Fiscal policy tightened in 2016 to adjust to lower oil revenue. The authorities adopted a structural tax reform in late 2016 to help achieve fiscal targets while protecting social and infrastructure spending. The reform aims to increase revenue by about 3 percent of GDP over the medium-term. Public debt declined marginally to 50.2 percent of GDP in 2016 but is projected to fall to 41 percent of GDP in 2022 and remain sustainable (Figure 3).

  • Low and stable inflation in the context of a sound monetary and exchange rate policy framework. A series of temporary shocks pushed inflation out of the target band in early 2015. The central bank responded appropriately with a 325bps tightening cycle that finished in December 2016. As a result, inflation is converging to the target band steadily (4.7 percent in April, down from a peak of 9 percent in July 2016). 12- and 24-month-ahead inflation expectations are within the target band. The authorities remain committed to the flexible exchange rate regime and consider it the first line of defense against external shocks.

  • Sound financial system and absence of solvency problems that may threaten systemic stability. The financial system remains well capitalized, liquid, and profitable despite the economic slowdown. Non-performing loans increased but remain relatively low (3.7 percent in January 2017). Attention to proper loan classification and restructuring practices will help manage credit risks. House prices are marginally misaligned but risks are mitigated by low loan-to-value ratios and small mortgage portfolios. Official stress tests suggest existing countercyclical provisions would help banks remain above the 9 percent minimum regulatory capital following large macro-financial shocks.4 Corporate balance sheets have worsened somewhat but corporate debt is modest by international standards (46 percent of GDP).

  • Effective financial sector supervision. The authorities have implemented many of the 2013 FSAP recommendations and plan to bring financial sector regulation and supervision closer to Basel III over the coming year. A law awarding further regulatory powers over holding companies of financial conglomerates is expected to be adopted during the first half of 2017. These steps will strengthen powers to align capital with group-wide risks, and help manage corporate and overseas risks.

  • Data transparency and integrity. Colombia’s data continue to meet the high standards found during the 2006 data ROSC. Colombia remains in observance of the Special Data Dissemination Standards (SDDS). The authorities worked with the Statistics Department in 2016 to improve the information and procedures relating to the submission of Government Finance Statistics.

Figure 1.
Figure 1.

Colombia: Recent Economic Developments

Citation: IMF Staff Country Reports 2017, 149; 10.5089/9781484303320.002.A001

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

Colombia: External Sector Developments

Citation: IMF Staff Country Reports 2017, 149; 10.5089/9781484303320.002.A001

Sources: Banco de la República; Haver Analytics; and Fund staff estimates.
Figure 3.
Figure 3.

Colombia: FCL Qualification Criteria

Citation: IMF Staff Country Reports 2017, 149; 10.5089/9781484303320.002.A001

Sources: Banco de la República; Ministerio de Hacienda y Crédito Público; Datastream; Haver; and Fund staff estimates.1/ Combined permanent 1/4 standard deviation shocks applied to interest rate; growth; and non-interest current account balance.2/ 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 (about 30 percent real).3/ 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 deficit.4/ 30 percent permanent real depreciation in 2017.

14. Colombia’s government effectiveness continues to be strong. Colombia scores well, and has improved its ranking, in the government effectiveness and corruption control indicators by the World Bank (Figure 5). The regional development plans in the peace agreement with the FARC will boost the presence and effectiveness of the government in the regions worst-hit by the armed conflict.

Figure 4.
Figure 4.

Colombia: Reserve Coverage in International Perspective

Citation: IMF Staff Country Reports 2017, 149; 10.5089/9781484303320.002.A001

Sources: World Economic Outlook; IFS; and Fund staff estimates.1/ The current account is set to zero if it is in surplus2/ The blue lines denote the 100-150 percent range of reserve coverage regarded as adequate for a typical country under this metric.3/ Calculated based on the ARA metric augmented by a buffer for commodity exporters.
Figure 5.
Figure 5.

Colombia: Indicators of Institutional Quality

Citation: IMF Staff Country Reports 2017, 149; 10.5089/9781484303320.002.A001

Sources: World Bank and Fund staff estimates

Safeguards Assessment

15. Staff has completed the safeguards procedures for Colombia’s 2016 FCL arrangement. The authorities provided the necessary authorization for Fund staff to communicate directly with the Banco de la República Colombia’s external auditor, Deloitte & Touche Ltd (Deloitte) Colombia. Deloitte issued an unqualified audit opinion on the Banco de la República Colombia’s 2015 financial statements on February 17, 2016. Staff reviewed the 2015 audit results and discussed these with Deloitte. No significant safeguards issues emerged from the conduct of these procedures.

Staff Appraisal

16. The FCL arrangement for Colombia provides valuable protection against tail risks. The successive FCL arrangements have provided a buffer against tail risks and signaled the strength of Colombia’s policy framework. The FCL arrangement provided the authorities space to continue adjusting to the permanent oil price shock, while shielding Colombia from external risks. In this regard, staff agree with the authorities that Colombia’s international reserves and the FCL arrangement in an amount equivalent to SDR 8.18 billion (400 percent of quota) would continue to serve as useful buffers against external risks.

17. Oil-price risks have receded but policy uncertainty and protectionism are new risks that could affect global growth and generate spillovers to emerging markets. Moreover, Colombia’s vulnerability to capital account shocks increased as foreign participation in the local-currency government debt market reached an all-time high.

18. In staff’s assessment, Colombia continues to meet the qualification criteria for access to FCL resources. The IMF Board assessment of the 2017 Article IV Consultation completed in May 2017 commended Colombia for the strength of its policy framework and excellent track record of policy implementation. The authorities are firmly committed to maintaining very strong policies going forward. Staff therefore recommends the completion of the review under the FCL arrangement for Colombia. Staff agrees with the authorities’ strategy and would encourage a reduction in access in any future arrangement as risks to the global outlook and commodity prices recede. A carefully-crafted communication strategy will help facilitate exit.

Updated External Economic Stress Index

The external economic stress index summarizes external shocks and Colombia’s exposures. It was initially presented in Colombia’s staff report on the June 2015 FCL arrangement. Its methodology is explained 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 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 methodology and weights are unchanged from previous Colombia FCL reports. These unchanged weights do not capture Colombia’s reduced exposure to current-account shocks nor its increased exposure to capital-account shocks.

The downside scenario reflects external risks from policy uncertainty and a global growth slowdown if protectionism gained traction. In the adverse scenario, stress in financial markets due to policy uncertainty would lead to an increase of the VXEEM by two standard deviations. Policy uncertainty or protectionism would lower U.S. growth by ½ percentage points. Volatile global financial conditions and decompression of term premia would trigger a 100bps increase in long-term U.S. interest rates. Oil prices would fall 24 percent with respect to the baseline due to weak global growth. The ESI in the adverse scenario would remain above the levels in the adverse scenario described in the FCL request, but its decline with respect to the baseline would be slightly lower.

A01ufig7

Colombia: External Economic Stress Index

(Negative values indicate above average stress)

Citation: IMF Staff Country Reports 2017, 149; 10.5089/9781484303320.002.A001

Source: Fund staff calculations.
Table 1.

Colombia: Selected Economic and Financial Indicators

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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.

Includes foreign holdings of locally issued public debt (TES); does not include Banco de la República’s outstanding external debt.

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

Table 2A.

Colombia: Summary Balance of Payments

(In millions of US$, unless otherwise indicated)

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

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

Table 2B.

Colombia: Summary Balance of Payments

(In percent of GDP)

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Sources: Banco de la República and Fund staff estimates and projections.
Table 3.

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.

Table 4.

Colombia: Operations of the Combined Public Sector 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.

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

Excludes Ecopetrol.

For 2016, excludes proceeds from the sale of

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. Overall balance plus interest expenditures

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.

Table 5.

Colombia: Monetary Indicators

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Sources: Banco de la Republica; and Fund staff estimates and projections.