Tougher times ahead

Uribe: Colombia's president has had a lot to shout about, with an approval rating well above 60%, but he is struggling to contain a growing fiscal deficit as he positions himself for the 2006 election

Last year Colombian spreads narrowed a sizeable 90 basis points to about 340bp over US treasuries, generating more than 10% in total returns, several notches above the market as a whole. Uribe's success in pushing the country's Marxist guerrillas into retreat after four decades of internal conflict has cut kidnapping and terrorist attacks, boosted business confidence and helped attract investment. Those gains have translated into economic growth of almost 4% in 2003, the highest rate in nearly a decade, and paved the way for a repeat
performance in 2004.

But if Uribe, who has an approval rating well above 60%, has a lot to shout about, exacting times are surely ahead. Disappointing third-quarter GDP growth of 2.4% has prompted the central bank to question the government's 2004 growth target of 4%, and Colombia's fiscal deficit will end the year far above an IMF target of 2.5% of GDP. Uribe has also failed to make progress on crucial tax and social security reforms and the chances of doing so in the short term look ever slimmer as political jockeying for the 2006 elections begins.

Resistance from political parties unhappy to raise taxes so close to an election year meant the government was forced to withdraw its key tax bill from congress in early December after it was unable to gather support, even from Uribe's own party. It was the first time in three decades that Colombia's congress had rejected a request by the government to raise taxes. The failure has dealt a political blow to the administration and has raised questions about how it will manage its finances next year. According to Carola Sandy, analyst at Credit Suisse First Boston in New York, the bill's failure also ?casts doubts on the government's ability to advance necessary structural reforms to tighten medium-term fiscal finances?.

The tax bill would have brought in revenues worth 0.6% of GDP by levying value-added tax on a wider range of goods and services, but now the government faces a fiscal deficit of 5.6% in 2004 and a projected deficit of 6.1% in 2005. It must turn to cost-cutting to finance the 2005 budget and infrastructure spending is likely to suffer most, given that it is one of the few areas the government can touch without the approval of congress.

Debt load

Such a large fiscal deficit will increase investors' concerns about the country's ability to pay its debt on time, especially when Colombia already has a high public debt load at 53% of GDP. With US interest rates expected to rise over the next year, pushing up the South American nation's financing costs, Colombia has left itself open to any possible swings in investor sentiment.

Investors will also face political uncertainty towards the end of 2005 as the election nears. Colombia's congress recently voted to allow presidents to stand for a second term, giving Uribe a chance to run again. But his re-election is far from assured as voters press for bigger rises in their standard of living and analysts predict a shift from security to economic issues, where the president, a strong ally of Washington, appears weakest. Uribe's social spending on hospitals, schools and the poor will also be limited by the large budget deficit, dampening his ability to win over voters with popular public works.

Colombia does enjoy a two-year, $2.1 billion stand-by loan with the IMF that has bolstered confidence in the country's bonds, however, and the country hopes to win an extension to the credit line that would run up until the end of 2006. A landmark free-trade deal with the US by the middle of 2005 is also likely, helping Colombia maintain its trade surplus thanks to demand for commodities such as coffee and oil. The country also plans to promote oil exploration in northern Colombia to avoid becoming a net hydrocarbon importer by 2008.

Although such developments are not seen as enough to prevent next year's economic growth from slowing to about 3.5% as the world economy cools, the outlook for investors is far from disastrous. ?The free trade agreement is an important achievement and president Uribe's focus on domestic security is essential to deal with Colombia's single most serious problem, so these factors support the view that Colombia's fundamentals are on a long-term strengthening path,? says José Cerritelli, Latin American strategist at Bear Stearns.