Colombia faces oil price test
No short-term response to price shift; fiscal discipline key to economy.
|Mauricio Cárdenas, Colombia’s minister of finance
Colombia is proposing a new tax law to Congress that it hopes will fill a growing fiscal shortfall without hurting the pace of growth in one of the region’s outperforming economies.
Mauricio Cárdenas, Colombia’s minister of finance, gave further details of the administration’s fiscal plans to delegates of the Felaban conference in mid-November, hosted in Colombia’s second city, Medellin. “The cornerstone of our economic model is fiscal discipline – [our policy is] the opposite of populism and we have made it compulsory to reduce the structural deficit every year. We are very conservative fiscally – we could be characterized as centre-right – but very progressive in redistributing income.”
The aim is to keep current tax collection stable at about 17% of GDP in 2015 ($61.1 billion). The proposed law will see some temporary taxes, which were due to be phased out being renewed, such as the financial transactions tax and a wealth tax, which combined account for about $6 billion.
|We don’t have to respond immediately
to oil price fluctuations
However, even with the extension of these taxes – and the introduction of others (such as an increase in corporate tax on profits of around $500,000-equivalent from 9% to 12%) – the falling price of oil will pressure the fiscal base, of which 20% comes from oil.
Cárdenas acknowledges the challenge that falling oil prices are having on the government’s tax base but says that it will not make any short-term response.
“Six years ago, Colombia produced 500,000 of barrels a day,” he says. “Today it is 1 million. This increase in production is very important – that is the best way to face falling prices,” says Cárdenas. “We don’t have to respond immediately to oil price fluctuations: we have established a committee whose main function is to define the long-term oil price and then use that to define our structural goals and establish the national budget. And in the short-term we can use public finances to stabilize the effects of fluctuation – that doesn’t mean there won’t be an impact but it is being smoothed.”
Forced fiscal target
However, economists suggest that Colombia’s forced fiscal target implies a decreasing cap for the fiscal deficit, which in the event of lower oil-related fiscal revenues would oblige the government to either cut spending or quickly find other sources. The new tax law is expected to help but no significant new revenues are projected and the administration has committed to significant new public expenditure in health, education and other social programmes that are aimed at redistributing wealth and reducing poverty.
Colombia’s strong growth [last year Colombia grew by 4.7% and this year Cárdenas expects it to grow at the same rate] amid a regional downturn has been led by its stronger fiscal position and better ratings – which have lowered the cost of public finances – and increased investment, led largely by FDI which is running at 30.2% of GDP.
An HSBC report on the impact of lower oil prices on the region, lead-authored by Andre Loes, chief economist of Latin America, says about one-third of this targets the oil industry, which, although down from a peak of 48% in 2010, leaves the government vulnerable to a downturn in the oil industry.
“At around $80 per barrel there would be a deep impact on public finances,” says the report, which notes that the government needs to address the problems that are causing output to fall – the slow pace of environmental licensing that has hindered exploration and production (E&P) activities and attacks on oil pipelines by the country’s guerilla groups.
The government is attempting to speed up licensing and is in advanced peace negotiations – both of which should help to boost production in the medium term, but, for HSBC “oil production remains a concern that compounds those risks stemming from lower oil prices, since it is unlikely that the Colombian government could expand output to compensate for lower prices in the medium term”. In the longer term, the country faces dwindling proven reserves, which now stand at 6.6 years in 2013, down from 8.1 in 2009.
While the falling oil price will hit production profitability, Fabiola Ortiz, director of corporate ratings at Standard & Poor’s, says the current level will not lead to cuts in E&P investment plans. She notes that the three leading regional oil companies, Venezuela’s PDVSA, Mexico’s Pemex and Brazil’s Petrobras, have an average cost of production of about $12, $23 and $42 a barrel respectively.
However, while Venezuela has the cheapest production costs, it is the most exposed to lower oil prices. The economy is completely dominated by the commodity: it accounts for 60.5% of fiscal revenues, 96.7% of exports and oil exports as a proportion of GDP is 20.9%. As a result, the oil price is the main driver of the sustainability of the country’s external accounts and ultimately its solvency.
“The persistence of weaker oil prices would represent a material headwind for external balances and growth,” says Loes’ report. “The Maduro administration would have to seek a deep adjustment, mainly through the FX rate channel. It is worth noting that we already expect a contraction in Venezuela for the current year (-3.6%), 2015 (-1.0%) and 2016 (-2.0%).”