Well-managed commodity-rich economies in high-yielding developing regions have received a tide of speculative capital post-crisis, heaping on currency appreciation pressures and savaging export competitiveness.
But that was the easy bit. Portfolio flows to emerging markets are vanishing across the board in tandem with the commodity price correction and the prospect of a tighter US monetary policy. The good times are over. South America is now roiled by a strong negative terms-of-trade shock, with limited fiscal and monetary tools to soften the blow.
Colombia, in particular, is in the line of fire. Its stock market has collapsed over the past year, as of late-August the peso was down over 20% against the dollar year-on-year, the fiscal deficit is set to hit 3% of GDP in 2015.
Sovereign credit markets, however, are, at first blush, eerily calm. Yields on Colombian peso-denominated government securities have barely budged since 2014, in contrast to Brazil. Over the past three years, the country’s debt has outperformed the Latin American benchmark, and in March 2014, JPMorgan doubled the quantum of Colombian bonds in its sovereign indices. The relative tranquillity in the bond market is a clear statement of market confidence in the centre-right administration of President Juan Manuel Santos Calderon and his fiscal commander in-chief Mauricio Cárdenas, Euromoney Finance Minister of the Year for 2015.
Policy credibility, an under-appreciated and abstract virtue, takes years to secure and can be quickly lost. But over the years, Cárdenas has built up Colombia’s external defences, boosted the fiscal framework, and sought to diversify the economy. In office since September 2012, and promptly re-installed in Santos’ second term in 2014, Cárdenas is rightly credited for his deft stewardship of the economy, which has been the growth leader for Latin America in recent years expanding 4.9% in 2013, 4.6% in 2014, while a slower but still-decent pace of expansion is expected this year at 3.2%.
Colombian growth has overtaken that of Peru, driven, in part, by luck given the composition of its commodity exports (oil and coal versus its neighbour’s dependence on copper and gold, where prices have fallen more precipitously), credit growth and infrastructure investment. In short, a revenue-neutral tax reform in 2013 that secured a jump in formal-sector jobs and the 2013 $2.7 billion stimulus gamble – which offered subsidies on mortgage loans for low and middle-income housing, in an effort to redress inequality – paid off.
Cárdenas, a former mining minister, has deftly navigated the commodity boom and, thus far, the bust. After all, his views championed in 2011, for example, now look remarkably prescient. In his capacity as Latin America head for the Brookings Institution, a Washington DC think-tank, he issued sharp warnings that China’s rapacious appetite for commodities might have delayed structural reform and efforts to boost savings and investments across Latin America.
True to form, the China-driven correction in commodity revenues, which typically accounts for a fifth of government revenues, has blown a hole in the trade balance across South American producers, and ignited investor fears, more generally, about the emerging market commodity-driven growth model. Colombia has not been immune.
The current account deficit is expected to hit 6% of GDP this year, half of which will need to be covered by hot money flows. While markets have taken fright over the splurge in pro-cyclical spending in recent years in the likes of Argentina and Brazil, Cárdenas, by contrast, has recited the mantra of fiscal responsibility and imposed a 2.2% structural deficit cap, though a cyclical shortfall at a higher level is permitted when the economy is running below potential, such as this year. In addition, the government is seeking to shift public spending towards sectors with higher fiscal multipliers.
Alberto Bernal, head of research at Bulltick Capital Markets in Miami, highlights market faith invested in the finance minister. “The external environment has changed drastically in the last couple of years. In my view, the continued soundbites of Minister Cárdenas on the need to comply with the fiscal rule have been positive for confidence.”
In an interview with Euromoney last year, Cárdenas summed up his pro-market philosophy. “We are sticking to the fiscal rule, which we think is fundamental for our economic credibility. The framework we have has allowed Colombia to gain better access to the financial markets – we have a higher credit rating than we had four years ago and the interest we pay on our bonds is much lower so the fiscal rule is something we will defend.”
He has a point. Euromoney Country Risk, which tracks the views of 400 economists around the world on a regular basis, calculates that, as of June 2015, Colombia improved its sovereign risk-ranking by seven places since December 2013 from 46 to 39. The data also note Colombia’s marked improvement in its access-to-capital score, from 4.75 in June 2013 to 7.33, as of June 2015, while the sovereign has significantly improved its relative risk-ranking over South American peers in recent years.
But Colombia faces a big stress test in the next two years.
Catalina Tobón, Bogota-based economist at investment firm Skandia, explains the finance minister’s balancing act. “In the short-term, these are not easy times for Colombia. The government has focused on boosting competitiveness through infrastructure spending but this will take a while to bear fruit. Right now the industrial sector is adjusting to the FX adjustment that might take two or three years to play out. Meanwhile, the FX depreciation will complicate monetary policy because of its inflationary effects. However, in part thanks to fiscal policy, central bank independence, and our healthy financial sector, markets don’t seem to be too concerned about the need to finance the current account deficit. I think Cárdenas deserves some credit for this.”
The minister has also embarked on an aggressive infrastructure investment plan, by attracting private and multilateral financing through the national development bank to finance projects at the construction stage, and offering a degree of debt relief upon project completion.
What’s more, a $25 billion road infrastructure programme is expected to boost growth in the next few years, which, by some estimates, could raise the trend growth rate by 0.7% to above 5% in the long-term. The plans have already partially paid off. The country’s investment-to-GDP ratio reached a record 29.6% of GDP June last year, thanks to policy stability, as well as strong external financing conditions and terms-of-trade gains, according to the Institute of International Finance.
In an August IMF report that announced the renewal of a $5.45 billion flexible credit line to Colombia, first secured in 2009, the executive board at the policy lender notes the constructive fiscal stance and policy co-ordination are key reasons why markets expect Colombia will be barricaded from capital storms, despite market expectations that the peso will remain in the line of fire for the rest of the year.
The IMF notes: “Colombia’s macroeconomic policies have provided flexibility to mitigate the impact of the recent sharp decline in world oil prices. The fiscal rule represents an important buffer against oil price fluctuations, allowing a smooth adjustment of expenditure to a dimmer medium-term oil outlook. The flexible exchange rate regime continues to play an important shock-absorbing role in helping the economy adapt to shifts in global economic and financial conditions, and the banking and corporate sectors remain in good financial health.”
Still, Cárdenas is no neoliberal market fundamentalist and has enacted a progressive tax reform to boost redistribution and expand the revenue base, including a wealth tax and an increase in corporate taxes – moves that have earned him domestic rebuke from self-interested parties. Crucially, some of the proceeds have been used to invest in the rural sector, education and childhood development, in part, to boost the government’s peace talks with the rebel faction Farc.
Cárdenas, a prolific tweeter with ample political leverage, shouldn’t waste Colombia’s crisis. The government needs to secure financing for public-private partnership projects already in the pipeline, and implement new fiscal reforms to increase non-oil tax revenue and to establish an equitable tax code. But in Cárdenas, the South American economy has the best chance of succeeding in its bid to diversify and graduate to a high-income status.