Colombia needs to win the peace

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Colombia will elect a new president in the first half of next year and, if the urgency to address the country’s financial position wasn’t already clear enough, the country’s December downgrade by Standard & Poor’s to one notch above junk throws the need for fiscal reform into sharp relief.

Juan-Manuel-Santos-peace-talk-R-600
Colombia's president Juan Manuel Santos speaks in Bogota in November at the
first-anniversary celebrations of the peace signing

Should Colombia not take action to shore up its weakening public accounts, it would place its investment grade rating in jeopardy in doubt and risk the country becoming the only member of the Pacific Alliance to have this status.

When downgrading the country, Standard & Poor’s specifically highlighted Colombia’s “diminished policy flexibility” due to “weakened fiscal and external profiles”, as well as its climbing external debt.

The country has long struggled to widen its tax base. Successive finance ministers have struggled to combat widespread evasion and shift the high burden from its corporates. That failure has made the fall in oil prices since 2014 more of a problem. In 2016 the central government ran a financial deficit of 4.0% of GDP – well above its 2.0% structural target. For 2017 the target was an unambitious readjustment to 3.6% (especially given that tax changes have increased revenues by 0.7%).

Public debt is therefore rising steadily, albeit from comfortable levels, to 44.3% of GDP currently, from 32.0% in 2012.

Boost and broaden

The new president will therefore need to boost and broaden the base of Colombia’s tax revenues. The fiscal take is just 14.8% of GDP – lower than its peers in its rating level and among the Pacific Alliance countries.

The peace agreement – a hugely positive development and one that should help GDP growth – will also cost about 1% of GDP. And it is to be hoped it does help economic growth because, with a solid consensus outlook of around 3% for next year, it is still at the lower end of the range for Latin America.

Meanwhile, expenditures will prove difficult to cut. As elsewhere in Latin America revenues are rigid and will need unpopular social reform (pensions top the agenda) if there is to be a significant reduction in the fiscal deficit.

Standard & Poor’s move will likely be followed by Moody’s and Fitch, both of which have Colombia on a negative outlook and at a rating two-notches above speculative grade. Preventing another, more serious, ratings action in 2019 should be the focus of the next president’s economic agenda.