Country Report Colombia
Peace talks between the FARC and the government are likely to be protracted, but could help to reduce security issues and boost the reputation of Colombia and the energy sector. Meanwhile, an important tax reform may help to reduce Colombia’s high income inequality and labor informality.
Strengths and weaknesses
Strong macroeconomic track record
Colombia has been able to deal well with the large political and economic shocks it has been exposed to.
Dependence on commodity exports
The level of diversification of the Colombian economy is relatively low and the country is dependent on the export of a narrow range of commodities, which makes the country vulnerable to commodity price fluctuations.
Presence of guerilla movements and criminal groups
Guerilla movements and criminal groups continue to control some parts of the country. This results in security risks.
Inadequate provision of infrastructure
The level of infrastructure development is relatively low, which constrains the growth potential of the economy.
1. Peace talks continue
In late 2012, peace talks started between the government and the left-wing guerilla movement FARC. The conflict between the government, paramilitary groups and left-wing guerilla movements has been ongoing for decades now. According to official figures, 600,000 people have been killed and 3 million people have been displaced as a result of the conflict. However, the force of the FARC rebel movement has decreased strongly in the past decade. Military successes of the army have weakened the capabilities of the FARC and several of its senior leaders have been captured or killed. Nevertheless, the rebel movement continues to pose security risks. It still controls remote parts of the country and has increasingly resorted to attacks on oil facilities in recent years. In early April, FARC top commander Pablo Catatimbo travelled to Cuba to attend the peace talks, which has been interpreted as a good signal. Furthermore, government sources have stated that progress has been made on issues such as rural development and seem optimistic about the possibility of concluding a deal this year. Meanwhile, the ELN, another left-wing guerilla movement, has also stated that it wants to hold peace talks with the government. However, the talks with the FARC are likely to be protracted. While a big majority of Colombians seems to support the decision of President Santos to negotiate with the FARC, according to a poll 70% of respondents were in favor in April 2012, the issue of granting amnesty to FARC members remains very controversial. A peace deal may provide a boost to the energy sector, as this sector has suffered from attacks on pipelines and railways, and may improve the international reputation of Colombia. It will also help to reduce social issues. While some FARC members may continue to be active in illegal activities, such as drug trafficking, after the conclusion of a peace deal, local security analysts expect many members to demobilize and return home.
2. Government implements tax reform
In late 2012, the Colombian congress approved an important tax reform, which has been implemented in the beginning of this year. Under the old system, several taxes, such as the income tax and the value added tax, were regressive, as high income people enjoyed a number of preferential treatments and benefits. Furthermore, labor and social security costs have traditionally been relatively high in Colombia, while declaring and paying taxes has been relatively costly for Colombian companies. All these factors have contributed to a number of important social problems. The regressive elements of the old tax system contributed to income inequality, which is very high in Colombia. With a Gini-index of 55.2, income inequality is very high in Colombia even by Latin American standards. Inequality has been one of the factors that contributed to the political violence that has plagued Colombia. Colombia also has a very high informal labor rate. The World Bank estimated that 53% of workers were employed in the informal sector. Meanwhile, at around 10%, the (formal) unemployment rate in Colombia is still relatively high. As informal workers tend to earn less and have fewer opportunities to improve their economic situation, informality is one of the factors that entrenches inequality. The new tax system is meant to address these issues. The tax system will become more progressive and labor taxes will be replaced with profit taxes, which will make it more attractive for firms to hire (formal) workers. The authorities expect the reforms to lower the Gini-index by about two points and to create 400,000 to 1,000,000 new jobs.
3. Oil sector continues to do well, but manufacturing sector less so
Meanwhile, Colombia’s important oil sector has continued to do well. Oil production grew from 533,000 barrels per day (bpd) in 2007 to 944,000 bpd in 2012. Production grew as more parts of the country were brought under government control, which boosted investment in oil production. As Colombia has large oil reserves and investment is likely to remain strong, oil production may increase to 1.5m bpd in 2020. Recently, the manufacturing sector has performed less well. In the 12 months up to February 2013, industrial production has fallen in 9 of the 12 months. Particularly in the last months of 2012 and the first months of 2013, the performance of the sector has been weak. In February 2013, industrial production fell by 4.5% yoy, the largest fall since 2009. It seems that the appreciation of the peso and weak external demand explain this weak performance. In April 2013, the government launched a package of measures to boost the manufacturing, agricultural and construction sectors. In March, the central bank reduced its benchmark interest rate by 50 basis points to 3.25%. One year ago this rate still stood at 5.25%. This rate cut was possible, as inflation was only 1.9% yoy in March, and remained thus far below the 3% inflation target. The economy grew by 2.8% in the first quarter of 2013, but the government expects the economy to recover in the rest of the year.
Colombia’s exports primarily consist of energy products and the country thus has a relatively small economic base. Oil (product) exports account for more than 50% of exports and oil revenues account for 18% of the revenues of the central government. In early 2013, a structural fiscal rule has been introduced, which limits the structural deficit to 2% of GDP. Colombia runs a current account deficit of roughly 3% of GDP (see figure 2). In particular the income deficit is sizeable. However, in recent years the current account deficit has been more than covered by large inflows of FDI. These large inflows, which are partially explained by investment in the extractive sector, are likely to continue in the coming years. The FARC and ELN guerilla movements and criminal groups continue to pose security risks in Colombia. However, the level of violence is much lower than in the nineties and the guerilla movements are no longer systemic risk. Even by Latin American standards, inequality remains very high in Colombia and the majority of the labor force works in the informal sector. Furthermore, Colombia’s infrastructure is underdeveloped. However, democracy is well-entrenched in Colombia and the quality of its macroeconomic institutions is relatively good. The level of dollarization in Colombia is very low, which allows some flexibility in exchange and monetary policy.