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Colombia: low commodity prices weigh on economic growth and public finances

Country Report


Flag Colombia
Low commodity prices have been weighing on economic growth and the public finances, but the external position is expected to remain relatively strong. The latter is due to a flexible exchange rate regime and adequate monetary policy. Implementation of the peace deal with guerrilla movement FARC would improve the security situation in Colombia markedly.

Strengths (+) and weaknesses (-)

(+) Strong fiscal track record

Colombia has been able to deal well with large political and economic shocks. The fiscal rule allows public spending to gradually adjust to during an economic downturn and oil price shock, but stipulates a downward trend and specific targets for the budget deficit thereafter.

(-) 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 guerrilla movements and criminal groups

Guerrilla movements and criminal groups continue to control or at least have strong influence in some parts of the country. This results in increased security risks.

(-) Inadequate provision of infrastructure

The level of infrastructural development is relatively low, which constrains the growth potential of the economy. 

Key developments

1. Economic and fiscal performance in jeopardy due to low commodity prices

Low commodity prices have been weighing on economic growth and the Colombian economy is therefore expected to grow at a relatively slow rate in the medium term (2.2% in 2016 and 2.8% in 2017). Economic growth will mainly be driven by domestic demand, with private consumption and investment growth remaining at decent, albeit lower, levels. Advancements in the Fourth Generation (4G) infrastructure construction plan should boost investments in 2016. Improving infrastructure is necessary in order to boost the country’s competitiveness and increase economic growth in the long run (Colombia ranks 84th out of 144 on infrastructure quality according to the World Economic Forum). Private consumption is expected to slow in 2016 as a result of tighter credit conditions and increasing inflation. The central bank started to increase the policy rate in September 2015 (with a total of 325 basis points by August 2016) in response to increasing inflation expectations, which has resulted in higher lending rates. Low commodity prices also weigh on the public finances, as public oil-related revenues are expected to decline from 3.3% of GDP in 2013 to 0% in 2016 according to the IMF. The Colombian government has used the flexibility of the fiscal rule to adjust spending gradually to the impact of lower oil prices on public finances. As a result, the public debt ratio increased to 50% of GDP in 2015, up from 43% in 2013. For 2016 and thereafter, however, the rule stipulates a narrowing trend of the budget deficit. In order to do that while protecting social and infrastructure spending, a structural tax reform to increase tax revenues is required. The government plans to pass the reform by Congress later this year. Failure to lower the budget deficit would be negative for Colombia’s risk outlook.

2. External position weakened amidst low oil prices, but remains relatively strong

Low oil prices also continue to take a toll on Colombia’s external balances. The peso has depreciated significantly in 2014 and 2015 (70% to the USD) before gaining some strength in 2016 due to increases in the policy rate. However, the currency is still valued over 50% lower than at the start of the depreciation period in 2014. As a result of the large depreciation in 2015, imports became more expensive and declined. Nevertheless, as the decline in exports (measured in USD) was even larger, the trade and current account deficits increased. The income balance improved substantially in 2015 due to lower outflows. Positive for the external position is that total foreign direct investment (FDI) continues to cover a large part of the current account deficit, despite a decline of FDI in the oil sector. In addition, Colombia has sufficient FX reserves and a relatively high import cover of more than 8 months. Also, the amount of liabilities denominated in foreign currency is low at 13% of total liabilities in 2015.

Figure 1: Lower economic growth
Figure 1: Lower economic growthSource: EIU
Figure 2: Current and trade deficits increased
Figure 2: Current and trade deficits increasedSource: EIU

3. Peace deal with guerrilla movement FARC is close

In August 2016, the Colombian government and guerrilla movement Revolutionary Armed Forces of Colombia (FARC) agreed upon a final peace accord resulting in a permanent ceasefire and ending a 52 year long conflict. According to the agreement the guerrilla troops will disarm within 6 months after the final deal is signed (expected in September or October 2016) and the process will be monitored by the United Nations. Before the deal is implemented, it has to be ratified by the Colombian people through a referendum, which will be held on 2 October 2016. The outcome of the referendum is uncertain, as the people of Colombia feel that the government has conceded too much to the FARC in order to strike a deal. Also, many Colombians see the upcoming vote as a referendum on Santo’s administration, while his approval rating stands at a meagre 25%. If implemented, the peace deal will improve the security situation in Colombia markedly, but security problems won’t disappear entirely because social problems like large inequality remain. An additional positive development for future security improvement is that the government announced the initiation of peace talks with the second largest guerrilla movement ELN in March 2016.

4. Coffee production expected to decrease slightly and corn imports to remain broadly stable

The agricultural sector amounts to around 7% of Colombia’s GDP. Coffee is Colombia’s main agricultural export product, with coffee exports amounting to USD 2m in 2015 (6% of total Colombian exports). Colombia is the third-largest coffee exporter globally. According to the United States Department of Agriculture (USDA), Arabica production in Colombia has increased from 7.7m 60 kg bags in 2012 to 13.6m bags in 2015-16, but is expected to decline slightly again to 13.3m in 2016-17 due to expected heavy rains towards the end of 2016. Despite this, bean exports, mostly to the US and Europe, are forecast to gain 100,000 bags to 11.5m in 2016-17. Coffee prices have increased since start of 2016. Fresh flowers is the second largest agricultural export product category, and the country ranks second globally behind the Netherlands (with an estimated market share of 16% of the global market), with the US as its key buyer. Corn and wheat account for around 40% of Colombia’s agricultural imports, because Colombia lacks competitiveness internationally in the cereal sector due to high production and logistical costs. Corn imports are expected to reach 4.5m metric ton (MT) in 2016-17, with over 90% coming from the US. Around 95% of corn imports are destined for animal feed, the remainder for human consumption. Two thirds of Colombian animal feed is destined for the poultry sector, with this being the preferred animal protein in Colombian diets. Despite the increase in consumer prices for poultry in 2015, resulting from the peso depreciation, poultry demand is expected to continue to rise as household incomes are expected to increase according to USDA. Consequently, corn imports are expected to remain elevated or even increase further. USDA estimates that wheat consumption in 2016-17 won’t change from the year before, remaining at 1.8m MT. The governments’ infrastructure investment plan could lower logistical costs, but only in the medium to long term. Large-scale investments in agribusiness are unlikely to pick up until Congress approves law reforms and guarantees on land property rights. Implementation of the peace deal with FARC could contribute to further investment in agricultural development, but this will only have a significant impact on agricultural trade in the long term. Colombia signed free trade agreements over the past decade with among others the US, Canada, Chile and the EU. This will give Colombian producers gradually more access to foreign markets and opens the domestic market to foreign suppliers.

Factsheet Colombia
Factsheet ColombiaSource: EIU, CIA World Factbook, UN, World Economic Forum, Transparency International, Reporters Without Borders, World Bank.

Background information

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 2012, a structural fiscal rule has been introduced, stipulating a downward trend and specific targets for the budget deficit. Colombia has run sizeable current account deficits in recent years. In particular the income deficit is sizeable (but improved markedly in 2015). However, the current account deficit is largely covered by inflows of FDI. These inflows, which are partially explained by investment in the extractive sector, are likely to continue in the coming years. The FARC and ELN guerrilla movements and criminal groups continue to pose security risks in Colombia.

However, implementation of a peace deal with the FARC is close which would improve the security situation markedly, the level of violence is much lower than in the nineties and the guerrilla movements no longer pose a systemic risk. Even by Latin American standards, inequality remains very high in Colombia and the majority of the labour 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.

Economic indicators of Colombia
Economic indicators of ColombiaSource: EIU

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