Tax hikes and rate cuts appear to have turned around Colombia’s economy after the slump in oil prices saw its revenues collapse and external deficit soar.
Tough government measures have tackled what economists have called the worst shock the country has faced since the Great Depression of the 1930s.
Oil revenues fell by 97% from 2013 to 2016. At one stage oil provided 19.7% of government revenues, last year just 0.6%.
Exports dropped from $67.2bn in 2013 to $41.6bn in 2016, while foreign direct investment in the oil sector fell from $5.1bn to $1.6bn in the same period. The current account deficit shot to 6.5% of GDP in 2015 having been as low as 2.9% in 2011.
The tax reform buoyed investors, who placed $8.5bn of orders for Colombia’s first dollar bond in 15 months, a $2.5bn dual tranche, in January.
At one stage investors feared Colombia could lose its investment grade rating of Baa2/BBB/BBB. Yet in March Fitch removed its negative outlook, praising the “disciplined policy response” to the oil crisis and highlighting the tax reform passed in December 2016.
The rebound is under way: the current account deficit fell from 6.5% in 2015 to 4.5% last year, and Daniel Velandia, chief economist at Credicorp in Bogotá expected it to reach 3.5% this year.
“The tax reform was a vital step in the right direction,” Velandia said. “It will allow Colombia to restart under the new normal.”
This has all added to the sense that the worst is past. But in the short term, the tax reform threatens to hold back the recovery. The VAT increase from 16% to 19%, was lauded by investors and analysts but not the voters.
“We are confident that Colombian growth will accelerate a little bit in 2017,” said Edward Glossop, economist for Latin America at Capital Economics.
Glossop and Velandia, with respective growth predictions of 2% and 2.1% this year, are not as bullish as the finance ministry, which sees growth hitting 2.5%. Velandia sees GDP expansion at 2.8% in 2018 — versus government forecasts of 3.5%.
Importantly, the central bank has room to manoeuvre. As inflation dropped from a peak of nearly 9% in July 2016 to around 5% in February 2017, it made three 25bp cuts from December to March to bring the rate to 7%.
Economists predict a solid recovery. Two concerns — Donald Trump’s potential protectionism and the Odebrecht corruption scandal — should have a limited impact on the country.
Odebrecht was not present in any Fourth Generation (4G) road building concessions, which Velandia said would be “the main engine for economic growth”.
Odebrecht was a majority shareholder in the concessionaire of the Ruta del Sol project from a previous road-building programme. This contract has been cancelled and will be retendered. The government’s flagship 4G programme is not directly contaminated. “By next year, nine 4G projects that have financing already will be under way, and we expect the programme to contribute around 0.4% to GDP,” said Velandia.
Furthermore, as the shock of the VAT hike fades, a different aspect of the tax reform could start to provide benefits, he said. Corporate tax rates will fall from 40% this year to around 37%.
“This will be very important in allowing various sectors to find new markets and be more competitive,” says Velandia.Such a move would help treat Colombia’s biggest long-term challenge: diversifying away from the oil sector.