COLOMBIA: Freeing up Colombia’s economy

In the enviable position of boasting low inflation as EM currencies tumble, Colombia appears well placed to withstand the shocks of changing global monetary policy. But for the economy to make sustainable strides, long-term improvements are needed – starting with infrastructure

  • By Oliver West
  • 29 Mar 2014
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In Armenia, in Colombia’s coffee region, you can visit a museum telling you all about a great engineering achievement: a tunnel passing through a nearby section of the Andes known as La Línea.

What you cannot do is travel through the tunnel – because nearly a century after the idea was first floated, the tunnel has still not been finished.

Admittedly, the winding 35km mountain drive through La Línea between the small towns of Calarcá and Cajamarca is the most stunning you’ll ever make in your life. But it will probably take you several hours as you find yourself stuck behind a convoy of heavy goods vehicles.

This is one reason why it is cheaper to transport a shipping container from Shanghai to the Pacific town of Buenaventura than it is to make the final 340km leg of the journey from Buenaventura to the capital Bogotá.

The terrible state of Colombian transport infrastructure may seem like an old joke by now, but the problem is very real. Of all the countries to have a free trade agreement with the US, Colombia is the one with the highest export costs to the US.

With FDI levels needing to be maintained and manufacturers needing to improve competitiveness, the time is now for Colombia’s president Juan Manuel Santos’s infrastructure plans – more than three long years in the making – to finally materialise. 

PUTTING THEORY INTO PRACTICE

Santos immediately identified poor infrastructure as a restriction on Colombian growth when he was elected in 2010, but  tangible progress is hard to come by.

Nevertheless, the National Infrastructure Agency that Santos’s government created has been working on a legal framework for concessions and new infrastructure law that should – in theory – allow projects to get off the ground quickly and be completed on schedule and budget.

Santos is favourite to win re-election to the presidency in May, and analysts say that in his second term theoretical reforms need to give results.

The previous system that sometimes saw the government pay out on an entire contract before works had even begun finally reached a nadir with the building of the third phase of Bogotá’s Transmilenio bus system. The project took two years longer than planned after an infamous corruption scandal in 2010 that ended with Samuel Moreno, the capital’s mayor at the time, in jail.

But under the new system, says Daniel Velandia, head of research and chief economist at Credicorp Capital in Bogotá, “there are no longer down payments: the contractor will have to complete stages of the projects before being paid.

“And there is a 20% limit to the extension of the contract in the case of extra costs. It should make the sector much more resilient to corruption.”

The government is planning around $25bn of investment in roads in the next four years, and more than $50bn in infrastructure in total in the next decade.

“Infrastructure will increase competitiveness and, as of 2015, will be a dynamic element in helping economic growth reach around 4.5%,” says Juan Pablo Espinosa, head of economic research at Colombia’s largest bank, Grupo Bancolombia.

“But there are still obstacles to overcome. Hard work is required to make sure the required financing will arrive, and a huge number of works will be undertaken simultaneously, requiring a lot of machinery, human capital and resources: it will be a big challenge for the country.”

Wílmar Ariza, portfolio manager at Andean Capital Management, a hedge fund in the Colombian capital, is confident the effects of infrastructure projects will begin to be seen in 2015.

“Santos is very aware that there is an infrastructure deficit, and it is his real chance to leave a print on history,” says Ariza.

DODGING DUTCH DISEASE

More pressingly, EM nations are dealing with capital outflows as a result of normalising US monetary policy. In terms of continuing to attract foreign investment therefore, big infrastructure plans will have come at an opportune time.

But to deal with external shocks, the exporter of the world’s largest emeralds has another gem up its sleeve: “Colombia’s low level of inflation is a precious stone for the economy,” says Ariza. “It allows the government to let the currency depreciate, and that should allow the economy to adjust sufficiently to external shocks. Sectors that were becoming less competitive should recover and give a new dynamic to the economy.”

The Colombian peso has depreciated from below 1,800 to the dollar in March 2013 to above 2,050 in February 2014. Yet inflation hit a 15 year low of 1.94% in 2013. This has allowed the central bank the rare luxury among EM nations of continuing to build its international reserves through dollar purchases.

“Colombia is in an ideal situation: the price of its main export (oil) is high, and its currency is weak,” says Credicorp’s Velandia. “That is not normal but is the best possible scenario. Colombia is so comfortable with its position that it is still buying dollars.”

Indeed, Colombia had been trying to devalue its currency to allow manufacturers to compete long before a few words from former Fed chairman Ben Bernanke inadvertently triggered the desired effect.

Therefore, some hope that manufacturers and other exporters can now benefit and drive growth.

“If the lower exchange rate reactivates exports in non-traditional areas such as manufacturing, those sectors could start to finally recover,” says Bancolombia’s Espinosa. “That will help not only growth but also levels of employment: industry is the third largest urban employer in Colombia by sector.”

But opinions are mixed.

Oil comprises some 55% of Colombia’s exports; add mining and you get two-thirds. Neither sector was suffering much from lack of demand, so neither is likely to benefit from a weaker peso – though admittedly dollar royalties are now worth more to government finances. Oil production is no longer growing at a fast rate.

This stability in oil production means exports overall may not see huge growth, but that’s no bad thing, says Munir Jalil, chief economist for the Andean region at Citibank in Colombia.

“It is positive that the oil industry, rather than continuing to increase output, is stable,” says Jalil. “Colombia was showing symptoms of Dutch Disease, but the energy sector should no longer be a hindrance to manufacturing.”

Velandia also credits the 2011 fiscal law, which obliges the government to reduce the fiscal deficit from 2.4% in 2013 to 0.8% by 2023. “The fiscal law helps us to avoid Dutch Disease by ensuring we do not waste oil proceeds,” he says, also re-emphasising the importance of better infrastructure to improve competitiveness.

DIVERSIFYING INVESTMENT

Oil’s dampening effect on manufacturing has gained it something of a bad name in Colombia. But Fitch reckons oil exports will limit Colombia’s current account deficit at 3.4% in 2013 versus 3.1% in 2012, “a smaller deterioration than for regional investment-grade commodity exporters such as Chile and Peru,” according to the rating agency.

More importantly, the country has so far been able to finance that deficit with foreign direct investment (FDI) – largely in oil and mining. Indeed, FDI reached a record $16.8bn in 2013, despite adverse conditions.

“One of the great differentiating factors in Colombia’s favour versus its neighbours’ is that we are not as dependent on China, and more dependent on oil,” says Velandia.

Having the US and EU as larger trade partners than China – a drag on growth in recent years – could finally bear fruit. But though oil versus the more vulnerable Chinese-dependent commodities exported by Peru, Chile and Brazil is a short-term advantage, it is important not to become complacent.

Santos’s government has reformed the royalties law in a way that Velandia believes “should ensure less corruption and better use of the proceeds of oil exports”, by creating a committee, called OCAD, to approve the usage of the royalties.

“Previously 80% of the royalties went to just eight of Colombia’s 32 regions; the regional governments didn’t know what to do with so much money,” says Velandia. “Now the money is much better spread and monitored.”

Fitch estimates regional governments alone could invest COP18tr ($8.75bn) in 2013–14, with much destined for infrastructure. 

POWERING UP

But Colombia’s biggest challenge now “is to understand that the energy industry is large and mature, and that we can’t ask much more of it,” says Jalil at Citi. “In the next couple of years, we have to think about which sectors will be generating growth, and what are we going to sell to attract more dollars.”

Bancolombia’s Espinosa sees positive signs. “Our dependency on mining and energy has reduced from 75% of FDI in 2009 to under 50% in 2013, so that will help us continue to finance our current account with FDI in a more balanced manner,” he says.

“Other sectors like manufacturing, transport, communications and financial services have taken a more important role as a destination for foreign investors,” adds Bancolombia’s Espinosa.

Indeed, manufacturing as a percentage of FDI grew from 12.67% in 2012 to 22.7% in the first three quarters of 2013, according to the latest available data from the central bank.

Here, infrastructure could take centre stage again, with Velandia estimating around 30% or 40% of the investment needs to come from abroad.

Colombia still faces serious problems that not only have shocking social implications but also debilitate growth – with the large wealth inequality among them. But if this really is a turning point for Colombian infrastructure, almost all stand to benefit, with improved transport links to some of Colombia’s poorest areas, for example.

Meanwhile, the government remains in negotiations with the FARC guerrillas and estimates peace could lead to 1%–2% GDP growth. Not all agree with the estimate, but there would certainly be fewer attacks on infrastructure.

And as Citi’s Jalil points out, better transport will not only help exporters, but importers.

So next time you’re in Colombia, look out. If they make it through La Línea tunnel (supposedly to be completed by November 2014), the three Made-in-China t-shirts for $5 deals available in much of downtown Bogotá could get even cheaper.

- Follow us on twitter @emrgingmarkets

  • By Oliver West
  • 29 Mar 2014

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