There is little doubt about why Colombian president Alvaro Uribe was inaugurated to a second four-year term in August. After pushing through a constitutional change that allowed him to run for immediate re-election, Uribe coasted to victory on the twin coat-tails of an aggressive fight against terrorism and a booming economy.
Uribe has gone further than any of his recent predecessors in forcing the communist Revolutionary Armed Forces of Colombia (FARC) rebels into a corner, and his administration claims that it is making headway in dealing with the drug trade, which feeds the rebels. The gains, however, are small and on their own cannot explain the 62% of the votes won by Uribe in the May elections, when he beat his nearest competitor by more than 40 points.
While the renewed confidence in the Uribe administration and Colombia as a whole is due in part to the get-tough policy with rebels, drug traffickers and paramilitary groups, it is the country’s surging economy that has investors and bankers taking a look – and they like what they see.
“The government’s economic team ... enjoy high credibility both locally and with ranking agencies and multilateral lenders. They are doing all the right things,” says Daniel Castellanos, a senior analyst for Spain’s BBVA.
Best performance
Colombia is enjoying its best economic performance in years. The economy has emerged from a deep recession in the late 1990s and initial years of this decade, and analysts say that there are few internal problems in the near future. According to government figures, gross domestic product (GDP) has been growing, while inflation and unemployment have been decreasing since the start of the decade. GDP expanded by 5.1% in 2005, compared to 4.8% in 2004, 3.9% in 2003, 1.9% in 2002 and 1.5% in 2001.
Inflation dropped from 7.1% in 2001 to 4.9% in 2005, and unemployment went from 15% of the economically active population in 2001 to 11.7% last year. In addition, exports have been increasing rapidly, rising to $21.2 billion last year, nearly double the 2001 figure.
Most importantly for the government, foreign direct investment (FDI) made an important jump in 2005, hitting $10.2 billion. (FDI was only $3.1 billion in 2004 and $1.8 billion the year before that.) The increase in FDI is important for Colombia to recuperate its investment-grade ranking, which it lost in the late 1990s.
Finance minister Alberto Carrasquilla says much of the change is due to the confidence the Uribe government has generated locally and internationally over the past four years. “We have worked on the internal security problem, which is a concern of existing and potential investors, and we have undertaken fiscal adjustments and started an ambitious privatization process. There is rising confidence in the future outlook for Colombia, which means that what we are doing is right,” he tells Emerging Markets in an exclusive interview.
New phase
In the coming four years, Carrasquilla says he needs to continue with fiscal adjustments, push for more deregulation and make Colombia more business friendly for local investors as well as foreign capital.
The first step includes an increase in public spending on basic services, coupled with the initial efforts to reform the country’s cumbersome tax system. Carrasquilla says the 11% increase in public spending planned for next year is aimed at making up for the cuts that were implemented when Colombia experienced one of its worst recessions in 1999. The $48.4 billion budget for 2007 includes new spending on education, health care, infrastructure and the military. “We are trying to rationalize this investment, which will be about 2% of GDP. It is a level we think is sustainable and necessary for our economy to be competitive,” says Carrasquilla.
The more controversial piece of the plan is a reduction in the highest bracket income tax and streamlining the number of taxes levied, as well as applying the value added tax (VAT) to more staple goods, such as milk, rice and potatoes, and giving the country’s poorest 5 million families a $120 annual stipend to offset the higher prices. If approved by Congress – a likely scenario at this stage – corporate and individual income taxes for the highest category would fall from 38.5% to 32%.
Analysts applaud the measure, but wish that Carrasquilla had been a bit bolder with the proposal. “While the reduction [in income tax] is not steep, and a drop to 25% would have been much better, this is a step in the right direction and, as such, helps sell the country to foreign investors,” says Alberto Bernal, an analyst with Bear Stearns.
Income tax cut
Bernal and other analysts say that Colombia must continue to whittle down its income tax if it wants to be competitive in the future. Even with the drop to 32%, Colombia will still have the highest income tax rate in South America. The top rate in neighbouring Peru is 30%, while in Chile – the model for most of the region’s countries – it is 17%.
“Foreign investors looking at Colombia may find it interesting, but it is not the most attractive option with an income tax rate above 30%,” says Bernal.
Tax collection is currently close to 16% of GDP and should stay at this level under the new tax plan. The 2007 budget, which Congress must vote on by mid-October, projects a budget deficit of 1.7% of GDP, up from 1.5% targeted for this year.
While analysts are confident in Carrasquilla’s management of the economy, there are some concerns. Internally, there are worries about the fiscal deficit in the medium-term – Colombia had a balanced budget in 2005 – and analysts are urging the government to begin laying the groundwork for pension reform and an overhaul of the system that transfers resources from the central government to local government. The current mechanism expires in 2008 and without a change would put a major strain on government resources.
The principal concern in the near future is the status of the Colombia Trade Promotion Agreement (CTPA), the free trade pact negotiated with the US and signed in March. The CTPA has not been debated by the Colombian Congress, and US president George Bush has not yet sent it to the US House of Representatives and Senate for debate. As a result, it is unlikely that the US Congress will get to the CTPA before the end of the year because of the upcoming elections.
Failure to pass the CTPA in the coming months would not be as urgent if the Andean Trade Promotion and Drug Eradication Act (ATPDEA) were not set to expire on December 31, 2006. Since the early 1990s, ATPDEA and its predecessor, the Andean Trade Preference Act, have allowed four Andean nations – Bolivia, Ecuador, Colombia and Peru – to export more than 6,000 items to the United States. These unilateral trade bills are largely credited with the boom in Colombia exports.
“Failure to pass the CTPA and the expiration of ATPDEA would be a strong blow, because Colombia would lose its capacity to export to the United States. And this would mean loss of income and jobs,” says Bernal of Bear Stearns.