Colombia faces downgrade threat after rejecting peace deal, tax reforms in doubt
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Colombia faces downgrade threat after rejecting peace deal, tax reforms in doubt

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The Colombian government’s much vaunted tax reforms are in jeopardy following the country’s vote against the FARC peace deal. Credit ratings agencies will be watching carefully

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The Colombian government’s stinging loss in its referendum on a peace deal with Marxist rebels could complicate a long-anticipated tax reform to boost revenue. Meanwhile, the value of Colombian assets have fallen on fears the shock result could lead to a ratings downgrade.

President Juan Manuel Santos’s government, and most political and economic analysts, were banking on a solid win in the October 2 referendum for the peace agreement signed a few days earlier with the Revolutionary Armed Forces of Colombia (FARC). It would have ended 52 years of war and, according to the government, lasting peace would have added one point annually to GDP growth. 

A slim majority of Colombians saw things differently, with the “no” camp receiving 50.2%, a victory of approximately 54,000 votes. 

The huge blow to the Santos government, which spent four years negotiating the 297-page agreement, could undermine a revenue-raising tax reform that should go to Congress on October 10. The stakes of the reform are high, with failure to improve revenue potentially leading to a downgrade in its creditworthiness by rating agencies.  

Previously, financial markets had largely ignored Colombia’s peace process, but the country’s currency and sovereign bonds slumped this week in response to the shock vote. The peso weakened from Cp2,868 per dollar before the vote to Cp2,960 early on Tuesday, while the government’s dollar bonds were down between 1.5 and 2.5 points in secondary markets. JP Morgan said on Monday that “the market will likely price in the risk of a downgrade to Colombia’s rating”.

The tax reform has been in the works for months. It includes three large areas, increasing value-added tax (VAT), reducing and simplifying corporate taxes and eliminating loopholes to reduce tax evasion. The details have not been released, but the reform should include a three point increase in the VAT to 19%. 

REWORKING THE NUMBERS

Finance Minister Mauricio Cárdenas said while the final numbers are still being worked out, he believes that a reduction in capital expenditures in the 2017 budget and increased revenue from the tax reform would allow the government to comply with its fiscal rule. 

“Tax reform, together with the 2017 budget, will reaffirm Colombia’s fiscal sustainability. Fiscal consolidation is going to reassure Colombia’s BBB rating,” he said before the referendum. 

The referendum results means the government is going to have to work much harder to get Congress to go along.  

“The failure of the referendum is a serious blow for the government and particularly President Santos himself. The key risk is that he starts to face more resistance in Congress as other political players try to take advantage of his weakened position,” said Adam Collins, Latin American economist at London’s Capital Economics.  

Ramón Aracena, chief economist of the Institute of International Finance’s Latin America Department, agreed that Santos is now in precarious position. “The capacity of the government to implement a required tax reform for next year is diminished, because the Santos government has no political capital now to push forward the reforms,” he said.

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