Fitch Ratings has changed its outlook on Colombia’s ratings from stable to negative while issuing downgrades to several key ratings. The agency downgraded both Colombia’s long-term local currency (LTLC) issuer default rating (IDR) and its long-term senior unsecured local currency bonds to BBB from BBB+.
Fitch’s new negative outlook for the nation’s ratings, which comes days after it placed Bancolombia and Banco de Bogotá on negative watch, is predicated on various factors. The first issue cited is Colombia’s current account deficit, which reached 6.4% of GDP in 2015. Though the firm is predicting a drop to 5.8% by the end of this year, it still sees the potential for the account deficit to average 5.3% through 2018, a rate way above the median of 1.6% among BBB-rated nations.
The external debt also hit 37% of GDP in 2015, and there are fears that the fall of oil revenue and peso depreciation in recent years could put this debt as high as 48% of current external receipts in 2016. The BBB median is 20%. Central government deficit — now up to 3.9% of GDP from 3.1% in 2015 — is equally troubling compared to similarly rated countries.
While there is no sense that the sky is falling, such concerns are very real and come on top of the central bank’s need to focus on driving down an inflation rate of 8.6%, the highest the country has seen in 16 years. “Colombia’s ratings balance its flexible and credible policy framework, improved external buffers, and a record of macroeconomic and financial stability against high commodity dependence, limited fiscal flexibility, and structural constraints in terms of low GDP per capita and weak governance indicators,” wrote Fitch in a statement.
Colombia Ratings Criteria Change
Although the overall outlook change is clearly disconcerting, there is some positive spin to be had for the other revisions. Fitch’s rationale for the downgrade to LTLC IDR is more due to an alteration to its ratings criteria than any real-world, on-the-ground changes within Colombia’s economy.
“In line with the updated guidance contained in Fitch’s revised sovereign rating criteria — dated July 18, 2016 — and as part of a broader portfolio review, Fitch concluded that the credit profile of Colombia no longer supports a notching up of the LTLC IDR above the long-term foreign currency IDR,” said the company in a statement. “This reflects Fitch’s view that neither of the two key factors cited in the criteria that support upward notching of the LTLC IDR are present for Colombia. Those two key factors are: (1) strong public finance fundamentals relative to external finance fundamentals, and (2) previous preferential treatment of local currency creditors relative to foreign currency creditors.”
Amid the outlook change and downgrades, the other good news is that Fitch affirmed the country ceiling at BBB+, which is in line with its previous assessments. The agency also affirmed Colombia’s senior unsecured foreign currency bonds rating at BBB and short-term foreign currency rating at F2. A new short-term local currency IDR of F2 was assigned as well.
Colombia Ratings Change Potential
The negative outlook means that Colombia’s ratings are more likely to fall than rise in Fitch’s subsequent reviews. The most probable reasons that a downgrade could occur are the government’s failure to reduce its fiscal deficit or stabilize its debt burden. The nation’s large external imbalances and macroeconomic imbalances, which could undermine the credibility of the policy framework, are other key risks.
There is also some, albeit unlikely, chance of Colombia getting a ratings upgrade in the near term, says Fitch. The biggest boon to that possibility would be the government finding a way to reduce its current account deficit and put the country on an improved debt trajectory.
Fitch also lists the peace process as a potential driver of growth. Colombia is in the final stages of reaching an accord with the Revolutionary Armed Forces of Colombia (FARC) guerrilla group to end more than a half-century of war. The government expects an agreement to be reached soon, allowing the nation to vote by plebiscite on peace before the end of the year.
“The implementation of a peace agreement could provide a confidence boost in the short term and medium- to long-term benefits (i.e., with investment in energy and agriculture) that could increase growth prospects,” wrote Fitch. “In the near term and, given the wider fiscal deficit, such an agreement would highlight the importance for the government to rebuild its revenue base to accommodate required investment without jeopardizing fiscal consolidation.”
Photo Credit: Solvency II Wire