S&P Lowers Colombian Currency Rating to Junk: BB+

On Wednesday, Standard & Poor Global Ratings announced that it has lowered its long-term foreign currency rating for Colombia from investment grade BBB- to junk status, BB+. The move comes amid weeks of sometimes violent unrest after hundreds of thousands of took to the streets to protest a poorly presented fiscal reform package by (now sacked) finance minister Alberto Carrasquilla.

The move further weakens Colombia’s precarious financial position brought on by the COVID-19 pandemic, causing an almost 7% contraction in the country’s economy. Colombia counts heavily on both exports of petroleum and imports of international tourists; both sectors hurt badly by worldwide COVID restrictions on travel and discretionary consumption.

S&P: “We believe Colombia’s fiscal adjustment will prove to be more protracted and gradual than previously expected, diminishing the likelihood of reversing the recent deterioration in public finances.”

According to JP Morgan’s Katherine Marney, Fitch may likely downgrade Colombia as well, as the country already sits at the firm’s lowest investment grade before junk. There is also a danger of government owned entities with their own credit ratings being downgraded as well.

The downgrade can trigger investment selloff and hinder the ability of Colombia and Colombian firms to borrow money as many investment vehicles may only invest in quality (investment grade) debt.

“On the issue of eggs, it depends on its quality. Let’s say $1,800 COP (48 cents, US) a dozen or something like that.” – Sacked Colombian Finance Minister Alberto Carrasquilla

The downgrade comes after Colombian President Ivan Duque failed to have his fiscal reform package passed—or even considered in the Colombian congress after massive protests erupted in the country. Then Finance Minister Alberto Carrasquilla had taken to the airwaves to sell the package to the country, but stumbled badly when he had no idea how much a dozen eggs cost—he guessed less than $0.50 US—and couldn’t articulately describe why the administration in the tax reform he authored imposed taxes on basic staples like eggs & rice, while leaving sugared soft drinks exempt (hint: the owners of Colombia’s 2 largest domestic soft drink brands are Duque administration supporters).

In response to the initial, mostly peaceful and organized strike, Duque sent out national riot police who violently attempted to disrupt the protests. This had the reverse effect, and deeply angered even many who were not participating in the initial strikes or protests, and large swaths of the country quickly descended into violence and chaos. The international airport to Cali had to temporarily close, and the country still faces supply disruptions and road blockages.

With presidential elections next year and Duque’s political capital completely exhausted, it is difficult to see how a plan that can adequately shore up Colombia’s dangerous deficit can be passed in the remaining months of Duque’s presidency.

On Wednesday, Standard & Poor issued a statement saying (in part) the following:

Rating Action

S&P Global Ratings lowered its long-term foreign currency sovereign credit rating on Colombia to ‘BB+’ from ‘BBB-‘ and its long-term local currency rating to ‘BBB-‘ from ‘BBB’. The outlook on our long-term ratings is stable. We also lowered our short-term foreign currency rating to ‘B’ from ‘A-3’ and our short-term local currency rating to ‘A-3’ from ‘A-2’.

S&P: “We believe that fiscal adjustment will prove to be more protracted and gradual than previously expected, diminishing the likelihood of reversing the recent deterioration in public finances. We therefore lowered our long-term foreign currency rating on Colombia to ‘BB+’ from ‘BBB-‘.”

We revised down Colombia’s transfer and convertibility assessment to ‘BBB’.

Outlook

The stable outlook reflects our expectation of economic recovery in 2021 following the significant contraction last year. The combination of renewed GDP growth and certain fiscal measures is likely to gradually curtail Colombia’s fiscal deficits, resulting in net general government debt stabilizing above 60% of GDP. The stable outlook also incorporates our expectation for an institutional solution to recent and significant social unrest, which would result in prospects for political and institutional stability for the medium to long term.

Downside scenario

We could lower our ratings on Colombia in the next 12 to 18 months if the potential long-term damage caused by the pandemic, other domestic developments, or new external shocks prevent the Colombian economy from recovering in 2021 and result in lower-than-expected GDP growth in subsequent years. Such a scenario would most likely result in consistently higher fiscal deficits than currently projected and a steady increase in the government’s debt burden, leading to a downgrade. A perceived deterioration in Colombia’s institutional effectiveness, evidenced by an inability to form political and social consensus to sustain growth and its fiscal profile, could also lead to a downgrade.

Upside scenario

We could raise our ratings on Colombia within the next 12 to 18 months if economic growth is faster than expected, coupled with structural fiscal measures that reduce Colombia’s fiscal financing gap, lower the debt burden, and strengthen public finances. A larger and more diverse export sector, helping to reduce external vulnerability and strengthen economic resilience, could also lead to an upgrade over the medium to long term.

Rationale

The downgrades follow the withdrawal of a fiscal reform introduced to Congress in a context of high spending pressures, which has resulted in a significantly lower likelihood of Colombia improving its fiscal position following a recent and marked deterioration. Given the country’s high external vulnerability and moderate economic profile (balanced by adequate institutions and monetary credibility), in our view Colombia’s debt levels, stabilizing at about 60% of GDP during 2021-2024, and relatively large fiscal deficits are no longer consistent with an investment-grade (‘BBB-‘ or higher) foreign currency rating.

S&P: “The outlook is stable, reflecting our view that economic recovery, coupled with certain fiscal measures, will stabilize the government’s recently worsening debt burden over the coming two to three years.”

An ambitious fiscal reform proposal presented to Congress on April 15, 2021, aimed to finance transitory and structural higher spending–mainly transfers to the most vulnerable segments of the population–while helping to consolidate fiscal deficits. The fiscal reform was expected to be diluted during the Congress debate but to yield some additional and permanent current revenue. Instead, it was met by marked political opposition and protests from some segments of the population. While the larger protests since April 28 have been mostly peaceful, some violence has also occurred. These developments forced the government to withdraw the fiscal reform proposal by May 2, 2021.

The government, under new leadership at the Ministry of Finance, is looking to conciliate with various groups participating in the protests, as well as other social groups, and garner political support across party lines to make an alternate fiscal policy proposal. Prospects for substantial structural reforms are low in the near term, given ongoing protests and the approach of national elections next year. COVID-19 exacerbated the weakness in Colombia’s fiscal profile, though the worsening trend was present for most of the past decade. Moreover, as in many other emerging markets, the pandemic showed the substantial weakness of the country’s safety nets, which will most likely drive spending growth over the long term.

The COVID-19 pandemic and its related economic contraction significantly widened Colombia’s fiscal deficit. Discounting the transitory fiscal impact of the economic contraction and absent structural fiscal improvements, we expect the change in net general government to be 3%-4% of GDP in 2021-2024. Conversely, renewed economic growth should contribute to stabilizing net general government debt at about 60% of GDP during 2021-2024, compared with 43% in 2019. The general government interest burden is expected at just below 15% of general government revenue for 2021-2024.

Colombia’s rating fundamentals remain weaker than those of similarly rated peers. That said, in our opinion, Colombia’s flexible credit line with the IMF, our expectation of adequate access to the international debt markets, and a credible and efficient monetary policy continue to mitigate external risks and support Colombia’s creditworthiness.

Image by David Mark from Pixabay