What Are the Challenges Posed by a Possible Fiscal Rule Change in Colombia?

The Colombian government’s intention to amend the country’s fiscal rule highlights continuing challenges to consolidation sufficient to stabilize debt/GDP durably, according to Fitch Ratings.

Finance Minister Ricardo Bonilla said this month that the government would present a bill to make the rule more flexible, in a package of measures aimed at boosting weak economic growth that is weighing on public finances. Real GDP growth slowed sharply to 0.6% last year following a strong post-pandemic rebound, and Fitch forecasts a modest 1.1% expansion in 2024. President Gustavo Petro has previously said the fiscal rule should accommodate counter-cyclical public spending.

Colombia’s ‘BB+’/Stable sovereign rating, affirmed on December 7, 2023, is constrained by fiscal challenges, high commodity dependence and structurally large current account deficits. Large fiscal deficits, an increasing public debt burden and the decline in fiscal policy credibility were factors in Colombia’s downgrade to below investment grade in July 2021.

Tax reforms were passed in November 2022, and high nominal GDP growth and peso appreciation supported deficit and debt reduction in 2023. But obstacles have arisen to consolidation. November’s Constitutional Court ruling on tax deductibility of oil and coal company royalties prompted the government to increase its 2024 central government deficit target to 5.3% of GDP in February’s Financing Plan, from 4.4%.

Fitch Ratings see risks to the revised target, for example, in securing Congressional approval for an arbitration system to speed up settlement of tax disputes. Budget rigidities limit the scope for spending cuts other than to capital expenditure, which could further weaken growth prospects.

The New York-based ratings agency also expect rising expenditure to meet some social demands, although prospects for Petro’s landmark pension and healthcare reforms are uncertain. In April, a Senate committee rejected a healthcare bill, although Petro says he will reintroduce healthcare reforms and may seek constitutional changes to implement them.

The Senate has passed a pensions bill that, if approved by the Chamber of Representatives by June 20, would take effect from July 2025. Allotted contributions up to a threshold of 2.3x the minimum wage would no longer go to individual accounts in private pension funds, but to the pay-as-you-go public pension fund and a new public savings fund.

The bill would prevent people moving existing pension assets from the private to the public system, which often pays wealthier workers higher benefits. By ending competition between the private and public systems, it would eliminate the implicit subsidy for wealthier workers that increases the public system’s long-term costs.

The bill creates a solidarity pillar for people three years beyond retirement age who are economically vulnerable or who are in dire poverty and do not qualify for a pension. The government estimates its initial cost at 0.3% of GDP. However, the absence of parametric reforms means the overall estimated pension liability would increase over time. Governments could be tempted to increase pensions and extend coverage, adding to fiscal pressures from a large structural central government deficit.

The public savings fund would be managed by the independent central bank of Colombia, which has contributed to the country’s record of macroeconomic stability. The impact on domestic funding markets depends on the fund’s investment guidelines. For example, a publicly run fund could boost government financing sources to the detriment of the private sector.

Lower house approval of the pensions bill is not certain and Fitch has not incorporated additional costs from healthcare and pension reforms into its fiscal forecasts. The rating agency’s baseline is for general government debt/GDP to rise to 56.3% in 2025, as forecast primary surpluses will not stabilize the ratio even as growth rises to 2.8% in 2025.

No detailed legislative proposal to amend the fiscal rule has emerged and it is unclear whether Congress would approve one. Without major changes in fiscal policy, medium-term central government deficits will be about 4.5% of GDP. This would not comply with the rule’s existing provisions.