Clearing Skies: Moody’s Upgrades Colombia Outlook to Stable from Negative

Moody’s Investors Service yesterday changed the outlook on the Government of Colombia to stable from negative. Concurrently, Moody’s has affirmed Colombia’s long-term local and foreign-currency issuer, senior unsecured debt ratings and foreign-currency shelf senior unsecured ratings at Baa2. The short-term local and foreign-currency ratings were also affirmed at Prime-2 (P-2).

The key drivers for today’s rating affirmation and decision to move the outlook back to stable are:

1. Recovering economic activity and fiscal consolidation efforts by the current administration are likely to stabilize the government debt burden;
2. Colombia’s credit profile remains aligned with its Baa2 peers and is more robust than that of its Baa3 peers even after the deterioration observed following the terms-of-trade shock in 2015-16.

Colombia’s foreign-currency long-term bond and deposit ceilings remain unchanged at A3 and Baa2, respectively. The foreign-currency short-term bond and deposit ceilings remain Prime -2 (P-2). The local-currency long-term bond and deposit ceilings remain A2.

RATINGS RATIONALE FOR THE AFFIRMATION OF THE Baa2 RATING

Moody’s: Recovering economic activity and fiscal consolidation efforts by the current administration are likely to stabilize debt ratios.

In Moody’s view, the measures that the administration of President Ivan Duque plans to implement, accompanied by a recovery in economic activity, will stabilize the debt-to-GDP ratio over the coming years.

The Colombian economy experienced a severe terms-of-trade shock caused mainly by falling oil prices as well as a significant deceleration in investment. An economic recovery began in earnest in 2018, with the economy expanding 2.6%, up from 1.3% in 2017. Moody’s expects that the economy will continue to recover in 2019-21 with growth in the 3.0%-3.5% range, converging toward Colombia’s potential growth rate of 3.5%. Economic performance will be supported by rising private investment and consumption, which will compensate for a lower contribution from public spending as the government pursues fiscal consolidation.

Moody’s expects the government to meet this year’s fiscal deficit target of 2.7% of GDP set by the country’s fiscal rule. A rise in government revenue this year following the tax reform approved in December 2018, in addition to the authorities’ decision to rein in spending by freezing a portion of the 2019 budget, will support this goal.

The rating agency notes that the forecasted decline in revenue for the upcoming years as a consequence of the reduction in corporate income tax rates and various VAT exemptions included in last year’s tax reform will challenge additional fiscal consolidation in line with the targets set by the fiscal rule beginning in 2020. However, initiatives related to reducing tax evasion, and efforts to contain the growth in expenditure categories such as subsidies, will support a gradual decline in fiscal deficits. Therefore, Moody’s expects that fiscal deficits will remain below 3% of GDP, implying small primary surpluses. This baseline scenario is supported by the authorities’ stated commitment of conducting fiscal policy in a manner that would support the stabilization of debt ratios by ensuring that the primary balance remains in surplus.

Moody’s baseline scenario is that the economy will expand at annual rates above 3.0% and that central government deficits will be below 3% of GDP during 2019-21. This will support the stabilization of its debt burden at 49% of GDP. At the general government level, which Moody’s looks at for peer comparisons, the debt-to-GDP ratio will stabilize at around 52%.

“Colombia’s credit profile remains aligned with its Baa2 peers and is more robust than that of its Baa3 peers even after the deterioration observed following a severe external shock in 2015-2016” – Moody’s

Colombia’s economic growth had been stronger than the median for Baa-rated peers until 2014, i.e. just prior to the sharp decline in oil prices. Because of the magnitude of the terms-of-trade shock in 2015-16, which was intensified with a decrease in consumer and business confidence, Colombia’s economic performance worsened significantly in 2015-17. Moody’s forecasts that GDP growth will gradually converge to its potential level of 3.5% in 2018-20. At that level, Colombia’s economic performance will be aligned with the median for Baa-rated sovereigns. Moody’s also notes that Colombia’s growth outlook is more favorable when compared to Baa3-rated peers’ average GDP growth of 2.3% in 2018-20.

Colombia’s government debt metrics worsened in previous years with the general government debt burden rising to 52.6% of GDP in 2018 from 39.6% in 2013. This deterioration was driven by large fiscal deficits, weak economic growth and the effect of the sharp exchange rate depreciation, particularly in 2014-16. As Moody’s expects the debt burden to stabilize at around current levels, the debt ratio will come above the median for Baa2-rated peers, which Moody’s projects will stand at 44% of GDP in 2019-20. However, Moody’s notes that the government’s debt burden will remain below the median for Baa3-rated peers, which it forecasts to reach 61% of GDP on average in 2019-20.

Colombia’s interest burden — measured as the ratio of interest-to-government revenue — has also worsened to 10.8% in 2018 from about 8% in 2013-14. This mainly reflects the loss of income due to lower oil prices and the stagnation of tax revenue despite multiple reforms over the years. However, at 12.2% of revenue in 2019-20, Colombia’s interest burden will be aligned with Indonesia, Government of (Baa2 stable; 13.4%) and the Philippines, Government of (Baa2 stable; 12.6%), and will be significantly below India, Government of (Baa2 stable; 22.0%).

RATIONALE FOR THE STABLE OUTLOOK

The stable outlook reflects Moody’s view that downside and upside risks are broadly balanced now that medium-term growth prospects and commitment to fiscal consolidation will prevent an erosion in the country’s fiscal strength. The latter was a key concern for the decision to assign a negative outlook in February 2018.

The outlook also incorporates the rating agency’s view that risks stemming from the country’s external accounts will remain contained. Moody’s expects the current account deficit to remain around 4% of GDP, with net foreign direct investment flows providing a stable source of financing for the external gap. The agency also considers that Colombia’s floating exchange rate and the buffer provided by the country’s foreign exchange reserves (15.5% of GDP as of March 2019) mitigate risks posed by the external accounts.

WHAT COULD MOVE THE RATING UP OR DOWN?

There would be upward pressure on the rating if the government were to reduce fiscal deficits sustainably, addressing challenges derived from Colombia’s low tax intake and rigid expenditure structure. Economic growth at its potential level of 3.5% or a rising growth potential and lower-than-expected budgetary imbalances, which would lead to declining government debt ratios, would also put upward pressure on the rating. Rising government revenue would also help improve debt affordability, where Colombia lags most of its rating peers. Bolstering the fiscal policy framework, including aspects such as the fiscal rule, budgeting and resource allocation among different levels of government, would also be credit positive.

Downward pressure on the rating would likely result from continued primary deficits, which could lead to a persistent increase in government debt metrics. Another severe shock to economic growth may also put downward pressure on the rating given that metrics have already deteriorated. Additional negative pressure would emerge should the current account deficit widen and if the country became more reliant on external debt inflows to finance the gap, and if this led to a weakening of the country’s external buffers.

• GDP per capita (PPP basis, US$): 14,392 (2017 Actual) (also known as Per Capita Income)
• Real GDP growth (% change): 1.3% (2017 Actual) (also known as GDP Growth)
• Inflation Rate (CPI, % change Dec/Dec): 4.1% (2017 Actual)
• Gov. Financial Balance/GDP: -2.3% (2017 Actual) (also known as Fiscal Balance)
• Current Account Balance/GDP: -3.3% (2017 Actual) (also known as External Balance)
• External debt/GDP: 40.0% (2017 Actual)
• Level of economic development: High level of economic resilience
• Default history: No default events (on bonds or loans) have been recorded since 1983.

On 21 May 2019, a rating committee was called to discuss the rating of the Government of Colombia. The main points raised during the discussion were: The issuer’s economic fundamentals, including its economic strength, have increased. The issuer’s fiscal or financial strength, including its debt profile, has not materially changed.

The principal methodology used in these ratings was Sovereign Bond Ratings published in November 2018. Please see the Rating Methodologies page on www.moodys.com for a copy of this methodology.

The weighting of all rating factors is described in the methodology used in this credit rating action, if applicable.

This is a reprint of a Moody’s press release issued 23 May 2019