The revision of Colombia’s 2020 deficit target by the country’s Fiscal Rule Advisory Committee acknowledges the weakening of key fiscal metrics that will stem from the economic downturn amid coronavirus containment measures, says Fitch Ratings. The prospect of fiscal deterioration was the key driver of Fitch’s downgrade of Colombia’s sovereign rating to ‘BBB-‘/ Negative from ‘BBB’/Negative at the start of April.
The nine-member Committee on April 16th unanimously supported widening the 2020 government deficit limit to 4.9% of GDP from 2.2%. It said that the new target reflects government estimates that the economy would contract by 1.6% in 2020, and that downside risks to this forecast could result in a wider deficit. In addition to the contribution of weaker growth (1.3pp of GDP), the new target incorporates additional spending in response to Venezuelan immigration (0.4pp) and the committee’s invocation of the counter-cyclical spending clause in Colombia’s fiscal rule (20% of the estimated output gap, or 1.7pp).
Measures to address fiscal deterioration could face social and political constraints given last year’s social protests and the expected rise in unemployment as the economy shrinks this year, as well as the approach of presidential elections in 2022.
The new target is close to Fitch’s revised 2020 central government deficit forecast of 5% of GDP. This is wider than the 4.5% deficit Fitch forecasts when they downgraded Colombia, chiefly because they revised their real GDP forecasts following the government’s recent decision to extend the nationwide lockdown before a gradual re-opening in the coming weeks. Fitch now expects a 2.0% contraction this year, although this will be followed by a stronger recovery, with 3.3% growth forecast in 2021 (up from Fitch’s previous 2.3% forecast).
Weaker growth and a wider deficit mean the ratings agency now forecasts general government debt/GDP, which has risen steadily over the past six years, to increase to 52% in 2020, a marginal increase from their previous forecast of 51% but up 8pp from 2019, partly due to peso depreciation. The higher deficit will be financed from government funds (FAE and FONPET). The government also will require financial institutions to buy so-called ‘Solidarity Bonds’, for a value of 3% of demand deposits and 1% of time deposits as of 31 March. It expects this measure to yield around 0.8% of GDP.
The risk that a deeper or longer-lasting recession than Fitch currently forecasts puts additional pressure on metrics, such as GDP per capita and economic growth volatility, as well as the fiscal deficit and debt-to-GDP that is reflected in the Negative Outlook on Colombia’s sovereign rating. The Negative Outlook also reflects risks to the capacity and quality of the government’s policy
response that could limit its effectiveness in decisively cutting deficits and stabilizing debt over the coming years, given the scale of the coronavirus and oil shocks. Fitch forecasts the central government fiscal deficit to drop back to 3.8% of GDP in 2021 as transitory spending fades. But government tax revenue will remain under pressure, in part due to the expected fall in oil revenue.
Prudent and consistent policymaking has underpinned macroeconomic and financial stability in Colombia, and the authorities’ record includes introducing revenue-enhancing tax reforms in response to previous shocks. However, frequent revisions to fiscal targets (as allowed by the fiscal rule) and reliance on one-off extraordinary measures had reduced fiscal policy credibility prior to the coronavirus crisis and the latest oil price collapse. The government’s annual medium-term fiscal framework, due in June, will give an indication of its fiscal priorities beyond its initial crisis response. Measures to address fiscal deterioration could face social and political constraints given last year’s social protests and the expected rise in unemployment as the economy shrinks this year, as well as the approach of presidential elections in 2022.