Fitch Ratings last week downgraded Colombia’s Long-Term Foreign Currency Issuer Default Rating (IDR) to ‘BBB-‘ from ‘BBB’ with a negative rating outlook. The downgrade reflects the likely weakening of key fiscal metrics in the wake of the economic downturn caused by a combination of shocks stemming from the sharp fall in global oil prices and efforts to combat the coronavirus pandemic.
Right now, Fitch expects a moderate contraction of the Colombian economy by 0.5% in 2020, driven by significant slowdown in domestic demand and oil exports, followed by a modest recovery of 2.3% in 2021. A rise in the debt burden in recent years and an expected fall in tax revenues have left the government with less fiscal space to counteract economic shocks, in Fitch’s view. The negative outlook reflects downside risks to the outlook for economic growth and public finances, and to the capacity and quality of the government’s policy response to decisively cut deficits and stabilize debt over the coming years, given the scale of the shock.
- Colombia LT IDR BBB- Downgrade BBB
- ST IDR F3 Downgrade F2
- LC LT IDR BBB- Downgrade BBB
- LC ST IDR F3 Downgrade F2
- Country Ceiling BBB Downgrade BBB+
- senior unsecured
- LT BBB- Downgrade BBB
The recession and fall in oil price will negatively impact government revenues while the fiscal package announced by the government (1.4% of GDP to date) will increase government spending, However, the government has announced its intention to use government funds at the FAE (stabilization fund) and FONPET (a public sector local and regional government pension fund) to finance the higher spending. As a result, Fitch expects the central government deficit to widen to 4.5% of GDP in 2020, up from 2.5% of GDP in 2019. General government debt/GDP is expected to rise above 50%, up from 44% in 2019 (and well above 30% of GDP in 2013 when Colombia was upgraded to BBB), in part due to the sharp depreciation of the Colombian peso (the foreign- currency debt represented over 30% of the total at year-end 2019). GG interest to revenues has also risen significantly to close to 11.6% from 8.7% since 2013, as well.
Although Fitch expects some fiscal consolidation in 2021 as transitory spending fades, government tax revenues will continue to remain under pressure, although possibly higher profits from the central bank and tax administration measures could help make up for some of the losses in 2021. Significantly lower dividends and income taxes from the oil sector as well as further tax cuts associated with the 2019 Economic Growth Law will lead to an overall central government deficit of 3.5% of GDP. As a result, the trajectory of government debt will continue to rise through the forecast period.
Fitch believes that the risks to its fiscal and debt projections are mainly on the downside. Weaker- than-expected economic growth performance, possible additional fiscal support package, difficulty in cutting spending given budgetary rigidities, could keep fiscal deficits higher for longer. The heightened uncertainties surrounding length of the quarantine, the global economic outlook and potentially prolonged low oil price environment represent significant downside risks to Colombia’s growth outlook. A more pronounced downturn could lead to a further deterioration in key sovereign metrics such as GDP per capita, economic growth volatility, the fiscal deficit, and debt to GDP. The recognition of domestic liabilities related to pensions, health and negative court rulings as well as the depreciation of the peso are additional risks to debt stabilization.
In Fitch’s view, although Colombia’s overall macroeconomic policy framework remains solid, the predictability and credibility of the medium-term fiscal policy has deteriorated relative to ‘BBB’ peers, as witnessed by a steady rise in debt to GDP, the difficulty in raising permanent tax revenues, reliance on non-recurrent sources of revenue to meet fiscal targets and the vulnerability of government revenues to oil price shocks amid rigid expenditure demands and low fiscal buffers. Fitch believes additional changes in the short to medium term fiscal targets are likely when the Fiscal Council meets in April given the expected economic downturn and low oil price environment as considered in the fiscal rule.
Fitch believes that further fiscal policy measures to achieve a sustainable increase in the non-oil revenue base are needed to further fiscal consolidation over the medium term to stabilize General Government (GG) debt, given the fiscal spending rigidities. Prospects for such measures appear uncertain given the natural priority to deal with the pandemic. In addition, the possibility of rising social tensions (given the recent protest activity and the expected rise in unemployment rate) as well as the 2022 presidential election cycle, could detract from the implementation of credible measures to address the fiscal weaknesses.
In addition to the significant fiscal deterioration, Colombia’s vulnerability from external shocks has increased as witnessed by the deterioration in its external debt and liquidity metrics. Fitch expects the current account deficit will widen to 4.6% of GDP in 2020, up from 4.3% of GDP in 2019. A fall in exports and remittances are the prime contributors in the deterioration although sharply contracting household consumption and investment will suppress imports. Over the last 10 years, FDI has covered around 70% of the current account deficit. However, the widening current account deficit will lead to an increase in net external debt, which is expected to rise to 17% of GDP in 2020 from 1.6% in 2013, and is expected to continue to increase despite an adjustment in the current account deficit next year to 3.2% of GDP. Higher external financing needs make Colombia vulnerable to the tightening external financing conditions. Despite the increase in Colombia’s international reserves position in 2019, Fitch’s liquidity ratio will remain below 100% for 2020.
Inflation ended at 3.8% in 2019 at the upper end of the 3+/- 1% inflation target. In March 2020, the central bank cut interest rates by 50 bp to 3.75% after remaining on hold for an extended period since May 2018 citing the weak economic outlook that would signify disinflation despite the peso depreciation (over 20% since February 2020). The central bank has also intervened in the local market to provide liquidity – including outright purchase of government and local corporate debt. It has also intervened in the FX market through derivatives (both forwards and swaps).
Fitch revised the Colombian banking sector outlook to Negative on March 27 to reflect the weaker operating environment that will increase asset quality deterioration and affect profitability. However, the banking systems capital and provisioning were relatively solid going into the downturn.
Colombia’s investment grade rating reflects the government’s conservative macroeconomic policies that have underpinned macroeconomic and financial stability. Its ratings are constrained by high commodity dependence, weaker external accounts, rising government debt burden and structural weaknesses in terms of low GDP per capita and weaker governance indicators relative to peers.
ESG – Governance: Colombia has an ESG Relevance Score (RS) of 5 for both Political Stability and Rights and for the Rule of Law, Institutional and Regulatory Quality and Control of Corruption, as is the case for all sovereigns. Theses scores reflect the high weight that the World Bank Governance Indicators (WBGI) have in our proprietary Sovereign Rating Model. Colombia has a medium WBGI ranking in the 45th percentile, reflecting a track record of peaceful political transitions, a moderate level of rights for participation in the political process, moderate institutional capacity, established rule of law and a moderate level of corruption. Colombia scores especially poorly in the area of political stability.
SOVEREIGN RATING MODEL (SRM) AND QUALITATIVE OVERLAY (QO)
Fitch’s proprietary SRM assigns Colombia a score equivalent to a rating of ‘BBB-‘ on the Long-Term Foreign Currency (LT FC) IDR scale.
Fitch’s sovereign rating committee did not adjust the output from the SRM to arrive at the final LT FC IDR.
The removal of the +1 notch under Macroeconomic performance, policies and prospects since the previous review reflects the deterioration of fiscal credibility relative to peers given the continued rise in debt to GDP, reliance on extraordinary revenues to meet revised targets under the fiscal rule as well as difficulties in raising permanent sources of tax revenues.
Fitch’s SRM is the agency’s proprietary multiple regression rating model that employs 18 variables based on three-year centred averages, including one year of forecasts, to produce a score equivalent to a LT FC IDR. Fitch’s QO is a forward-looking qualitative framework designed to allow for adjustment to the SRM output to assign the final rating, reflecting factors within our criteria that are not fully quantifiable and/or not fully reflected in the SRM.
The main factors that may, individually or collectively, lead to a downgrade or other negative rating action include:
- Failure to achieve a fiscal consolidation consistent with stabilization and eventual reduction in government debt burden;
- Damage to medium term growth prospects;
- Sustained large external imbalances that lead to a continuous rise in the external debt burden.
- The main factors that may, individually or collectively, lead to an upgrade or other positive rating action include:
- Fiscal consolidation consistent with an improved trajectory for public debt dynamics;
- A return to economic growth prospects consistent with medium term potential above 3%;
- Reduced external imbalances that improve external debt and liquidity ratios.
BEST/WORST CASE RATING SCENARIO
International scale credit ratings of Public Finance issuers have a best-case rating upgrade scenario (defined as the 99th percentile of rating transitions, measured in a positive direction) of three notches over a three-year rating horizon; and a worst-case rating downgrade scenario (defined as the 99th percentile of rating transitions, measured in a negative direction) of three notches over three years. The complete span of best- and worst-case scenario credit ratings for all rating categories ranges from ‘AAA’ to ‘D’. Best- and worst-case scenario credit ratings are based on historical performance. For more information about the methodology used to determine sector-specific best- and worst-case scenario credit ratings click here.
Colombia has an ESG Relevance Score of 5 for Political Stability and Rights as World Bank Governance Indicators have the highest weight in Fitch’s SRM and are highly relevant to the rating and a key rating driver with a high weight.
Colombia has an ESG Relevance Score of 5 for Rule of Law, Institutional & Regulatory Quality and Control of Corruption as World Bank Governance Indicators have the highest weight in Fitch’s SRM and are therefore highly relevant to the rating and are a key rating driver with a high weight.
Colombia has an ESG Relevance Score of 4 for Human Rights and Political Freedoms as strong social stability and voice and accountability are reflected in the World Bank Governance Indicators that have the highest weight in the SRM. They are relevant to the rating and a rating driver.
Colombia has an ESG Relevance Score of 4 for Creditor Rights as willingness to service and repay debt is relevant to the rating and is a rating driver for the U.S., as for all sovereigns.
Except for the matters discussed above, the highest level of ESG credit relevance, if present, is a score of 3. This means ESG issues are credit-neutral or have only a minimal credit impact on the entity(ies), either due to their nature or to the way in which they are being managed by the entity(ies). For more information on Fitch’s ESG Relevance Scores, visit www.fitchratings.com/esg
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