The Economic Fallout of Colombia Rejecting Peace

Colombians shocked the world — and proved the fallibility of polling — when they rejected a peace deal that took four years to forge. President Juan Manuel Santos and his negotiators spent four years in Havana, Cuba, agreeing with guerrillas on an accord that would have ended 52 years of conflict with the Revolutionary Armed Forces of Colombia (FARC).

Despite a huge ceremony last week to formally sign the agreement, the nation’s peopled decided not to ratify the 297-page deal yesterday at the ballot. Now, the nation has no official peace and nobody knows what the next steps will be.

Fortunately, everybody is saying the right things. President Santos immediately validated the outcome — in which his “Yes” campaign lost by a mere 57,000 votes — and FARC top commander Rodrigo Londoño, aka Timochenko, says his guerrillas have no plans to re-take up arms. The opposition political party that supported the victorious “No” vote has met this afternoon to decide how it can work with its political opponents, and potentially the FARC, to reach a new peace deal that will be tolerable to the nation.

Even with all the major actors calling for unity, what all this means for the country at large is confusing. That goes double for the economy.

For now, stability reigns. Things could quickly change if any of the primary players decide to deviate from the calm and hopeful course we have seen in the less than 24 hours since the results came in. But everything is expected to remain orderly for the near term.

There is economic fallout, however. And the following key issues remain the biggest question marks now that peace has been defeated at the poll.

Colombia’s Currency

The peso took a hit this morning — dropping as much as 2.8%. This is a currency that has moved around a lot over the past month, however. Even after tumbling in the wake of the peace vote, it remains stronger than it was a week ago at this point before OPEC agreed to cut its oil production.

There is certainly a risk that it could fall further. And that would spell worse news for a government whose debt and account deficits have been moving in the wrong direction of late.

But the peso hit a record weakness earlier this year at 3,436 pesos to the dollar. It currently sits at 2,930 to the dollar. Unless some level of unexpected chaos erupts this week, it is unlikely to experience the type of volatility we saw in February — and even that was manageable temporarily before it started to regain some strength.

Perhaps most importantly, Brent crude is up big today. It has surpassed $50 USD per barrel for the first time since mid-August — and is up from around $46 USD last Tuesday — and the Colombian has been generally moving in line with oil prices for the past two years. If the oil rally continues, the peso may care nothing for the FARC news and reverse course to start appreciating again.

Bond Outlook

The Wall Street Journal chronicled some damage to securities, specifically looking at local-currency bonds that will come due in the next decade. “The Colombian peso was down 1.8% Monday afternoon from Friday’s close,” wrote WSJ reporter Sara Schaeffer Munoz. “The country’s borrowing costs increased, with yields on local-currency bonds due in 2024 rising by 0.15 percentage point to 6.79%, after having fallen ahead of the vote.”

The local, Bogotá-based outlet La Republica also noted the the “unexpected rejection of the agreement led to a wave of bond sales and Colombian pesos.”

The Colombian 10-year government bond was unaffected, however — and in fact gained on the first day after the peace vote came in. “Colombia government bond 10Y increased 2.56% to 7.21 on Monday October 3 from 7.03 in the previous trading session,” noted Trading Economics. The 10-year bond has dropped more than 7% this year after a steady, pronounced climb throughout 2015.

More generally, there has been an elevated interest in the Colombian bond market of late. Franklin Templeton “plowed $1.6 billion USD into Colombian debt through the second quarter,” reported Bloomberg in September, to make the company the largest foreign holder of the bonds. Citigroup told investors recently that it is expecting more inflows into the market for Colombian bonds.

What effect the failure of the peace deal has on that momentum remains to be seen.

Tax Reform

Before the peace vote, the stage was set for the Santos government to finalize a tax reform plan and send it through to Congress. This was expected to happen not long after the accord was ratified, and all hope was that the needed overhaul would become reality before the end of the year.

Now, who knows what will happen? Capital Economics, a London-based analyst and research firm, believes there is reason to worry about whether the plan is still on the table in its prior form.

“One major risk is that an important tax reform proposal that had been due to be introduced to the legislature later this month now gets delayed or watered down,” said Capital Economics in an analyst note. “This would raise serious concerns about the government’s fiscal position, which has been looking increasingly strained due to lower oil prices and the weakening economy.”

The firm cautioned that Santos could now find find himself in a much weaker position to make anything happen in the country. “President Santos has staked his legacy on securing the peace deal and its rejection has seriously undermined his position,” stated Capital Economics. “The next presidential elections are not due until 2018, but it possible that Mr. Santos now finds it more difficult to govern.

Ratings Agency Expectations

Fitch Ratings, which put Colombia’s ratings on negative outlook in July, weighed in today. In short, the agency believes that the “No” vote doesn’t necessarily have to have a negative impact on the nation’s economy. But the thorny issue of tax reform remains necessary.

“Fitch’s expectation is that the government will continue to implement a consistent and credible policy response to address economic challenges in terms of high current account deficits, high — albeit declining — inflation, and the negative impact of lower oil prices on fiscal accounts,” said Erich Arispe, Fitch’s Colombia analyst.

The message of the words appears clear: Tax reform is still the priority, and the underlying fundamentals show that officials in Bogotá still must make it happen soon. If not, more negative actions could be looming — a move that would have a major effect on the international outlook of Colombia’s economy.

“Fitch’s base case is that the government will introduce and obtain congressional approval for a revenue positive tax reform by the end of 2016,” said Arispe. “It is difficult to judge the final outcome, but a net positive revenue measure and its successful implementation are important to compensate the loss of oil-derived revenues from an already-low revenue base and replace expiring taxes in 2018.”

“Post-Conflict” Funding Complications?

Adam Isacson, a Colombia expert at the Washington Office on Latin America (WOLA), is wondering how the development will affect post-conflict funding. Nations and other bodies across the world — with the United States leading the way — have pledged hundreds of millions to support programs that were expected to hit the ground running as soon as the peace deal was ratified.

The United States has been the biggest supplier of aid to Colombia since the Bill Clinton administration. This used to come from its “Plan Colombia” program to fight drug tracking and support the nation’s military. It changed the nomenclature earlier this year — to “Peace Colombia” — and presumably won’t shift course in dispersing that money now. President Barack Obama has maintained that bipartisan support exists for a plan that will continue no matter who replaces him in the White House next January.

But the logistical questions about U.S. congressional involvement do mean this isn’t 100% clear as of today. The possibility of some $130 million USD of expected funds disappearing does exist, according to Isacson.

“The White House’s proposed ‘Peace Colombia’ aid package may suffer a deep cut,” writes Isacson for WOLA. “It was approved by both houses of Congress, but the 2017 foreign assistance budget law has not yet been reconciled, and may be rewritten after the U.S. presidential elections. The lack of a peace accord to implement may cause the US$450 million appropriation for Colombia to fall back to its 2016 level of about US$320 million. Meanwhile, other international donors may similarly redirect foreign aid funds to urgent needs elsewhere in the world, such as the Syrian refugee crisis.”

Photo: Presidencia de la República.