After Standard & Poor took a similar ratings action in May, Fitch has downgraded Colombia’s long term sovereign debt rating to BB+ from BBB- while revising the outlook to stable. Having lost investment grade ratings from two ratings agency, Colombia’s debt falls into junk status, after having held an investment grade rating since 2011.
Colombia has not defaulted on sovereign debt since before World War 2, though public finances have worsened steadily, due both to the COVID-19 Pandemic and the public’s vehement rejection of President Ivan Duque’s (above) fiscal reform package presented earlier this year. When Duque’s finance minister Alberto Carrasquilla took to national media to sell the fiscal package, he was soundly ridiculed after having no idea how much a dozen eggs (that he sought to tax) cost in Colombia. Carrasquilla had to resign while Colombians took to the streets to reject the tax reform proposal, but also to express broader dissatisfaction with the Duque administration via nationwide protests and major strikes.
This led to a, by many accounts, disproportionate reaction by Colombia’s ESMAD riot police, which further fed popular outrage, leading to almost daily unrest throughout the country over the past two months. Duque seems to have lost control of the National Police, with them now attacking protesters and noncombatants, all while intensive care units throughout the country are at 100% capacity, some hospitals closing to new patients or treatment.
Colombia now needs to fix its troubled finances more urgently than before, though politically crippled Duque has little political capital to push through a significant tax package, and presidential elections are almost exactly a year away. Duque is now so unpopular, and the social situation has deteriorated so much that his presidential helicopter came under fire as he approached the border city of Cúcuta. With this uncertainty, Fitch issued the downgrade, dropping Colombia out of an investment grade credit rating for the first time in a decade. Fitch’s edited analysis follows:
KEY RATING DRIVERS
The downgrade reflects the deterioration of the public finances with large fiscal deficits in 2020-2022, a rising government debt level, and reduced confidence around the capacity of the government to credibly place debt on a downward path in the coming years. Colombia’s gross general government debt (GGGD) to GDP is forecast to reach 60.8% in 2021, more than double the 30% level when Fitch upgraded Colombia back to the ‘BBB’ category in 2011. Fitch expects debt to continue to rise through 2022 and does not expect significant debt reduction over the medium term, leaving Colombia vulnerable to shocks. Furthermore, Fitch sees significant risks to the government’s fiscal consolidation plan, given the reliance on tax administration efforts and divestments, as well as the uncertainty of the impact of the pending tax reform.
The impact of the Covid-19 pandemic, reflecting the 6.8% GDP contraction in 2020, led to a sharp rise in general government debt to GDP, reaching 58.3% of GDP in 2020 (versus 54.2% for ‘BBB’ median and 59.1% for the ‘BB’ median), up from 44.7% in 2019. Fitch’s debt dynamics forecasts have weakened further since Fitch’s last review. Fitch now expects GGGD to GDP to continue to rise over the forecast period to 64.4% of GDP by 2023. Debt could stabilize around 64% by 2024 but, in Fitch’s view, further fiscal consolidation initiatives beyond those already identified would likely be necessary to begin to reduce the debt level in a meaningful way thereafter.
The passage of any reforms will be difficult to achieve given the growing social pressures, the government’s low popularity and the upcoming elections.
The pandemic has had a significant impact on Colombia’s population and its macroeconomic outcomes. Despite numerous lockdowns, deaths have reached over 100,000 and the country is currently experiencing a severe third wave of infections. The economic impact of the coronavirus and the lockdown responses included a sharp rise in the unemployment rate (to over 20% in May 2020) as well as in rates of poverty. However, the pace of vaccinations is now picking up (with around 23% of the population receiving a least one jab according to Our World in Data) and unemployment has fallen to 15% as some of the hardest hit parts of the economy begin to reopen.
Against this backdrop, the president’s approval rating remains low (27% in late June according to a poll done for Semana magazine), hindering the government’s reform agenda. At end-April 2021, the government introduced a tax reform that included extending the base for personal income taxes and broadening the VAT base in order to begin a fiscal adjustment as well as to extend social programs such as cash transfers to the vulnerable and unemployment benefits. This proposal caused a backlash among the population that resulted in protests and a national strike. As a result, the government withdrew the reform proposal, reflecting insufficient support in the Congress.
Fitch expects the government to reintroduce a revised tax reform package in July 2021 when the new session of Congress commences and is targeting a benefit of around 1.2% of GDP on a net basis. However, Fitch believes that the majority of the fiscal benefit will be obtained only in 2023 (given reliance on corporate income tax measures) while the government extends some pandemic related spending such as cash transfers into 2022. There is a risk that the new tax reform could be watered down. Additionally, the passage of any reforms will be difficult to achieve given the growing social pressures, the government’s low popularity and the upcoming elections (congressional and presidential elections scheduled for March 2022 and May 2022 respectively).
Colombia’s central government deficit widened to 7.8% of GDP in 2020 as a result of the severe economic downturn, which led to a fall in revenues and an increase in government spending, reflecting measures implemented to combat the pandemic and reactivate the economy. The government announced an extension of some pandemic related measures through 2022. As a result, Fitch forecasts central government deficits of 8.2% in 2021 and 6.9% of GDP in 2022 (general government deficits are about 1.0% of GDP lower on average in last decade). Fitch has included government-targeted divestment proceeds in its revenue figures, totaling 1.2% of GDP in 2021 and 0.6% of GDP in 2022, with the latter figure subject to some uncertainty. Without these proceeds, the fiscal deficits would even be higher.
The government outlined a fiscal consolidation strategy in its Medium-Term Fiscal Framework published in mid-June 2021 that would unwind pandemic related spending and increase revenues through an increase in taxes and tax administration. The fiscal adjustment targets a five-year transition period to reach a deficit of around 2.5% of GDP (versus previous projection of 1% of GDP). The government has outlined an updated fiscal rule to be presented with its new tax reform proposal that will include a debt anchor of 55% of GDP with a limit of around 70% of GDP.
Near-term growth prospects have brightened given the reopening of the economy as well as the significant monetary and fiscal stimulus measures implemented by the government. Fitch has raised its GDP growth forecast to 6.3% in 2021, up from Fitch’s previous forecast of 4.9%. Fitch sees some upside to even the revised forecast if the coronavirus pandemic outlook improves and social protests remain subdued, albeit there is a greater than usual degree of uncertainty surrounding forecasts.
Colombia’s gross general government debt (GGGD) to GDP is forecast to reach 60.8% in 2021, more than double the 30% level when Fitch upgraded Colombia back to the ‘BBB’ category in 2011.
Fitch expects growth of 3.8% in 2022, somewhat above potential. While Fitch believes that there has likely been some permanent economic scarring from the pandemic, the large influx of Venezuelan immigrants will likely provide a boost to medium-term growth prospects. Currently favorable terms of trade should also provide tailwinds to growth prospects.
Inflation and inflation expectations have been contained, with inflation at the lower end of the target. The central bank cut rates by 250 basis points to 1.75% between February 2020 and September 2020. Expectations are for the central bank to begin to tighten by 4Q21 as the output gap closes.
The current account deficit narrowed significantly in 2020 due to import contraction and reduced outbound profit remittances as well as an increase in inbound remittances. Fitch expects the deficit to widen to 4.4% of GDP in 2021 as a result of higher imports as the economy recovers. FDI historically has covered around 70% of the current account deficit (CAD) and Fitch expects the favorable financing of the CAD to continue during the forecast period.
Net external debt to GDP has risen over the last decade and is expected to continue to rise over the forecast period to 21.5% of GDP by 2023 from 16.4% in 2020 due partly to sovereign external borrowing to finance large deficits. Colombia’s external liquidity has improved markedly over the last three years as a result of the central bank’s international reserve accumulation policy. International reserves rose to USD58.5 billion at year-end 2020, up significantly from USD52.7 billion in 2019. As a result, Fitch’s external liquidity ratio rose to 108% in 2021 from 89% in 2019. Additionally, Colombia maintains access to a flexible credit line with the IMF for USD12.2 billion (out of a total program of USD17.6 billion).
FACTORS THAT COULD, INDIVIDUALLY OR COLLECTIVELY, LEAD TO NEGATIVE RATING ACTION/DOWNGRADE:
- Public Finances: A failure to achieve fiscal consolidation that leads to a significant deterioration in Colombia’s general government debt to GDP ratio relative to the ‘BB’ peer median;
- Macro: Diminished medium-term growth prospects well below Colombia’s historical potential of 3.5%, leading to continued high unemployment and poverty levels with social ramifications;
- External Finances: Sharp further increase in net external debt to GDP, raising external vulnerabilities.
FACTORS THAT COULD, INDIVIDUALLY OR COLLECTIVELY, LEAD TO POSITIVE RATING ACTION/UPGRADE:
- Public Finances: Achieving sustained primary fiscal balances consistent with a steadily declining GGGD to GDP ratio that enhances fiscal policy credibility;
- Macro: Higher sustained medium-term economic growth above Colombia’s historical averages of about 3.5%;
- Structural: Steady improvement in governance indicators that leads to improved social cohesion and reform momentum, improving Colombia’s structural fiscal position as well as medium term growth prospects.
SOVEREIGN RATING MODEL (SRM) AND QUALITATIVE OVERLAY (QO)
Fitch’s proprietary SRM assigns Colombia a score equivalent to a rating of ‘BB+’ on the LT FC IDR scale.
Fitch’s sovereign rating committee adjusted the output from the SRM to arrive at the final LT FC IDR by applying its QO, relative to SRM data and output, as follows:
- Macroeconomic: +1 notch added to compensate for the disproportionate negative impact of the GDP volatility variable on the SRM score driven by the impact of the pandemic shock, which we believe will be temporary, and would otherwise add excess volatility to the rating. Colombia has a long track record of stable positive growth with only one year of negative growth in the last 30 years.
- Fiscal: Fitch has introduced a -1 notch to reflect Colombia’s rigid spending profile and limited ability to achieve a structural fiscal consolidation consistent with debt reduction over the medium-term. This is evidenced by reliance on one-off divestments and the increasing political impediments to reducing spending or passing comprehensive structural tax reform measures, as well as a high degree of uncertainty about the impact on revenues from improved tax administration both in terms of size and timing.
BEST/WORST CASE RATING SCENARIO
International scale credit ratings of Sovereigns, Public Finance and Infrastructure 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, visit https://www.fitchratings.com/site/re/10111579.
Fitch’s oil price assumptions for 2021 are USD63/barrel and USD55/barrel for 2022.
REFERENCES FOR SUBSTANTIALLY MATERIAL SOURCE CITED AS KEY DRIVER OF RATING
The principal sources of information used in the analysis are described in the Applicable Criteria.
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 therefore highly relevant to the rating and a key rating driver with a high weight. As Colombia has a percentile rank below 50 for the respective Governance Indicator, this has a negative impact on the credit profile.
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. As Colombia has a percentile rank above 50 for the respective Governance Indicators, this has a positive impact on the credit profile.
Colombia has an ESG Relevance Score of ”4[+] for Human Rights and Political Freedoms as the Voice and Accountability pillar of the World Bank Governance Indicators is relevant to the rating and a rating driver. As Colombia has a percentile rank above 50 for the respective Governance Indicator, this has a positive impact on the credit profile.
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 Colombia, as for all sovereigns. As Colombia has track record of 20+ years without a restructuring of public debt and captured in Fitch’s SRM variable, this has a positive impact on the credit profile.
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.