Fitch Ratings believes the concerns with the final amounts of the top-up payment (DR8) for Colombia’s Fourth Generation (4G) toll roads have largely dissipated. All Fitch-rated Colombian public initiative 4G toll roads have signed or are close to signing agreements with grantor Agencia Nacional de Infraestructura (ANI) to amend their concessions and clarify the discrepancies in the calculation of the top-up payments scheduled in the eighth year.

ANI and the concessionaires agreed there is no measurement of the monthly compliance index prior to the signing of the Act of Termination of each toll road tranche (unidad funcional, UF). In addition, it is not possible to consider those monthly periods in which there is no measurement of the compliance index in calculating of the DR8. Therefore, the compliance index will be calculated based on the indicators effectively measured. It was also agreed that ANI’s obligation to pay the interests generated by the delayed payment of any remaining amounts of the DR8 would be waved, where applicable.

The concessions, of which total or partial DR8 is already due, expect to receive their payments between May and June 2023. Fitch expects the DR8 amount received will be equal or very close to what was originally estimated by the concessionaires and considered in the original projects’ financial models. Fitch will closely monitor the reception of such payments and any other related event. Publicly rated issuers that had or will have concession amendments in connection with this matter include: Fideicomiso P.A. Costera, Fideicomiso P.A. Pacifico Tres, P.A. Autopista Rio Magdalena and Patrimonio Autonomo Union del Sur.

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.

“On the issue of eggs, it depends on its quality. Let’s say $1,800 COP (48 cents, US) a dozen or something like that.”

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).

RATING SENSITIVITIES

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.

KEY ASSUMPTIONS

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.

ESG CONSIDERATIONS

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.

Cover Image by vkingxl from Pixabay

This is unchanged from the New York-based agency’s previous rating for the country and represents positive news for a government whose budget challenges led a rival rating agency, Standard & Poor’s, to downgrade Colombia’s long-term rating foreign currency rating to BBB-, one level above junk, in December 2017.

The third large global agency, Moody’s Investor Services, has most recently rated Colombia at Baa2, its equivalent to Fitch Rating’s BBB, or two notches above junk. Moody’s did, however, assign Colombia a negative outlook in February.

The BBB affirmation by Fitch Ratings hits during a week when oil prices, the Andean nation’s largest export, rose to a level not seen in nearly four years.

The collapse of oil prices toward the end of 2014 has been the biggest culprit in Colombia’s economic slowdown, contributing to a budget crunch in Bogotá as gross domestic product (GDP) only expanded by 2.0% in 2016 and a paltry 1.8% in 2016, which was the lowest level since 2009.

Colombian Finance Minister Mauricio Cárdenas highlighted the fact that the country has been able to maintain a BBB rating with Fitch Ratings dating back to 2013 and throughout this downturn. To him, managing to not lose this coveted rating — something the government fought to retain when it rose taxes in the final days of 2016 — signifies that the overall investment climate and reputation of Colombia has improved.

“Fitch sees a clear, stable horizon,” said Cárdenas in a statement. “This confirms that an orderly adjustment was made, that the economy is stable, and that the rating agencies now consider Colombia a better place to invest, with lower country risk, than it was in the past.”

Among the factors cited by Fitch Ratings in affirming the rating are Colombia’s debt — which still presents some cause for worry but is in line with BBB peers — and an inflation rate that has moderated over the past 18 months. In April, inflation fell again, albeit slightly, to 3.13%, which is now well within the 2%-4% target range of the Colombian central bank.

The agency also again highlighted its concerns about whether the current account deficit can continue to drop fast enough to hit the rate targets set forth in the country’s so-called “fiscal rule.” Progress in this area looks to be on track for 2018, with higher oil prices helping to ease some of the worry about the deficit meeting the mandated level of 3.1% of GDP. But over the longer term, the macroeconomic fundamentals mean that reaching the lower rates in years to come will be difficult.

“Fitch anticipates that the adjustment of the current account deficit will continue significantly in the coming years due to better export dynamics,” stated Bancolombia, the country’s largest bank, in a note to investors after Fitch affirmed its rating. “Against this, we believe that the correction could be lower due to a rebound in imports in line with the recovery of domestic demand.”

Bancolombia is in agreement with Fitch that Colombia will hit the 2018 target of having a fiscal deficit of 3.1% of GDP. But the Medellín-based bank contrasted the agency’s rationale for 2019 figures with its own (somewhat) more optimistic expectation.

“The agency believes it will be difficult to reach the target of a total deficit of 2.4% of GDP in 2019 in the absence of the implementation of further measures,” stated Bancolombia. “This is explained by increasing pressures on spending in a post-conflict scenario and strengthening of infrastructure. In this regard, we believe the target could be met in 2019, although this would be largely linked to the current dynamics of oil prices.”

Richard Francis of Fitch Ratings, speaking about Colombia today at a Council of the Americas event in Washington, said that Fitch Ratings has forecasted 2.6% GDP growth for the country in 2018. Though below its earlier projection of 2.8%, this figure is in line with the latest prediction of the Colombian central bank. It is, however, below the more optimistic predictions of closer to 3% made in early 2018 by the International Monetary Fund and World Bank.

But while higher growth for 2018 would help ease fiscal concerns to some degree for the incoming president — who will be decided by an election in May that Fitch expects to go to a runoff in June — the budget will remain troublingly tight for the foreseeable, stated Francis.

He added that the remaining challenges will still likely require ongoing adjustments and tough fiscal decisions going forward if Colombia wants to retain the necessary fundamentals, including concerns about adhering to the fiscal rule, to retain its BBB rating.

Despite the austerity approach of the federal government since the price of oil dropped suddenly in late 2014, reaching the goal will “likely depend largely on reducing spending, which has been steady over the last five years,” stated the New York-based credit rating agency.

The target fiscal deficit rate of 2.2% for 2019 is the key component of the so-called “fiscal rule” that the nation has adopted over a multi-year framework.

The nation was able to hit its 2017 target of 3.6% due to above-forecast incoming revenues, but Fitch noted that this came in part due to a surprise windfall from massive telecom fines and that the hyped tax reform passed in late 2016 did not contribute as much as officials had hoped it would.

“Estimated additional revenues from the 2016 tax reform did not meet expectations, reaching just 0.4% of GDP in 2017, lower than the 0.7% of GDP originally estimated,” stated Fitch.

This means that the tax reform likely won’t be enough to close the gap for 2019 and that the incoming government — after President Juan Manuel Santos leaves office mid-year following the conclusion of his second term — will have to grapple with ways to cut spending to obey by the fiscal rule.

READ MORE: Colombian GDP Grew by Just 1.8% in 2017 – Lowest Rate Since Global Recession

There is time, however. Fitch Ratings believes that the economy will turn around this year (to 2.8% GDP growth), and that this — along with a recovering oil sector bringing in more royalties and interest expenses dropping — will allow the country to hit its fiscal deficit target of 3.1% for 2018.

But the 2019 outlook, even if crude prices remain at current levels and the economy performs as expected, still doesn’t add up without some spending cuts or another tax reform, which would prove politically difficult to enact in a climate in which many citizens will still be feeling the pinch of lower economic activity as they go to the polls to vote in both congressional and presidential elections this year.

“The new administration takes office in August,” stated Fitch Ratings. “Its first major challenge will be to present the 2019 budget, testing its commitment to meet the current fiscal rule’s targets.”

(Photo credit: U.S. Air Force / Airman 1st Class Jessica McConnell)

The one-notch downgrade leaves the nation dangerously close to junk status, something that policymakers in Bogotá have been working to avoid for better part of two years since the economy began to wobble in the wake of oil prices plummeting.

Specifically, S&P highlighted Colombia’s “diminished policy flexibility” due to “weakened fiscal and external profiles” and external debt in its analysis following the move.

The New York-based agency also downgraded Colombia’s long-term local currency sovereign credit rating from BBB+ to BBB.

S&P had previously affirmed Colombia’s higher sovereign in January following a tax reform that helped to plug holes in the federal budget. But even then it had maintained a negative outlook, and a year of low economic growth, in addition to other negative trends for certain fiscal fundamentals, has led to the downgrade.

Colombia’s economy grew by just 2.0% in 2016, which was the lowest expansion since 2009. The majority of financial analysts — including those from the International Monetary Fund (IMF), the Ministry of Finance in Bogotá, and the Colombian central bank — expect the 2017 GDP growth rate to to come in even below that figure.

Following the announcement from S&P, Colombian Finance Minister Mauricio Cárdenas stated that he thinks the central bank should leave the nation’s key interest rate on hold next week at its final meeting of the year. “I believe that with this news it would probably be convenient to take a break, analyze the decision, evaluate the moment, and resume cuts from January next year,” said Cárdenas, according to Reuters.

In its analysis, Moody’s listed four factors as its key rationale to upgrade EPM’s ratings:

• Moody’s Baa2 rating for the city of Medellín (with a stable outlook)
• the “high level of dependence” between the company and Medellín
• the strong probability of “extraordinary support” from Medellín if EPM faces financial distress
• “EPM’s intrinsic credit profile,” which is based upon Moody’s baseline credit assessment (BCA) of baa3

Moody’s also noted the significance of EPM’s ability to reduce its debt last year after dealing with both a “severe El Niño phenomena” (that caused drought and lowered hydropower production) and a major disruption to its energy plant in Guatape. The company improved financial metrics in the second half of the year were also aided by Colombia’s $2 billion USD sale of Isagen, which EPM had a stake in and benefitted from, as well as a recovery in generation operations.

Between the debt reduction and a belief that EPM is now better prepared to withstand risks posed by the extreme weather cycles, Moody’s felt comfortable upgrading the rating.

“The raising of the baseline credit assessment to baa3, from ba1, reflects management’s commitment to maintain a prudent financial policy as evidenced by the group’s commitment to maintain the consolidated debt to EBITDA below 3.5x on a sustained basis,” stated Moody’s. “This was the case for the last 12 months ending February 2017.”

The upgrade also reflects optimism surrounding EPM’s Ituango hydroelectric plant, which is reportedly about two-thirds complete and is expected to provide some 2,400 megawatts of capacity after it begins operating (with a projected online date sometime in 2018). Moody’s was encouraged by the utility’s announcement that it plans to remain patient in terms of pursuing growth until after the Ituango plant comes online.

“The raising of EPM’s BCA to baa3 captures Moody’s expectation of the successful commission of Ituango first phase’s four units — of 1,200 megawatts — starting end of next year,” stated the rating agency. “The significant progress in the construction of the Ituango plant (over 65%) and the completion of the more complex milestones underpin this anticipation … The stable outlook captures mainly Moody’s expectation for the successful commissioning of Ituango”

Photo credit: Empresas Publicas de Medellín (EPM)

Banco Agrario (Banagrario), a state-run development bank that aims to finance projects and offer services tied to agriculture, livestock, fishing, forestry, and other rural activities, also had its long-term foreign currency and long-term local currency issuer default ratings affirmed at BBB. Fitch changed the outlook on its ratings from negative to stable.

“Banagrario’s viability rating is highly influenced by the bank’s business model and its low, although
improving, asset quality,” stated Fitch Ratings in its assessment. The agency added that Banagrario’s rating was moderately influenced by its consistent profitability, high income diversification, strong capital position, and low cost funding structure.

“In Fitch’s views, Banagrario’s business model is consistent with its key role for the development of
the government’s agricultural policy,” stated Fitch. “The bank maintains a clear focus and a strong franchise in the small and medium-sized agricultural producer markets. However, its market share in the Colombian banking system is moderate, at 3.2% of total loans and 2.5% of total deposits. In the agency’s opinion these elements strengthen the bank’s franchise in its specific segment but limit the scope of its business model and challenge the asset quality metrics.”

Fitch also noted that, while Banagrario displayed improving asset quality in 2016, it continues to lags the rest of the nation’s banking industry while its net profits also decreased last year and it remains tied to Colombia’s higher-risk agriculture sector.

But on the positive side of the ledger, according to Fitch Ratings, the Bogotá-based institution has achieved high income diversification — through stable income “generated by valuation of held-to-maturity instruments” — and lowered its non-performing loans ratio to 5.89% on the strength of an improved collections process.

“Banagrario’s profitability is consistent and supports a stable internal capital generation and good
capital levels,” stated Fitch Ratings. “The bank’s profitability is underpinned by high income diversification, as an important proportion of stable income is generated by valuation of held-to-maturity instruments. In Fitch’s opinion, Banagrario’s profitability is sustainable in the medium term but remains sensitive to changes in asset quality.”

The outlook improvement followed the New York-based ratings agency making the same upgrade to Colombia’s sovereign rating, which it correlates highly with Ecopetrol’s credit situation. The cities of Bogotá and Medellín also received an outlook change from negative to stable last week in the wake of the nation’s upgrade.

Fitch Ratings first put Colombia’s sovereign rating outlook on negative watch last July. It followed suit with the same action for Ecopetrol, Bogotá, and Medellín.

According to Ecopetrol, its outlook upgrade reflects a sound financial position and the ability to respond to a high volatility oil price environment as well as the the firm’s “solid relationship with the Republic of Colombia and its strategic importance for the supply of crude and refined products for the country.” This is supported by strong cash generation, an adequate capital structure, and a high capacity to meet its debt payment obligations, said Ecopetrol in a statement.

Just days earlier, Ecopetrol reported its 2016 earnings. While noting that it had suffered a difficult operating year marked by low oil prices, CEO Juan Carlos Echeverry announced that the company has planned to devote some $650 million USD to exploration investment in 2017, more than double the amount it spent last year.

“Adding reserves and maintaining the pace of production are the company’s focus,” said Echeverry. “The exploration campaign will be stepped up significantly in regions of high prospectivity. Investment in exploration will rise from $280 million USD to $650 million USD, thus increasing offshore wells from two to six and onshore wells from five to 11 from 2016 to 2017. Enhanced recovery will continue to leverage additional reserves in mature fields. We stress that a strong cash position allows us to assess opportunities for inorganic growth in the Ecopetrol Business Group’s reserves.”

In its analysis, Fitch highlighted the country’s improving macroeconomic imbalances, current account deficit reduction, falling inflation rate, and “diminished uncertainties surrounding Colombia’s fiscal consolidation path due to passage of tax reform measures in December 2016.”

The controversial tax reform was the largest push last year by the administration of President Juan Manuel Santos to improve the country’s fiscal standing. Finance Minister Mauricio Cárdenas noted that retaining Colombia’s investment-grade rating for the long-term was a top priority, making Fitch’s recent outlook upgrade the course change that officials in Bogotá had been seeking.

In Standard & Poor’s most-recent assessment, two months ago in January, the agency similarly affirmed its BBB rating, at two notches above junk. It was not confident enough, however, to change its outlook and has retained a negative view on the country.

Colombia’s Economic Indicators

Fitch Ratings relatively rosier report highlights what it called Colombia’s “faster than expected” adjustment, overseeing a current account balance that fell to 4.4% of GDP in 2016 after ending 2015 at 6.5%. The New York-based ratings agency projects further improvement this year with a drop to 3.6%.

Furthermore, Fitch is leaning on the reputation of the Ministry of Finance and the central bank to withstand potential headwinds and bring inflation back down closer to its target level of between 2%–4% by the end of 2017. The country also has international reserves of some $47 billion USD (nearly nine months of current external payments) and the backstop of a $11.5 billion USD line of credit with the International Monetary Fund.

“Colombia’s track record under its inflation-targeting regime, exchange rate flexibility, and sound banking system have underpinned its capacity to absorb external shocks and maintain broad macroeconomic and financial stability,” said Fitch Ratings.

On the negative side, the agency noted that Colombia’s central government deficit has increased, rising from 3% of GDP in 2015 to 4% in 2016. While stressing that cost-containment measures will likely remain necessary for the medium term, even following the extra revenue that the tax reform will provide, Fitch projected this number to fall to 3.3% in 2017.

More troubling is a gross general government debt that reached nearly 50% in 2016 — nearly 10 percentage points above the median level for Fitch’s BBB-rated economies — due to the sharp and extended depreciation of the Colombian peso. Fitch sees some stabilization ahead but believes the nation’s debt will remain above the BBB median.

It also listed the following elements as downside risks for the Colombian economy: Failure to reduce the fiscal deficit and stabilize the government’s debt burden; a re-emergence of large external imbalances that lead to continued increase in external debt burden; or a persistent period of low economic growth that undermines fiscal performance and support for the government’s macroeconomic policy framework.

But, as suggested by the outlook upgrade, the overall sentiment on Colombia from Fitch Ratings is much more positive at this point than it has been during the previous nine months. “The BBB rating balances Colombia’s flexible and credible policy framework, improved external buffers and a record of macroeconomic and financial stability against high commodity dependence, limited fiscal flexibility and structural constraints in terms of low GDP per capita and weak governance indicators,” said Fitch in its analysis.

Bogotá and Medellín Outlooks Upgraded to Stable

Today, Fitch followed suit on its recent upgrade to Colombia’s sovereign rating with the same actions for the cities of both Bogotá and Medellín. Both have had their BBB ratings affirmed and their outlooks improved from negative to stable.

“Bogotá has a solid operating performance and manageable debt levels, including a significant increase in debt to cover its development plan,” said Fitch it it analysis. “Fitch’s ratings reflect the district’s strong socioeconomic profile and weight in the national economy in terms of GDP contribution as positive factors.”

It sees the main risk for Bogota as being able to meet the capital’s many social and infrastructure needs, particularly those related to transportation.

For Medellín, Fitch credits the city for its significant cash flow, “dynamic collection” of municipal taxes, and the financial support it receives from Empresas Públicas de Medellín. But like Bogotá, it has infrastructure challenges, on top of debt, that present downside potential.

“The main risks or limitations for Medellin are a manageable, but still higher, debt burden, political risk associated with the public sector and quality of the administration, and high infrastructure needs,” said Fitch Ratings.

Full Ratings Breakdown

Colombia
Long-Term Foreign-Currency Issuer Default Rating: BBB
Long-Term Foreign-Currency Issuer Default Rating Outlook: Stable

Long-Term Local-Currency Issuer Default Rating: BBB
Long-Term Local-Currency Issuer Default Rating Outlook: Stable

Country Ceiling: BBB+

Short-Term Local Currency IDR: F2
Short-Term Foreign-Currency IDR: F2

Senior Unsecured Foreign-Currency Bonds: BBB
Senior Unsecured Local-Currency Bonds: BBB

Bogotá
Long-Term Foreign-Currency Issuer Default Rating: BBB
Long-Term Foreign-Currency Issuer Default Rating Outlook: Stable

Long-Term Local-Currency Issuer Default Rating: BBB
Long-Term Local-Currency Issuer Default Rating Outlook: Stable

Bogota $300 million USD equivalent, 9.75% Colombian peso-denominated notes due 2028: BBB

Medellín
Long-Term Foreign-Currency Issuer Default Rating: BBB
Long-Term Foreign-Currency Issuer Default Rating Outlook: Stable

Long-Term Local-Currency Issuer Default Rating: BBB
Long-Term Local-Currency Issuer Default Rating Outlook: Stable

While the public was widely opposed to a measure that will raise the value-added tax (VAT) from 16% to 19% on many items, the overhaul is expected to raise an additional $2 billion USD (6.2 trillion Colombian pesos) for the government in 2017 and lower the risk that credit agencies will downgrade Colombia’s sovereign rating.

Photo: Finance Minister Mauricio Cardenas says the overhaul “is a difficult measure that will require a large sacrifice of all Colombians — but it is necessary.” (Credit: World Economic Forum)

Fitch Ratings and Standard & Poor’s both put the nation on negative outlook this year and Fitch dropped the country’s long-term local currency (LTLC) issuer default rating (IDR) and its long-term senior unsecured local currency bonds to BBB from BBB+ — just two notches above junk status.

Finance Minister Mauricio Cardenas, just after submitting the plan to Congress in October, highlighted the importance of preserving Colombia’s investment-grade rating and how much that factored into the administration’s push to pass the reform this year. “Colombia has a BBB rating,” he told Bloomberg in an English-language interview on U.S. television. “I think this is something we’re going to preserve. And we’re going to introduce all the decisions that are necessary to keep our BBB rating.”

Private Sector Burden

In addition to raising sales tax — known as IVA locally — the so-called “reforma tributaria” will reduce the overall tax burden for companies. Due to the number of Colombians who work in the informal economy on top of widespread evasion, the private sector currently pays an abnormally high percentage of the total taxes collected by officials in Bogotá.

The new provisions, which come into force on January 1, will lower the overall tax rate for companies from 43% now to 33% by 2019. “We don’t need all the revenues at once,” Cardenas told Bloomberg. “This is something that would need to be something that is eased in, introduced in terms of revenues during the next few years to comply with our fiscal rule — and our fiscal rule is quite strict.”

New protocols to detect and punish tax evaders are also included in the reform, something that the government has trumpeted in recent months to counterbalance the widespread opposition to the tax raise. Those found guilty of evading taxes can now face up to nine years in prison.

Spending Political Capital

President Juan Manual Santos’ peace accord with the Revolutionary Armed Forces of Colombia (FARC) guerrilla group passed Congress earlier this month. But the original agreement was rejected by a popular referendum in October — by just over 50,000 votes out of some 13 million cast — and the amended deal still faces ongoing opposition from rival legislators who boycotted the ratification vote in Congress.

Though the president has controlling support within the Congress, doubt had swirled earlier this fall as to whether the administration would still have enough political capital left to also hammer through an unpopular tax code overhaul following the unexpected complications getting peace approved.

After the approval, Cardenas lauded Congress members for making the right call. “These decisions aren’t easy,” he told the press. “They are unpopular on the first reading. But behind that is the greater interest of the nation.”

Popular Disapproval

Nelson Fabian Rubio, a taxi driver in Bogotá, was clear about why he voted against Santos’ peace in the nation’s October 2 referendum: it would affect his wallet. He admits being uncomfortable with the relative impunity for FARC guerrillas who committed heinous crimes when he voted “No.” But his decision was rooted in fear that his meager salary would be cut even more.

Living in a country where inflation hit a 16-year high and economic growth is slowing, he is struggling to get by. The extra costs needed to fund post-conflict social programs — along with a feared tax hike — mean that he sees the accord as wrong for his family and wrong for Colombia.

Whether such fears are real or perceived, they drove some to reject the deal. Nelson, a Bogotá-born 33-year-old with two kids, has never really known the war. Even Pablo Escobar’s terrorist bombing campaigns on the capital in the early 1990s occurred when he was just a kid.

Instead, Nelson, and millions like him, worry more about rent, groceries, car maintenance, and medical bills than the contents of the rejected peace agreement. He doesn’t trust the government to spend revenue wisely and he certainly had no interest in seeing more of his paycheck going to federal coffers.

Too Little, Too Late?

Some have been skeptical that the proposed reforms would go far enough to stave off more negative action from the ratings agencies. Sergio Clavijo, head of the Bogotá-based economic think tank ANIF, told Finance Colombia earlier this fall that this move should have come years ago. He questions whether it will bring in revenue quickly enough to appease the international investment community.

“Too late,” said Clavijo. His organization advised the government to make the VAT changes in 2012. “They didn’t hear us,” he said. “And now they are in shambles.”

Even with more incoming revenue, he was still wondering in October if this would make Fitch, Standard & Poor’s, and Moody’s hold off from further downgrades. “It’s going to be very hard actually to avoid at least the reduction of one of the two notches that holds us above the investment grade,” said Clavijo. “Very likely, I reckon that, in a year time, once markets realize that the expected additional tax revenue is coming too late and too little, one notch will be gone.”

The Big Sacrifice

The government had to make some concessions in order to get the measure approved. One major change from the initial proposal was killing the planned tax on sugary drinks. This measure does not appear in the final reform and that loss will lower the amount of revenue raised by the government, including funds that were earmarked for health initiatives.

Despite changes like this, the administration knows that most Colombians remain upset. The majority of voters were against the peace deal yet still had a very similar, if re-worked, agreement imposed upon them. And now here comes a tax overhaul that even fewer citizens support — at the end of an economically challenging year beset by heavy inflation and high food prices.

Cardenas believes it was essential, however. He says the government needed to act to set itself up for the long term, swallowing a tough pill now in order to ensure the massive economic growth and security improvements of the past decade are not squandered by the oil-price plunge.

“Raising VAT to 19% is a decision that requires a lot of effort,” Cardenas told BluRadio. “I am the first to recognize that it is a difficult measure that will require a large sacrifice of all Colombians — but it is necessary.”