Despite the outlook shift, the New York-based firm has maintained Ecopetrol’s global rating at BB+ and ratified its independent credit profile (Stand-Alone) with investment grade at bbb-, while noting that a review of Ecopetrol’s independent profile is not expected during the next 12 months.

In a statement about the outlook shift, Ecopetrol highlighted that “S&P has stated that Ecopetrol will continue to play an important role in the Colombian economy, and given the government’s participation in the company, its rating will correlate to that of Colombia.”

Photo: Campo Recetor Oilfield in Casanare, Colombia. (Credit Ecopetrol)

The credit rating reflects the stability of the company’s financial results, in line with the favorable oil price environment. Additionally, the rating agency highlights the predictability in revenues and cash flow from the acquisition of Interconexión Eléctrica S.A. (ISA) and its lines of business into the Ecopetrol Group.

The rating agency considers Ecopetrol’s liquidity position as adequate, given that its cash sources would be at least 1.2 times above the company’s own needs for the next 12 months.

In its rating report, S&P notes that Ecopetrol has an extensive portfolio of projects for the next 10 years and specific decarbonization goals to face the challenges of the energy transition, in line with the plans of the new government.

Ecopetrol is the largest company in Colombia and one of the main integrated energy companies in the American continent, with more than 18,000 employees. In Colombia, it is responsible for more than 60% of the hydrocarbon production of most transportation, logistics, and hydrocarbon refining systems, and it holds leading positions in the petrochemicals and gas distribution segments.

With the acquisition of 51.4% of ISA’s shares, the company participates in energy transmission, the management of real-time systems (XM), and the Barranquilla – Cartagena coastal highway concession. At the international level, Ecopetrol has a stake in strategic basins in the American continent, with drilling and exploration operations in the United States (Permian basin and the Gulf of Mexico), Brazil, and Mexico, and, through ISA and its subsidiaries, Ecopetrol also holds leading positions in the power transmission business in Brazil, Chile, Peru, and Bolivia, road concessions in Chile, and the telecommunications sector.

See also:

Clearly this came too late to save the Investment Grade at S&P or Fitch due to the previous structure of the bill – a disaster for the country in both economic and social terms as Colombia ripped itself apart on the streets. But that is now in the past and Colombia needs to look forward. As Finance Minister Restrepo points out, the priority right now is for the country to regain its financial credibility which previous to the pandemic was one of the most admired across Latin America. The “line in the sand” fiscal rule has now gone but due to the measures taken there is the hope that the deficit will drop from the anticipated 8.6% in 2021 to 2.7% in 2026.

The hope now is that the country can put the tax reform, and the protests that accompanied them, behind it – it is a long shot that the ratings agencies will do anything in the near future, trust needs to be built and ahead of what will be a bitterly fought election – that will be tough.

The country’s recovery will depend on all manner of factors going forward. Life is firmly into the ‘new normal’ mode as we continue to adapt to COVID. There are still issues with vaccine supply and also the usual hard core who fear that the WHO is injecting 5G chips into their bodies but one of the biggest issues that remains is not ‘injection reluctance’ but ‘office reluctance’. Bogota remains a relative ghost town when the mom & pop businesses that sit on every street corner need the offices full in order for them to survive.

We saw consumer confidence disappoint last week; the hope is that Duque’s signature yesterday will help that situation. The propensity number to purchase housing, consumer durables and vehicles is still struggling however at least in that last category we are seeing some recovery. Through August a total of 53,852 vehicles were sold, an increase of 54% YoY and only down 5% versus 2019.

Rupert’s opinions & analysis as an independent expert contributor are his own and not necessarily those of Finance Colombia or the BVC.

These are still small acorns, but there is big pickup in electric and hybrid vehicles. Over 5,000  vehicles were sold during the first half of this year The government also appears set to remove the quota on how many such cars are subject  to the 5% import tariff as opposed to the standard 35%. Thus far there is a preference for hybrid due to the ongoing lack of electric infrastructure however this is slowly improving.

Another area which is still spluttering into life is internal tourism. According to the DANE in Q2 8.1% of the populous undertook a trip, in 2019 (2020 really isn’t a comparison) that number stood at 17.9%. To many this will be a surprise given that the airlines internally have seen one of the fastest recoveries in domestic travel.

The big dog as ever when it comes to the Peso, which continues to struggle despite inflows into the bond markets from overseas in August, is oil. Production is struggling to recover – in July it stood at 731,255 boepd , up 5.3% MoM however still down 0.5% from 12 months ago. This is something of a lost opportunity with Brent prices cresting $70 again with the oil bulls again speculating about $100 oil. This week we even saw the return of an oil scourge, the dynamiting of overland pipelines by terrorists. Ecopetrol doesn’t anticipate any severe disruption, but a very unwelcome development.

Still much to do…

That is about it for today – remember these are just themes that jump out at me – please refer to your local analyst, economist, salesperson or soothsayer for more details.

 My regards to all,

 Roops

The investment, said to be $70 million USD of convertible credit, brings the airline into proximity with both bankrupt Colombian carrier Avianca and Mexican carrier Volaris. Volaris was founded by Roberto Kriete, who previously sold El Salvador-based Grupo Taca to Avianca, but later fell out with then Avianca Chairman Germán Efromovich. After United Airlines took Efromovich’s shares as collateral for a half-billion dollar loan, the US carrier appointed Kriete, and his Caoba allies José Guardian and Rodrigo Salcedo to Avianca’s board of directors.

Caoba is Spanish for Mahogany

Guardian and Salcedo, through Caoba Capital, also have a stake in Kriete’s Volaris. Caoba founder José Guardian previously worked for Roberto Kriete as vice president of finance, treasury, and strategic development for Taca Airlines. Salcedo also served on the board of directors of Volaris.

The deal has caused speculation to take flight on whether there will be any potential tie-ups between Sky Airlines, Avianca, and / or Volaris. Volaris and Sky are both low-cost carriers, but Avianca has a legacy model that would conceivably be harder to integrate. Not only this, Avianca is heavily dependent upon its membership in the Star Alliance, and partnership with United Airlines of the US and Copa Airlines of Panamá.

Caoba Capital, as an investor in Avianca, is well positioned to assemble an alliance involving one or more of the three airlines. In fact, a source told El Mercurio that Caoba will “obviously” seek synergies with Avianca to create a stronger South American network.

All three airlines with ties to Caoba may see their networks under siege, as Colombian low-cost carrier Viva has already begun offering routes into Mexico and filed for permission to begin routes to Chile. Mexico’s unrelated Viva Aerobus has begun Colombia routes, and Avianca’s own Star Alliance Partner Copa’s Wingo subsidiary is cannibalizing Avianca’s home turf alongside Viva.

Volaris seems to be doing well. S&P just this afternoon returned Volaris to its IPC Mexican index, but Sky and Avianca are in much weaker positions facing competition from highly-liquid Copa Airlines and its Wingo subsidiary, and fast-growing Viva, backed by the deep pockets of Cartesian Capital and Irelandia Aviation. Avianca will need to repay the debt-package it is assembling in the hopes of emerging from Chapter 11 bankruptcy in the US court system, and also re-engineer itself to compete in a hotly contested Andean and Central American market that it completely dominated just five years ago.

The ratings agency highlighted the Ecopetrol’s strategic relevance for Colombia and the benefits of being an integrated business which has allowed the petroleum driller and refiner to capture opportunities along the value chain, despite the impacts of the COVID-19 pandemic. Furthermore, the rating agency referenced Ecopetrol’s solid financial position in the oil and gas industry with proven access to capital markets. 

S&P also highlighted the company’s efforts to establish decarbonization goals and considers that ISA acquisition represents a substantial progress regarding the group’s energy transition allowing diversification towards a regulated and predictable business such as transmission.

Ecopetrol is the largest company in Colombia and one of the main integrated oil and gas conglomerates in Latin America with more than 13,000 employees. It accounts for more than 60% of the hydrocarbon production in Colombia, and it owns the largest refineries and most of the country’s oil-pipelines and multi-purpose pipelines network. It also participates in the commercialization of energy and in the distribution of gas.

At the international level, Ecopetrol focuses on strategic basins on the American continents, with E&P operations in the United States (the Permian basin and the Gulf of Mexico), Brazil and Mexico. 

Above photo: Ecopetrol Huila colloidal dispersion gels injection plant (CDG) in its Dina Cretaceous field

The decision by Fitch last week to join S&P in putting Colombia on the ‘Junk’ list was perhaps only a surprise in terms of the agency’s own mixed messaging over the previous weeks with comments (I paraphrase) such as ‘No necessary hurry…perhaps we will wait until tax reform etc.” This led some/many locals to believe that the agency was going to give Colombia just a little more rope before pulling the chain but as it transpired they acted much quicker than anticipated – we will get to the reasons, in my view anyway, in a moment.

The markets appear to have taken the move in its stride – TES bond yields hardly flinched and whilst the Peso ascended somewhat, in the greater scheme of things it isn’t going to make a difference – by late Friday as well on the forex market once again. I would hesitate to say that in a normal environment this move was priced in as there was hope for a delay however the key here, especially with the MSCI COLCAP is that prices have under-performed so spectacularly in 2021 that there is little downside at this point. Any further decline in stock prices and investors will almost be forced to step in.

Additionally, with respect to Fitch, this is not Moody’s dropping Colombia by two notches from Baa2 to Ba1 – that would unquestionably would shake the market – we can likely expect a drop to Baa3 in the short term, however for the time being that should be the size of it.

So what tipped Fitch’s decision? Officially there were few surprises in the comments:

“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,”

Rupert’s opinions & analysis as an independent expert contributor are his own and not necessarily those of Finance Colombia or the BVC.

There were some additional references to this needing a couple of years to correct the situation however (and here beginneth the lesson), between the lines it seems a simpler situation.

All three agencies said publicly many months ago that they were looking for the tax reform to right the fiscal ship which has been listing badly ever since COVID struck – to put it bluntly, the authorities have failed to deliver – and it is on them.

1. Whilst ‘Tax Reform I’ was well motivated in terms of trying to help the needy as well as balance the books – there was a clear misread of the local situation. This was no Robin Hood reform – the middle class felt targeted at the expense of the rich, a no-go area less than a year ahead of congressional elections.
2. Having changed Finance Minister from Alberto Carrasquilla to José Restrepo I feel a bigger error was committed. Against the background of the vitriolic street protests it was thought wise to try and seek a ‘Tax Reform II’ by consensus – this at a time when the ratings agencies had made it clear that they wanted to see what the government was going to do about the collapse of the first version. Unfortunately, history has taught us that doing anything via consensus, let alone governing, is at the best a lengthy process and at worst a search for the impossible. The more people you ask, the more ideas you get but of course the objections you encounter will also increase.

More fold is the message it sends. At a time when international bodies such as the EU, UN and Human Rights Watch have Colombia under the microscope, overseas stakeholders are looking for leadership – rapid, agile decision making. Instead they see a congress taking a month’s holiday and a drawn out process to put the numbers on the table. Instead, the day after Tax Reform I was withdrawn, Tax Reform II could have been drafted. It required some radical  surgery but those are usually the easiest to do; no pincers required. Remove the unpopular stuff, take a deep breath and create some one-off taxes to plaster over the cracks, perhaps repatriate US$5bn in reserves, add in some sugary drinks VAT as well as other similar areas – it is arguably that simple. Keep the wolf from the door for 24 months while the world corrects itself and then take another look.

That may sound brutally simplistic, but we have already seen what the alternative looks like – and it’s not pretty.

Finance Minister José Restrepo was correct to point out that the Colombian economy is resilient and that the appetite for local peso bonds from overseas (~ US$2.9bn over the last three months) means that confidence remains solid, that said many analysts and strategists expect Colombian assets to see a negative reaction despite the fact that much of Fitch’s decision to downgrade Colombian debt to junk was widely priced in, some outflows seem inevitable.

There has recently been a rash of local bond offerings which have seen modest oversubscription despite the earlier S&P downgrade – there was a brief hiatus of perhaps 10 days after that decision but in reality rates remain low which put into historical context, opportunity still knocks. The actions of the TES market suggests that yields won’t be gapping upwards as such – one company that will be watching carefully is Ecopetrol who only last week announced they would be looking at at US$1bn+ shelf offering.

These are complicated times of course but whilst Investment Grade is a holy grail that any country should be doing their utmost to preserve – it is also not a death sentence to lose it. Other markets have thrived despite trading at Junk status for years – Brazil & South Africa spring to mind – which still enjoy flourishing capital markets.

Here is to an end to the procrastination, a speedy congressional vote and open minded ratings agencies.

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That is about it for today – remember these are just themes that jump out at me – please refer to your local analyst, economist, salesperson or soothsayer for more details.

My regards to all,

Roops

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

So instead let’s look elsewhere.

Colombia’s COVID numbers are still far too high, a new record last Thursday. Fortunately we haven’t had to go the Peruvian route of tripling the official death-count, however at the same time the country is edging up the global table and on a daily basis is within the top ten of new fatalities. Nonetheless, the country is planning to re-open over the next week or so. City mayors are already drawing up their ‘Reactivation plans’ for the economy. This will include colleges and bars, and there will also be less testing for both domestic and international flights.

There is of course some trepidation: the vaccination program is moving ahead slowly but in a structured fashion. Fortunately, Colombia has a very young population when compared with the developed world and therefore the elderly and vulnerable have been inoculated relatively quickly. Before long, the <50’s will be called and hopefully that will mean that death rates will come down quickly.

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One area that has been impacted by COVID and the more recent disturbances is the oil sector, with production being hit just at the moment when global prices are returning to respectable levels.

Whilst the Ministry of Mines reported that at the end of 2020, Colombia still had 6.3 years of reserve life, unchanged from 2019; the fact is that this is the consequence of 2020 production being the lowest since 2010 and also that the reserve figure for 2020 is actually lower than that registered in 2018.

The latest export data for April provides little conclusive evidence given the easy comparison with 2020. There was a rise of 108% FOB to $800 million USD – however there was a decline of 27% in terms of tonnage which fell to 2 million tons. According to Tanker Trackers there has been a pickup in May due to Chinese demand and refineries coming back online, but the market will await the formal data from DANE (Colombian statistics agency) in a few weeks.

Rupert’s opinions & analysis as an independent expert contributor are his own and not necessarily those of Finance Colombia or the BVC.

At a micro level we find logistical problems for all producers, from Ecopetrol down to smaller operators such as Geopark and Frontera, being caused by the recent demonstrations and road blockages. None of this helps the overall situation. On top of the logistical issues, Ecopetrol has also suffered a downgrade from S&P who removed their investment grade rating, however analysts don’t feel it will impact capex in the short-medium term.

Whilst oil is threatening to become the new coal in terms of popularity, it is important for Colombia in the short term to maintain production at optimal levels in order to capitalize on the anticipated forthcoming global economic rebound.

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Another area affected by the recent protest is that of urban employment – the anticipation was that in April there would be a continuation of the downward trend, however that wasn’t to be the case.

Consensus was for a 16.4% reading, down from 16.8% in March – however the final number was 17.4%. That is much lower than the 23.47% in April 2020, however if we dial back further to April 2019 we find 11.14%.

Some of the impact is unquestionably due to the recent upheaval however there has been a more general sluggishness ever since the COVID crisis started to abate. The caveat as ever is that close to 50% of Colombian employment is ‘informal’ and therefore water-tight analysis is very complicated.

The same has been true of Total Unemployment which gauges the whole country. In April 2019 the number was 10.33%, in 2021 it was 15.05%. These numbers also reveal another separate weakness in the system: women continue to suffer disproportionately. A year ago we can see that the overall number was at 14.6% (Male 11.9%, Female 18.4%) – today we find that for men the number remains at 11.9% whilst those for women have risen to 19.9%.

There have been various announcements from both the national and regional administrations with regards to employment programs however the proof will be in the pudding, especially when it comes to women.

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Market flows for the month of May were impacted by the formal re-balance from the COLCAP to the MSCI COLCAP. Volume on that day totaled US$250 million, the highest for some considerable time.

Foreigners were the most active during the month with 43.6% of total volume – after that it was AFPs (17.5%) & Brokerage Firms (17%). In terms of direction, foreigners were the only sizable net sellers (US$75mn) – AFPs took up the slack with US$77mn in net purchases. The other sectors were relatively neutral in terms of buys/sells.

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Finally returning to the current crisis, President Duque insists that Tax Reform II will be one of consensus and Finance Minister Restrepo repeated that it is the highest priority…but observers are already asking why is it taking so long ?

There is frustration at the apparent lack of progress, given the amount of items that have been ruled out of the reform, this should have been a fairly quick process. If the option of repatriating some of the international reserves is to be ignored then there is only a short list of resources that can be used.

There is little hope of the bill even being presented before Congress heads to the beach in a few weeks and Finance Minister Restrepo has already alluded to that. However this needs to be on the table as soon as they return in July. S&P has acted, Moody’s has indicated displeasure, and Fitch is just one notch from moving Colombia to junk – it’s time to finish with the consultancy and submit the bill.

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That is about it for today – remember these are just themes that jump out at me – please refer to your local analyst, economist, salesperson or soothsayer for more details.

My regards to all,

Roops

• Ecopetrol S.A. (NYSE: EC) — Colombia’s largest petroleum company, majority owned by the government
• Grupo de Inversiones Suramericana S.A. (Grupo Sura) — Colombia’s largest Insurance conglomerate
• ISAGEN, S.A. E.S.P. — A Colombian Energy and infrastructure provider controlled by Canada’s Brookfield Asset Management
• Oleoducto Central, S.A. (OCENSA).— Oil pipeline operator affiliated with Ecopetrol

Although the following two entities have ratings above that on Colombia’s sovereign rating, S&P downgraded them to ‘BBB-‘ from ‘BBB’ while assigning a stable outlook:

• Enel Americas S.A. — Electrical utility subsidiary of European utility conglomerate Enel.S.p.A.
• Emgesa S.A. E.S.P.— Wholesale electricity provider, also a subsidiary of Enel.

The ratings on both entities are higher than on Colombia’s sovereign rating, primarily because of the potential support they would receive in case of financial distress from their parent companies — Enel SpA (BBB+/Stable/A-2) in the case of Enel Americas, and Enel Americas for Emgesa.

S&P also lowered the issue-level ratings on OCENSA parent A.I. Candelaria Spain to ‘B+’ from ‘BB-‘. The ratings firm says that this is because they still see a notch differential due to its total reliance on subordinated dividend payments from its sole investment, OCENSA, which distributes them after funding its operating and financial needs.

S&P also affirmed the ‘AA’ rating on toll highway developer Sociedad Concesionaria Vial Montes de María S.A.S. (Puerta de Hierro). The outlook remains stable.

The latter rating action follows the failure of the government’s fiscal reform proposal amid high spending pressures, resulting in a sharply lower likelihood of Colombia improving its fiscal position following a recent and marked deterioration. Given high external vulnerability, comparably weak economic profile–balanced by adequate institutions and monetary credibility–Colombia’s debt will stabilize at around 60% of GDP during 2021-2024 and will post relatively wide fiscal deficits. These factors are no longer consistent with an investment-grade foreign currency rating (readers may refer to S&P’s “Colombia Long-Term Foreign Currency Rating Lowered To ‘BB+’ On Persistent Fiscal Weakness; Outlook Stable“, published on May 19, 2021, for further details).

This is because according to Standard & Poor, these firms continue to be exposed to Colombia’s sovereign risk given that they operate in what S&P deems highly regulated sectors (dependent on rate adjustments approved by government regulators) and that demand for their services is in some cases correlated to the country’s GDP growth pace. Consequently, S&P believes the entities could suffer from heavier regulation in a sovereign stress scenario, and wouldn’t be able to generate or maintain sufficient cash to honor their financial obligations under a sovereign default scenario.

Ecopetrol

This is the case for Ecopetrol, of which Colombia’s government is a controlling shareholder. Therefore, ratings on the company and its subsidiaries move in tandem with those on the sovereign. In S&P’s view, the final rating on Ecopetrol is capped at the level of the ‘BB+’ foreign currency rating on Colombia, given the ratings firm’s expectation that the government could have a tendency to increase taxes or dividends if it faces fiscal or external stress, which could restrict Ecopetrol’s financial flexibility. Additionally, S&P’s assessment that the company has a very strong link with the government also limits the rating. As a result of the downgrade of Ecopetrol, S&P took a similar rating action on its subsidiary, OCENSA, because the ratings agency doesn’t believe there are meaningful regulatory mechanisms or other structural barriers that restrict the parent from accessing the subsidiaries’ cash flows in a scenario of distress. In addition, Ecopetrol is OCENSA’s main client, representing more than 80% of its revenue in 2020.

A.I. Candelaria Spain

S&P also lowered the issue-level rating on Candelaria’s notes, given 100% of its equity interests in OCENSA and its total reliance on subordinated dividend payments from the latter entity, which distributes them after funding its operating and financial needs. In addition, given that OCENSA is not publicly traded, it might be difficult for Candelaria to liquidate its investment if needed, and for S&P to forecast asset valuations relative to debt with certainty. The rating on Candelaria’s notes also captures the existing governance principles contained in the shareholders’ agreement whereby Candelaria holds veto powers over OCENSA’s material decisions such as business plans, large investments, and changes to the dividends policy.

Isagen

Isagen sells about 35% of its energy to distributors, which have their rates set by the regulator. Therefore, S&P says that it believes payments to Isagen–in case of a regulatory interference in distributors’ rates–could deteriorate. In addition, Isagen sells a portion of its output on the spot market, which could also be at its regulatory floor amid recession. Therefore, the sovereign rating caps the rating on Isagen, in S&P’s view.

Grupo Sura

S&P believes that Grupo Sura wouldn’t pass a Colombian sovereign default stress test scenario. The sovereign rating cap and risk to Grupo Sura in a sovereign default scenario reflect the high correlation between the company’s assets and dividends, and the country’s economy, because around 40% of assets operate mostly inside Colombia. The company is exposed to Colombia’s financial system because Grupo Sura has a stake in Bancolombia, which represents approximately 25% of the dividend stream. S&P says this limits the rating on Grupo Sura to the sovereign level because it is highly likely that a sovereign default would entail a significant shock to the country’s financial system.

Enel Americas

S&P predicts around 35% of Enel Americas’ EBITDA to come from Colombia in 2021, followed by Brazil (about 45%), Peru (15%), and Argentina (5%). Although Enel Americas’ debt repayment capacity remains stronger than those of the sovereigns where it operates, mainly because of the potential support it would receive from its parent company Enel in case of financial distress, the company’s downgrade reflects its sensitivity to deteriorating country risks.

The rating action on Emgesa follows the one on Enel Americas, given that the former plays an important role in the latter’s strategy in Latin America. Therefore, S&P expects the latter to support Emgesa under any foreseeable circumstance, including a hypothetical sovereign default of Colombia.

Puerta de Hierro –  Sociedad Concesionaria Vial Montes de María S.A.S.

S&P affirmed the rating on Puerta de Hierro as it reflects the guarantor’s creditworthiness. This is because Puerta de Hierro’s notes benefit from an irrevocable financial guarantee for interest and make-whole premium payment, in respect to the maximum guaranteed principal amount and for up to $350 million on principal from the US Government’s Development Finance Corp. (DFC). However, S&P revised downwards the project’s operations phase stand-alone credit profile to ‘bb+’ from ‘bbb-‘ because they consider the creditworthiness of the project’s main offtaker (Agencia Nacional de Infrastructura) to be one notch below its ‘BBB-‘ local currency rating on Colombia for the following reasons:

• There are no cross-default clauses linking these obligations with sovereign debt;
• S&P views the reporting of ‘Vigencias Futuras’ and other contingent liabilities as transparent because the government explicitly recognizes payment obligations and contingent liabilities that arise from this transaction. However, the government doesn’t report these 4G Highway-related obligations as sovereign debt.

Outlook

The stable outlook on these entities mirrors that on Colombia. The ratings on the latter pose a limitation on credit quality of corporate and infrastructure entities, given their exposure to sovereign risk. Therefore, S&P expects the ratings on these entities to move in tandem with the sovereign ratings in the next 12 to 18 months.

The stable outlook on Enel Americas mirrors that on Brazil and Colombia, its two main markets. Ratings on Emgesa are the same as on the parent and would move in tandem with the latter.

The stable outlook on Puerta de Hierro’s notes reflects S&P’s expectation of full coverage for the debt repayment given DFC’s financial guarantee. Therefore, the outlook on project’s notes reflects that on the US rather than Colombia. Moreover, the stable outlook reflects the guarantee coverage of over 60% stemming from the appreciation of the Colombian peso.

Downside scenario

In the next 12-18 months, S&P says it may downgrade these companies in case of a similar rating action on Colombia. The firm could lower the sovereign ratings if the potential long-term damage caused by the pandemic, other domestic developments, or new external shocks, prevent the Colombian economy from recovering in 2021 and results in lower-than-expected GDP growth in subsequent years. A perceived deterioration in Colombia’s institutional effectiveness, such as the inability to find political and social consensus to sustain growth and the country’s fiscal profile, could also translate into a downgrade.

S&P might also downgrade Enel Americas in case of a negative rating action on Brazil or if it believes that the company has become a less integral subsidiary for Enel. In such a case, they say they would also downgrade Emgesa.

S&P could lower the rating on Puerta del on Hierro in the next 12-24 months if DFC’s credit quality weakens, which could happen if S&P lowers the rating on the US or the relationship between the US government and DFC weakens.

Upside scenario

In the next 12-18 months, S&P indicates it could upgrade these companies if it takes a similar action on the sovereign rating on Colombia, while everything else remains equal. This can occur if there is faster-than-expected economic growth, coupled with structural fiscal measures, which reduce Colombia’s fiscal financing gap, lower the debt burden, and strengthen public finances. A larger and more diverse export sector, helping to reduce external vulnerability and strengthen economic resilience, could also result in the upgrade over the middle to long term.

In the next 18 months, S&P also says it could raise the rating on Puerta de Hierro’s notes if it either raises the rating on the US or if S&P believes the relationship between the US government and DFC strengthens.

See also: Colombians Take To The Streets To Protest, Lambast President Duque’s Fiscal Reform Package

The downgrade of the sovereign follows the withdrawal of a fiscal reform introduced to Colombia’s congress in a context of high spending pressures, which has resulted in a significantly lower likelihood of Colombia improving its fiscal position following a recent and marked deterioration. Given the country’s high external vulnerability and moderate economic profile (balanced by adequate institutions and monetary credibility), Colombia’s debt, stabilizing at about 60% of GDP during 2021-2024, and relatively large fiscal deficits are no longer consistent with an investment-grade (‘BBB-‘ or higher) foreign currency rating.

The downgrade of the two government-owned development banks reflects their very important economic roles and links to the government. Similarly, the ratings on the sovereign cap those on Banco Davivienda, given the commercial bank’s large exposure to country risk and the highly sensitive nature of its businesses to sovereign stress. Finally, S&P says the rating actions do not reflect a deterioration in the entities’ stand-alone credit profiles (SACPs).

See Also: S&P Lowers Colombian Currency Rating to Junk: BB+