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.

________________________________________

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

• 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+

The move further weakens Colombia’s precarious financial position brought on by the COVID-19 pandemic, causing an almost 7% contraction in the country’s economy. Colombia counts heavily on both exports of petroleum and imports of international tourists; both sectors hurt badly by worldwide COVID restrictions on travel and discretionary consumption.

S&P: “We believe Colombia’s fiscal adjustment will prove to be more protracted and gradual than previously expected, diminishing the likelihood of reversing the recent deterioration in public finances.”

According to JP Morgan’s Katherine Marney, Fitch may likely downgrade Colombia as well, as the country already sits at the firm’s lowest investment grade before junk. There is also a danger of government owned entities with their own credit ratings being downgraded as well.

The downgrade can trigger investment selloff and hinder the ability of Colombia and Colombian firms to borrow money as many investment vehicles may only invest in quality (investment grade) debt.

“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.” – Sacked Colombian Finance Minister Alberto Carrasquilla

The downgrade comes after Colombian President Ivan Duque failed to have his fiscal reform package passed—or even considered in the Colombian congress after massive protests erupted in the country. Then Finance Minister Alberto Carrasquilla had taken to the airwaves to sell the package to the country, but stumbled badly when he had no idea how much a dozen eggs cost—he guessed less than $0.50 US—and couldn’t articulately describe why the administration in the tax reform he authored imposed taxes on basic staples like eggs & rice, while leaving sugared soft drinks exempt (hint: the owners of Colombia’s 2 largest domestic soft drink brands are Duque administration supporters).

In response to the initial, mostly peaceful and organized strike, Duque sent out national riot police who violently attempted to disrupt the protests. This had the reverse effect, and deeply angered even many who were not participating in the initial strikes or protests, and large swaths of the country quickly descended into violence and chaos. The international airport to Cali had to temporarily close, and the country still faces supply disruptions and road blockages.

With presidential elections next year and Duque’s political capital completely exhausted, it is difficult to see how a plan that can adequately shore up Colombia’s dangerous deficit can be passed in the remaining months of Duque’s presidency.

On Wednesday, Standard & Poor issued a statement saying (in part) the following:

Rating Action

S&P Global Ratings lowered its long-term foreign currency sovereign credit rating on Colombia to ‘BB+’ from ‘BBB-‘ and its long-term local currency rating to ‘BBB-‘ from ‘BBB’. The outlook on our long-term ratings is stable. We also lowered our short-term foreign currency rating to ‘B’ from ‘A-3’ and our short-term local currency rating to ‘A-3’ from ‘A-2’.

S&P: “We believe that fiscal adjustment will prove to be more protracted and gradual than previously expected, diminishing the likelihood of reversing the recent deterioration in public finances. We therefore lowered our long-term foreign currency rating on Colombia to ‘BB+’ from ‘BBB-‘.”

We revised down Colombia’s transfer and convertibility assessment to ‘BBB’.

Outlook

The stable outlook reflects our expectation of economic recovery in 2021 following the significant contraction last year. The combination of renewed GDP growth and certain fiscal measures is likely to gradually curtail Colombia’s fiscal deficits, resulting in net general government debt stabilizing above 60% of GDP. The stable outlook also incorporates our expectation for an institutional solution to recent and significant social unrest, which would result in prospects for political and institutional stability for the medium to long term.

Downside scenario

We could lower our ratings on Colombia in the next 12 to 18 months 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 result in lower-than-expected GDP growth in subsequent years. Such a scenario would most likely result in consistently higher fiscal deficits than currently projected and a steady increase in the government’s debt burden, leading to a downgrade. A perceived deterioration in Colombia’s institutional effectiveness, evidenced by an inability to form political and social consensus to sustain growth and its fiscal profile, could also lead to a downgrade.

Upside scenario

We could raise our ratings on Colombia within the next 12 to 18 months if economic growth is faster than expected, coupled with structural fiscal measures that 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 lead to an upgrade over the medium to long term.

Rationale

The downgrades follow the withdrawal of a fiscal reform introduced to 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), in our view Colombia’s debt levels, 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.

S&P: “The outlook is stable, reflecting our view that economic recovery, coupled with certain fiscal measures, will stabilize the government’s recently worsening debt burden over the coming two to three years.”

An ambitious fiscal reform proposal presented to Congress on April 15, 2021, aimed to finance transitory and structural higher spending–mainly transfers to the most vulnerable segments of the population–while helping to consolidate fiscal deficits. The fiscal reform was expected to be diluted during the Congress debate but to yield some additional and permanent current revenue. Instead, it was met by marked political opposition and protests from some segments of the population. While the larger protests since April 28 have been mostly peaceful, some violence has also occurred. These developments forced the government to withdraw the fiscal reform proposal by May 2, 2021.

The government, under new leadership at the Ministry of Finance, is looking to conciliate with various groups participating in the protests, as well as other social groups, and garner political support across party lines to make an alternate fiscal policy proposal. Prospects for substantial structural reforms are low in the near term, given ongoing protests and the approach of national elections next year. COVID-19 exacerbated the weakness in Colombia’s fiscal profile, though the worsening trend was present for most of the past decade. Moreover, as in many other emerging markets, the pandemic showed the substantial weakness of the country’s safety nets, which will most likely drive spending growth over the long term.

The COVID-19 pandemic and its related economic contraction significantly widened Colombia’s fiscal deficit. Discounting the transitory fiscal impact of the economic contraction and absent structural fiscal improvements, we expect the change in net general government to be 3%-4% of GDP in 2021-2024. Conversely, renewed economic growth should contribute to stabilizing net general government debt at about 60% of GDP during 2021-2024, compared with 43% in 2019. The general government interest burden is expected at just below 15% of general government revenue for 2021-2024.

Colombia’s rating fundamentals remain weaker than those of similarly rated peers. That said, in our opinion, Colombia’s flexible credit line with the IMF, our expectation of adequate access to the international debt markets, and a credible and efficient monetary policy continue to mitigate external risks and support Colombia’s creditworthiness.

Image by David Mark from Pixabay

The term ‘junk’ always appears melodramatic; after all it’s only a few letters (BB+) and Finance Minister Restrepo was quick to state that Colombia would still be able to obtain the external financing it needs. However, the psychological impact is quite clear. S&P, after the tax bill was proposed a few weeks ago, reiterated their BBB- rating but now they have changed their tune…

“The downgrades follow the withdrawal of a fiscal reform introduced to 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.”

The big question is what Fitch (BBB-) & Moody’s (Baa2) chose to now do. Will they wait to see what is contained within ‘Tax Reform II’ when it is resubmitted? The issue is that there is little clarity on when that will be. Congress will shut down for the holidays in just over a month and there has been no progress report on the behind-the-scenes negotiations taking place.

On the bright side, S&P improved their outlook from Negative to Stable as the economy continues to reopen. The government is aiming for near normality in 2H21 and yesterday announced that the frontiers with our neighbors will be opening soon, although some are questioning that in the case of Brazil which is still bedeviled with problems.

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

One doubts that the already emboldened protesters will directly add this to the list of achievements. The government has already offered subsidies on university education and a youth employment program – however indirectly they are making inroads, and they show few signs of stopping. Yesterday the next battleground—the health reform—was voted down in Congress, so that is one less thing to worry about.

That is why it is uber-urgent to get ‘Tax Reform II’ into the public forum. The government needs to show they mean business and are seeking equality. This  may calm the situation if well explained, and also prevent the other ratings agencies from taking adverse action. It doesn’t have to be a picture-perfect reform, just one that gets the job done in as least a painful form as possible.

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Ironically yesterday there was a very successful bond auction as Isagen issued a total of $600 billion COP ($160 million USD) in bonds (5-20 years). Overall demand was at $220 million USD and it showed that there is still plenty of demand for Colombian paper.

Unfortunately, that was scheduled to be followed by another bond issuance today by Bancoldex however events have overtaken them and the offer has been postponed:

“The change in the rating of the nation is an event occurring after the publication of the notice of offer, which is beyond the control of Bancóldex and that materially affects the financial conditions under which the placement of the ordinary bonds offered would be carried out”

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This one brief statement by Bancoldex is a precursor of what the markets may be facing over the next 24 hours. The peso may well struggle and the COLCAP is likely to be nervous. Much will depend on Fitch. Moody’s has Colombia 2 notches into Investment Grade however if Fitch decides to take action there will be a lot of concern.

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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

Quintero also thanked EPM’s Vice President of Strategy & Planning Mónica Ruiz Arbeláez for serving as interim CEO since February 1^st while a formal talent search was conducted to replace former CEO Álvaro Rendón, who was fired earlier this year by Quintero, leading to a bitter public dispute.

Calderón has a background in finance and investment, working as a credit analyst for Standard & Poor in Paris, serving as the Colombian consul in Boston, Massachusetts during the Juan Manuel Santos administration, and holding several investment banking roles in Bogotá at C&C Gold, Silk Investment Bank, and Grupo Pegasus. Calderón also served a stint working on mergers and acquisitions for Colombian petroleum company Ecopetrol. Calderón also served on the board of directors of Perú Minerals S.A.C.

Analysis

On one hand, investors may hope that a head with a background in banking and finance can bring much needed stability to EPM, a multinational utility owned by the city of Medellín that has been plunged into controversy in the past year due to perceived breakdowns in governance. The current board of directors, all appointed by Mayor Quintero, is relatively light on relevant corporate experience.

Quintero during his mayoral campaign insulted then CEO Jorge Londoño, implying he was corrupt, but the mayor’s chosen replacement lasted barely a year, falling out with the politico accusing him of violating the utility’s managerial independence.

One observation that stands out in Calderon’s background is, based on the biography provided by EPM, he has no utility or operational experience, having worked his entire career in deal making—investment banking and M&A. This in no way indicates that Calderón isn’t up for the job, but EPM’s challenges are its troubled Hidroituango hydroelectric project, the monumental operational task of rehabilitating recently acquired Electricaribe, and managing EPM’s vast utility holdings spanning from Chile in the south to México in the north.

The millions of customers that rely on EPM and its subsidiaries for reliable services along with the institutional bondholders who depend on EPM for timely payments will be counting on Calderón’s ability to pivot from a career doing deals to quite literally keeping the lights on, the water clean & flowing, and shielding EPM from populist political machinations from the other side of Medellín’s 55^th street that separates EPM’s headquarters from city hall.

The $500 million issuance was oversubscribed by $3 billion USD, or 3.5 times the target raise. The 10 year bonds are rated BBB by Fitch Ratings and BB+ by Standard & Poors.

Elena Maestre, Director of Finance and Management Control of Telefónica Colombia, indicated that the resources obtained from this placement will allow the company to advance in its process of substitution of financial liabilities and improve its maturity profile.

S&P Global Ratings has downgraded Avianca from “CCC-” to “D”

The NYSE also told Avianca that it will apply to the SEC to delist the ADSs once any applicable procedures are completed, including any appeal by Avianca of the NYSE decision.

The Colombian Stock Exchange, the Bolsa de Valores de Colombia (BVC) has also notified Avianca that the Company’s preferred shares continue to trade on the BVC but the airline’s preferred shares continue to be ineligible for repo transactions and are inadmissible as collateral for margin calls in other types of transactions, and as of yesterday, no futures or options contracts in respect of Avianca’s preferred shares may be entered into.

Avianca has created an information site, aviancawillkeeponflying.com to provide the company’s position on the bankruptcy filing.

See Also: What might happen to Avianca? Will Copa purchase the Airline? (click)