What Jumps Out : Meat Loaf (and the ratings agencies)

I am fairly sure the term Meat Loaf is hard to throw into a blog regarding a ratings downgrade without some explanation, however if the clue ‘Two Out of Three’ still leaves you lost – I can’t help any further.

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