I take the opportunity to be in this incredible country that is Colombia to analyse its macroeconomy and its potential

1. Overview

At the end of the 1990’s, Colombian economy suffered the most serious recession in its last fifty years. It was so deep that output decreased about 5% in 1999. In addition, the unemployment rate started to rise consistently from 7.5% in the 1980’s and reached 20% in 2000. This increase in unemployment was accompanied by a gradual reduction in inflation from 41.65% in 1992 to 9.75% in 2000. Past Governments have worked hard to tackle this issue and reverse the macroeconomic trend by implementing various policies.

Current overview

In 2014, according to the World Bank, Colombia is now the 31^st biggest economy in the world with $378.1bn of GDP. Colombia is part of the CIVETS, which regroups the six favoured emerging markets behind BRIC countries, which demonstrates the economic potential of Colombia.

On June 15^th 2014, Colombian voters handed President Juan Manuel Santos a mandate to continue his efforts to negotiate a peace deal with leftist guerrillas (FARC) and end more than a half-century of internal conflict.

Under an effective countercyclical framework, Colombia’s growth was 4.1% in 2013 and is expected to reach 4.5% in 2014. Growth in 2013 was above the South American regional average which was 3.7%, and although there remains fiscal pressures from the slower economic activity and labour unrests, the government remains committed to fiscal stability. To date, the Colombian Government has managed to stabilise the country’s inflation at 2.79% and the current unemployment rate is at 8.80%.

The monetary policy framework in Colombia is based on an extended Inflation Targeting strategy that aims at maintaining a low and stable inflation rate, stabilizing output around its natural level and contributing to the preservation of financial stability. A key issue regarding the exchange rate in the monetary policy framework in Colombia is the set of conditions that allow the exchange rate to work as a shock absorber. As in other open emerging economies, in Colombia the bulk of shocks are real, not nominal. Thus, a flexible exchange rate regime is appropriate to stabilize the economy in the face of those shocks, especially in the context of rigid formal labour markets. Importantly, a flexible exchange rate regime is necessary for a countercyclical monetary policy response to the shocks. Therefore, ensuring the conditions for a flexible exchange rate is crucial.

The peso has lost 15% of its value against the US dollar since early 2013, when the government took steps to weaken the currency to protect the export sector. The Central Government fiscal deficit is almost unchanged at 2.3% of GDP, below the 2.4% expected result of 2013, and in line with the fiscal rule. Finally The overall public debt was reduced from 32.6% in 2012 to 32.3% of GDP in 2013.

2. Long strengths and weaknesses

The country continues to exhibit very positive macroeconomic conditions, even though there are some long-terms challenges that need tackling.

Strengths

• Strong macroeconomics track record through a well-balanced public budget. The deficit reduction policy was to alter the tax structure by reducing the corporate tax rate to 30% of revenues, eliminating double taxation (tax deductions related to inflation adjustments and increasing personal income taxes). As a result, inflation is under control at around 3%.
• Strong availability of its factors of productionso   Land –26^thlargest nation with abundance of natural resources. Colombia is well placed to tap into new sources of growth provided by natural capital (e.g. Petroleum, Gold, Natural Gas and Emeralds).

o   Labour – overall strong and young availability of workforce with high levels of education. Strategy to fight unemployment established in 2010 was based on three key reforms: (1) in depth reform to the education system; (2) implementation of a social safety net to help the most vulnerable strata of population; (3) reform of the labour code aimed to: (i) reduce and flex non-wage costs; (ii) introduce mechanisms to help make wages more flexible; and (iii) provide a wider variety of hiring modalities and ways to organize the time within the firms[1]. As a result, unemployment rate has been declining from 17.87% in 2002 to 9.19% in 2014 and it is forecasted to reach 7% in the next 5 years.

o   Capital – accumulation of capital, the investment rate has been increasing gradually since 2000 and has now reached a high record above 30% of GDP.

o   Enterprise – 20.6% new businesses launched within the last three years, compared to an average of 11.8% in the Andean economic region. Achieved through education and tax relief measures.

o   Financial services are relatively sophisticated with a considerable market size, developed under a model of specialized ‘vehicles’ subject to severe restrictions on permissible activities, especially for deposit-taking institutions.

Weaknesses

• Negative dominance of natural resources related FDI, to the detriment of the manufacturing and service sectors where it has actually been declining in absolute terms in the wake of the recent global financial crisis. There has been a lot of FDIs in minerals but specifically with no manufacturing value added.
• Dutch disease. Too high dependence on commodity exports, especially oil. The level of diversification of the Colombian economy is relatively low and the country is dependent on the export of a narrow range of commodities, which makes the country vulnerable to commodity price fluctuations.
• Political and social instability (FARCS conflict) will 1) cost a lot of money; 2) discourage external investments. To raise funds, Colombia needs to borrow from international markets and raise taxes, which will impact negatively savings and consumption levels.
• Colombia shows a strong gap in improving the productivity of human capital, generating poverty traps and limits the availability of skilled labor force.
• Ambitious transportation infrastructure plan, worth $25bn investment to be completed in the next 5 years. It will add competitiveness:
  • By increasing the investment grade from 1% of GDP to 3% of GDP and keep it there for at least 10 years.
  • By increasing employment across industries that feed the construction sector
  • By doubling speed of transportation (trucks will go twice faster), the cost of operations will be cut by half.

Increase of FDIs. Colombia has one of the largest, portfolio of projects in the pipeline with private sector investors and are a very stable country for private investors

2. Analysis of Colombia’s trade position and its comparative advantage

Trade position

Colombia recorded a trade surplus of 0.06 USD Billion in May of 2014. Balance of Trade in Colombia averaged -0.07 USD Billion from 1980 until 2014, reaching an all-time high of 0.81 USD Billion in December of 2011 and a record low of -1.15 USD Billion in April of 2014.

The trade of balance has been much more volatile since 2007, which coincides when the NAFTA agreement was signed between the US and Colombia.

The Country’s leading markets for exports were U.S. 36.6 %, Spain 4.8%, China 5.5%. Its leading suppliers were U.S. 24.2%, China 16.3%, Mexico 10.9%, and Brazil 4.8%. Today there are 10 agreements in course including agreements with the European Union, Canada, Panama, Korea, Israel and Costa Rica and initial conversations have started with Japan.

Colombia exports

In the past 5 years, exports have on average gradually increased. However, exports amounted to USD 4.3 billion in April of 2014, compared with last year’s USD 4.9 billion (-13.1% yoy). This drop is due to a fall in manufacturing shipments (-19.8%) and lower sales were recorded to the United States (-41.4%), India (-43%), Venezuela (-27.2%) and Ecuador (23.5%). Export growth remains modest and below the import pace due to supply problems, particularly in the mining sector.

Colombia imports

Like the exports, imports have gradually increased in the last 5 years. Imports increased 5.6% yoy to USD 5.5 billion in April of 2014, against USD 5.2 billion one year earlier. Higher imports were made from the United States (+12.3%) mostly fuels, mineral oils and products and cereals; imports of aeronautical from France increased 170.9% and those of electrical recording, iron and steel from China rose 13.6%. Both public spending and household consumption are gaining momentum, fuelling import demand.

Impact of the trade agreements

The positive impact of the NAFTA and other trade agreements are:

• Opened new markets for its exports (+47% increase in just three years)
• It has expanded the variety of goods available to businesses and consumers meaning a reduction in the country’s vulnerability to the volatility of commodity prices.
• It has increased competition and thereby reducing the extent of monopolistic pricing and the inefficiency that results from it, and pushing up the rate of productivity growth.
• Increased FDI from on average USD 200m prior to 2007 to USD 3,900m in 2014. Laws and decrees were created to remove barriers of trade.
• With the entry of new participants in the Colombian market and entry of domestic firms in the U.S., it is expected that Colombian firms increase their investment in R&D in order to position their products in the national and international markets, which will benefit domestic consumers who will have a greater variety and quality of products available.

The negative impact of these trade agreements are:

• Local companies are not ready yet to go out to the market due to a lack of knowledge and skills and a lack of exposure to inexperienced industries. Not yet experienced economies of scale and will not be able to withstand foreign competition.
• Not all industries will have benefited from NAFTA (e.g. small agricultural producers are competing against a flood of cheap imports, which means prices and income dropped).
• These agreements make Colombia become much more dependent and vulnerable to these partners’ economies, especially the USA.
• Drug cartels benefit from NAFTA
• Colombia’s economy still has competitive disadvantages to maximize the expansion of Colombian’s export markets. The geography of the country, with three major mountain ranges presents difficulties in transporting goods from the Midwest to the coast and their subsequent export

Colombia’s comparative advantages

I firmly believe that Colombia’s existing and well established comparative advantages are:

• Its location (adjacent to two Oceans) and its natural resources. Colombia has a wealth hardly comparable to any other country in the world. This biodiversity allowed the country to establish itself as a very important supplier of raw materials worldwide because of the relative abundance of resources that it has.

• Its workforce, with a large pool of qualified professionals with great prospect with scope for improvement.

• Its sound economy. Currently, Colombia has established itself as one of the main destinations of foreign direct investment: high rates of growth and low inflation that has been submitted, the tax reforms implemented and it has shown outstanding performance among financial turbulence, have become one of the most promising emerging economies and stronger macroeconomic fundamentals.

• Colombia is looking to capitalise on new industries (e.g. tourism).

3. Impact on the macroeconomy if there is a sustained fall in the real exchange rate

If there was a sustained depreciation in the real exchange rate it would impact mainly two aspects of Colombia’s macroeconomy:

• Balance of trade through both imports and exports – it would work in Colombia’s short-term favour as it would grow exports and contract imports, thus reducing the deficit
• Imports – increases the price of imports, such as machinery (#1 import) and reduces the foreign price of a country’s exports. If consumers (e.g. US) buy fewer imports, while exports grow, AD will rise – and there may be a multiplier effect on the level of demand and output. The potential drawback for Colombia is that in order to produce more, therefore export, it needs machineries.
• Exports – exporting countries would find it cheaper to buy products from Colombia. However, the risk for Colombia would be a rise in inflation.
• Higher demand from a fiscal stimulus e.g. lower direct or indirect taxes or higher government spending. If direct taxes are reduced, consumers have more disposable income causing demand to rise. Higher government spending and increased borrowing creates extra demand.
• Also, monetary stimulus to the economy: A fall in interest rates may stimulate too much demand.
• Debt is denominated in US Dollars if the Peso falls then it means that they would need more Pesos for a given Dollar.

4. Impact of the financial crisis on Colombia’s economy

The current global financial and economic crisis is the most serious threat that the world has faced in over half a century. It is worth considering that Colombia experienced the worst recession in its history in 1999, a crisis that originated in the mortgage and financial sector. As a result a number of macro-prudential measures were taken early 2000, including a strengthening of financial regulation, which was essential to avoid a contagion through the financial channel in the global crisis of 2008. Thus, the effects of the crisis were short-term and the country quickly regained the path of economic growth.

Colombian economy was not isolated from the events of the global economy. GDP growth for 2008-1Q revealed the first contraction in four years. It is rather difficult to establish if this change in the trend was a consequence of the international crisis, but from that moment on the overall economic growth started its slowdown. By 2009-Q1 the adverse impacts of the crisis had become more evident, especially in the labour market and poverty reduction effectiveness. According to the Colombian Central Bank most of the slowdown in the economy was due to internal and regional factors, rather than the international crisis. Growth rate decreased from a maximum of 6.9% in 2007 to a minimum of 1.5% in 2009, as a consequence of the poor results in the areas of exports, financial markets, and remittances. One of the main impacts of the slower growth rates was the increased unemployment rates.

As in many other developing countries, policy response in Colombia has limited to some sort of counter-cyclical measures, mainly related to interest rates management, prioritization of already planned government expending on infrastructure, and precautionary securing of public debt financing. Measures include the undoing of recent credit tightening by the Central Bank. From April 2006 to the beginning of the second semester of 2008, the Central Bank increased interest rates from 6% to 10%, in the face of increased governmental expending, high foreign capital inflows, and an expansionary credit market. To try to smooth the impact of the crisis, since the late 2008 and during 2009, the Central Bank decreased the interest rate by 650 basis points, leading to a 3.5% interest rate, the lowest in recent Colombian history, helping grow consumption. Also, the Central Bank dismantled the requirement for commercial banks to marginally increase the amount of deposits they have to keep from lending to the public and the requirement for borrowers in the international market to deposit in the Central Bank a share of the amounts borrowed. The central government took measures to face the likely decrease in government revenue. It obtained Congress approval to increase the fiscal deficit by 0.6% of GDP, as well as to postpone expending in about the same amount. Furthermore, a FCL (worth US$11m) was contracted in May 2009 with the IMF to secure coverage against adverse balance of payments shocks and for increasing the scope for countercyclical measures.

All experts are in agreement that the economy has been able to face the global financial crisis thanks to its sound macroeconomics fundamental. In fact in 2009 the country had a positive growth of 1.7%, while the other economies in the region in general and emerging economies registered negative growth. The main transmission channel of the crisis was real, since a decline in growth in the developed world was presented thus affecting external demand for export products of Colombia. This drop in external demand affected the dynamics of Colombia’s exports and by extension the overall economy. However, as mentioned, the Colombian economy quickly regained the path of growth, and in 2010 showed an increase of 4.0% and 6.6% in 2011

5. Recommendations to improve future long-term growth

In June 2014, Colombia President was re-elected with a campaign around “peace”. It was welcomed by Europe and the US, which have largely been relying on Santos’s image as a moderate to justify their continued relationship with Colombia. Therefore, please find below Colombia’s key objectives by order of priority to sustain and grow Colombia’s macroeconomics.

Peace process

The key success factor to growing the economy is for Colombia to experience a peace process with the Marxist FARC. It will create greater social and economic stability in the medium term. The economy of the country relies on that peace process because:

• The new transportation infrastructures will inevitably go through FARC territories, and due to the size of the investment cannot risk being blown up.
• FDI will only increase if the country can show stability as conflict means instability and investors will lose confidence and exit.
• Tourism is a huge opportunity but like in the financial sector, tourists will only come if they feel in security.
• Reduce public spending is a key component in the budget. Peace will come with a huge cut in defence budget, which can they be partially be reinvested. Currently Colombia’s military expenditure accounts for 3.3% of GDP.
• It will slow down the migration of internal population towards the capital city Bogota. Non-skilled people would benefit more to the economy if they were farming than living in favelas around Bogota.

Transportation infrastructures

One of the main bottlenecks faced by the country is poor quality and coverage of transportation infrastructure, which increases transaction costs and transport, thereby reducing the competitiveness of various sectors of the economy, such as industry and trade. According to the World Economic Forum, Colombia is ranked 108 of 144 in infrastructure quality, and less than 15% of the roads are paved. Transport also carries an important social and environmental load, which cannot be neglected. At macroeconomic level, transportation and the mobility it confers are linked to a level of output, employment and income within a national economy. The aim is for transportation to account for 6% of the GDP. The added value and employment effects of transport services usually extend beyond employment and added value generated by that activity; indirect effects are salient. The Government has developed a $ 60bn ambitious plan which aims to reduce this gap by developing infrastructure projects fourth generation (4G), which will be built and will conform more than 8,000km of roads and highways between 2012 and 2020.

Public finances

Colombia has made significant achievements in economic terms in recent years as the reduction of inflation, institutional fiscal framework with strong public finances, reducing poverty and inequality. It is crucial for Colombia to reduce its military expenditure and reinvest it into education and raising national income to develop new sectors (e.g. IT, R&D).

Financial Direct Investments

Capital flows, especially foreign direct investment (FDI), are one of the key components of globalization and international integration of developing economies. Larger inflows of foreign investments are needed for the country to achieve a sustainable high trajectory of economic growth. FDI has an employment creation effect. If more jobs are created it will increase the consumption and savings, therefore increasing GDP. As a consequence, we should consider offering foreign companies a tax relief to install their operations in Colombia as well as employing and training Colombian workers.

Benoit Mercier