Colombia Shifts to Keep Its Balance Amid Slide in Oil Prices

 

JANUARY 14, 2016 [COLOMBIA, OIL, ECONOMY]
Pablo Echavarria, CFA


Accepting short-term fiscal and foreign exchange pain for long-term macroeconomic gains, which may compound with infrastructure investment and possibly peace dividends.

I had the opportunity to travel to Miami this week to meet with a number of Latin American companies and attend a series of presentations given by several political leaders from across the continent. While the region remains exposed to the fluctuations in commodity prices, which in the case of oil has hit levels not seen since the early 2000s, I was encouraged by the ability of several countries in the region to weather this powerful storm. Take Colombia, which is essentially tied with Argentina as Latin America’s third-largest economy after Brazil and Mexico. In 2013, oil exports represented 53% of the country’s total exports. For 2016, Colombia’s finance minister expects this number to decline to 32%. On the fiscal side, oil revenues to the government’s coffers accounted for 3.3% of gross domestic product (GDP) three years ago. That number is expected to decline to 0.2% in 2016. The collapse in oil prices has created an important shock to the country’s terms of trade, as well as to its fiscal accounts. While many would have expected Colombia’s economic growth to plummet alongside the fall in oil revenues, a series of shrewd fiscal initiatives and a flexible exchange rate have allowed the country to adjust, and set the foundations for a macroeconomic recovery over the medium term.

To cope with the decline in oil revenues, Colombia’s Finance Ministry has done two things: It raised taxes by 1.4% of GDP, a preventive measure taken in 2014, when oil prices started to decline. Secondly, it cut the government budget by 1.2% of GDP. While these steps are painful in the short run—and will likely lead to slower economic growth—they are imperative to maintain the country’s long-term economic balance. Equally encouraging, Colombia’s flexible exchange rate has contributed to the adjustment process, with the peso depreciating meaningfully versus the U.S. dollar over the last two years. A lower peso should help the country’s exports become more competitive, and also curb the pace of import growth. Lastly, to reduce the inflationary pressures from currency depreciation, the central bank has raised interest rates 75 basis points over the last year, and is likely to continue raising interest rates until inflation falls back to the 2% to 4% target range. In short, Colombia is embarking on a rebalancing process that should help the economy reduce its long-term reliance on oil and other hard and soft commodities. It’s already made some progress, as services now comprise nearly 60% of GDP.

Many would say these economic reforms on their own are sufficient, especially since they are being carried out during a global economic slowdown. However, the government’s initiatives don’t stop there. For five years, the country, which benefits from long coastlines on both the Atlantic and Pacific Oceans, has been planning a number of important infrastructure investments, a plan which the government dubs 4G (4th Generation Infrastructure Investment). This plan aims to invest $20 billion in revamping the country’s deficient infrastructure. The projects are being financed through partnerships with private investors: domestic pension funds, foreign investors, amongst others. Infrastructure has long been a bottleneck for Colombia, and completion of the program should help cushion the hit from lower oil prices in the short-run. It should also help lay the foundations for an improvement in the country’s long-term growth potential, which Colombia’s free trade agreements with the United States, the European Union, Canada and others will also enhance.

Lastly, President Juan Manuel Santos, who served as defense minister in the previous administration of Alvaro Uribe, has embarked on peace negotiations with the Fuerzas Armadas Revolucionarias de Colombia. More commonly known as the FARC, the deeply unpopular Marxist guerrilla group is Colombia’s largest and oldest insurgency. It is beyond the scope of this article to comment on whether this process, which began in 2012, will ultimately be successful. Partial accords have already been reached on land reform, legalizing the FARC as a political party, combating narcotrafficking (a major source of FARC financing), the structure of justice tribunals and reparations to war victims. The two sides set a March deadline for reaching a deal after an announced breakthrough in September. We would note that past efforts for a negotiated settlement failed to bear fruit.

A resolution to the more than 50-year long conflict would yield a number of visible benefits to the country. It might boost annual GDP growth nearly 2%, the government estimates. Benefits would include a potential reallocation of state resources away from financing the fight against the guerrillas and into value-added activities such as education or healthcare. In the meantime, violence, though still prevalent, has been steadily diminishing over the last decade. According to Colombia’s Ministry of Defense, the national homicide rate per 100,000 has fallen to around 11.4 from 15.8 in 2006.

Colombia, which is slightly larger than Texas and California combined, has come a long way in recent years. The poverty rate among its roughly 48 million people, three-quarters of whom are urbanized, has declined from 37% in 2010 to 28% currently, while the unemployment rate has fallen to 9% from 11.8% in 2010. However, this was accomplished during a period of high commodity prices, which provided a substantial tailwind to economic growth. A more complete evaluation of the country’s progress will take place over the next few years, as we observe how Colombia copes with a more challenging external environment. Time will tell whether the country will be able to consolidate the economic gains. Early signs are encouraging: after expanding an estimated 2.5% in 2015, the economy is expected to grow 3.2% in 2016—despite the aforementioned headwinds.

Latin America has long been associated with periods of boom and bust, as well as significant economic and political instability. However, alongside Chile and Mexico, Colombia provides a good example of a country in the region that is taking the necessary steps to cushion some of the blows dealt by volatile external factors. While it would be naïve to suggest Colombia can fully transcend a collapse in energy prices, thoughtful economic adjustments help reinforce the confidence of foreign investors, maintain the flow of foreign direct investment and facilitate progress. To be sure, Colombia remains quite poor, with a per capita income in dollar terms of just under $6000, and much remains to be done. But if the country and its relatively youthful population—the median age is 29 years—can navigate the difficult external environment and emerge relatively unscathed, the potential for improvement is robust.

Important Information
Before investing, carefully consider the Fund’s investment goals, risks, charges, and expenses. For a prospectus or summary prospectus containing this and other information, contact your financial advisor or visit our literature center. Read them carefully before investing.

Investments carry risks, including possible loss of principal. Additional risks may be associated with investments outside the United States, especially in emerging markets, including currency fluctuations, illiquidity, volatility, and political and economic risks. Investments in small- and mid-capitalization companies may increase the risk of greater price fluctuations. Investments in the Fund are not FDIC insured, nor are they bank deposits or guaranteed by a bank or any other entity.

The performance data quoted represents past performance; it does not guarantee future results.

The views expressed are subject to change and do not necessarily reflect the views of Thornburg Investment Management, Inc. This information should not be relied upon as a recommendation or investment advice and is not intended to predict the performance of any investment or market.

The performance of any index is not indicative of the performance of any particular investment. Unless otherwise noted, index returns reflect the reinvestment of income dividends and capital gains, if any, but do not reflect fees, brokerage commissions or other expenses of investing. Investors may not make direct investments into any index.

Please see our glossary for a definition of terms.

Thornburg mutual funds are distributed by Thornburg Securities Corporation.

Thornburg Investment Management, Inc. mutual funds are sold through investment professionals including investment advisors, brokerage firms, bank trust departments, trust companies and certain other financial intermediaries. Thornburg Securities Corporation (TSC) does not act as broker of record for investors.