On April 29, 2016, the Executive Board of the International Monetary Fund (IMF) concluded the Article IV consultation1 with Colombia.
Colombia showed strong resilience to changing global conditions in 2015. Despite facing a terms-of-trade shock larger than most of its peers, Colombia posted one of the highest growth rates in the region (3.1 percent) and achieved important social gains with improvements in poverty reduction, income inequality and financial inclusion. Growth was underpinned by a strong real private consumption while private investment slowed down. The decline in oil prices eroded exports and fiscal revenue, and led to a strong depreciation of the peso which fueled inflationary pressures as the external adjustment process got under way. The central government reaffirmed its commitment to the fiscal rule and achieved its structural balance target through timely expenditure cuts and revenue increases from the end-2014 tax reform. The central bank initiated a tightening cycle in September to ensure the anchoring of inflation expectations and contain the widening current account deficit.
A moderation in domestic demand will guide a soft-landing in 2016. Colombia is facing a second large terms of trade shock. Growth will slow to 2.5 percent, as private investment will moderate despite the advances in the 4G infrastructure agenda. As the current weather shocks subside, inflation will moderate and gradually converge toward the target band. The ongoing fiscal restraint and monetary policy tightening will help bring the current account toward levels consistent with a more subdued outlook for global financing. The large peso depreciation would boost non-traditional exports but they will also be constrained by the weak economic outlook in Colombia’s neighbors.
A broadly sound financial system and corporate and household balance sheets also contributed to Colombia’s resilience. The real growth in bank credit has moderated in recent months but some areas are still growing at a fast pace. Consumption-related credit has slowed down more markedly in line with subdued durable-good consumption; however, commercial credit has remained buoyant due in part to corporates’ efforts to replace external credit lines. Corporate and household leverage remains modest by international standards.
The medium-term outlook is favorable but surrounded by downside risks. Growth will gradually approach its medium-term potential of about 4 percent supported by the 4G infrastructure agenda and some recovery in non-traditional exports and oil prices. The current account deficit will gradually decline and approach its medium-term sustainable level through a combination of import compression and export expansion. The main near-term risks stem from Colombia’s still significant near-term external financing needs and potential capital inflow reversals resulting from volatile global financial conditions. Further declines in oil prices could fuel additional currency depreciation and inflation. On the upside, bringing the peace process to fruition could further improve business confidence and capital inflows, reinforcing the recovery that will follow the necessary adjustment process.
Executive Board Assessment2
Executive directors were encouraged by the Colombian economy’s resilience to adverse global conditions, which has been supported by its strong policy framework and the authorities’ coordinated and proactive policy response. Directors commended the tightening of macroeconomic policies, in particular by allowing the flexible exchange rate to be the first line of defense to absorb the impact of a large and persistent terms-of-trade shock. They also noted that the country recorded one of the strongest growth rates in the region over the past year, which supported further progress in reducing income inequality and enhancing financial inclusion.
Directors noted that Colombia’s medium-term outlook is generally favorable, but clouded by heightened downside risks. They shared the view that volatility in global financial markets, including stemming from China’s ongoing economic adjustment, vulnerability to swings in market sentiment, and the weak economic outlook of some of Colombia’s neighbors pose key risks. Directors concurred that the resolution of the domestic peace process could unleash further regional development and foster business competitiveness.
Directors welcomed the central bank’s resolve to tighten monetary policy to guide inflation expectations back to the target range. Some additional policy tightening may be needed, if conditions warrant it, to help guide the current account deficit toward its medium-term equilibrium level. They emphasized that exchange rate flexibility should continue to be used as a shock absorber. Directors noted that the broadly smooth functioning of local financial markets amid the very large peso depreciation reflects the well-earned credibility of the inflation targeting regime.
Directors saw merit in further fiscal consolidation and welcomed the authorities’ commitment to the fiscal rule. They called for prompt efforts to implement a structural tax reform this year which will protect key social spending, while adhering to the rule’s targets. Directors encouraged efforts to step up domestic revenue mobilization by broadening the base and enhancing tax administration, while also making the tax system more efficient and progressive in order to replace revenues lost with the oil price shock.
Directors commended recent advances in financial regulation and supervision that have further expanded the ability to respond to changing global and local conditions. They encouraged the authorities to continue reforming the regulatory framework in line with Basel III and strengthening the resolution framework. Directors welcomed the authorities’ efforts to enhance their stress-testing framework and corporate surveillance, but also noted the importance of continued vigilance of corporate sector developments and the timely approval of the financial conglomerates law. They commended the authorities for volunteering to be the first emerging market to undertake a pilot self-assessment under the FSB’s “Key Attributes of Effective Resolution Regimes for Financial Institutions.”
Directors welcomed further efforts to advance a well-designed structural reform agenda that will underpin economic diversification and inclusive growth over the medium term. They welcomed recent progress on the public-private partnership-based infrastructure agenda and called for continued efforts to improve the business environment, strengthen competitiveness, and improve access to quality education.
Colombia: Selected Economic Indicators 1/
1 Under Article IV of the IMF’s Articles of Agreement, the IMF holds bilateral discussions with members, usually every year. A staff team visits the country, collects economic and financial information, and discusses with officials the country’s economic developments and policies. On return to headquarters, the staff prepares a report, which forms the basis for discussion by the Executive Board.
2 At the conclusion of the discussion, the Managing Director, as Chairman of the Board, summarizes the views of Executive Directors, and this summary is transmitted to the country’s authorities. An explanation of any qualifiers used in summings up can be found here: http://www.imf.org/external/np/sec/misc/qualifiers.htm.