The Good Gets Going

Latin American economies made a lot of noise in 2014, and most of it was unsettling to market observers. To the east, Maduro continued his combinative stance, while contending with a hostile opposition, as Venezuelans scoured grocery store shelves for toilet paper. In Brazil, the Real lead a global decline in emerging market currencies and put the country on the path to a contraction in 2015. At the center of this, Colombia consistently generated reassuring signals, and while a quiet economy garners less international attention, 2014 went down as a year of strong growth, with the trend set to continue into 2015.

To be sure, Colombia faced its share of adversity in 2014. Low crude prices took their toll on the oil-driven economy, which translated into an economic slowdown. The national economy has continued to lose momentum since the beginning of this year. Exports experienced an extraordinary contraction in January, and the peso depreciated to a multi-year low of 2,687 to the dollar in March 2015. Meanwhile, a decline in oil revenues prompted the government to cut its 2015 budget by 3% as oil revenues account for 20% of government income. This move has developers and construction firms especially unnerved, as cutbacks will mainly gut infrastructure and administrative spending.

On the political front President Santos was reelected by a slim margin, which signaled policy continuity and stability to the market. This means continuity in the peace process, where the government and the FARC guerillas are making progress toward a deal. Both parties reached an agreement to remove landmines and the government pledged to temporarily stop bombing FARC positions.

BUILT TO LAST

Before addressing the future, Colombia’s remarkable navigation of the hectic year warrants a closer look, as it underscores how important regulatory reform and political will are. The national statistics agency announced that the economy expanded 3.5% in 4Q2014, which, while under market expectations, still put overall growth for the year at 4.6%. While this assessment is on the bullish end of the spectrum, other institutions’ numbers are close behind. Trading Economics estimates that the economy expanded by just over 3%, while the Central Bank of Colombia pegged growth at 4%.

With the energy sector unable to pull its weight other parts of the economy are responsible for much of the growth throughout 2014, and into 2015. This in turn is an outcome of attractive monetary conditions and fiscal policy. In 2014, the government pushed through tax increases to help close the budget gap. At their March 2015 policy meeting, the bank’s board held the key rate at 4.5% for the seventh straight month—the bank isn’t blinking. The board members argued that inflation accelerated for temporary reasons. They also pointed out that, “…because the reduction in oil prices and national income is permanent in nature, domestic spending in the economy should be adjusted.” While these policies sustained investor confidence, it was also the government’s decision in 2013 to lower mortgage rates via an agreement among banks and a public subsidy that set the stage. This helped to boost construction, which is growing at over 10% in 2014 and kept the economy strong. Wise monetary management of this sort within an inflation-targeting framework has a long history of containing inflation between 2 and 4% since 2009, barring the devaluation and the incumbent pressures.

Combined, these incidents indicate a seismic shift up the chain from extractive economic pastimes to value added undertakings. The subtext of all this is somewhat more complicated, and headlines tend to gloss over the fact that Colombia is still emerging from long-entrenched irregularity that has only exacerbated social inequality. Much of this is manifested in the country’s informal economy, which policy makers are working to stamp out. A recent OECD publication pointed out that, “productivity remains low, reflecting weak framework conditions, such as informality, low education quality, inadequate skills, low investment in R&D, and a distortive tax system.” In response, the publication prescribed, “better enforcement of bureaucratic procedures such as licensing, improved monitoring of institutions vulnerable to corruption, and reducing barriers to trade and competition in some markets.” Underscoring all this was a call to make education and training available to Colombians who heretofore have not benefited from the economic gains of past decades.

REFORMS MATTER

President Santos also pushed through progressive tax reforms as the crisis dragged on that let the government make important stimulus investments without hampering the growth of small businesses. In 2012, the government cut payroll takes, while compensating by raising taxes on the well to do. The result is strong growth in the formal sector, at 8% a year, as the country’s large informal sector continues to shrink. President Santos also implemented fiscal discipline in the public sector to reduce its deficit. Unsustainable state spending had long deterred growth as the private sector financed cozy deals between well-connected business people. Now, the government deficit is less than 1% of GDP. This in turn has boosted investor confidence. According to the Economist, J.P. Morgan more than doubled its share of Colombian bonds in 2014.

The IMF estimates that growth rates were closer to 3.3%, but this slight decline belies the important story—that years of healthy growth rates have raised per-capita incomes and the living standards of millions of Colombians. In 2000, the average Colombian made $3,074, which was almost $1,500 less than the Latin American and Caribbean average of $4,524. By 2013, incomes more than doubled to $7,831 according to World Bank data and these rates continue to climb. Some economists even predict that a finalized peace deal could add an additional 2% to yearly growth and deliver jobs to rebel-controlled territories where economic development is lacking.

CORE AND PERIPHERY

Economic activity is concentrated in the center of the country, and in coastal regions that are critical to trade. This means that many rural areas remain underdeveloped, with years of violence exacerbating economic malaise. Bogotá D.C. is a sleek state at the core of the country—both physically and economically. For obvious reasons, it leads GDP contribution with $81.13 billion in 2012; 24.8% of the national economy. Finance drives the state’s economy, contributing 31.9% as of 2011, followed by shops, restaurants and hotels with 13.9%. To the northwest, Antioquia has the second largest economy, with a distant second of $43.14 billion in 2012.
Other areas of the country are less developed, such as Vaupés, which lies in the Amazon region and is almost impenetrable. This rural state’s economy clocked in at a paltry $89.5 million in 2012. The primary economic activities consist of logging and fishing, and any major transportation is aquatic or aviation. Colombia’s states present a formidable diversity of development and possibility, and moving forward, both the federal and local governments face the challenge of promoting growth, while protecting the country’s remarkable natural resources and habitats.

STIMULATING GROWTH

If Colombia is working hard to distinguish itself from its regional partners—and competitors—by creating that will attract expanding multinationals, and growing national firms. For the Santos administration, this must be manifest at all levels of society—through inclusive growth. The 2015 national budget included increased spending on education and early childhood development—in spite of decreasing oil revenue, which the OECD noted was a step in the right direction. To promote the formal sector and transfer the benefits of development to ordinary Colombians, the government is enhancing worker protections. Protection against unemployment was recently enhanced, public employment services deployed, and voluntary savings schemes for workers put in place. These reforms represent numerous other steps that extend from public sector governance to infrastructure development that should modernize labor and business in the country.

MOVING FORWARD

For the remainder of 2015, and into the next year, Colombia Reports identified three factors that will determine the growth of the national economy. For starters, oil accounts for half on the country’s exports, and the industry will have to contend with low prices for the next few years. This is playing out in two ways in the industry, with the first being consolidation and economizing. This means steps like reducing approval time for the exchange of oil blocks between companies from one year to a maximum of three months. The second is the opening of exploration contracts and promoting exploration so that, when prices return, Colombia is ready to move.

The most recent tax reforms will also define budgets in both the state and private sector. The reformed taxation rates will raise 12.5 billion pesos that should balance the 2015 budget and ensure future investment. The government hopes to raise 53 billion pesos over the next four years through increased wealth and surcharge taxes. It also hopes to see more companies entering the formal sector, along with their tax revenue.
Exports, imports, and inflation are all intricately connected, and will write the dénouement of Colombia’s short-term economic tale. Colombia started 2014 with one of the worst performing currencies, with the peso at a 5-year low against the US dollar. By 2015, devaluation was exacerbated to a multi-year low of 2,687 to the US dollar. Such conditions are good news for dollar-backed oil sales, but will run up prices on foreign imports. Imports like automobiles are growing more costly, and consumers will turn to locally produced items, especially those with locally sourced components. How this will play out on inflation rates is still unclear and Colombia Reports suggested the Central Bank require some leeway within their 2-4% target range to adjust it accordingly.