The Colombian government debt segment is the largest in the country in terms of traded volume, and one of the largest and most liquid of its kind in Latin America – with a total amount outstanding of COP230trn ($69bn), or 26.3% of GDP, and an average monthly traded volume of COP100trn ($30bn) in 2016. Colombian government bonds, widely known as TES, are issued by the Ministry of Finance to finance the budget deficit; however, the ministry also issues short-term bonds in coordination with the central bank for liquidity management purposes.
Background
There are two types of TES bonds: fixed-rate, which held a 69% share of outstanding TES in 2016, and inflation-linked, with a 31% share. These bonds mainly trade on one of two electronic trading platforms: the central bank’s Sistema Electrónico de Negociación (SEN) for primary dealers and the Mercado Electrónico Colombiano (MEC), managed by the Colombian Stock Exchange.
The TES market is mainly composed of local players, but the amount of domestic debt held by foreigners has increased substantially in the past few years as part of the government’s goal to introduce more liquidity and dynamics to local markets. One strategy has been to reduce withholding tax on foreign TES holders. The tax rate was cut from 33% to 14% in 2012, leading to a sizeable pickup in foreign investor ownership, from 3.6% to 26% of outstanding TES at the end of 2016. The tax rate is expected to remain unchanged for the time being, but the Ministry of Finance has announced its intention to reduced it further or eliminate it entirely, matching peer countries in the region and reducing borrowing costs.
Thanks to improved macroeconomic stability, the government has been able to obtain market financing at longer maturities and lower interest costs. The average maturity of TES instruments increased from 2.7 to five years during the past decade, while the average coupon fell from 11.6% to 8.8% in that time.
At the beginning of 2016 Colombia’s public debt segment sold off sharply amid concerns of a potential hard landing of the Chinese economy and from oil prices collapsing to a 12-year low. The outlook on Colombia’s fiscal and external accounts deteriorated, which led to major rating agencies Standard & Poor’s and Fitch to revise their outlooks on the country’s “BBB” sovereign rating to negative.
Meanwhile the ongoing exchange rate depreciation coupled with the effects of El Niño on food and energy prices pushed inflation to a 15-year high, which also led to an upward adjustment of the central bank’s policy rate. The yield on 10-year benchmark TES bonds due in 2024 rose to a 6-year high of 9% in the first quarter of 2016.
Projection
Renewed expectations of greater global monetary stimulus and signs of a stabilising Chinese economy reversed the upward trend in TES yields by mid-2016. Local inflation began a steady decline in the third quarter, while the government presented a tax reform bill to make up for lost oil revenues and preserve its “BBB” sovereign rating. The yield on the 10-year benchmark TES bonds dropped to 6.75% by end-2016.
Foreign inflows to the TES market saw a strong recovery, with net purchases reaching COP21trn ($6.3bn) in 2016 – the highest annual figure on record and even surpassing those seen in 2014 (COP18.5trn, $5.6bn), when JPM organ increased the weight of Colombian TES following the reduction of withholding tax for foreign debt holders in 2012.
Looking to 2017 the tax reform should lift pressures on fiscal accounts and prevent a rating downgrade, while local inflation is expected to drop further towards the central bank’s target range, leading to several policy rate cuts. These developments should benefit TES bond prices and lead to a steeper yield curve. However, the TES market may still be vulnerable to weaker foreign capital inflows.
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