Colombia: Mixed outcome from increased credit rating
A recent move by Standard & Poor’s (S&P) to increase Colombia’s foreign debt rating is welcome news for both policymakers and investors looking for opportunities in emerging markets. However, the country continues to face challenges to economic growth, including currency appreciation and the need for more investment in physical infrastructure.
S&P lifted Colombia’s foreign debt rating on April 24th by one level to BBB, the second-lowest investment grade, citing structural changes in fiscal policy, the creation of a windfall fund that can be used to finance countercyclical actions, an improved debt profile and the development of capital markets.
Colombia last received a credit rating increase in 2011, shortly after the parliament passed a fiscal rule establishing a ceiling on the central government’s structural deficit. Authorities plan to improve the fiscal balance over time, targeting a reduction in the deficit to 2.3% of GDP by 2014, declining to 1% by 2022.
The debt-to-GDP ratio has been falling since the fiscal rule was approved, dropping from 36.1% in 2011 to around 32% in the first few months of 2013.
Peace negotiations between the national government and the FARC rebel group also played a role in boosting the credit rating. Colombian officials, including President Juan Manuel Santos, appear optimistic that the negotiations will eventually bring an end to the conflict that has dragged on for more than 50 years and contributed to a deterioration of finances.
The director of the US Agency for International Development, Rajiv Shah, said peace would pave the way for private investment to extend its reach into rural areas of the country. He also reiterated the US’s commitment to supporting Colombia, both financially and as a key ally in the peace process.
Shortly after the S&P credit rating increase was announced, the yield on the Colombian peso bond due in 2024 fell four basis points to 4.84%, the lowest level since its issuance in 2009, according to a report by Bloomberg. The news of the credit rating increase also pushed up the peso, rising by 0.1% against the dollar on April 24.
Indeed, the move by S&P may create additional challenges for the central bank, which has struggled with currency appreciation for more than a year. The peso’s value rose by nearly 10% in 2012, although it has come down since January. Following the S&P announcement, the finance minister, Mauricio Cardenas, told the press that Colombia would act to counter any significant dollar inflows resulting from the credit upgrade.
Even prior to the rating change, the central bank had reiterated its willingness to intervene in currency markets to slow appreciation of the peso. According to a mid-March statement by the central bank governor, Jose Dario Uribe, the bank was planning to buy a total of $3.5bn in dollars between January and May of this year, up from $4.8bn during 2012.
The policy interest rate has also been cut several times over the past year, although it has remained unchanged since March, when it was lowered to 3.25%. While lower interest rates can curb capital inflows and slow currency appreciation, they can also act to over-stimulate the economy. This is not yet a problem in Colombia, but further rate reductions could bring a risk of inflation, central bank co-director Adolfo Meisel told the Wall Street Journal in mid-May.
Meisel added that the economy is expected to expand by about 4.3% this year, following 4% growth in 2012. S&P has given Colombia a “stable” long-term outlook, saying a significant slowdown in rebel activity had paved the way for investors to explore opportunities in areas of the country previously deemed off limits.
S&P noted Colombia could see further credit rating increases, if security continues to improve, investments are made in improving infrastructure and prudent macroeconomic policies are maintained. Investors will also be watching to see if the other two major rating agencies, Fitch Ratings and Moody’s, follow suit and lift Colombia above the lowest level investment grade.