eco TV Week

Deterioration of public finances in Colombia: why and should we be concerned?

10/1/2021

The deterioration of public accounts in Colombia can be explained as much by cyclical factors than structural ones. It is also symptomatic of a greater difficulty in enacting an ambitious fiscal reform especially in the face of rising social tensions in the country. Although public finances are unlikely to improve decisively in the short term, the country exhibits a number of strengths that should help contain the build-up of risks in the medium term. Colombia should be in a better position to ensure the sustainability of its public finances if it is better able to engage the population at large and generate greater consensus around fiscal issues. 

Salim HAMMAD

TRANSCRIPT // Deterioration of public finances in Colombia: why and should we be concerned? : October 2021

Over the summer, Colombia lost its investment grade status, which it had acquired back in 2011. According to two out of the three main rating agencies, Colombia is now considered to exhibit a weaker capacity to honor external debt payment, compared to ten years ago. So what explains this change in sovereign rating? and should we be concerned ? Hello and welcome to this new edition of EcoTV week.

Despite the introduction of a fiscal rule in 2012, Colombia’s public debt ratio has doubled over the past 10 years exceeding more than 60% of GDP by the end of 2020. Three main families of factors can be mobilized to help explain this trend.

First, public accounts have been increasingly challenged by a series of cyclical shocks. For example, the reversal of the commodity super-cycle in 2014-2015 generated a sizeable shock to public revenues in a country where oil and coal represent almost half of exports. Then, the migrant shock associated to the influx of more than one million Venezuelans in 2018-19 also generated increased spending pressures on health, education and housing. Finally, we must not forget the fiscal package deployed by the authorities to counteract the effects of the Covid-19 crisis on businesses and households. These types of shocks have at times led to a revision or a suspension of fiscal rules, materializing in all cases into increased budget deficits.

Second, another set of explanatory factors are structural in nature. In particular, Colombia has faced chronic difficulties to significantly broadening its tax base – despite the deployment of 12 fiscal reformd over a period of 20 years. In reality, some of the difficulties in raising revenues reflect above all a structural weakness of the economy, namely a very high level of informality in the labor market estimated at some 47% of the labour force. Another contributing factor stems from the depreciating trajectory of the Peso since 2014. Indeed, this decline in the purchasing power of the currency has contributed to mechanically accentuate the public debt ratio given that about 35% of the debt is denominated in foreign currency.

A third element in recent years has been the rise of social tensions and their impact on the process of fiscal reform. To understand this point, let's take a step back time for a moment. The signing of the peace agreement with the FARC in 2016, has contributed to gradually displace some of the security concerns, that had been so prevalent in Colombian society and helped, instead, social issues further come to the fore.  In many ways, the Covid-19 crisis has helped further accelerate this phenomenon. As a result, it is therefore not surprising that in recent years we have witnessed more frequent waves of protests. And the latter have stir a broad-based movement of demonstrators all demanding greater social protection, a reduction in inequality and better access to the job market.  We can understand in this context that fiscal reforms have contributed to further crystallize social tensions and complexify -- as we saw earlier this year – the fiscal adjustment effort. 

So is this deterioration worrying? 

It is true that in the short term, we are unlikely to witness notable improvements in public accounts owing to the fact that the conditions to stabilize the public debt ratio are currently not being entirely met.  That said, in the medium term, a build-up of risks is partly mitigated by the presence of a medium-term fiscal framework which should help preserve against the risk of fiscal slippage. This characteristic is not shared by many emerging markets. In addition, structural reforms destined to improve public debt management has helped reduce the vulnerability of public accounts to financial shocks. And finally, and this is an important point, Colombia has shown a great ability over time to generate growth, even in the face of adversity.  

More than these elements, however, it will be the ability of the authorities to generate and enhance social dialogue that is likely to weigh most decisively on the trajectory of public finances.

That's it for today, thank you for your attention and see you next time for an another edition of EcoTV week.

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