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Analysis

Peace agreement bolsters Colombia

by Ricardo Adrogué, Brigitte Posch, Michael Simpson


Colombia remains on a sound macroeconomic footing. In addition to the positive effect of December’s peace agreement with the Revolutionary Armed Forces of Colombia (Farc), healthy growth and decreasing inflation since 2009 have allowed Colombia to recover more quickly than its neighbours following the global financial crisis.

While the country’s current account deficit has widened, this worsening is due in large part to technical pressures and the scale of the 2014-16 oil price shock, rather than fundamental weaknesses.

Fall in oil revenue

These factors do not mean that Colombia will avoid all difficulties. The fall in oil revenue means that the government will have to implement significant fiscal adjustments through tax reform.

Barings

That said, Colombia’s history of sound fiscal management and record in implementing challenging reforms ought to encourage confidence.
There are reasons to be optimistic about Colombia’s equity markets. Discipline on the part of businesses which are now adjusting after the fall in oil prices, rather than simply awaiting a rebound in crude prices, has allowed Colombia to outperform other emerging markets. Total returns in dollars were up 15% for the MSCI Colombia Index in 2016, compared to 9% for the MSCI Emerging Markets Index. The potential cut of the effective tax rate to 32% by 2019 from 42% would also stimulate the corporate sector.

Given the passage of the tax reform and other supportive factors, Barings expects Colombia to retain its investment grade status. The government is forecasting GDP growth of 2.5% in 2016 and 3% in 2017.

Tax reforms and investment rating

Tax reforms and the maintenance of the investment grade rating will play a pivotal role in helping the economy reach these projections. Meanwhile, Colombia’s increasing openness to foreign trade and investment is likely to prove very positive for business confidence. Total trade has more than tripled since 2005 and foreign investment has increased fivefold, reflecting the maturating of the Colombian economy.

As far as the new US president is concerned, some commentators expect that Donald Trump may attempt to alter America’s complex foreign trade and investment pacts.

However, yields on US bonds have already started to rise since his victory in November 2016. If this tightening continues, as generally expected, investment into emerging markets, such as Colombia, could slow. Conversely, markets seem to be factoring in a rise in US economic activity in the light of Trump’s proposed tax cuts, corporate deregulation, and increased infrastructure spending. 

Stronger demand from the US could support trade and investment activity with Colombia. The country’s key priority, however, must be to secure internal peace and lay the foundations for substantive fiscal reform. ▪

Ricardo Adrogué is Head of Emerging Markets at Barings. Brigitte Posch is Head Portfolio Manager of EM Corporate Strategies at Barings. Michael Simpson is Head of Barings’ Latin American Equity Team.

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