IHS expects Colombian economic growth to decelerate in 2016

The Colombian economy faced many challenges in 2015. Oil prices started a downward spiral in July 2014, and have reached lows not seen in more than five years. The downward trend of crude prices was the result of the largest supply excess since the 1980s, and lower global demand. This generated a deflation of oil prices that brought volatility to financial markets. China's slowdown also induced lower commodity prices, provoking the world economy to head into a deflationary spiral.

With oil exports accounting for more than 50% of its export revenues and 20% of its fiscal revenues, Colombia is still experiencing cash flow and credit deterioration. Fortunately when the oil supply shock hit oil-exporting countries, Colombia was in a privileged situation due to its strong external and fiscal position with a solid macroeconomic framework in place. However, even with these buffers, Colombia did not enjoy immunity and the shock is still affecting the economy.

The Colombian economy grew at a rate of 3.1% in 2015, which is considered satisfactory compared to other Latin American countries. During 2015, Colombia still exhibited, for the second consecutive year, investment rates of 30% of GDP and despite the reduction in investments in the oil sector (down more than 30%), foreign inflows to the country still amounted to approximately USD12 million, which is a signal of investor confidence in the country.

Drivers of growth during 2015 were the solid macroeconomic framework with efficient macroeconomic management, strong consumer demand and good performance of public works with a more competitive exchange rate. Factors that dragged economic growth down were weak external demand, coupled with problems of smuggling and informality within a tight fiscal scenario, an increasing current-account deficit, and higher inflation. The best-performing sectors during 2015 were Financial and Real Estate services (4.3%), Commerce and Restaurants and Hotels (4.1%) and Construction (3.9%). The manufacturing industry was the worst performing, up by a tepid 1.3%.

However, this year is expected to be more challenging than 2015. Oil prices have decreased even more during the first two months of the year, reaching record lows of USD26 pb. In this context, domestic demand numbers are showing moderate results. The latest numbers in retail show that retail sales grew 2.2% year on year (y/y) in January, and growth during the last 12 months was 2.4%. However, consumer confidence is weakening and staying negative. During February, consumer confidence at the lower social stratum showed the lowest confidence level since 2002. According to the Consumer Opinion Survey, during February the consumer confidence index registered a -21% balance, similar to January's results. February was the index's seventh consecutive monthly fall.

Manufacturing is improving remarkably compared to previous years, when the appreciated exchange rate had been posing some competitiveness difficulties. During January, the industrial sector grew 8.2% compared to January 2014, the refining oil and fuel sector grew 26.6% and the car manufacturing industry grew an important 59.2%. In the last 12 months, industry grew 1.7%. The industrial sector is finally adjusting its production structures to produce more and take advantage of the depreciated exchange rate. A depreciated exchange rate also poses some difficulties since it makes imported raw material more expensive. Regarding the emergence of a more competitive industry in Colombia, there is important work to be done. Competitiveness indicators put Colombia in an average position. In 2015's competitiveness index from the World Economic Forum, Colombia improved five places to 61st out of 140 countries, in third place behind Chile and Mexico among the Latin American countries. According to the World Forum economic report survey, factors that make doing business in this country difficult are tax levels, corruption and lack of adequate infrastructure. Solving these problems will need important institutional reforms that are still pending. An important and ambitious infrastructure programme has begun this year, which aims to solve the country's major infrastructure gaps. For 2016, the administration will continue to promote the National Strategic Projects of National Interest (PINE), and the first phase of adjudicated projects from the infrastructure programme.

The external sector was the most affected at the beginning of the year, when oil and fuel exports decreased 46.9%. Manufacturing exports also performed poorly, decreasing 17.6%. The overall annual result on the external front exhibited a decrease of almost 36.6%%, explained mainly by a reduction of almost half in oil and extracting sectors. The decrease was primarily due to a decline in prices that were not compensated for with more volume. Within this more difficult scenario we expect a deceleration in the first quarter of the year.

Outlook and implications

Despite the current low oil price scenario, we expect Colombian economic growth to decelerate but still achieve a moderate growth rate of 2.7% in 2016. Economic growth will come from domestic demand, mainly private consumption and investment. Investment has provided 30% of GDP during 2015 and 2014, despite the difficult economic scenario. The implementation of the infrastructure programme should also boost the economy. However, consumption is expected to moderate due to tighter credit conditions. In this sense 2016 will be a very challenging year, mostly negatively influenced by external factors.

The biggest challenges for Colombia are fiscal and external. Lower oil prices will force Colombia to make adjustments to manage its economy with less investment flows to the oil sector, less oil export revenues and less money in the state's coffers.

Authorities are projecting a fiscal deficit of 2.4% during 2016. The central government deficit will increase from 3.0% in 2015 to 3.6% in 2016, which is expected to be compensated for by a higher surplus in the decentralised sector and a decrease of 0.1% in the Central Bank deficit, to finally end at 2.4%, close to the non-financial sector deficit target of 2.3% in 2015.

During 2016, Colombia can expect a stronger impact on its fiscal accounts compared to 2015, mainly due to the lag of income transfers to the state. The dividends the state receives from Ecopetrol are always from the previous administrative period, so during 2016, the dividends from Ecopetrol will have been earned during 2015, when oil prices were at their lowest.

In the same way tax revenues for 2016 are calculated on results obtained during 2015. In this context, we will see an increase in net public debt from 35.3% of the GDP in 2015 to 37% of the GDP in 2016, breaking the decreasing debt path that Colombia had been experiencing since 2011. Also, the depreciation of the dollar will have also a negative impact on tax collection. We expect lower imports due to the peso's depreciation and this also means less import taxes. Given this hardship scenario, the state's room for manoeuvre will shrink and it will need to foster domestic demand.

The main assumptions the administration has made to be congruent with the 2.4% deficit target are related to an increase of 8% in fiscal revenues, due to more efficiency in tax collection and due to the 2014 increase in the income tax rate. Authorities are also expecting a loss of 50% due to fewer profits from Ecopetrol. The rest is expected to be financed by domestic and external debt.

During the first two months of the year, the fiscal situation has worsened and it seems that a larger expenditure cut will be needed to achieve the central government's fiscal target of 3.6% of GDP. In this sense, it is very probable that we will see debt swaps and more debt to close the fiscal hole that low oil prices are generating.

The current-account deficit reached 7% during 2015 and it's expected to will be approximately 6.5% during 2016. Authorities expect the adjustment to take place through a depreciated exchange rate, which should help lower the import bill. The Finance Ministry has stated that the government has the goal to reduce the current-account deficit from USD19,600 in 2015 to USD16,000 during 2016. This is still financed by foreign direct investment, however if the current-account deficit keeps widening it will require adjustments in the interest rate and increases in non-commodity exports to avoid vulnerabilities in Colombia's external position and increases in the country's risk premium.