On March 16, Standard and Poor’s raised Colombia’s credit rating to investment grade. Other leading rating agencies are expected to follow suit, and President Juan Manuel Santos has said he foresees credit upgrades from both Fitch and Moody’s within a few months.
This is a major symbolic victory for Colombia’s economic policymakers, reflecting improved global confidence in the government’s finances and in the local economy more generally. High-level officials have been talking about reaching investment grade status for months, and the prospect of a rating upgrade at a time of widespread optimism about the Colombian economy has helped spur local politicians into action on the fiscal deficit. On this issue, Santos has taken the lead, making fiscal rebalancing his first half-year in office.
The upgrade will likely have some concrete impact as well. It validates investors’ already growing enthusiasm for Colombia and will open the door to international institutional investors, like pension funds, that pay close attention to credit ratings. Over time, it will probably mean that the national government will pay lower borrowing costs.
Most analysts agree that Colombia deserved this upgrade. The country lost investment grade status about a decade ago, amidst fears about the sustainability of government finances as well as an escalation in drug-related violence. Since then, the government has remained committed to meeting its international debt obligations. In the meantime, South America has experienced a period of rapid growth and levels of violence in the country have come down significantly. In this sense, given Colombia’s commitment to fiscal prudence and improving domestic conditions, a credit rating upgrade was only natural.
Interestingly, the statement that accompanied S&P’s move also emphasized Colombia’s resilience to external shocks, a reference to the country’s relatively swift and robust recovery from the recent global economic downturn. This recovery has been truly remarkable. Over the past three years, not only has the U.S. – Colombia’s chief trading partner – faced its deepest crisis in eighty years, but trade with Venezuela, another key export market, ground to the halt amidst political tensions. Colombia’s impressive growth in spite of these challenges reflects both the fundamental strength and the local economy and the growing diversity of its trading partners.
Of course, the country still has plenty of problems. The unemployment rate remains unacceptably high. In February of this year, 12.8% of the workforce was without a job. Meanwhile, although the security situation has improved, these improvements have proven vulnerable and fragile. Following the demobilization of paramilitary groups half a decade ago, new drug gangs have taken their place. Today, they have a palpable presence in a large fraction of Colombia’s municipalities, including many large cities, and are killing, displacing and extorting civilians daily.
These ongoing problems pose a risk to Colombia’s long-term economic and fiscal picture, and the unfortunate flipside of credit rating upgrades is that they often lead to a kind of celebratory complacency. This risk is particularly acute in Colombia, where achieving investment-grade status has been a major political objective. If the country simply rests on its laurels, it will pass up opportunities for much-needed reforms, and remain vulnerable to latent economic problems.
The country has benefitted from high commodity prices, and the mining sector in particular seems full of potential, but these short- and medium-term sector-specific booms will not guarantee long-term growth or fiscal sustainability. Moreover, some recent actions to help balance the budget – such as selling shares of Ecopetrol, a government-owned petroleum company – are one-off measures that do not directly address underlying imbalances. Real budget balancing will inevitably require politically controversial reforms, spending cuts and tax increases. Reducing waste due to government corruption, still a major problem, should also be a priority.
Many elements of Santos’s broader social and security agendas will also put pressure on the budget, and their exact cost is hard to predict. Skeptics have long argued that executing the president’s ambitious land reform plan, which will return large swaths of territory to displaced peasants, would be extremely expensive to administer. Recent events have underscored the potential cost of this reform, especially given ongoing security problems in the countryside. Dozens of displaced activists and peasants working to return to their land have been murdered in recent months, in many cases by neoparamilitary drug gangs.
Building on the security improvements of the past decade will therefore be very expensive. Driving guerrillas out of the cities, an impressive task in itself, is much easier than eradicating complex drug networks that have deeply infiltrated the political establishment and business community. As mentioned above, reversing decades of illegal land grabs and bringing lasting security to drug-ravaged towns and slums, will be both tricky and expensive. And all of this comes at a time when the U.S. is cutting military aid under Plan Colombia, an anti-drug collaboration scheme. Over the past three decades, according to the government, the armed conflict has led to $70 billion in additional military spending, and successfully ending the conflict will add significantly to this number.
The credit upgrade also carries some risks for Colombia’s economic policymakers. Investors’ growing interest in Colombia is likely to further boost already robust capital inflows, which put upward pressure on the peso. Like many fast-growing developing countries, Colombia must therefore be creative and prudent in taking measures to avoid any dramatic strengthening of the local currency, or else risk hurting exporters. Moreover, sustained growth will require significant investment in education and poverty reduction programs. Colombia remains one of the world’s most unequal countries, and its long-term economic fortunes will depend largely on the integration of its large underclass into the formal economy.
The good news is that Colombia does not seem likely rest on its laurels. In a recent meeting with Finance Minister Juan Carlos Echeverry – during which he talked about tax revenues, the S&P upgrade, and his 5% growth target– he also called on the Minister to pursue even higher credit ratings. “We have ambitious objectives,” said the President, “and we are reaching them… but we should not, for any reason, let our guard down.”