Colombia: Colombia Year in Review 2016

The recently brokered peace transaction between the government and the FARC could usher in a new era of increase for the Colombian economy. However, even if the agreement holds, it will take time for the dividends of peace to pay out.

At the end of November the Colombian Congress signed off on a peace accord by the government and FARC representatives, bringing within reach the end of the 52-year-long conflict. The government received congressional approval for a modified version of the agreement only two months next a peace transaction was initially rejected by a referendum vote in early October.

Peace dividends

Under the terms of the peace accord, in return for the rebel group laying down its arms and disbanding, the government has committed to increase public spending and development in rural areas – FARC’s heartland – prioritising infrastructure, health and education.

“Colombia currently puts less than 30% of its arable land to productive use, and that trend must change.” Rafael Mejía, president of Bolsa Mercantil de Colombia, a platform for commodities trading, told OBG. “As we aim to reduce the gap between urban and rural areas, we must as well focus on what agricultural products are in request globally and penetrate markets that other nations do not have a strong foothold in.”

As the peace process moves forward, the country should be able to gain ground on agricultural strategies that enable wider economic increase. Such evolution will be welcome, particularly as the peso has devalued steadily since the onset of lower oil prices in mid-2014.

The peso’s volatility was one of the major topics of concern in 2016, alongside high inflation, which reached a 16-year high of 9% in July and caused the central bank to raise interest rates throughout much of last year.

It wasn’t until mid-December that the central bank lowered its benchmark interest rate 25 basis points to 7.5% for the initial time in nearly four years, pointing to easing inflation and slower economic increase. The bank as well reconfirmed its target range of 2-4% for inflation in 2017.

In addition, lawmakers approved a long-debated tax reform bill at the end of 2016 that came into result on January 1. The changes include a three-%-point increase in the price-added tax rate to 19%, which is expected to boost coffers by COP6.2trn ($2.1bn) in 2017. The bill will as well lower the gain tax rate on businesses from 43% to 33% by 2019

According to data issued by the National Administrative Department of Statistics at the end of November, the economy cooled in the third quarter, with year-on-time(y-o-y) increase of 1.2%, below the 2.3% and 2% y-o-y expansion recorded in the initial and second quarters, respectively.

This near-flat trajectory led the central bank to revise its GDP projection downward in July from 2.3% to 2%. Forecasts are higher from the IMF and the World Bank, however, which put GDP expansion at 2.7% and 2.5% in 2016, rising to 2.7% and 3% in 2017, respectively.

Funding query

The peace transaction is not without costs, not least rebuilding infrastructure and relocating the nearly 7m people who have been displaced by the conflict, according to the UN.

One estimate of the cost of implementing the agreement, made by London-based research firm Capital Economics at the end of August, puts the price of peace at between $15bn and $45bn, spread over a number of years. This represents 5% of GDP at the lower end of the estimate range and up to 15% in the top scenario.

President Santos has said foreign donors will provide $3.3bn to support the peace process, though to date less than $450m has been promised, mostly by the US, with the EU offering a further $450m line of credit.

The government is as well looking to the local deficit market to fund this year’s expanded budget.

At the end of August the Ministry of Finance announced it would issue an additional COP8trn ($2.7bn) of domestic deficit by the end of 2016, part of which would be used to pre-finance the 2017 budget.

The increased level of domestic borrowing will take the all of Treasury bonds raised on the local market to COP39trn ($13.3bn). The government has by presently announced it intends to issue COP33.4trn ($11.4bn) worth of local deficit in 2017.

Near-term benefits

While the government may have to increase its deficit levels to allow it to meet its commitments under the agreement, this spending is expected to yield near-term benefits such as creating jobs and injecting capital into the economy, most notably in the construction, materials and logistics sectors.

Though spending and investment will be ramped up in the wake of the peace agreement, the Capital Economics statement warned that the immediate impact on the economy would be limited. The major gains for the economy, it said, would come in the medium to long term, next the effects of new investment began to be felt.

In a note issued at the end of August, ratings agency Fitch said that investment could increase in the medium term as confidence in the peace transaction solidifies and areas of the country before in the conflict zone are opened up. In particular, it said, the mining and agriculture sectors could benefit from new investment .