Colombia should increase the value-added exports and reduce commodity volatility.

BY WALTER T. MOLANO

Colombia has emerged as the new paradigm of sound macroeconomic management in Latin America.
While various strains of socialism reign in the southern cone of the continent, Colombia has become known for its prudence.

The decline in commodity prices half way through 2014, spurred the government to launch an important fiscal reform to make up for the expected shortfall. They did this, despite the fact that they are probably the government that depends the least on oil royalties. Unfortunately, the fiscal shortfall may still crest over the 3 percent of GDP mark in 2015, and the current account deficit will most likely be north of 6 percent of GDP.

The prolonged slump in the commodities market revealed some of the weaknesses of the Colombian economic model. The government in Bogota was correct to exploit its natural areas of comparative advantage. With two branches of the Andes bisecting its territory, as well as its close proximity to Venezuela, it was logical that minerals and oil would be bountiful. Tens of billions of dollars poured into the sectors. The country became a major producer of nickel, with an annual output of more than 81 million pounds. Its gold production topped 1.3 million ounces and silver production was more than 300,000 ounces. However, coal was king, with an output of about 60 million tons. Colombia's coal has very low sulfur, making it sought after by power plants, particularly in North America. A similar situation occurred in the oil sector. Colombia's daily production soared to more than 900,000 barrels per day, with almost two-thirds of the output slated for the export market. Only Trinidad and Tobago exports a larger percentage of its domestic oil production in the Western Hemisphere.

The combination of rising export levels and soaring commodity prices led to the massive appreciation of the Colombian peso. Known locally as the super-peso, the overvalued currency allowed Colombian corporates to go on a buying spree, particularly in Central America. It also permitted Colombian households to embark on unprecedented consumption frenzy, leading to a spike in construction activity and home prices. Unfortunately, the opposite is now happening, as commodity prices drop. The currency went into a free fall at the end of last year, losing 50 percent of its value during an 18 month period. Colombia's reliance on volatile commodity exports makes it vulnerable to drastic changes in the international markets. The massive devaluation of the currency has ignited a huge inflationary surge and the decline in commodity prices has put many producers under pressure. To make matters worse, many were indebted in dollars. Therefore, declining prices and a weaker currency is bringing some operations to the brink of insolvency.

Therefore, it is time to tweak the model. President Alvaro Uribe's obsession with signing a free trade agreement with the U.S. may have been more motivated by politics than economics. He wanted to move the country closer into the U.S. political orbit. However, there were also good economic reasons to make the move. Colombia has the third largest population in Latin America. Much of the population is concentrated in three cities, and the level of education is very good. This makes it an excellent candidate to become an important manufacturing base. With deep water ports on the Atlantic and the Pacific, Colombian manufacturers have access to a broad range of markets and destinations. Unfortunately, this was not an option during the last seven years when the currency was soaring. Manufacturers were hobbled by the continued inflow of cheap imports, but the tide has finally changed.

Now is the opportunity to channel capital into areas with higher value-added content. Many investors are starting to realize that extraction costs in the Colombian mineral and oil sectors are too high because many of the mines and oil fields are in regions that are difficult to access. Taxes are also onerous, but labor costs are becoming exceedingly attractive. By tweaking the economic model, Colombia can shift into a level of development that can created higher paying jobs and imbue the economy with greater stability. The Colombian economy could become more akin to Mexico, which has increased the value-added content of its exports and is less vulnerable to the violent swings in the international commodity markets.

Walter Molano is head of research at BCP Securities and the author of In the Land of Silver: 200 Years of Argentine Political-Economic Development.