Will Colombia's plan to spur the economy be effective?

BY LATIN AMERICA ADVISOR
Inter-American Dialogue

Colombia's government on April 15 unveiled a $2.74 billion stimulus package that is intended to boost the economy and cool the appreciation of the peso. New measures will also encourage private pension funds to invest more money abroad, among other steps, said Finance Minister Mauricio Cárdenas. What factors have led to the peso's appreciation and slower economic growth in Colombia? Will the government's plan be effective? What sectors of Colombia's economy are doing well, and which are hurting the most? 

Ben Ramsey, executive director for Latin America Research at J.P. Morgan in New York: Colombia's economy moved from an above-trend 6.6 percent pace of GDP growth in 2011 to slightly below-trend 4.0 percent growth in 2012 (the authorities estimate potential GDP growth between 4.5 and 4.8 percent). The data suggest the third quarter of last year was already the low point for activity, with fourth-quarter GDP and first-quarter indicators pointing to a gradual, if still somewhat choppy, recovery path. Colombia's economy has been characterized on the positive side by strong demand from household consumption and a natural resource extraction boom, drivers which have contrasted with mediocre performance from the agriculture sector and an increasingly struggling manufacturing sector. Amid these cross-currents, the wild card for overall quarterly GDP results has come from rather volatile swings in public infrastructure investment and construction. A stronger Colombian peso-itself a function of higher commodity prices, ample global liquidity and a lower risk premium on Colombian credit-has added to the drag on the lagging sectors, but we do not think the peso's strength per se fully explains competitiveness concerns. Nor do we think the indirect measure to increase U.S. dollar demand from pension funds should provide much immediate relief. Nonetheless, manufacturing and agriculture are politically sensitive, employment-generating sectors, and the recently announced stimulus is clearly aimed at injecting them with some life via higher and accelerated government investments, combined with some fiscal alleviation and extension of credit. Overall, the measures were well received, and they reduce the risk around our prevailing view that the economy can return to trend-like growth by the second half of 2013. That said, even prior to the package, we were expecting a marked increase in previously delayed public investment, and execution capacity is a more important variable than good intentions. 

Erich Arispe, director in the sovereign ratings group of Fitch Ratings: Colombia's growth slowed down to 4 percent last year due to underperformance in construction (public works and residential), manufacturing and agriculture. The deceleration continued in the first quarter of this year as persistent weakness in construction and manufacturing was accompanied by negative shocks to the mining (coal) sector. Strong credibility and benign inflation dynamics have allowed the central bank to provide policy stimulus (200 basis points of cuts since last July) to boost domestic demand. Officials have also increased their intervention in the foreign exchange market to avoid loss of competitiveness and potential macroeconomic imbalances from a strong currency. Appreciating pressures have moderated in 2013 due to lower domestic interest rates, changes in the public sector external financing plans and relative deterioration in global risk perceptions. In addition, the government recently introduced the Productivity and Employment Impulse Plan (PIPE) to provide a boost to housing and public works and increase demand for foreign exchange through diversification of pension funds' assets. Fitch believes that Colombia is presently undergoing a cyclical downturn and that growth could recover and approach the economy's potential, averaging 4.5 percent in 2013-2014 as the mining sector stabilizes and the policy stimulus filters through to credit, construction and confidence. Nevertheless, a higher growth trajectory could be facilitated by progress on the competitiveness-enhancing agenda. The country faces the challenge of reducing labor costs and infrastructure gaps to support sectors not directly related to mining and hydrocarbons. Transportation infrastructure has been flagged as a key factor weighing on Colombia's competitiveness, growth and diversification prospects. 

Felipe Carvallo, assistant vice president and analyst at the Financial Institutions Group of Moody's de México: President Santos' stimulus plan includes measures for easing the appreciation of the peso, which will aid Colombian exporters of raw materials affected by lower prices on their products. The elimination of specific tariffs, as well as the temporary elimination of electricity and gas surtaxes, will ease cost pressures on small- and mid-sized enterprises. However, most importantly, the stimulus plan includes commitments to long-delayed infrastructure concessions, a further $388 million in infrastructure investments and $927 million of subsidies for residential construction, all of which will boost demand for corporate loans over the next two years. Despite banks' expectations that commercial lending would drive growth in 2012, the growth of the portfolio lagged at 11.5 percent, versus consumer loans which grew 17.3 percent. Commercial lending was directly affected by delays in the approval of the large-scale infrastructure concessions that were listed in the announcement. We expect the banks with the largest commercial portfolios will benefit from the boost in the construction sector, which accounted for 16.6 percent of total commercial loans as of year-end 2012. Banks focused on middle-class mortgages will also benefit from increased mortgage demand related to interest rate subsidies for middle-class residences worth $44,000-$109,000. The 250-basis-point subsidy, which the government gives directly to borrowers to incentivize them to shop for the lowest rate in the market, is substantial when compared with the average mortgage rate for middle-class borrowers of 12.2 percent as of the last week of March.

Republished with permission from the Inter-American Dialogue's daily Latin America Advisor