The medium term: More questions than answers
Several signs indicate that the Colombian economy is still not recovering. In employment indicators, retail trade, manufacturing and construction, things do not look very promising. Most retail sub-sectors are either falling, or performing very poorly. So the slowdown drags on, with no recovery in sight. Unfortunately, employment figures are starting to reinforce that undeniable fact. Given these considerations, inflation trends and the composition of the Central Bank’s monetary board, we expect a strong cut in intervention interest rates, probably to about 5% by yearend.
We expect the current account deficit to normalize this year. The Central Bank projects that it will reach 3.7% of GDP this year, and continue to fall, to 3.2% of GDP in 2019. That would be welcome, as a smaller CAD reduces external vulnerabilities, particularly amid slower FDI inflows. But the bad news is that the CAD shrinkage is due to falling imports, the result of a weak currency, not to export recovery.
The outlook for exports is rather bleak; they are expected to remain at current levels (11.6% of GDP) for the next three years. But imports are projected to fall, from 17.4% of GDP in 2015 to 13.8% of GDP in 2019. This would allow the CAD to fall to 3.2% of GDP in 2019, about its pre-oil price slump level.
Portfolio investment is also expected to fall. If FDI fails to behave as the government hopes, currency devaluation pressure will rise.
The government depicts a much more benign external scenario for the next few years, with a falling CAD, to be financed mostly by FDI, which would suggest a slightly strengthening currency. Among risks are that FDI may not surge in response to peace as hoped. While desirable, peace has also created uncertainty, and political division. Fiscal policy will also need to reflect these new spending commitments, and the possibility of a tax reform is a significant deterrent to investment.
The government’s new Medium Term Fiscal Framework depicts an extremely rosy fiscal outlook, underestimating the size of the challenges to complying with the fiscal rule. The 2017 budget deficit target of 3.6% of GDP is unlikely to be met. The government remains committed to a fiscal rule with which it can only comply in paper. Hence, a modification seems ever more likely, and will probably be at the top of the incoming administration’s agenda.
President Santos is preparing the reshuffling of his cabinet to prepare for the closing year of his eight-year long term. These last political moves are crucial, as, for instance, the alliances made with the Conservative Party shall play a key role in the election of the next president.
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