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March 17, 2017
A Concluding Statement describes the preliminary findings of IMF staff at the end of an official staff visit (or 'mission'), in most cases to a member country. Missions are undertaken as part of regular (usually annual) consultations under Article IV of the IMF's Articles of Agreement, in the context of a request to use IMF resources (borrow from the IMF), as part of discussions of staff monitored programs, or as part of other staff monitoring of economic developments.
The authorities have consented to the publication of this statement. The views expressed in this statement are those of the IMF staff and do not necessarily represent the views of the IMF's Executive Board. Based on the preliminary findings of this mission, staff will prepare a report that, subject to management approval, will be presented to the IMF Executive Board for discussion and decision.
Colombia continues its remarkably smooth adjustment to a combination of external and domestic shocks guided by a strong policy framework. Timely policy tightening last year helped narrow somewhat macroeconomic imbalances, including those related to the current account deficit and inflation. Further adjustment is needed this year, so monetary and fiscal policies have to continue to be tight but could be eased somewhat to support the recovery, while protecting financial stability. The peace agreement and the structural tax reform are important milestones that will buttress medium-term inclusive growth, together with the authorities' infrastructure agenda.
The policy response to the shocks of recent years has been very effective, but there is still a road ahead to complete the adjustment, building on peace and structural reform.
An orderly response to a sequence of shocks ...
Colombia withstood multiple external and domestic shocks in 2016. The global oil price further declined, eroding fiscal revenue and exports; and economic difficulties in regional partners hampered export diversification efforts. On the domestic side, a nationwide truck-drivers' strike and protracted effects of El Niño fueled inflationary pressures and constrained activity.
Fiscal policy remained anchored by the structural fiscal rule, while monetary policy flexibly reacted to changing conditions. The central government continued its fiscal restraint. The structural balance target was achieved through a combination of primary expenditure cuts and some tax administration gains. Weak expenditure execution at subnational governments was within the norm for first-year administrations and added to the demand restraint coming from fiscal policy. The central bank's tightening cycle continued until August and brought the policy rate above its neutral level to contain inflation, which reached a multi-year high in July. With inflation moderating rapidly as previous shocks dissipated late in the year, the central bank started an easing cycle in December.
The policy tightening was appropriate and guided a faster-than-expected adjustment. Real GDP growth declined to 2 percent as domestic demand decelerated markedly, which helped narrow the current account deficit faster than expected. Monetary policy tightening preserved the anchoring of inflation expectations and underpinned a welcome moderation in credit growth. Latest data suggests GDP growth could remain subdued in the first part of 2017 despite early signs of some recovery in non-traditional exports.
... requires a policy mix that further advances the adjustment while protecting the recovery.
The near-term outlook is favorable but also exposed to risks. The approval of the structural tax reform and the conclusion of the peace agreement removed two major sources of uncertainty and will support economic activity going forward. Amid better external conditions and the dissipation of the 2016 domestic shocks, the mission expects real GDP growth to pick up mildly in 2017 to 2.3 percent, as investment, including 4G-related projects, rebounds. The current account deficit will further narrow supported by higher oil prices and non-commodity exports. Inflation will continue its downward trend despite the temporary impact of the VAT increase. Downside risks stem in part from the still relatively high (but moderating) gross external financing needs and include bouts of financial volatility; further declines in oil prices that could cut fiscal revenues and fuel currency depreciation and inflation; political uncertainty, global as well as domestic, could damage confidence and delay investment. Weaker than expected performance of non-traditional exports is a risk to achieving a sustainable external position. On the upside, a rapid implementation of the peace agreement could bring forward the peace growth dividend.
A gradual easing of monetary policy and a smaller fiscal drag will help the recovery in 2017. Rapidly declining inflation and well-anchored inflation expectations create room for some monetary policy easing during the year. Bringing the policy rate closer to its neutral level will support domestic demand while also continue to guide the current account deficit closer to its medium-term equilibrium. The mission shares the authorities' view that the interest rate policy decisions will bring inflation to the 3 percent target in the policy horizon and that the precise path of monetary easing will remain data-dependent. The demand restraint coming from fiscal policy will ease, as spending by regional governments picks up, while the authorities bring the central government deficit toward the 3.3 percent of GDP target. The flexible exchange rate regime will remain the first line of defense against external shocks.
The mission welcomes the structural tax reform as it will allow a more balanced fiscal consolidation while improving competitiveness. The reform rightly reduces the corporate tax burden while simplifying the tax system. The progressivity of the reform is somewhat limited by the small impact it has on personal income tax revenue. The mission welcomes the authorities' plan to devote the reform's yield to protect public investment and key social programs including those related to the peace agreement, while adhering to the fiscal consolidation mandated by the fiscal rule. This will help reduce public debt in relation to GDP and contribute to further reduce external risks. The mission encourages the authorities to continue efforts to improve tax administration as this will be key to achieve the expected yield from the reform. On the expenditure side, recent efforts to improve the targeting of subsidies and call for expert recommendations to improve expenditure efficiency are also welcome.
A structural reform agenda focused on diversification and inclusion...
Colombia's medium-term outlook is favorable. Colombia's strong growth performance during the last decade was partly due to favorable demographics and the investment response to the commodity boom. Its medium-term outlook will depend more on productivity growth and diversification of growth drivers. The prompt implementation of the authorities' reform agenda, summarized in the Colombia Repunta program--including the strengthening of infrastructure and education and the streamlining of regulation--would boost actual and potential growth. Removing tariff barriers in key sectors and continued efforts to reduce non-tariff barriers and improve coordination across government agencies would improve competitiveness and facilitate export diversification. Efforts to promote new export markets and products are starting to bear fruit. The mission expects growth to strengthen in 2018 and further over the medium-term.
The implementation of the peace agreement will boost inclusive growth over the medium and long term. The mission welcomes the authorities' commitment to implement the peace agreement while protecting fiscal sustainability, using wisely the fiscal space created by the tax reform and giving priority to strengthening the state's presence in the most vulnerable municipalities. The mission shares the authorities' emphasis on expenditure reallocation as a key funding source and encourages the authorities to promptly incorporate the peace-related financial plan into the medium-term fiscal framework.
... will support the adjustment and recovery while preserving financial stability
While the financial system appears sound, latent risks warrant close monitoring. Strong prudential standards (including on provisioning and collateral) have helped cushion the impact of shocks and the authorities' stress tests suggest that banks can withstand large macro-financial shocks. Capital adequacy is nearly double the regulatory minimum and bank profitability is within the historical average. Non-performing loans (NPLs) have increased only marginally despite the marked economic slowdown. However, some worsening in corporate balance sheets over the past two years and recent softening in labor market pose upward risks to NPLs. The mission welcomes the authorities' continued monitoring of credit risk associated with a further increase of commercial NPLs as well as those risks stemming from the fast growth of consumer and mortgage credit.
The mission welcomes the authorities' efforts to bring financial sector regulation and supervision closer to Basel III. The planned adoption of the Basel III capital standard by deducting goodwill from common equity Tier 1 capital will help strengthen the quality of bank capital. The introduction of Basel III capital buffers is under consideration; staff urges the authorities to adopt the minimum tier 1 capital recommended by Basel. The mission encourages the authorities to seek the prompt approval of the conglomerates law which will improve the toolkit to manage risks from weaker corporate balance sheets and overseas exposures. The mission encourages ensuring that the law enables supervisors to require capital adequacy levels that properly account for group-wide risks. The mission encourages close monitoring and supervision of credit risk including by ensuring that banks classify loans appropriately. The mission welcome the authorities' plans to improve the risk framework by incorporating country risk and operational risk and to increase staff at the Financial Superintendency.
The mission would like to thank the Colombian authorities for their cooperation and candid and open discussions.