Colombia and the IMF
Press Release: IMF Approves a US$2.1 Billion Stand-By Credit for Colombia
Country's Policy Intentions Documents
Free Email Notification
of Intent, Memorandum of Economic Policy, and Technical
Memorandum of Understanding
Mr. Horst Köhler
International Monetary Fund
Washington, D.C. 20431
1. The attached Memorandum of Economic Policy (MEP) and Technical Memorandum of Understanding (TMU) describe the economic policies and objectives for 2003 and 2004 of the new Government of Colombia, headed by President Uribe Velez, in support of which we request a Stand-By Arrangement (SBA) for a period of 24 months from December 2002 in the amount of SDR 1,548 million. We also request the cancellation of Colombia's Extended Fund Facility Arrangement that is scheduled to expire on December 19, 2002, if the SBA is approved before that date.
2. The program for 2003 and 2004 is designed to reinforce macroeconomic policies and reduce vulnerabilities at a time when the external environment has become increasingly difficult and Colombia faces the challenges of fostering higher economic growth, providing enhanced social services, and strengthening domestic security. The government believes that its economic program and the policies described in the memorandum will promote growth and improve opportunities for all Colombians. In a comprehensive manner, the new administration's program enhances fiscal revenue; curtails spending; tackles corruption; supports the economic recovery; and aims at promoting a better distribution of income, social services, and opportunities.
3. With the implementation of the policies outlined in the attached MEP, the government will seek to ensure that the program and its objectives are fully achieved. If the need arises, the government will stand ready to take additional measures. During the period of the arrangement, the Colombian authorities will maintain a close policy dialogue with the Fund.
1. Colombia has achieved considerable macroeconomic stabilization since the crisis of 1998-99, despite an increasingly difficult security situation and an often adverse external environment. Fiscal consolidation has advanced, structural reforms have been put in place, inflation has been reduced, and the banking system has been restructured. Up to earlier this year, these achievements had given the country good access to international financial markets and helped stabilize the currency.
2. This year, however, the country has been subject to contagion from other countries in the region, and from midyear the peso came under pressure in the foreign exchange markets. As in most other countries in the region, the sovereign bond spreads widened sharply. This situation was aggravated by the widening of the fiscal imbalance and the difficult domestic security situation.
3. Faced with these challenges, the new government moved quickly after taking office in August to rein in the fiscal imbalances. First, it proposed and congress approved budget cuts for 2003. The result was an austere budget in which noninterest expenditure increased by less than expected inflation. In addition, it levied a one-off tax on net wealth, and in September presented to congress a package of tax measures and key structural reforms. The government also has begun to implement a program to reduce and restructure the public administration, and has advanced on a reform plan for the public finances. Moreover, the government has secured congressional approval of an initiative to submit to a nationwide referendum early next year a number of political and economic measures.
4. The government is determined to strengthen internal security, which is vital for the recovery of confidence in the economy. This objective will not be pursued at the expense of macroeconomic stability, as demonstrated by the imposition of the wealth tax, which will yield about 1 percent of GDP to help finance the additional security needs in 2002 and 2003. Through fiscal consolidation the government intends to gain firm control over the public debt dynamics and reduce the economy's exposure to shocks, thus helping to foster economic growth, employment, and social equity. The Fund's support will be essential by providing comfort to the markets, helping the administration to implement needed policy adjustments and reforms, and by providing additional resources.
5. There will be quarterly reviews with the Fund during 2003. The first review, scheduled for completion before end-March 2003, will focus on (a) the outcome of proposals put forward by the government both to the congress and in the referendum and will assess the need for any additional measures to ensure that the fiscal target is attained; (b) the use of domestic credit by the public sector, the quarterly path for inflation consistent with the annual inflation target established by the central bank board; and (c) reaching detailed understandings on the changes in the special (privileged) pension regimes for teachers and other groups. Based on these understandings, the relevant structural benchmarks for end-June 2003 will be converted into a structural performance criterion for end-June. The second review is scheduled for June 2003, the third review for September, at which time the frequency of reviews in 2004 also will be decided, and the fourth review for December.
6. The government will provide the Fund the information necessary to monitor implementation of the program, as well as other data that may be needed to adequately follow economic and financial developments. The Colombian government expects technical assistance from the Fund and the World Bank to improve its fiscal information system. During the period of the arrangement, and as needed, the authorities will consult with the Fund on policy issues and program implementation.
II. Recent Economic Developments and the Outcome for 2002
7. Real output grew by about 1.5 percent in 2001 and is expected to grow by slightly more in 2002, as suggested by recent indicators. Nationwide unemployment, however, remains near 16 percent.
8. Fiscal performance improved markedly between 1999 and 2001, but the public sector finances weakened this year. When the present administration took office in August 2002, the deficit of the combined public sector risked rising to nearly twice the EFF target of 2.6 percent of GDP. The fiscal slippage reflected a revenue shortfall on account of lower-than-expected economic growth and spending commitments made by the previous administration. In an effort to control the problem, particularly the unfinanced military expenditure, immediately after taking office the new government levied a temporary tax on net wealth by emergency decree. The deficit is currently projected to be 4.0 percent of GDP.
9. Net debt (i.e., excluding treasury notes held by public sector entities) of the nonfinancial public sector increased from the equivalent of 38.8 percent of GDP in 1999 to an estimated 50.7 percent of GDP in 2002, partly because of this year's sharp depreciation of the peso. Domestic debt represents about half of total public debt, and only 4 percent of the total domestic debt is indexed to the U.S. dollar. Colombia has continued to lengthen the average maturity of its internal debt, and has successfully pursued a strategy of extending the maturities of its external debt and reducing the exposure to exchange rate risk, most recently through a swap operation in June this year.
10. Monetary policy is cast within a framework of inflation targeting. Inflation is expected to decline to 6 percent this year, in line with the central bank's target, completing four years of compliance with the announced targets. The recent depreciation of the peso has had an impact on producer prices, but has not to date had a notable effect on CPI inflation. The central bank's monetary policy stance has remained largely unchanged since the first half of 2002, but the bank has intervened in the foreign exchange market by a small amount to support the peso, using its rules-based intervention mechanism.
11. The monetary base grew at a yearly rate of 26.2 percent through September 2002, reflecting an increase in the demand for currency, while broad money increased by 9.0 percent. Bank credit to the private sector increased in 2001 after falling for two consecutive years, and is growing slightly more this year. The lack of a stronger recovery of private sector credit is due mainly to weak demand.
12. The banking system has continued its recovery since the crisis of 1999, but weaknesses remain, particularly among the mortgage banks. The banks' operating environment has been strengthened significantly with the adoption of tighter regulations for loan-loss provisions, loan classification and capital adequacy, consistent with international best practices. Supervision has improved markedly with the continuing implementation of recovery plans for weak institutions, closer coordination between the supervisory authorities, and adoption of regulations for prompt corrective action. Support mechanisms have been firmly established by the central bank and the bank restructuring agency (FOGAFIN). FOGAFIN also has designed mechanisms to strengthen the capital base of financial institutions.
13. Despite the slowdown of the world economy and the volatility of private capital markets, Colombia's net international reserves (NIR) position has remained strong, covering more than 100 percent of external debt falling due within the next 12 months. The current account deficit is expected to remain unchanged at about 1.8 percent of GDP this year. However, conditions in international capital markets deteriorated sharply in 2002, leading to a fall in public and private capital inflows that will nonetheless finance the current account deficit and provide for a small accumulation of reserves. For the most part, the foreign financing is taking the form of direct investment and medium- and long-term borrowing by the public sector. Colombia's total external debt is projected to increase from 48.1 percent of GDP in 2001 to about 53 percent in 2002, due to the recent sharp depreciation of the peso and the slow growth.
III. The Program for 2003
14. The government's program will allow Colombia to retake the fiscal consolidation path in 2003 through robust and durable policies that will ensure sustainability of the public debt. Fiscal action and a strong structural agenda will ensure that these objectives are attained within a framework of continued macroeconomic stability supported by prudent monetary policies and a further strengthening of the financial system. We understand that the Fund's Executive Board would consider Colombia's request for an SBA by about December 20, 2002, by which time important elements of the government's reform program will have advanced, including the approval by congress of the proposed tax and pension reforms.
15. The macroeconomic framework for the program is based on real economic growth of between 2.0 and 2.5 percent and inflation in the range of 5 to 6 percent in 2003. The current account deficit is projected to narrow to 0.8 percent of GDP, reflecting some rebound in nontraditional exports and also, in part, more difficult access to external financing. Notwithstanding the smaller current account imbalance, the planned fiscal adjustment will allow the excess of private savings over investment to decline and ease the constraint on private sector activity.
16. A strengthening of the public finances is a central element of the program, designed to reduce the combined public sector deficit from 4.0 percent of GDP in 2002 to 2.5 percent of GDP in 2003, and to continue the consolidation process in subsequent years. The adjustment in 2003 will be achieved mainly through the revenue and expenditure measures summarized in this paragraph, which will more than offset increasing security spending and interest payments and a decline in the operating surplus of the public enterprises related to a further fall in oil production. The combined public sector deficit in 2003 will be adjusted upward to the extent any new external financing on concessional terms becomes available, up to a maximum of 0.5 percent of GDP for the year as a whole, to strengthen the security effort and the consolidation of peace as set out in the attached Technical Memorandum of Understanding (TMU), which also establishes the quarterly limits on the fiscal deficit in 2003. The reduction of the overall deficit will raise the primary surplus of the nonfinancial public sector to 3 percent of GDP next year, from 0.7 percent of GDP in 2002. The main fiscal actions contemplated under the program are:
17. Comprehensive and far-reaching structural reforms and additional fiscal action will complement these measures to achieve the targeted improvement in the public finances during the program period and over the medium term:
18. The government already has taken steps in planning additional measures to address issues of accountability, transparency, and flexibility of the public finances. The agenda for these reforms is set out in the TMU.
19. The financing of the fiscal program will be based on an appropriate combination of domestic and external sources:
20. The government recognizes a number of risks that may threaten the full implementation of its program, such as an unanticipated increase in security spending, insufficient support for the government's economic initiatives, including those in next year's referendum, and volatility in the external markets. Thus, the government has identified contingency measures designed to safeguard the program against such events. These include additional tax measures and spending cuts, particularly bringing forward the measures discussed in paragraph 17 (third bullet point) above. In the case of financing shortfalls, the government will consider temporary use of resources in the Petroleum Stabilization Fund, whose current balance is nearly 1.5 percent of GDP. With regard to security spending, initial returns indicate that the wealth tax earmarked for this purpose is yielding more than anticipated. If these additional resources plus the fiscal contingency measures just mentioned were not sufficient to finance unanticipated military spending increases, the government would consider the possibility of issuing long-term bonds on concessional terms.
21. Monetary policy will continue to be conducted within a framework of inflation targeting with a floating exchange rate. The inflation target for 2003 has been set as a range of 5 to 6 percent (with a point target for Colombian legal purposes at 5.5 percent) with a long-run target of 3 percent. The programmed increase in VAT is expected to have a transient upward effect on headline inflation during 2003. The central bank has established a quarterly trajectory for headline inflation, consistent with its annual target and will review with the Fund any major divergence from the trajectory as set out in the TMU. Reflecting its inflation targeting strategy, the central bank will stand ready to take appropriate actions to keep future inflation on target.
22. External viability of the program will be established by targeting a quarterly floor for the central bank's net international reserves (NIR), which for program purposes will rise by US$318 million in 2002 and US$243 million in 2003 to reach US$10,543 million at end-December 2003. The accumulation in 2003 reflects the projected income on the international reserves, and is consistent with no net exchange market intervention by the central bank under the floating regime for the peso. However, the baseline targets may be adjusted downwards to allow interventions called for to control destabilizing exchange rate fluctuations, as set out in the attached TMU. In case of a cumulative decline in NIR in excess of US$1,000 million during any rolling 30-day period, consultations will be held with the Fund on how the loss of reserves can be controlled, as explained in the attached TMU.
24. Business and labor market conditions will be enhanced by policy action in the areas of labor market reform, and the trade regime.
IV. Further on the Program for 2004 and the Medium Term
25. Fiscal consolidation will continue in 2004 and over the medium term, building on the fiscal measures and structural reforms already described. Economic conditions are expected to improve in 2004. Real GDP growth is expected to increase to above 3 percent, accompanied by a widening of the external current account deficit to 1.5-2.0 percent of GDP. The wider deficit would be financed by direct investment, continued strong multilateral support, and access to external financial markets. Monetary policy will be geared to supporting a moderate further decline in inflation within a framework of inflation targeting and a floating exchange rate.
26. The public sector deficit will be reduced to 2.1 percent of GDP in 2004, supported by the measures outlined above and any additional action that may be required. This will reduce the nonfinancial public sector's debt to 50.1 percent of GDP. The full program for 2004 will be developed at the review scheduled for September 2003.
27. The government is committed to prudent debt management policies and will reduce the nonfinancial public debt as a percent of GDP during the period of its mandate; moreover, it will pursue policies that will permit a further reduction of the public debt-to-GDP ratio during the rest of the decade. The government expects that steady debt reduction, continued improvement in the indicators of economic vulnerability, and strong economic management, will boost confidence and allow Colombia's credit rating to improve, and the cost of its borrowing to fall.
28. Since 1999 Colombia has reduced the economic imbalances that threatened to thwart economic growth and social progress. Inflation has been reduced, competitiveness and financial stability have been restored. However, recently, the economy has underperformed, and the progress on poverty alleviation has been unsatisfactory. With security and economic recovery its highest priorities, the new administration is fully committed to pursuing the fiscal consolidation and structural reforms required to bring about the changes needed to allow all Colombians to benefit from the opportunities that a revitalized economy will create.
1. This memorandum sets out the definition of concepts, specific performance criteria for December 31, 2002 and March 31, 2003, and the structural benchmarks for the remaining period of the program, as well as the assumptions that apply under the program supported by the stand-by arrangement.
I. Fiscal Targets
2. The overall balance of the combined public sector (PS) is defined as the sum of the overall balances of the nonfinancial public sector (NFPS), the operating cash result (quasi-fiscal balance) of the Banco de la República (BR), the overall balance of the Fondo de Garantías de Instituciones Financieras (FOGAFIN), and the net fiscal costs borne by the central administration and the rest of the NFPS related to financial sector restructuring. The NFPS consists of the general government and the public enterprises; the general government includes the central government, the territorial governments, and the social security system; the central government includes the central administration and the national decentralized agencies as indicated below. The net fiscal costs borne by the central administration and the rest of the NFPS related to financial sector restructuring (not part of the NFPS balance) are defined to include interest payments and amortization of the bonds used to compensate financial entities for the mortgage debt reductions approved by the congress in December 1999, the interest payments on the bonds used to recapitalize public banks, the costs of closing Caja Agraria, and any additional fiscal charges (including interest costs) related to the recapitalization, restructuring, liquidation, and privatization of financial entities.
3. For any given calendar quarter, the overall PS balance is measured, in Colombian pesos, as the sum of: (i) its net domestic financing; (ii) its net external financing; and (iii) privatization proceeds, as defined below.
4. The PS net domestic financing comprises (i) the change in its net credit from the financial system, excluding bonded debt; (ii) the change in its bonded debt (including domestic bonds denominated in or indexed to foreign currencies) excluding any valuation changes; (iii) the change in the budget carryover (rezago presupuestario, which includes cuentas por pagar and reservas de apropiación) of the central administration and changes in the floating debt (cuentas por pagar) of the social security system (Instituto de Seguro Social, Cajanal, and Caprecom) and main public enterprises: Ecopetrol, Telecom, the national electricity companies (ISA, ISAGEN, and the national electricity distributors), and the national coffee fund; (iv) the change in the amount of public funds administered by Fiduciarias; and (v) the operating cash result of the BR. Any capitalization of interest on new issues of government bonds after September 1, 1999 and the accrual of the inflationary component of indexed bonds will be included—on a quarterly basis—as interest expenditure for the purpose of measuring the PS deficit.
5. The financial system comprises the banking sector, mortgage banks, finance corporations (corporaciones financieras), FEN, IFI, finance and leasing companies (compañías de financiamiento comercial), Bancoldex, Finagro, and Findeter. The banking sector comprises the BR and the commercial banks.
6. The PS net external financing is defined as the sum of (i) disbursements of project and nonproject loans, including securitization (titularización) of export receipts; (ii) proceeds from bond issues abroad; (iii) the net changes in short-term external debt including prepayment of exports; and (iv) any change in arrears on external interest payments; minus (v) net increase in the financial assets held abroad by the PS; (vi) cash payments of principal on current maturities for bonds and loans; (vii) cash payment to settle any external arrears; (viii) any prepayment of external debt; and (ix) the value of any new leasing contracts entered into by the public sector during the program period, which is defined as the present value at the commercial interest reference rate (CIRR) (at the inception of the lease) of all lease payments expected to be made during the period of the lease contract excluding those that cover the operation, repair, or maintenance of the property.
7. Privatization proceeds are defined as the cash payments received by the PS. Nonrecurrent fees (e.g., prepayments) received by the PS for concessions to operate public services, such as in the telecommunications sector, are treated as privatization proceeds. For purposes of the program, such fees will be accounted for over the concession period, distributed in equal quarterly amounts. Proceeds from the decapitalization of public enterprises will be considered as privatization. To the extent that the purchasers of public enterprises assume their debts, the net financing used by these enterprises during the program period until their sale will be deducted from the net financing of the PS; if the PS assumes the debt, the net financing used by the enterprise during the program period before the sale will remain outstanding as part of the financing of the PS.
8. The joint operation between TELECOM and a resident firm, which is a subsidiary of a foreign company, will be registered in the fiscal accounts on an accrual basis. The operation involves the acquisition by TELECOM from a resident firm of fixed assets (represented by installed telephone lines) financed by a loan from the resident firm that will accrue interest. The breakdown of the debt service between amortization and interest payments, to be accrued in the fiscal accounts, will be determined by the internal rate of return corresponding to the cash payments to be made during the period of the joint agreement.
(i) The quarterly ceilings on the combined public sector deficit will be adjusted upward (larger deficit), and the ceiling on net disbursements of medium- and long-term external debt of the public sector (see below) will be adjusted upward by the full amount of any concessional loan disbursements beyond what is currently envisaged under the program, up to a maximum of 0.5 percent of GDP or US$360 million for 2003 as a whole, in support of the government's domestic security program "Seguridad Democrática." A loan will be considered concessional if it has at least a 35 percent grant element at the time of loan approval using the commercial interest reference rate (CIRR) as discount rate.
(ii) The cumulative quarterly ceilings on the combined public sector deficit will be adjusted downward by 130 percent of the revenue (gross deposits) of the petroleum stabilization fund (FAEP), as currently defined in the law, in excess of the baseline set out in the table below.
10. Exchange rate conversion. (i) For the PS balance, items denominated in foreign currency will be converted into Colombian pesos at the actual exchange rate of each transaction; (ii) for the net external financing of the PS, the local currency amounts of the net external financing transactions are calculated at the actual exchange rate of each transaction; (iii) privatization proceeds are converted to Colombian pesos at the actual market exchange rate of each transaction.
II. Monetary Targets
11. Reflecting the BR's inflation targeting framework for monetary policy, quarterly targets for 2002 and 2003 have been established for the 12-month rate of consumer price inflation, measured by the Indice de precios al consumidor (IPC) compiled by the Departamento Administrativo Nacional de Estadisticas (DANE). The authorities will complete consultations with the Fund (Executive Board) on the proposed policy response before requesting purchases from the Fund in the event that the observed quarterly inflation were to deviate from the programmed quarterly baseline target by 2 percentage points or more, as set out in the table below. In the event that the actual inflation deviates significantly from the programmed target within the 2 percentage point margin in any calendar quarter, the BR staff will report to the IMF staff on the reasons for the deviation and the policy response adopted, if any. The BR will provide Fund staff with monthly information and analysis of inflationary developments and forecasts, and keep the staff informed of all policy actions taken to achieve the inflation objectives of the program.
12. Adjustment. The inflation path could be adjusted by the direct effect of the VAT reform on the current consumer basket used to calculate the inflation target. For the first review scheduled for March 2003, the inflation path could be revised to take into account the VAT reform.
III. External Targets
13. The NIR of the BR (reservas de caja) are equal to the U.S. dollar value of gross foreign reserves of the BR minus gross foreign reserve liabilities.
14. Gross foreign reserves of the BR comprise (i) gold; (ii) holdings of SDRs; (iii) the reserve positions in the FLAR and the Fund; and (iv) all foreign currency-denominated claims of the BR on nonresident entities excluding accrued, but unpaid, interest on reserve assets and valuations. Gross foreign reserves exclude capital participation in international financial institutions (including Corporación Andina de Fomento (CAF), IDB, IBRD, IDA, BCIE, and the Caribbean Development Bank), the holdings of nonconvertible currencies, and holdings of precious metals other than gold. The pesos andinos are considered to be part of Colombia's gross foreign reserves.
15. Gross foreign reserve liabilities of the BR are defined as the sum of (i) all foreign currency-denominated liabilities of the BR with an original maturity of one year or less excluding accrued, but unpaid, interest on liabilities (causaciones); (ii) liabilities to the Fund, (iii) any position in derivatives that represent a claim on gross foreign reserves; (iv) any purchases from the Latin American Reserve Fund (FLAR); (v) any increase in medium- and long-term external debt of the BR over and above US$77.5 million, which is the level of the outstanding debt on September 30, 2002; and (vi) any foreign currency liabilities of the BR to residents, including financial institutions.
16. Adjustment. The quarterly NIR targets may be adjusted downward by up to US$2.0 billion to help secure orderly foreign currency market conditions consistent with transparent rules used by the central bank for foreign exchange intervention. In the event that NIR declines by US$1.0 billion during any 30-day period, the authorities will complete consultations with the Fund (Executive Board) on the proposed policy response before requesting purchases from the Fund.
17. This ceiling applies to the net disbursement (gross disbursement minus amortization/redemptions) of debt of the public sector (financial and nonfinancial) of nonconcessional external debt of maturity of over one year.
18. Guarantees. The government will maintain the policy of not guaranteeing private sector external debt.
19. Exchange rate conversion. (i) changes in the external debt will be valued in U.S. dollars at the exchange rate prevailing at the time of each transaction; (ii) the net international reserves are accounted for at the U.S. dollar value at the time of acquisition; (iii) all references of external debt to GDP are calculated at the end-period exchange rate over annual GDP.
IV. Structural Benchmarks
20. To be completed by December 31, 2002:
21. To be completed by March 31, 2003:
22. To be completed by June 30, 2003:
23. To be completed by December 31, 2003:
24. To be completed by March 31, 2004:
25. To be completed by September 30, 2004: