## 1. Updated External Economic Stress Index ## Source details **Canonical URL:** [1. Updated External Economic Stress Index](https://www.imf.org/-/media/files/publications/cr/2017/cr17149.pdf) ## Other formats - [Markdown version](/-/media/files/publications/cr/2017/cr17149.pdf.md) - [Structured JSON version](/-/media/files/publications/cr/2017/cr17149.pdf.json) --- ### Context and recent developments - Colombia is adapting smoothly to the large terms of trade shock experienced since 2014. - Growth and oil shock: - Growth moderated to 2 percent in 2016. - The decline in oil prices since June 2014 amounted to 50 percent. - Inflation and monetary policy: - Inflation started declining in August 2016 but remained above the target band due to the lagged impact of the large depreciation and weather-related shocks. - Inflation converged to the target band guided by monetary policy tightening. - The central bank started a gradual easing cycle in December as inflationary pressures abated. - A 325bps tightening cycle finished in December 2016. - Inflation was 4.7 percent in April, down from a peak of 9 percent in July 2016. - 12- and 24-month-ahead inflation expectations are within the target band. - External and fiscal balances: - Strong import compression narrowed the current account deficit to 4.4 percent of GDP in 2016, from 6.4 percent of GDP in 2015. - The fiscal deficit widened to 4 percent of GDP as oil revenue declined, but the structural fiscal balance improved. - Structural tax reform (December 2016): - Increased the VAT rate by 3 percentage points. - Simplified the tax code, reduced the high corporate tax burden, and included measures to improve formalization and tax administration. - Financial system: - The financial system remained well capitalized and liquid, though corporate balance sheets worsened somewhat. - Peace agreement and structural agenda: - The peace agreement with the FARC (signed December 2016) and the structural reform agenda underpin medium-term inclusive growth and infrastructure-led expansion. ### Financial markets and external position - Role of the FCL arrangement: - Colombia’s FCL arrangement provided support to pursue policy adjustments amid global and regional uncertainties and signaled policy strength. - The authorities treat the FCL arrangement as precautionary and intend to reduce access as risks recede. - The Executive Board last assessed Colombia’s adherence to the FCL qualification criteria on June 13, 2016, during approval of the current two-year FCL arrangement for 400 percent of quota. - Market responses and vulnerabilities: - Recent episodes of falling oil prices (13.4 percent in October–November, 2016; 10.8 percent in February–March, 2017) were associated with currency depreciations but had limited impact on other markets. - Sovereign bond and CDS spreads were 202 and 133 basis points respectively and have declined significantly since June 2016. - Nonresident holdings of local-currency government bonds increased 39 percent to US$21 billion since the FCL request and account for 25 percent of total domestic public debt. - Nonresidents hold about 50 percent of the outstanding 10-year benchmark bonds. - Gross international reserves stood at US$46.9 billion as of April 2017. - Equivalent to 140 percent of the ARA metric and 127 percent of the sum of short-term external debt at remaining maturity and the projected current account deficit. - External debt and financing: - External debt was 49 percent of GDP at end-2016. - External debt is projected to decline slightly to 46 percent of GDP in 2022 and would remain manageable under negative shocks. - Gross external financing needs declined to about 12 percent of GDP in 2017 and are expected to remain around 10 percent of GDP in the medium term. - The current account deficit is projected to decline to 3.8 percent of GDP in 2017. - FDI inflows are projected to remain around 3.4 percent of GDP in the next five years. - Public finances and debt: - Public debt declined marginally to 50.2 percent of GDP in 2016 and is projected to fall to 41 percent of GDP in 2022. - The structural tax reform aims to increase revenue by about 3 percent of GDP over the medium term. ### Outlook and risks - Growth outlook: - Staff projects growth to increase to 2.3 percent in 2017. - Medium-term growth is expected to reach 3.5 percent as infrastructure spending, tax reform effects, and peace-agreement confidence lift activity. - Inflation outlook: - Inflation is projected to converge to the target band in early 2018. - The effects of the VAT increase and indexation will delay convergence to early 2018. - External and global risks: - The updated External Stress Index indicates baseline external conditions are better than at the time of the FCL approval but would worsen significantly in adverse scenarios. - Global risks are tilted to the downside, including: - Global policy uncertainty and protectionism. - Uncertainty about U.S. policy actions and the possibility of a faster-than-expected pace of interest rate hikes in the U.S. - A global shift toward protectionism could reduce trade and commodity prices, raising risk premiums for open emerging markets. - Regional risks: - Spreads in Brazil and Ecuador have fallen, suggesting somewhat diminished risks. - Venezuela remains a deep economic crisis and a potential source of disruptive spillovers and humanitarian-related pressures for Colombia. ### Assessment of qualification for the FCL arrangement - Staff assesses that Colombia continues to meet the qualification criteria for an arrangement under the FCL based on: - Sustainable external position: - External debt 49 percent of GDP at end-2016; projected decline to 46 percent of GDP in 2022. - Current account deficit narrowed to 4.4 percent of GDP in 2016 and projected 3.8 percent of GDP in 2017. - Capital account dominated by private flows: - Portfolio inflows expected to decline as the current account narrows; FDI projected at 3.4 percent of GDP in the next five years. - Track record of steady sovereign access to international capital markets at favorable terms. - A relatively comfortable reserve position: US$46.9 billion as of April 2017 (140 percent of ARA metric; 127 percent of the sum of short-term external debt at remaining maturity and the projected current account deficit). - Sound public finances and a structural fiscal rule; VAT and tax reform to raise revenue by about 3 percent of GDP over the medium term. - Low and stabilizing inflation within a sound monetary and exchange rate policy framework. - Sound financial system with non-performing loans at 3.7 percent in January 2017 and corporate debt at 46 percent of GDP. - Effective financial sector supervision with steps to align regulation closer to Basel III and additional regulatory powers expected via legislation in the first half of 2017. - Data transparency and integrity: Colombia remains in observance of the Special Data Dissemination Standards (SDDS) and continued improvements to Government Finance Statistics. *Source: IMF Country Report excerpt (cr17149) — 1. Updated External Economic Stress Index* ### 14. Colombia’s government effectiveness continues to be strong ### Government effectiveness and regional plans - Colombia scores well, and has improved its ranking, in the government effectiveness and corruption control indicators by the World Bank (Figure 5). - The regional development plans in the peace agreement with the FARC will boost the presence and effectiveness of the government in the regions worst-hit by the armed conflict. - The authorities have conducted a number of stress tests, including one assessing the impact of a sudden and temporary increase in EMBIG spreads by 200 basis points and a drop in global confidence calibrated to mimic the impact of a sovereign downgrade. ### Safeguards assessment - Staff has completed the safeguards procedures for Colombia's 2016 FCL arrangement. - The authorities provided the necessary authorization for Fund staff to communicate directly with the Banco de la República Colombia’s external auditor, Deloitte & Touche Ltd (Deloitte) Colombia. - Deloitte issued an unqualified audit opinion on the Banco de la República Colombia’s 2015 financial statements on February 17, 2016. - Staff reviewed the 2015 audit results and discussed these with Deloitte. - No significant safeguards issues emerged from the conduct of these procedures. ### Staff appraisal and FCL assessment - The FCL arrangement for Colombia provides valuable protection against tail risks. - The successive FCL arrangements have provided a buffer against tail risks and signaled the strength of Colombia’s policy framework. - The FCL arrangement provided the authorities space to continue adjusting to the permanent oil price shock, while shielding Colombia from external risks. - Staff agree with the authorities that Colombia’s international reserves and the FCL arrangement in an amount equivalent to SDR 8.18 billion (400 percent of quota) would continue to serve as useful buffers against external risks. - In staff’s assessment, Colombia continues to meet the qualification criteria for access to FCL resources. - The IMF Board assessment of the 2017 Article IV Consultation completed in May 2017 commended Colombia for the strength of its policy framework and excellent track record of policy implementation. - The authorities are firmly committed to maintaining very strong policies going forward. - Staff therefore recommends the completion of the review under the FCL arrangement for Colombia. - Staff agrees with the authorities’ strategy and would encourage a reduction in access in any future arrangement as risks to the global outlook and commodity prices recede. - A carefully-crafted communication strategy will help facilitate exit. ### Risks and vulnerabilities - Oil-price risks have receded but policy uncertainty and protectionism are new risks that could affect global growth and generate spillovers to emerging markets. - Colombia’s vulnerability to capital account shocks increased as foreign participation in the local-currency government debt market reached an all-time high. *Source: IMF staff summary based on the content of the provided chapter.* ### Box 1. Updated External Economic Stress Index ### Purpose and methodology - The external economic stress index (ESI) summarizes external shocks and Colombia’s exposures. - It was initially presented in Colombia’s staff report on the June 2015 FCL arrangement. - Its methodology is explained in “Review of the Flexible Credit Line, the Precautionary and Liquidity Line, and the Rapid Financing Instrument—Specific Proposals”. - The methodology and weights are unchanged from previous Colombia FCL reports. ### Index components - The index is based on four major variables which capture external risks for Colombia: - the level of the oil price; - a proxy for oil exports as well as oil-related FDI; - U.S. growth, a proxy for exports, remittances, and other inward FDI; - the emerging market volatility index (VXEEM); and - the change in the 10-year U.S. government bond yield, proxies for risks to equity and debt portfolio flows. ### Weights and exposures - The unchanged weights do not capture Colombia’s reduced exposure to current-account shocks nor its increased exposure to capital-account shocks. ### Downside and adverse scenario assumptions - The downside scenario reflects external risks from policy uncertainty and a global growth slowdown if protectionism gained traction. - In the adverse scenario: - stress in financial markets due to policy uncertainty would lead to an increase of the VXEEM by two standard deviations; - policy uncertainty or protectionism would lower U.S. growth by ½ percentage points; - volatile global financial conditions and decompression of term premia would trigger a 100bps increase in long-term U.S. interest rates; - oil prices would fall 24 percent with respect to the baseline due to weak global growth. ### Resulting ESI outcome - The ESI in the adverse scenario would remain above the levels in the adverse scenario described in the FCL request, but its decline with respect to the baseline would be slightly lower. *Source: IMF staff (Box 1. Updated External Economic Stress Index).* ### 1. Updated External Economic Stress Index ______________________________________________________ 11 ### 1. Updated External Economic Stress Index ### Context and recent developments - Colombia is adapting smoothly to the large terms of trade shock experienced since 2014. - Growth and oil shock: - Growth moderated to 2 percent in 2016. - The decline in oil prices since June 2014 amounted to 50 percent. - Inflation and monetary policy: - Inflation started declining in August 2016 but remained above the target band due to the lagged impact of the large depreciation and weather-related shocks. - Inflation converged to the target band guided by monetary policy tightening. - The central bank started a gradual easing cycle in December as inflationary pressures abated. - A 325bps tightening cycle finished in December 2016. - Inflation was 4.7 percent in April, down from a peak of 9 percent in July 2016. - 12- and 24-month-ahead inflation expectations are within the target band. - External and fiscal balances: - Strong import compression narrowed the current account deficit to 4.4 percent of GDP in 2016, from 6.4 percent of GDP in 2015. - The fiscal deficit widened to 4 percent of GDP as oil revenue declined, but the structural fiscal balance improved. - Structural tax reform (December 2016): - Increased the VAT rate by 3 percentage points. - Simplified the tax code, reduced the high corporate tax burden, and included measures to improve formalization and tax administration. - Financial system: - The financial system remained well capitalized and liquid, though corporate balance sheets worsened somewhat. - Peace agreement and structural agenda: - The peace agreement with the FARC (signed December 2016) and the structural reform agenda underpin medium-term inclusive growth and infrastructure-led expansion. ### Financial markets and external position - Role of the FCL arrangement: - Colombia’s FCL arrangement provided support to pursue policy adjustments amid global and regional uncertainties and signaled policy strength. - The authorities treat the FCL arrangement as precautionary and intend to reduce access as risks recede. - The Executive Board last assessed Colombia’s adherence to the FCL qualification criteria on June 13, 2016, during approval of the current two-year FCL arrangement for 400 percent of quota. - Market responses and vulnerabilities: - Recent episodes of falling oil prices (13.4 percent in October–November, 2016; 10.8 percent in February–March, 2017) were associated with currency depreciations but had limited impact on other markets. - Sovereign bond and CDS spreads were 202 and 133 basis points respectively and have declined significantly since June 2016. - Nonresident holdings of local-currency government bonds increased 39 percent to US$21 billion since the FCL request and account for 25 percent of total domestic public debt. - Nonresidents hold about 50 percent of the outstanding 10-year benchmark bonds. - Gross international reserves stood at US$46.9 billion as of April 2017. - Equivalent to 140 percent of the ARA metric and 127 percent of the sum of short-term external debt at remaining maturity and the projected current account deficit. - External debt and financing: - External debt was 49 percent of GDP at end-2016. - External debt is projected to decline slightly to 46 percent of GDP in 2022 and would remain manageable under negative shocks. - Gross external financing needs declined to about 12 percent of GDP in 2017 and are expected to remain around 10 percent of GDP in the medium term. - The current account deficit is projected to decline to 3.8 percent of GDP in 2017. - FDI inflows are projected to remain around 3.4 percent of GDP in the next five years. - Public finances and debt: - Public debt declined marginally to 50.2 percent of GDP in 2016 and is projected to fall to 41 percent of GDP in 2022. - The structural tax reform aims to increase revenue by about 3 percent of GDP over the medium term. ### Outlook and risks - Growth outlook: - Staff projects growth to increase to 2.3 percent in 2017. - Medium-term growth is expected to reach 3.5 percent as infrastructure spending, tax reform effects, and peace-agreement confidence lift activity. - Inflation outlook: - Inflation is projected to converge to the target band in early 2018. - The effects of the VAT increase and indexation will delay convergence to early 2018. - External and global risks: - The updated External Stress Index indicates baseline external conditions are better than at the time of the FCL approval but would worsen significantly in adverse scenarios. - Global risks are tilted to the downside, including: - Global policy uncertainty and protectionism. - Uncertainty about U.S. policy actions and the possibility of a faster-than-expected pace of interest rate hikes in the U.S. - A global shift toward protectionism could reduce trade and commodity prices, raising risk premiums for open emerging markets. - Regional risks: - Spreads in Brazil and Ecuador have fallen, suggesting somewhat diminished risks. - Venezuela remains a deep economic crisis and a potential source of disruptive spillovers and humanitarian-related pressures for Colombia. ### Assessment of qualification for the FCL arrangement - Staff assesses that Colombia continues to meet the qualification criteria for an arrangement under the FCL based on: - Sustainable external position: - External debt 49 percent of GDP at end-2016; projected decline to 46 percent of GDP in 2022. - Current account deficit narrowed to 4.4 percent of GDP in 2016 and projected 3.8 percent of GDP in 2017. - Capital account dominated by private flows: - Portfolio inflows expected to decline as the current account narrows; FDI projected at 3.4 percent of GDP in the next five years. - Track record of steady sovereign access to international capital markets at favorable terms. - A relatively comfortable reserve position: US$46.9 billion as of April 2017 (140 percent of ARA metric; 127 percent of the sum of short-term external debt at remaining maturity and the projected current account deficit). - Sound public finances and a structural fiscal rule; VAT and tax reform to raise revenue by about 3 percent of GDP over the medium term. - Low and stabilizing inflation within a sound monetary and exchange rate policy framework. - Sound financial system with non-performing loans at 3.7 percent in January 2017 and corporate debt at 46 percent of GDP. - Effective financial sector supervision with steps to align regulation closer to Basel III and additional regulatory powers expected via legislation in the first half of 2017. - Data transparency and integrity: Colombia remains in observance of the Special Data Dissemination Standards (SDDS) and continued improvements to Government Finance Statistics. *Source: IMF Country Report excerpt (cr17149) — 1. Updated External Economic Stress Index* ### 14. Colombia’s government effectiveness continues to be strong. Colombia scores well, and ### 14. Colombia’s government effectiveness continues to be strong. Colombia scores well, and ### Government effectiveness and regional plans - Colombia scores well, and has improved its ranking, in the government effectiveness and corruption control indicators by the World Bank (Figure 5). - The regional development plans in the peace agreement with the FARC will boost the presence and effectiveness of the government in the regions worst-hit by the armed conflict. - The authorities have conducted a number of stress tests, including one assessing the impact of a sudden and temporary increase in EMBIG spreads by 200 basis points and a drop in global confidence calibrated to mimic the impact of a sovereign downgrade. ### Safeguards assessment - Staff has completed the safeguards procedures for Colombia's 2016 FCL arrangement. - The authorities provided the necessary authorization for Fund staff to communicate directly with the Banco de la República Colombia’s external auditor, Deloitte & Touche Ltd (Deloitte) Colombia. - Deloitte issued an unqualified audit opinion on the Banco de la República Colombia’s 2015 financial statements on February 17, 2016. - Staff reviewed the 2015 audit results and discussed these with Deloitte. - No significant safeguards issues emerged from the conduct of these procedures. ### Staff appraisal and FCL assessment - The FCL arrangement for Colombia provides valuable protection against tail risks. - The successive FCL arrangements have provided a buffer against tail risks and signaled the strength of Colombia’s policy framework. - The FCL arrangement provided the authorities space to continue adjusting to the permanent oil price shock, while shielding Colombia from external risks. - Staff agree with the authorities that Colombia’s international reserves and the FCL arrangement in an amount equivalent to SDR 8.18 billion (400 percent of quota) would continue to serve as useful buffers against external risks. - In staff’s assessment, Colombia continues to meet the qualification criteria for access to FCL resources. - The IMF Board assessment of the 2017 Article IV Consultation completed in May 2017 commended Colombia for the strength of its policy framework and excellent track record of policy implementation. - The authorities are firmly committed to maintaining very strong policies going forward. - Staff therefore recommends the completion of the review under the FCL arrangement for Colombia. - Staff agrees with the authorities’ strategy and would encourage a reduction in access in any future arrangement as risks to the global outlook and commodity prices recede. - A carefully-crafted communication strategy will help facilitate exit. ### Risks and vulnerabilities - Oil-price risks have receded but policy uncertainty and protectionism are new risks that could affect global growth and generate spillovers to emerging markets. - Colombia’s vulnerability to capital account shocks increased as foreign participation in the local-currency government debt market reached an all-time high. *IMF staff summary based on the content of the provided chapter.* ### Box 1. Updated External Economic Stress Index ### Box 1. Updated External Economic Stress Index ### Purpose and methodology - The external economic stress index (ESI) summarizes external shocks and Colombia’s exposures. - It was initially presented in Colombia’s staff report on the June 2015 FCL arrangement. - Its methodology is explained in “Review of the Flexible Credit Line, the Precautionary and Liquidity Line, and the Rapid Financing Instrument—Specific Proposals”. - The methodology and weights are unchanged from previous Colombia FCL reports. ### Index components - The index is based on four major variables which capture external risks for Colombia: - the level of the oil price; - a proxy for oil exports as well as oil-related FDI; - U.S. growth, a proxy for exports, remittances, and other inward FDI; - the emerging market volatility index (VXEEM); and - the change in the 10-year U.S. government bond yield, proxies for risks to equity and debt portfolio flows. ### Weights and exposures - The unchanged weights do not capture Colombia’s reduced exposure to current-account shocks nor its increased exposure to capital-account shocks. ### Downside and adverse scenario assumptions - The downside scenario reflects external risks from policy uncertainty and a global growth slowdown if protectionism gained traction. - In the adverse scenario: - stress in financial markets due to policy uncertainty would lead to an increase of the VXEEM by two standard deviations; - policy uncertainty or protectionism would lower U.S. growth by ½ percentage points; - volatile global financial conditions and decompression of term premia would trigger a 100bps increase in long-term U.S. interest rates; - oil prices would fall 24 percent with respect to the baseline due to weak global growth. ### Resulting ESI outcome - The ESI in the adverse scenario would remain above the levels in the adverse scenario described in the FCL request, but its decline with respect to the baseline would be slightly lower. *Source: IMF staff (Box 1. Updated External Economic Stress Index).* --- _Source: https://www.imf.org/-/media/files/publications/cr/2017/cr17149.pdf_