## 1. Foreign Exchange, Bond and Equity Market Developments Since Mid-2013

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### Background
- Colombia’s policy framework and recent performance:
  - Inflation-targeting regime, flexible exchange rate, structural fiscal balance rule, and effective financial supervision and regulation.
  - Real GDP grew at a pace of 4 percent and annual inflation averaged 2.7 percent in the last five years.
  - Policy improvements: inclusion of a fiscal sustainability principle in the constitution; introduction of a structural fiscal balance rule; overhaul of the oil and mining royalties system; comprehensive tax reform replacing payroll taxes with a corporate income tax.
  - Rising global integration: commodity-driven trade, substantial FDI, corporate external borrowing, and increased participation of nonresidents in domestic equity and government bond markets.
  - IMF Flexible Credit Line (FCL) approved in June 2013 for SDR 3.87 billion (about US$6 billion, or 500 percent of quota).

### Recent developments (through early 2014)
- Political and security:
  - Presidential elections in late May 2014; next president to be inaugurated in August 2014.
  - As of March 2014, peace talks with FARC reached agreement on two of five topics.
- Growth and labor market:
  - Real GDP growth: 2.9 percent y/y in the second half of 2012 and the first half of 2013; accelerated to 5.2 percent y/y in the second half of 2013; 4.3 percent in 2013 (up from 4 percent in 2012).
  - Employment rose strongly; unemployment declined to 9.7 percent in 2013.
  - Manufacturing production fell by 1.2 percent in the second half of 2013.
- Inflation and monetary policy:
  - Headline inflation: 1.9 percent y/y at end-2013 (target range 2‒4 percent); core inflation 2.4 percent y/y at end-2013.
  - As of March 2014, headline inflation 2.5 percent y/y and core inflation 2.6 percent; twelve-month inflation expectations 3 percent.
  - Central bank policy rate held at 3.25 percent from April 2013 to April 2014; increased by 25 basis points to 3.50 percent at end-April 2014.
- External sector and reserves:
  - Current account deficit: 3.3 percent of GDP in 2013 (staff table); authorities’ statement noted 3.4 percent of GDP in 2013.
  - Financial account surplus: 5 percent of GDP in 2013, largely driven by inward FDI of 4.4 percent of GDP.
  - International reserves rose to US$43.2 billion; reserves cover approximately 7 months of imports and over 100 percent of short-term external debt amortizations and projected current account deficit.
  - NIIP broadly unchanged at 27 percent of GDP; total external debt broadly stable at 24 percent of GDP.
- Financial markets and capital flows:
  - Peso (COP) depreciated by about 7 percent from May 22, 2013 to April 4, 2014; daily exchange rate volatility tripled to 1 percent in June, returning to pre-May 22 level by end-2013.
  - TES (domestic government) yields rose initially by over 200 basis points after May 22, 2013, then stabilized with 10-year TES yields at about 7 percent by end-2013 (about 200 basis points above pre-tapering levels).
  - Spreads on external government debt widened then partly stabilized; 5-year CDS at 90 basis points on May 22 rose initially by over 80 basis points then stabilized about 20 basis points above pre-May 22 levels.
  - Stock prices fell by up to 7 percent in June 2013 and up to 10 percent in January 2014; as of early 2014 stock prices about 5 percent above their May 22 level.
- Fiscal and public debt:
  - Central government fiscal deficit estimated at 2.4 percent of GDP in 2013.
  - Combined public sector balance slipped to a deficit of 1 percent of GDP in 2013 (from a surplus of 0.2 percent in 2012).
  - Public sector debt estimated at 35.2 percent of GDP at end-2013.
- Banking sector and credit:
  - Financial soundness indicators strong: non-performing loans 2.8 percent of total loans in 2013 with high provisions; profitability strong; liquidity adequate.
  - New capital requirements effective August 2013 enhanced banks’ capital quality; system risk-weighted capitalization ratio fell to 15 percent as of February 2014 (from 18 percent at end-2012) due to improved capital definition; solvency ratio close to 15 percent, above regulatory minimum 9 percent.
  - Credit to private sector growth slowed to 12.1 percent y/y at end-2013 (from 16 percent at end-2012); credit to private sector reached 39.2 percent of GDP in 2013.
  - Credit portfolio composition (end-2013): commercial loans 24 percent of GDP; consumer loans 11 percent of GDP; mortgages 3½ percent of GDP; microcredit 1 percent of GDP.

### Outlook and staff projections
- Baseline projections:
  - Real GDP growth projected at around potential, estimated at 4½ percent, in 2014 and beyond; staff table: Real GDP growth (percent) 2013 4.3, 2014 4.5, 2015 4.5, 2016 4.5, 2017 4.5, 2018 4.5, 2019 4.5.
  - Consumer prices (percent, end of period) projected: 2013 1.9, 2014 2.7, 2015 3.0, 2016 3.0, 2017 3.0, 2018 3.0, 2019 3.0.
  - Current account balance (percent of GDP): 2013 -3.3, 2014 -3.3, 2015 -3.3, 2016 -3.1, 2017 -3.0, 2018 -3.0, 2019 -2.9.
  - Combined public sector balance (percent of GDP): 2013 -1.0, 2014 -0.8, 2015 -0.6, 2016 -0.6, 2017 -0.7, 2018 -0.6, 2019 -0.6.
  - Total public sector gross debt (percent of GDP): 2013 35.2, 2014 34.7, 2015 33.5, 2016 32.2, 2017 31.0, 2018 29.8, 2019 28.6.
  - Staff projects central government deficit to decline to 1.9 percent of GDP by 2019 and combined public sector deficit to reach 0.6 percent of GDP by 2019; public sector debt projected to fall to 29 percent of GDP by 2019 from 35 percent at end-2013.
- Financial system deepening:
  - Participation of nonresidents in local government debt and equity markets projected to rise.

### Key downside external risks and quantified sensitivities
- Sharp decline in commodity prices, especially oil:
  - Oil exports account for more than one half of total exports.
  - Oil-related revenues amount to about 4½ percent of GDP and 16 percent of total government revenue.
  - Staff estimates: a US$10 drop in the price of oil would reduce exports by about US$3.3 billion (0.9 percent of GDP) and fiscal revenue by about 0.4 percent of GDP.
  - A staff VAR model suggests the same shock would cut real GDP growth by ½ of a percentage point on a cumulative basis after six months.
- U.S. interest rate normalization and global financial conditions:
  - A rise in U.S. interest rates could increase Colombian yields: a VECM shows a 100 basis point increase in 10-year U.S. Treasury yields translates into an increase of 91 to 123 basis points in 10-year TES yields after six months.
  - Claims of international banks on Colombian borrowers amounted to US$47 billion (12 percent of GDP) as of September 2013; a simulation suggests international bank lending to Colombian borrowers could decline by up to 6.6 percent of GDP in a sizable shock.
- Negative growth shocks in trading partners:
  - A multi-country VAR suggests a 1 percentage point slowdown in real GDP growth of China, the Euro area, and the U.S. could reduce Colombia’s real GDP growth by 0.3, 0.2 and 0.1 percentage points, respectively; a combined 1 percentage point slowdown in main regional trading partners could reduce Colombia’s real GDP growth by about ½ of a percentage point.

### Policy recommendations — near-term and medium-term
- Near-term macro stance:
  - Monetary policy: adjust policy rate as necessary to keep inflation within 2–4 percent range; use flexible exchange rate as shock absorber.
  - Exchange rate and reserves: use exchange rate and international reserves as shock absorbers; continue cautious reserve accumulation consistent with inflation-targeting and exchange rate flexibility.
  - Fiscal policy: maintain broadly neutral stance in 2014 with reallocation of spending to targeted stimulus; adhere to fiscal rule mandating structural balance improvement.
- Preserving fiscal sustainability:
  - Fiscal rule target: central government structural deficit set to decline to 1 percent of GDP by 2022 (from 2.4 percent of GDP in 2013); MTFF projects additional decline to 0.8 percent of GDP by 2024.
  - Revenue mobilization: focus on non-commodity revenues; support planned elimination of the financial transactions tax; options include broadening the tax base by lowering exemptions, fighting informality, extending the wealth tax, taxing dividends, or increasing the VAT rate.
  - Tax administration: improve information technology, standardize certification of accountants, tighten sanctions for non-compliance; authorities to implement IMF technical assistance recommendations.
  - Manage PPP contingent liabilities: standardize PPP contracts, limit outlays for service and recuperation to 0.4 percent of GDP per year, adopt accrual accounting under GFSM 2001 to better reflect budget implications.
- Financial sector and supervision:
  - Remove exceptions to large exposure limits, simplify limits, and require banks to hold more capital to reflect concentration risk.
  - Provide SFC full supervisory powers over holding companies of financial institutions; implement stress tests on tail risks; implement Basel II Pillar 2; enhance independence and legal protection of supervisory staff.
  - Monitor cross-border risks from Central American expansion; deepen stress testing and supervisory cooperation.
- Inclusive growth and structural reforms:
  - Reduce non-wage labor costs and contain pace of minimum wage growth to reduce informality.
  - Broaden pension coverage while ensuring sustainability: options include changing benefit formulas, equalizing retirement ages, and indexing retirement age to life expectancy.
  - Health sector: contain costs (pharmaceutical prices, clear hospital arrears) within legal framework.
  - Financial inclusion: lower borrowing constraints, improve public registries on movable property, promote mobile banking, enable simplified licensing for electronic money issuers, promote financial literacy, and tailor products for low-income households.

### Scenario analysis — Spillovers from U.S. monetary normalization (Box 3)
- Modelled scenarios (FSGM Western Hemisphere module) and outcomes:
  - Scenario 1 (faster U.S. recovery): stronger U.S. growth leads to positive spillovers for Colombia — stronger growth and better external and fiscal trends as export demand gains outweigh higher interest rates.
  - Scenario 2 (tighter U.S. and global financial conditions): adverse effects — slower growth and deterioration in external and fiscal performance due to higher cost of capital and reduced investment.
  - Scenario 3 (sharper tightening due to lower Fed tolerance for inflation): larger adverse effects on growth, external and fiscal variables.
- Quantitative illustrative response:
  - Response of Colombian 10-year Government Bond Yields to a 100-Basis Point Increase in 10-year U.S. Treasury Yields (cumulative after 6 months): 91.28 and 123.32 (basis points) as estimated responses.

### Reserve adequacy and accumulation policy (Box / Reserve assessment)
- Reserve adequacy:
  - Current reserves cover approximately 7 months of imports and over 100 percent of short-term external debt amortizations and the projected current account deficit.
  - Reserve ratios relative to broad money and pre-crisis benchmarks remain below pre-2008–09 levels.
  - Staff and authorities agree reserves adequate for normal times but might be insufficient for tail risks.
- Reserve accumulation implementation:
  - Pre-announced purchases: US$3 billion between February and May 2013 (minimum daily purchase).
  - End-May 2013: reduced to US$2.5 billion for June–September, removed minimum daily purchase.
  - October 2013: set quarterly ceiling US$1 billion after peso depreciation.
  - Q1 2014: quarterly US$1 billion ceiling maintained, but only US$0.7 billion bought.
  - Staff view: implementation prudent, consistent with exchange rate flexibility and inflation targeting.

### Manufacturing sector performance (Box 5)
- Overall 2008–2013:
  - Real GDP average growth: 4 percent between 2008 and 2013; manufacturing output grew only 0.1 percent on average.
  - Manufacturing share of real GDP declined from 14 percent at end-2007 to 11 percent in 2013.
- Firm-level findings:
  - On average, real exchange rate appreciation did not negatively affect manufacturing firms’ profitability; appreciation contributed positively to profitability on average, possibly due to imported intermediate inputs.
  - Export-intensive firms suffered greater losses with real exchange rate appreciation.
- Structural trade factors:
  - Trade disruption with Venezuela associated with average 12 percent lower profit growth after 2008 for affected industries.
  - Increased competition from China associated with average 7 percent lower profit growth after 2008 for affected industries.

### Financial inclusion (Box 9)
- Household inclusion gaps (2011 data):
  - Fewer people held debit and credit cards relative to comparators; less than 5 percent of the population received government payments through bank accounts; less than 10 percent held savings in a formal institution.
  - Informal finance widespread.
- Enterprise access:
  - In 2010, a greater share of small firms reported insufficient financing versus 2006; over 50 percent of firms with less than 20 employees identified access to finance as a major constraint.
- Policy measures:
  - Expanded physical infrastructure and correspondent banking: over 38,000 correspondents registered in 2013.
  - Subsidized account opening for Familias en Accion recipients; lowered financial transaction tax on low balances.
  - Interest subsidy program on new mortgages: granted to over 5,000 low-income families since 2009; extended into 2014 with subsidies up to 5 percentage points for a 7-year period.
  - Recommendations: improve registries on movable property, promote mobile banking, simplify licensing for electronic money issuers, promote financial literacy, and develop tailored products for low-income households.

### Staff appraisal — priorities and risks (summary)
- Recent performance and outlook:
  - Growth accelerated to 4.3 percent in 2013; inflation within target; unemployment fell to lowest level in over a decade; balance of payments surplus driven by FDI; financial system stable.
  - Medium-term growth projected around 4½ percent; inflation projected within 2–4 percent range.
- Main risks (tilted to the downside):
  - Sharp decline in commodity prices (especially oil); deterioration in global financial conditions; negative growth shocks in trading partners; U.S. monetary normalization leading to higher global risk aversion; adverse shocks from China; regional spillovers via trade or banks’ balance sheets.
- Policy priorities:
  - Decisive revenue-side action to meet medium-term fiscal consolidation goals; broaden tax base, reduce informality, and strengthen tax administration.
  - Address infrastructure deficit via PPPs and the 4G road concessions and through Financiera de Desarrollo Nacional (FDN); monitor PPP contingent liabilities and migrate to accrual accounting (GFSM 2001).
  - Address pension and health fiscal pressures: broaden coverage equitably while maintaining sustainability; contain health care costs.
  - Strengthen financial supervision for conglomerates and cross-border risks; implement Basel II Pillar 2 and enhance supervisory independence.
  - Foster financial inclusion and reduce non-wage labor costs to lower informality.

*Source: IMF staff report excerpts (document _cr14141).*

### 1. Foreign Exchange, Bond and Equity Market Developments Since Mid-2013 __________________ 21

### 1. Foreign Exchange, Bond and Equity Market Developments Since Mid-2013 __________________ 21

### Background
- Colombia has maintained a robust economic performance with an inflation-targeting regime, a flexible exchange rate, a structural fiscal balance rule, and effective financial supervision and regulation.
- Real GDP grew at a pace of 4 percent and annual inflation averaged 2.7 percent in the last five years.
- Authorities’ policy improvements include: inclusion of a fiscal sustainability principle in the constitution; introduction of a structural fiscal balance rule; overhaul of the oil and mining royalties system; and a comprehensive tax reform that replaced payroll taxes with a corporate income tax.
- Colombia’s ties to the global economy are rising: trade driven by commodity exports, substantial foreign direct investment, corporate external borrowing, and increased participation of nonresidents in domestic equity and government bond markets.
- In June 2013, the IMF’s Executive Board approved a new two-year Flexible Credit Line (FCL) for SDR 3.87 billion (about US$6 billion, or 500 percent of quota).

### Recent developments
- Political and security context:
  - Presidential elections in late May 2014; next president to be inaugurated in August 2014.
  - As of March 2014, peace talks with FARC reached agreement on two of five topics under discussion.
- Exchange regime and data:
  - Colombia has a floating exchange rate regime (de jure and de facto).
  - Colombia maintains an exchange restriction subject to Fund approval under Article VIII arising from the special regime for the hydrocarbon sector.
- Growth and labor market:
  - Real GDP growth accelerated to 5.2 percent y/y in the second half of 2013 after slowing to 2.9 percent y/y earlier.
  - Real GDP growth in 2013 averaged 4.3 percent, up from 4 percent in 2012.
  - Employment rose strongly; unemployment declined to 9.7 percent in 2013.
  - Manufacturing production fell by 1.2 percent in the second half of 2013.
- Inflation:
  - Headline inflation fell to 1.9 percent y/y at end-2013 (target range 2‒4 percent), down from 2.4 percent at end-2012.
  - Core inflation was 2.4 percent y/y at end-2013.
  - As of March 2014, headline inflation rose to 2.5 percent y/y and core inflation to 2.6 percent; twelve-month inflation expectations stood at 3 percent.
- External sector and reserves:
  - Current account deficit was 3.3 percent of GDP in 2013, up from 3.2 percent in 2012.
  - Financial account surplus was 5 percent of GDP in 2013, largely driven by inward FDI of 4.4 percent of GDP.
  - International reserves rose to US$43.2 billion.
  - Net international investment position (NIIP) broadly unchanged at 27 percent of GDP.
  - Total external debt broadly stable at 24 percent of GDP.
- Financial markets and capital flows:
  - Exchange rate depreciated by about 7 percent from May 22, 2013 to April 4, 2014; foreign exchange market volatility increased.
  - Yields on 10-year domestic government debt initially rose by over 200 basis points after May 22, 2013, then fell to 130 basis points over the pre-May 22 level as of April 4, 2014.
  - Spreads on external government debt increased.
  - Colombia maintained fluid access to international capital markets; Ecopetrol and the government issued long-term bonds in late 2013 and early 2014.
- Fiscal and public debt:
  - Central government fiscal deficit estimated at 2.4 percent of GDP in 2013, in line with the fiscal rule.
  - Combined public sector balance slipped into a deficit of 1 percent of GDP in 2013, from a surplus of 0.2 percent of GDP in 2012.
  - Public sector debt estimated at 35.2 percent of GDP at end-2013.
- Banking sector and credit:
  - Financial soundness indicators strong: low and well-provisioned non-performing loans, strong profitability, adequate liquidity.
  - New capital requirements effective August 2013 enhanced banks’ capital quality.
  - Credit to private sector growth slowed to 12 percent y/y at end-2013, from 16 percent at end-2012; financed largely through domestic deposits.

### Outlook and risks
- Outlook summary (staff projections and baseline):
  - Real GDP growth projected at around potential, estimated at 4½ percent, in 2014 and beyond.
  - Inflation projected to stay within the (2‒4 percent) target range; in 2014 inflation projected to rise gradually and remain well within the target range throughout the forecast period.
  - Current account deficit projected to remain at about 3 percent of GDP in the medium term.
  - 2014 central government deficit envisaged at 2.3 percent of GDP, down from 2.4 percent in 2013.
  - Combined public sector deficit projected to decline slightly to 0.9 percent of GDP in 2014, from 1 percent in 2013.
  - Staff projects central government deficit to decline to 1.9 percent of GDP by 2019 and combined public sector deficit to reach 0.6 percent of GDP by 2019.
  - Public sector debt projected to fall to 29 percent of GDP by 2019, from 35 percent at end-2013.
  - Financial system expected to continue deepening; participation of nonresidents in local government debt and equity markets projected to rise.
- Key downside external risks:
  - Sharp decline in commodity prices, especially oil:
    - Oil exports account for more than one half of total exports.
    - Oil-related revenues amount to about 4½ percent of GDP and 16 percent of total government revenue.
    - Staff estimates: a US$10 drop in the price of oil would reduce exports by about US$3.3 billion (0.9 percent of GDP) and fiscal revenue by about 0.4 percent of GDP.
    - A VAR model estimated by staff suggests the same shock would cut real GDP growth by ½ of a percentage point on a cumulative basis after six months.
  - A rise in U.S. interest rates could negatively impact Colombia if not accompanied by corresponding U.S. growth or if it leads to higher global risk aversion, capital outflows, and weaker growth in emerging markets.
  - Deterioration in global financial conditions could reduce external bank credit lines and portfolio flows:
    - Claims of international banks on Colombian borrowers amounted to US$47 billion (12 percent of GDP) as of September 2013.
    - A simulation suggests lending from international banks to Colombian borrowers could decline by up to 6.6 percent of GDP in the event of a sizable shock to international banks’ balance sheets.
  - Negative growth shocks in key trading partners:
    - A multi-country VAR model suggests a 1 percentage point slowdown in real GDP growth of China, the Euro area, and the U.S. could reduce Colombia’s real GDP growth by 0.3, 0.2 and 0.1 percentage points, respectively.
    - A combined 1 percentage point slowdown in main regional trading partners could reduce Colombia’s real GDP growth by about ½ of a percentage point.
- Domestic vulnerability risks:
  - High growth of house prices and consumer credit could pose risks; mitigants include households’ loan-to-value ratios of about 55 percent, fixed borrowing rates, and low bank exposure to mortgage loans.
  - Contingent liabilities from public-private partnerships (PPPs) remain a risk; mitigation includes a revamped legal framework for PPPs approved in 2012.

### Medium-term illustrative indicators (staff table extract)
- Real GDP growth (percent): 2013 4.3, 2014 4.5, 2015 4.5, 2016 4.5, 2017 4.5, 2018 4.5, 2019 4.5
- Consumer prices (percent, end of period): 2013 1.9, 2014 2.7, 2015 3.0, 2016 3.0, 2017 3.0, 2018 3.0, 2019 3.0
- Current account balance (percent of GDP): 2013 -3.3, 2014 -3.3, 2015 -3.3, 2016 -3.1, 2017 -3.0, 2018 -3.0, 2019 -2.9
- Combined public sector balance (percent of GDP): 2013 -1.0, 2014 -0.8, 2015 -0.6, 2016 -0.6, 2017 -0.7, 2018 -0.6, 2019 -0.6
- Total public sector gross debt (percent of GDP): 2013 35.2, 2014 34.7, 2015 33.5, 2016 32.2, 2017 31.0, 2018 29.8, 2019 28.6

*International Monetary Fund.*

### 15.      The authorities broadly agreed with the outlook and characterization of risks. Their

### _cr14141 - 15.      The authorities broadly agreed with the outlook and characterization of risks. Their

### Authorities' assessment and macro outlook
- The authorities broadly agreed with staff’s outlook and characterization of risks; their forecasts for the main macroeconomic variables are broadly in line with staff’s projections.
- Authorities highlighted Colombia’s exposure to external shocks, including:
  - concern about the pace and implementation of monetary policy normalization in the U.S. and its possible effects on global financial markets and economic growth in emerging markets;
  - risks of a slowdown in China with possible adverse implications for oil prices;
  - agreement with staff that shocks in the region could have a significant impact on Colombia.

### Risk Assessment Matrix (selected entries)
- LikelihoodImpactPolicy Advice
- Side-effects from global financial conditions: surges in global financial market volatility, triggered by geopolitical tensions or revised market expectations on UMP exit/emerging market fundamentals.
  - HighHigh
  - Use the exchange rate and international reserves as shock absorber.
- Protracted period of slower growth in emerging economies: maturing of the cycle, misallocation of investment, and incomplete structural reforms leading to prolonged slower growth.
  - HighMedium
  - Use monetary policy to support growth; speed up execution of capital projects in the public sector.
- Growth slowdown in China: Significant slowdown of growth in 2014. Growth may fall significantly below the authorities’ target, with the slowdown caused by a variety of possible reasons and absent offsetting stimulus measures
  - LowHigh
  - Use the exchange rate and international reserves as shock absorber; tighten fiscal policy.
- Continued buildup and eventual unwinding of excess capacity, eventually resulting in a sharp growth slowdown and large financial and fiscal losses (medium-term).
  - MediumHigh
  - Use the exchange rate and international reserves as shock absorber; tighten fiscal policy.
- Geopolitical risks (financial flows, commodity prices, and supply chains): a sharp increase in geopolitical tensions surrounding Russia/Ukraine that creates significant disruptions in global financial, trade and commodity markets.
  - MediumLow
  - Use the exchange rate and international reserves as shock absorber.
- Sustained decline in commodity prices, triggered by deceleration of global demand and coming-on-stream of excess capacity (medium-term)
  - MediumHigh
  - Use the exchange rate and international reserves as shock absorber; tighten fiscal policy.
- Bond market stress from a reassessment in sovereign risk: Euro area: Sovereign stress re-emerges due to incomplete reforms, unanticipated outcomes from the asset quality review and stress tests in the absence of a fiscal backstop
  - LowLow
  - Use the exchange rate and international reserves as shock absorber.
- United States: protracted failure to agree on a credible plan to ensure medium-term fiscal sustainability
  - LowHigh
  - Use the exchange rate and international reserves as shock absorber.
- Political or economic distress in Venezuela
  - HighMedium
  - Use the exchange rate and international reserves as shock absorber.
- Contingent liabilities from PPPs
  - MediumMedium
  - Standardize PPP contracts to lower risk of litigation, strengthen the role of the Ministry of Finance in the gataway process; boost project evaluation.
- Continued high growth of credit and house prices
  - MediumLow
  - Adopt prudential measures tailored to the risk profile of financial institutions.

### Outward spillovers
- Possible outward spillovers from Colombia are estimated to be limited.
- Main transmission channels:
  - financial sector via cross-border bank lending and foreign direct investment links — could be significant for some Central American countries (in particular El Salvador and Panama) where Colombian banks have a significant market share;
  - trade channel — Colombia’s share in total trade of individual trading partners is modest, suggesting limited real spillovers.

### Policy discussions — overview
- Discussions focused on: appropriate macroeconomic policy stance for 2014; policies to maintain fiscal, external, and financial sector stability; reforms to enhance the social security system; and actions to foster inclusive growth.

### A. Near-Term Policy Stance
- Monetary policy in 2013:
  - central bank held policy interest rate at 3.25 percent from April 2013 to April 2014 in light of soft growth, a negative output gap, and inflation at or below the lower bound of the target range.
  - Note: The authorities increased the policy rate by 25 basis points to 3.50 percent at the end of April, 2014.
- Fiscal policy:
  - reallocation of central government spending to provide targeted stimulus (e.g., mortgage interest subsidies) and use of royalties for investment spending by sub-national governments supported growth.
  - With the fiscal rule mandating a slight improvement in the central government’s structural balance, the fiscal policy stance is expected to be broadly neutral in 2014.
- Exchange rate policy:
  - authorities indicated the flexible exchange rate will continue to serve as a shock absorber.
  - after the U.S. Federal Reserve announced tapering intentions, the exchange rate weakened significantly; the central bank continued acquiring foreign exchange to strengthen its international reserve buffer, though at a slower pace.
  - authorities noted the exchange rate adjustment did not lead to important effects on balance sheets or inflation.

### B. Preserving Fiscal Sustainability
- Fiscal rule and targets:
  - central government’s structural deficit is set to decline to 1 percent of GDP by 2022, from an estimated deficit of 2.4 percent of GDP in 2013.
  - combined public sector balance projected to shift into a small surplus, from an estimated deficit of 1 percent of GDP in 2013.
  - public debt-to-GDP ratio projected to fall to 29 percent of GDP by 2019 from 35 percent at end-2013.
- Risks and assumptions:
  - staff cautioned that the long-term oil price assumed in computing the structural balance may be too optimistic; if the long-term oil price is lower, a larger fiscal adjustment would be required to meet the fiscal rule.
  - improvement in the non-resource primary balance projected in Colombia’s medium term fiscal framework: 1.9 percentage points of GDP by 2024.
- Revenue and expenditure challenges:
  - fiscal revenues expected to fall by up to 2.1 percentage points of GDP during the period, stemming from:
    - planned phasing-out of the financial transactions tax (0.8 percent of GDP);
    - expiration of the wealth tax (0.4 percent of GDP);
    - projected decline in oil revenues (0.9 percent of GDP).
  - authorities intend to seek efficiency gains in current expenditure; staff noted expenditure pressures may arise from infrastructure investment, social security, and any possible outlays related to a peace agreement.
- Revenue mobilization recommendations:
  - focus on non-commodity revenues which are low by international standards;
  - support for planned elimination of the financial transactions tax given distortionary effects;
  - options include broadening the tax base by lowering exemptions and fighting informality, extending the wealth tax, taxing dividends, or increasing the value added tax rate;
  - strengthen tax administration: improve information technology, standardize certification of accountants, tighten sanctions for non-compliance.
  - authorities indicated they will step up efforts to strengthen tax administration, including by implementing IMF technical assistance recommendations.
- Infrastructure program and PPPs:
  - 4G road concessions:
    - 4G would include projects valued at COP 47 trillion (about 7 percent of GDP) to be undertaken over the next 7 years through PPPs under a revamped legal framework approved in 2012.
    - bidding for the first 9 projects (for COP 11 trillion or about US$5 billion) expected to be completed in 2014, with construction set to begin in 2015.
  - Financiera de Desarrollo Nacional (FDN):
    - created to mobilize long-term financing to infrastructure, develop standardized financing structures for local institutional investors.
    - started operations with a small initial capital (about US$230 million) provided by the government, and is expected to receive capital injections by multilateral institutions.
    - governed by a 7-member Executive Board, of which some are independent.
  - plan to create a development fund with proceeds from sale of power company Isagen to support infrastructure investment.
- Managing fiscal risks from PPPs:
  - planned outlays for service and recuperation of costs after projects completed would not exceed fiscal space under the fiscal rule and would be limited to 0.4 percent of GDP per year;
  - outlays incorporated into overall available capital expenditure envelope in the medium-term fiscal framework;
  - authorities have added precautions by standardizing PPP contracts with World Bank, IADB and IFC technical assistance;
  - mission encouraged accelerating migration to accrual accounting under GFSM 2001 so budget implications of PPPs are better reflected; adoption of GFSM 2001 is in progress and contingent liabilities will continue to be reported in the medium-term fiscal framework.

### C. Enhancing the Social Security System
- Pensions: coverage and fiscal profile
  - Only about a third (about 7 million) of the employed population (about 21 million) contributes to a pension regime:
    - 4.7 million contributing to the private capitalization (defined-contribution) system;
    - 2.5 million contributing to the pay-as-you-go (defined-benefit) public regime.
  - Average benefits in the public regime are generous by international standards; replacement rate among the highest in the world.
  - statutory retirement age, particularly for women, is low.
  - outlays by the public pension regime projected at about 4 percent of GDP in the coming years, declining to 3 percent of GDP by 2050.
- Reform directions and costs:
  - authorities intend to broaden coverage and make the system more equitable.
  - staff advised creating space for expanded coverage by changing the benefit formula to reduce replacement rates for new retirees, equalizing retirement ages for men and women, and adjusting retirement age in line with life expectancy increases.
  - recently-reinforced social security programs (Beneficios Económicos Periódicos, Pensión Familiar, Cotización por Semanas) expected to foster savings and assist populations that do not qualify for a pension without incentivizing informality.
  - authorities intend to extend a non-contributory program for the elderly poor to cover the full eligible population (about 2.4 million), with a fiscal cost of 0.1 percent of GDP.

- Health system:
  - nearly universal coverage, but financial challenges due to system complexity, high administrative costs and constitutional entitlements leading to legal claims for expensive treatments.
  - public health spending currently at over 7 percent of GDP, expected to rise by about 1½ percentage points of GDP over the long term without reforms.
  - new statutory law approved in June 2013 should reduce legal claims for expensive treatments, but is under review by the Constitutional Court.
  - staff encouraged cost containment measures within existing framework, particularly on pharmaceutical prices, and efforts to clear hospital arrears.

### D. Preserving External Stability
- External position:
  - staff and authorities concurred current account deficit and real exchange rate are broadly in line with fundamentals.
  - according to the CGER and the External Balance Assessment (EBA), the real exchange rate in 2013 was about 8 to 13 percent overvalued, respectively.
  - staff estimates that recent significant depreciation of the peso in real effective terms has reduced the estimated misalignment.
  - staff’s analysis adjusting for extremely conservative oil reserves assumptions suggests the cyclically-adjusted current account deficit in 2013 (2.7 percent of GDP) was about 1 percent of GDP larger than its norm.
  - accounting for profit remittances by foreign companies would reduce this gap.
  - overall assessment: Colombia’s external position is strong, financing of the current account deficit largely through foreign direct investment, a relatively more stable source of financing.
- Manufacturing sector:
  - manufacturing output fell in the past two years and underperformed the rest of the economy.
  - staff firm-level analysis found no strong evidence that the exchange rate has negatively affected the manufacturing sector, especially given the real appreciation vis-à-vis currencies of Colombia’s manufacturing trade partners appears to have been more limited than the overall real appreciation.

*Source: IMF staff report excerpt (chapter/section provided in the source content).*

### 30.      International reserves appear adequate for precautionary purposes. Staff and the

### 30.      International reserves appear adequate for precautionary purposes.

### Reserve adequacy and assessment
- Staff and the authorities concurred that Colombia has an adequate reserve buffer for normal times, though they might be insufficient to cope with tail risks (Box 6).
- The current stock of international reserves covers approximately 7 months of imports and over 100 percent of the short-term external debt amortizations and the projected current account deficit.
- Reserve ratios measured relative to broad money, short-term external debt plus the current account deficit, and months of imports are still below the ratios prevailing prior to the global financial crisis of 2008–09.
- The authorities reiterated their intention to continue strengthening their international reserve position with the aim of returning to the pre-crisis reserve ratios.
- Staff and authorities concurred that the opportunity cost of accumulating reserves increases as they reach higher levels and that a careful cost-benefit-analysis is warranted.

### Reserve accumulation policy and implementation
- The authorities increased reserve buffers through foreign exchange purchases during periods of abundant external inflows.
- Policy steps and amounts:
  - Pre-announced minimum reserve accumulation amount: US$3 billion between February and May, 2013, with a minimum daily purchase.
  - End of May 2013: reduced program size to US$2.5 billion for June to September, and removed the minimum daily purchase.
  - October 2013: after significant peso depreciation, slowed pace and set a quarterly reserve accumulation ceiling of US$1 billion.
  - First quarter of 2014: maintained quarterly US$1 billion ceiling, but bought only US$0.7 billion.
- Staff view: implementation was prudent and did not undermine exchange rate flexibility or the inflation-targeting regime; reflected by significant exchange rate variability and well-anchored inflation expectations.
- Authorities have modified foreign exchange intervention policy in the past to preserve credibility of the inflation-targeting regime and remain committed to do so.

### Financial system structure and intermediation
- Total assets of the financial system amounted to COP 963 trillion (143 percent of GDP) as of end-2013.
- Asset composition (end-2013):
  - Credit institutions (mainly banks): 44 percent of the system’s assets or 62 percent of GDP.
  - Trust companies: 29 percent of the system’s assets or 40 percent of GDP.
  - Pension funds: 16 percent of the system’s assets or 22 percent of GDP.
- A small number of domestic conglomerates own a large share of the system’s assets.
- Credit to the private sector reached 39.2 percent of GDP in 2013.
- Credit growth dynamics:
  - Growth in credit to the private sector slowed to 12.1 percent at end-2013, from over 20 percent in mid-2011.
- Credit portfolio composition (end-2013):
  - Commercial loans: 24 percent of GDP.
  - Consumer loans: 11 percent of GDP.
  - Mortgages: 3½ percent of GDP.
  - Microcredit: 1 percent of GDP.
- Domestic capital market continued to deepen but remained dominated by government debt.

### Financial soundness and risks
- Financial soundness indicators remain robust:
  - Non-performing loans at 2.8 percent of total loans in 2013, with high levels of provisions.
  - Liquidity ratios were stable in 2013.
  - Profitability remained high, albeit somewhat lower than in 2012.
- Capitalization:
  - System’s risk-weighted capitalization ratio fell to 15 percent as of February 2014, from 18 percent at end-2012, due to introduction of an improved capital adequacy standard focused more on loss-absorbing types of capital.
  - The issuance of equity shares by a large bank in March is likely to have boosted the system’s capitalization ratio further.
- Staff welcomed the introduction of an improved quality of capital measure.
- Concentration risk:
  - Commercial loans to the largest 1,000 borrowers stood at 42 percent of total in 2013.
  - A fifth of the largest exposures went to the manufacturing sector, followed by commerce and construction.
  - Concentration continues to expose banks to corporate credit risk.
- Staff recommendations on concentration risk:
  - Remove exceptions to large exposure limits and further simplify the number of separate limits.
  - Require banks to hold more capital to reflect concentration risk in line with enhanced supervisory expectations.
  - Foster financial inclusion (see ¶38, Box 9) to help ease exposure to concentration risk.

### Supervisory framework and cross-border challenges
- Supervisory strengths and ongoing work:
  - Unified approach to supervision mitigates regulatory arbitrage.
  - The SFC exercises effective oversight and is strengthening supervision to fully implement a comprehensive risk management framework, including for conglomerates.
  - SFC enforces robust credit risk assessment, asset classification and provisioning frameworks, and ensures prudent management of market, liquidity and operational risks.
  - IFRS implementation is on track and expected to be fully applied by January 2015.
  - SFC received technical assistance from the Toronto Center on supervisory practice, including risk-based supervision.
- Regulatory capital changes:
  - New requirements include a higher minimum of 4.5 percent for Tier 1 capital that now excludes newly generated goodwill; recognition of voluntary reserves as part of Tier 2 capital up to 10 percent of total regulatory capital; and a deduction of deferred tax assets and pension liabilities from regulatory capital.
- Staff and authorities agreed on further priorities:
  - Provide the SFC full supervisory powers over holding companies of financial institutions to broaden consolidated prudential requirements and resolution of conglomerates.
  - Ensure capital ratios and buffers of banks that are part of financial and mixed groups reflect intra-group activities and future risks.
  - Implement stress tests on tail risks and consult with the market on tackling too-important-to-fail problems of systemically important banks and conglomerates.
  - Continue implementing risk-based supervisory enhancements, implement Basel II Pillar 2 supervisory framework, and enhance independence and legal protection of supervisory staff.
- Cross-border expansion and supervisory implications:
  - Colombia’s largest banking groups expanded in Central America; operations of large Colombian bank conglomerates represent over half of banking system assets in El Salvador and over 20 percent in Panama, Nicaragua and Honduras.
  - Acquired assets in Central America account for about a third of the Colombian parent banks’ assets.
  - A significant share of acquisitions was funded through debt issuance, implying some risk.
  - Staff advised a deeper framework for monitoring tail risks, including cross-border risks, as part of stress testing and capital planning.
  - SFC actions: participation in supervisory colleges, memorandums of understanding with host supervisors, access to home-host supervisory data, on-site visits to subsidiaries, and participation in a joint study with the Fund of financial interconnectedness in Central America and among Colombia and Central America.

### Fostering inclusive growth and financial inclusion
- Main medium-term challenge: foster more inclusive growth; poverty, unemployment, inequality, and informality remain elevated.
- Labor and tax policy context:
  - At end-2012, Congress approved a comprehensive tax reform: reduction in payroll and corporate income taxes, simplification of the VAT structure, introduction of a new tax on corporate profits, and an increase in progressivity of individual income tax.
  - Non-wage labor costs remain high at about 40 percent of total labor costs for average worker, compounding the effect of the minimum wage on informal employment.
- Recommended policy actions to reduce informality and foster inclusion:
  - Explore options for further reducing non-wage costs and contain the pace of growth of the minimum wage.
  - Continue structural reforms in the labor market, fiscal area, and financial sector.
- Financial inclusion progress and recommendations:
  - Colombia has expanded inclusion via targeted transfers, subsidized bank accounts and mortgages, and rural infrastructure, but account penetration conceals low balances and low usage.
  - Mission recommended:
    - Lower borrowing constraints and the cost of access to finance by improving quality and transparency of public registries on movable property.
    - Promote mobile banking.
    - Enable simplified financial licensing for electronic money issuers to foster competition.
    - Promote financial literacy and develop products tailored to low-income households, such as micro insurance.

### Staff appraisal: outlook, risks, and key policy priorities
- Recent performance and outlook:
  - Economic growth accelerated, averaging 4.3 percent in 2013.
  - Inflation within the target range; job creation robust; unemployment fell to the lowest level in over a decade.
  - Balance of payments posted a significant surplus driven by strong foreign direct investment, financing the current account deficit and strengthening international reserves.
  - Financial system remained stable.
  - Real GDP is projected to grow at around potential, estimated at 4½ percent over the forecast period, with inflation remaining within the 2–4 percent target range.
  - The balance of payments is projected to remain in surplus, financing a broadly stable current account deficit.
  - Authorities committed to significant fiscal consolidation expected to reduce the public debt ratio.
- Risks to the outlook (tilted to the downside):
  - Exposure to a sharp decline in commodity prices, especially oil.
  - Deterioration in global financial conditions.
  - Negative growth shocks in key trading partners.
  - U.S. monetary policy normalization could cause higher global risk aversion, capital outflows, and weaker growth in emerging markets if not accompanied by higher U.S. growth.
  - Adverse shocks in China affecting Colombia via trade, commodity prices, financial markets, and global growth.
  - Negative spillovers from the region via trade disruptions, increased investor risk perception, or shocks affecting balance sheets of Colombian banks operating in Central America.
- Fiscal and structural priorities:
  - Meeting medium-term fiscal consolidation goals requires decisive policy action on the revenue side; relying mainly on expenditure reduction would be difficult and undesirable for investment.
  - Scope to increase non-oil revenues by broadening the tax base and reducing informality; strengthen tax administration.
  - Address infrastructure deficit through PPPs, the fourth generation of road concessions, and a national financial institution specialized in infrastructure financing (FDN); monitor contingent liabilities and improve accounting/reporting including migration to accrual accounting under GFSM 2001.
  - Address contingent fiscal pressures from pension and health care systems; broaden pension coverage and increase equity while maintaining financial sustainability; contain health care costs within current legal framework.
- Reserves and external position (summary):
  - External position strong; international reserves appear adequate for precautionary purposes for normal times but might be insufficient to cope with tail risks.
  - Efforts to strengthen reserve buffers should remain consistent with exchange rate flexibility and the inflation-targeting regime; higher reserve levels warrant careful cost-benefit analysis.
- Financial supervision (summary):
  - Broadly effective but scope for improvement in supervising complex conglomerates and concentration risk; regional expansion requires deeper monitoring and stress-testing of cross-border risks; implement Basel II Pillar 2 and strengthen supervisors’ independence and legal protection.
- Inclusive growth (summary):
  - Continue reducing poverty, unemployment, inequality, and informality through labor market, fiscal, and financial sector reforms; reduce non-wage costs and contain minimum wage growth; foster financial inclusion via lower borrowing constraints, reduced cost of access to finance, financial literacy, and tailored products for low-income households.

*Source: _cr14141 - 30.      International reserves appear adequate for precautionary purposes.*

### 50.      Staff recommends that the next Article IV consultation takes place on the standard

### Staff recommends that the next Article IV consultation takes place on the standard 12‒month cycle.

### Article IV timing
- Staff recommends that the next Article IV consultation takes place on the standard 12‒month cycle. (¶50)

### Exchange restriction arising from special hydrocarbon regime
- Staff does not recommend approval of the retention of the exchange restriction arising from the special regime for the hydrocarbon sector, since the authorities have no plans for its removal. (¶51)

### Foreign Exchange, Bond and Equity Market Developments Since Mid-2013 (Box 1)
- Trigger and general effects:
  - The announcement by Federal Reserve Chairman Bernanke on May 22, 2013 that tapering could commence triggered a sharp re-pricing of risk across emerging markets.
  - Financial asset prices fell, price volatility increased, traded volumes and market liquidity declined, and government debt spreads rose, especially between end-May and August.
- Exchange rate and volatility:
  - The peso (COP) depreciated by about 7 percent vis-à-vis the U.S. dollar from May 22 until April 4.
  - Daily exchange rate volatility tripled to 1 percent in June, returning to the pre-May 22 level by the end of 2013.
  - Trading volumes remained broadly stable, while bid-ask spreads increased slightly.
  - The central bank slowed the pace of its foreign exchange purchases.
- Domestic government bond market (TES):
  - TES yields rose initially by over 200 basis points, posting the second largest increase among emerging markets after Turkey.
  - In subsequent months, yields fell somewhat, with 10-year TES yields stabilizing at about 7 percent, about 200 basis points above pre-tapering levels, by end-2013.
  - Bid-ask spreads and volatility increased, and traded volumes declined.
  - The yield curve steepened significantly.
- External debt and credit default risk:
  - Spreads over U.S. Treasuries were about 140 basis points on May 22 and widened initially by up to 70 basis points, later stabilizing at about 35 basis points over the May 22 level.
  - 5-year credit default swap spreads, at 90 basis points on May 22, rose initially by over 80 basis points, later recovering and stabilizing at about 20 basis points above pre-May 22 levels.
- Money market funds and liquidity regulation:
  - The decline in TES prices triggered redemptions in money market funds during June-August, raising concerns about liquidity risks.
  - In response, the authorities have begun working on a more robust and comprehensive liquidity regulation for these entities.
- Equity market:
  - Stock prices fell by up to 7 percent in June 2013 and by up to 10 percent in January 2014, with recoveries in subsequent months.
  - As of early 2014, stock prices were about 5 percent above their May 22 level.

### Savings and Investment in Colombia (Box 2)
- Terms of trade and income windfall:
  - Colombia’s terms of trade rose by 69 percent since 2004, driven by higher oil prices.
  - According to Adler and Magud (2013), the income windfall associated with such increase in the terms of trade amounted to 5.3 percent of GDP a year on average between 2004 and 2012.
- Saving behavior:
  - Colombia’s national saving rate rose by about 4 percentage points of GDP over the past decade to 21 percent of GDP in 2013, driven primarily by the public sector.
  - According to Adler and Magud (2013), the economy saved about 90 percent of the commodity windfall.
- Investment:
  - Gross investment rose by over 5½ percentage points of GDP over the past decade to over 24 percent of GDP (measured at current prices) in 2013, driven by the private sector.
  - Measured at constant prices, investment rose by almost 10 percentage points of GDP, reaching 28 percent of GDP in 2013.
  - Investment was primarily private and directed mainly to oil and mining, electricity, telecommunications, and the financial sector.
  - Public investment lagged behind, leaving a significant infrastructure deficit, in particular in roads.
- Projections:
  - Savings and investment are projected to continue rising over the forecast period.
  - The projected fiscal consolidation would lead to an increase in the savings ratio, while investment would be driven by continued strong economic growth prospects and the authorities’ ambitious road infrastructure program, to be executed through PPPs (¶23).

### Spillover Effects of the Normalization of Monetary Policy in the U.S. (Box 3)
- Channels of impact:
  - U.S. policy normalization will likely affect Colombia through higher U.S. interest rates pushing up domestic interest rates, possibly curtailing consumption, investment and growth.
  - Stronger U.S. growth expected with normalization will increase demand for Colombian exports, supporting growth.
  - Net effect depends on relative pace of U.S. rate increases and growth acceleration and on global spillovers.
- Effects on government bond yields:
  - A vector error correction model (VECM) shows that a 100 basis point increase in 10-year U.S. Treasury yields translates into an increase of 91 to 123 basis points in 10-year TES yields after six months.
  - The model suggests that after an initial overshooting in June and July of 2013, 10-year TES yields have converged to levels broadly in line with fundamentals.
- Macro scenarios (constructed with FSGM Western Hemisphere module):
  - Scenario 1 (black line): Faster-than-baseline U.S. recovery leads the Federal Reserve to withdraw monetary stimulus faster than in the baseline.
    - This scenario produces a positive impact on Colombia: stronger growth and better external and fiscal trends as stronger demand for exports outweighs higher interest rates.
  - Scenario 2 (dotted line): Tighter U.S. monetary conditions plus tightening of financial conditions outside the U.S.; vulnerable EMEs see market interest rates tighten by roughly 25 basis points more than in the U.S.; less vulnerable EMEs tighten by about ¾ as much as the U.S.; advanced economies by about ½ as much as the U.S.
    - This scenario yields adverse effects: slower growth and deterioration in external and fiscal performance due to higher cost of capital and reduced investment.
  - Scenario 3 (gray line): Market participants perceive the Fed as less tolerant of inflation overshooting, prompting further tightening; market interest rates rise by roughly an additional 40 basis points in the U.S. at the peak, 50 basis points in vulnerable EMEs, 20 basis points in less vulnerable EMEs, and 10 basis points in other advanced economies.
    - This scenario produces larger adverse effects on growth, external and fiscal variables.
- Quantitative illustrative responses and key assumptions:
  - Response of Colombian 10-year Government Bond Yields to a 100-Basis Point Increase in 10-year U.S. Treasury Yields (cumulative after 6 months): 91.28 and 123.32 (basis points) shown as estimated responses.
  - Key Assumptions Under Simulated Scenarios (differences relative to baseline):
    - First scenario: U.S. growth (percentage points) 0.5, 0.7, -0.4, -0.3; U.S. short-term rate (in basis points) 32, 84, 64, 33.
    - Second scenario: U.S. growth (percentage points) 0.5, 0.6, -0.4, -0.2; U.S. short-term rate (in basis points) 31, 79, 58, 28; Sovereign risk premium shocks (in basis points) Vulnerable EMEs 75/188/150/75; Less vulnerable EMEs 38/94/75/38; Advanced economies 19/47/38/19.
    - Third scenario: U.S. growth (percentage points) 0.5, 0.5, -0.5, -0.2; U.S. short-term rate (in basis points) 45/110/87/41; Sovereign risk premium shocks (in basis points) U.S. 16/38/40/25; Vulnerable EMEs 100/250/200/100; Less vulnerable EMEs 50/125/100/50; Advanced economies 25/63/50/25.
- Scenario outcomes summary:
  - Scenario 1: Positive spillovers dominate; Colombia experiences stronger growth.
  - Scenarios 2 and 3: Tighter global financial conditions increase cost of capital, reduce investment, lower potential output, and reduce demand for exports from trading partners; negative effects outweigh benefits of stronger U.S. growth.

### Colombia’s Fiscal Rule and Implementation in the Context of Resource Wealth (Box 4)
- Non-resource primary balance (NRPB) and benchmarks:
  - Common benchmarks for the NRPB are those that maintain net public wealth constant as a percent of non-resource GDP, in real per capita terms, or in real terms.
  - The central government’s non-oil balance for 2013, estimated at -3 percent of GDP, was below the least restrictive of the NRPB benchmarks (i.e., keeping wealth constant in real terms), even under an assumption of 120 years of natural resource production.
- Fiscal rule and medium-term framework:
  - The fiscal rule mandates the central government to reduce its structural deficit to 1 percent of GDP by 2022.
  - The authorities’ medium term fiscal framework (MTFF) projects an additional decline to 0.8 percent of GDP by 2024.
  - Oil and mineral revenues and interest payments are projected to decline by 0.9 and 0.6 percentage points of GDP during the same period, implying the NRPB would improve by 1.9 percentage points of GDP by 2024.
  - Starting from an estimated central government net public wealth of 58.7 percent of GDP in 2013, adherence to the MTFF implies real net public wealth bottoms out at 70 percent of its 2013 value in 2030 and starts increasing thereafter (assuming the 2024 primary balance is maintained).
- Fiscal consolidation challenges and illustrative adverse scenarios:
  - Staff simulated scenarios with adverse developments: a larger decline in oil and mining revenues (of 1.8 percentage points of GDP over the forecast period compared to 0.9 in the MTFF), and constant levels of spending in wages and salaries, goods and services, and investment as a share of GDP.
  - Required fiscal effort estimated as the permanent improvement in the central government’s primary balance required starting in 2015 to achieve the MTFF central government debt projection of 25.3 percent of GDP in 2024 (from 33.6 percent of GDP in 2013).
  - Fiscal effort magnitudes:
    - Compensating for a larger decline in oil and mining revenue would require a fiscal effort of 0.7 percentage points of GDP.
    - Maintaining stable ratios of current spending would imply a fiscal effort of 0.5 percentage points of GDP.
    - Maintaining stable investment ratios would imply a fiscal effort of 0.9 percentage points of GDP.
    - A more adverse growth and interest rate environment could cost 0.4 percentage points of GDP.
  - Overall, the authorities may face a total fiscal effort of about 2 to 2½ percentage points of GDP to meet their fiscal consolidation goals if the adverse scenarios considered materialized.

*International Monetary Fund staff report excerpts from the Colombia country documentation provided in the source content.*

### Box 5. The Recent Performance of Colombia’s Manufacturing Sector

### Box 5. The Recent Performance of Colombia’s Manufacturing Sector

### Overall performance 2008–2013
- Real GDP grew, on average, by 4 percent between 2008 and 2013.
- Manufacturing sector output grew only by 0.1 percent on average between 2008 and 2013.
- The share of manufacturing in percent of real GDP declined from 14 percent at the end of 2007 to 11 percent in 2013.
- The weakness of the manufacturing sector has raised concerns that the Colombian peso is overvalued.

### Real exchange rate and competitiveness
- Colombia’s real exchange rate remained fairly competitive against most major trading partners of manufacturing goods except for the U.S. and Mexico.
- Despite the real appreciation of the Colombian peso against the U.S. dollar, the appreciation of the bilateral real exchange rate since 2008 against most major trading partners has been fairly modest, with the exception of Mexico.

### Firm-level analysis — effects of real exchange rate appreciation
- A firm-level analysis shows that, on average, real exchange rate appreciation did not negatively affect manufacturing firms’ profitability.
- On average, real exchange rate appreciation has contributed positively to manufacturing firms’ profitability.
  - The positive correlation may be caused by the presence of imported intermediate inputs, if the export-weighted real effective exchange rate used in the analysis is correlated with the real effective exchange rate for imported intermediate goods.
- In contrast, export-intensive companies suffered greater losses with real exchange rate appreciation compared to companies that exported less.

### Structural trade factors affecting profit growth
- Regression results include two structural trade dummies to capture:
  - Trade disruption with Venezuela.
  - Increased trade competition from China.
- Both trade dummies have negative and significant coefficients:
  - Profit growth after 2008 was, on average, 12 percent lower for industries affected by trade disruption with Venezuela.
  - Profit growth after 2008 was, on average, 7 percent lower for industries that faced higher competition from Chinese imports.

### Data and reference
- The firm-level analysis uses a large number of manufacturing companies compiled by the Colombian Superintendence of Corporations (Superintendencia de Sociedades).
- For more information on the firm-level results, see the accompanying 2014 Selected Issues Paper—“Recent Performance of Colombia’s Manufacturing Sector: Exchange Rate or Structural?”

*Source: _cr14141 - Box 5. The Recent Performance of Colombia’s Manufacturing Sector*

### Box 9. Financial Inclusion in Colombia

### Box 9. Financial Inclusion in Colombia

### Financial inclusion of households
- Financial inclusion of households in Colombia has not grown as rapidly as overall credit to the private sector in recent years.
- Over the past decade, credit to the private sector has increased steadily, but this growth has mainly derived from an increase in the average size of loans, rather than the increase in the number of debtors (IMF, 2012).
- Colombia scores below upper-middle-income average and the average for LACs on financial inclusion indicators related to households.
- In 2011:
  - Fewer people held debit and credit cards (relative to comparators).
  - Less than 5 percent of the population received government payments through bank accounts.
  - Less than 10 percent held savings in a formal financial institution.
- Informal finance was widespread: a relatively larger share of adults declared having received a loan from, or having saved through, informal channels.

### Financial deepening across enterprises
- Financial deepening was not fully “shared” across enterprises.
- In 2010, a greater share of small firms claimed to have been affected by insufficient financing compared to 2006.
- Firms in the food industry were particularly affected.
- Over 50 percent of smaller-sized companies (with less than 20 employees) identified access to finance as a major constraint for their operations in 2010.

### Policy measures and infrastructure to improve access
- Colombia has implemented a number of improvements to reduce the costs of accessing financial services.
- Physical infrastructure has increased.
- Since 2006, banks have been allowed to provide financial services through correspondents for social transfers programs.
  - Over 38,000 correspondents were registered in 2013.
- The government has:
  - Subsidized the opening of accounts for most Familias en Accion transfers recipients.
  - Lowered the financial transaction tax on low account balances.
- A program of interest subsidies on new mortgages granted to over 5,000 low income families since 2009:
  - Has been extended into 2014.
  - Will cover up to 5 percentage points of the agreed interest rate for a 7-year period.

*Source: Box 9, "Financial Inclusion in Colombia," IMF country report content.*

### 2.9 percent y/y in the second half of 2012 and the first half of 2013, growth accelerated to

### _cr14141 - 2.9 percent y/y in the second half of 2012 and the first half of 2013, growth accelerated to

### Growth, employment, and inflation
- Real GDP growth:
  - 2.9 percent y/y in the second half of 2012 and the first half of 2013.
  - 5.2 percent y/y in the second half of 2013.
  - 4.3 percent in 2013 as a whole, up from 4 percent in 2012.
- Sector drivers: higher public investment and a solid expansion in private consumption; construction and agriculture leading sectors; exports and manufacturing subdued but starting to recover.
- Employment and labor market:
  - Employment rose strongly, particularly in the formal sector.
  - Unemployment declined to 9.7 percent in 2013 (noted elsewhere as 9.6 percent for 2013 in authorities’ statement).
- Inflation:
  - Subdued at 1.9 percent y/y at end-2013, slightly below the 2–4 percent target range.
  - Consumer price index (period average) 2013: 2.0; end of period 2013: 1.9.

### Monetary and exchange rate policy
- Policy interest rate:
  - Central bank held policy interest rate constant at 3.25 percent between April 2013 and April 2014.
  - In April 2014, the central bank increased the policy interest rate by 25 basis points to 3.5 percent.
- Policy stance: commitment to adjust the policy rate as necessary to keep inflation within the target range and to use the flexible exchange rate as a shock absorber.
- Exchange rate: acted as main shock absorber during U.S. tapering; depreciation occurred with no negative consequences for the economy or inflation.
- Reserves and FX operations:
  - International reserves accumulated through pre-announced daily purchases in the FX market.
  - Authorities consider pursued reserve level adequate for precautionary purposes but insufficient to cope with tail risks.

### Fiscal policy and public finances
- Fiscal performance:
  - Central government balance 2013: -2.4 percent of GDP.
  - Combined public sector balance 2013: -1.0 percent of GDP.
  - Public debt 2013: 35.2 percent of GDP.
- Fiscal rule and consolidation:
  - Fiscal target for central government in 2013: 2.4 percent of GDP (met).
  - Consolidation path: reach a structural deficit of the central government of 1.9 percent of GDP in 2018 and levels below 1 percent in 2022 onwards; public debt expected to fall to 26 percent of GDP thereafter.
- Revenue mobilization and spending efficiency:
  - Need for greater revenue mobilization; actions to broaden the tax base, reduce informality, and strengthen tax administration.
  - Tax revenue growth cited: COP 66 trillion in 2010 against 112 trillion in 2014.
  - Expenditure-side adjustments recommended, including reducing costs from healthcare provision.

### Financial sector soundness and supervision
- Financial soundness indicators: low and well-provisioned non-performing loans, strong profitability, and adequate liquidity.
- Capital and regulation:
  - New capital requirements effective August 2013 significantly enhanced quality of banks’ capital.
  - Solvency ratio close to 15 percent, above regulatory minimum 9 percent; since August 2013 complies with the quality of capital required by Basel III.
  - Liquidity regulation aligned with Liquidity Coverage Ratio of Basel III; liquidity regulation for non-banking institutions being evaluated and enacted.
- Cross-border expansion and supervision:
  - Expansion of Colombian banks in Central America diversifies risks but poses regulatory challenges.
  - Need to enhance supervision of complex conglomerates, exposure to concentration risk, and to develop deeper frameworks to monitor and stress-test cross-border risks.
- Market participation: participation of nonresidents in local government debt market and equity market projected to rise in near term.

### Outlook and risks
- Growth projection:
  - Real GDP projected to grow at around potential (about 4½ percent) in 2014 and beyond.
  - Authorities projected growth at 4.5 to 5 percent in 2014 (authorities’ statement).
  - Medium-term potential output currently at 4.6 percent; the four generation infrastructure project (4G) estimated to add around 0.7 percentage points to potential output.
- Inflation projection: expected to remain within the target range.
- External and financial risks:
  - Risks tilted to the downside: sharp decline in commodity prices (especially oil); deterioration in global financial conditions; volatility from U.S. monetary policy normalization, especially if not accompanied by a corresponding increase in U.S. growth.
  - Vulnerabilities to a Chinese slowdown via commodity prices and regional demand linkages.
  - External position assessed as strong: current account balance and real exchange rate broadly in line with fundamentals; current account deficit 2013 noted as 3.4 percent of GDP in authorities’ statement and -3.3 percent in staff table for 2013.
  - Financing: current account comfortably financed with capital inflows (5.3 percent of GDP in 2013), with FDI the largest fraction.
  - International reserves and the Flexible Credit Line arrangement provide buffers.

### Executive Board and authorities’ assessment
- Executive Directors:
  - Commended strong performance: faster economic growth, low inflation, robust job creation, declining unemployment.
  - Emphasized risks remain tilted to the downside and need for continued prudent policies and structural reforms to promote more inclusive growth.
  - Commended adherence to the fiscal rule and commitment to medium-term consolidation; called for greater revenue mobilization and spending efficiency.
  - Noted strong external position and adequate reserves; welcomed authorities’ recognition of trade-offs in further reserve accumulation.
  - Urged enhancements in supervision of complex conglomerates and cross-border risk monitoring.
- Authorities:
  - Broadly agree with staff assessment and policy recommendations.
  - Highlighted three pillars of resilience: sustainable fiscal policy, a strong financial system, and an inflation targeting regime with exchange rate flexibility, well backed by the FCL.
  - Note that fiscal rule enjoys broad support and government commitment to meeting targets.
  - Emphasize structural reforms to reduce informality, broaden pension coverage, and strengthen financial inclusion; infrastructure program (4G) expected to boost competitiveness and growth.

### Key statistics (selected from staff table)
- Real GDP growth: 2007: 6.9; 2008: 3.5; 2009: 1.7; 2010: 4.0; 2011: 6.6; 2012: 4.0; 2013: 4.3; 2014 (proj): 4.5.
- Consumer price index (period average): 2013: 2.0; 2014 (proj): 1.9.
- Consumer price index (end of period): 2013: 1.9; 2014 (proj): 2.7.
- Central government balance (% of GDP): 2013: -2.4; 2014 (proj): -2.3.
- Combined public sector balance (% of GDP): 2013: -1.0; 2014 (proj): -0.8.
- Public debt (% of GDP): 2013: 35.2; 2014 (proj): 34.7.
- Current account (deficit -) (% of GDP): 2013: -3.3; 2014 (proj): -3.3.
- Gross domestic investment (% of GDP): 2013: 24.3; 2014 (proj): 25.0.
- Gross national saving (% of GDP): 2013: 21.0; 2014 (proj): 21.7.
- Broad money (M2) 12-month change: 2013: 16.0; 2014 (proj): 13.4.
- Credit to the private sector 12-month change: 2013: 12.1; 2014 (proj): 12.6.
- Interest rate (90-day time deposits; nominal): 2013: 4.1.

*Based on IMF staff report and authorities’ statements contained in the provided document.*

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_Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2014/_cr14141.pdf_