## Monetary and Financial Conditions in Colombia

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### Recent developments and macroeconomic performance
- Poverty rate: 24.1 percent in 2015 (from 24.6 percent in 2014).
- Gini coefficient: 52.2 in 2015 (after near 54 for three consecutive years).
- Real GDP growth: 3.1 percent in 2015; staff estimates a small positive output gap in 2015.
- Inflation (2015):
  - Headline inflation: 6.8 percent.
  - Core inflation: 5.2 percent.
  - Inflation expectations: 4.5 percent.
- External position and reserves:
  - Current account deficit: 6.5 percent of GDP in 2015.
  - International reserves: US$46.3 billion (broadly constant).
  - External debt: 40 percent of GDP.
  - NIIP: -44 percent of GDP.
- Financial conditions and credit:
  - Bank real credit growth: exceeded 8 percent (y/y) in December 2015.
  - Commercial credit growth faster; consumer credit growth slower; mortgage credit and house price growth remained brisk despite some moderation.
- External shock and environment:
  - Large decline in oil prices produced a much larger terms-of-trade shock than the regional average.
  - Weaker growth among key trading partners (notably Venezuela and Ecuador) and tighter external financial conditions.

### Monetary policy, FX intervention, and policy responses
- Central bank policy:
  - Policy rate increases started in September 2015 in response to increasing inflation expectations.
  - Cumulative 200 basis point spike in the policy rate through the tightening cycle.
  - Policy rate increased to 6.5 percent in March (presented as "this year" in text).
- Fiscal actions:
  - Government cut expenditures early in 2015 by about 0.5 percent of GDP.
  - End-2014 tax reform yielded 0.5 percent of GDP.
  - Expenditure reallocation focused on school construction and housing subsidies.
- Dollar Auction Program (FX intervention):
  - Start date: October 30, 2015 with subsequent adjustments.
  - Objective: Moderate disorderly increases in the exchange rate and provide FX market liquidity.
  - Modality: Auction of call dollar options for about US$500 million (about 1/3 of daily turnover); option strike price = average spot exchange rate at the previous day; sold through Dutch auctions.
  - Rule-based trigger: sale/exercise requires daily exchange rate movement to exceed a threshold vs 20-days moving average.
  - Trigger history: 7 percent (Oct 30), lowered to 5 percent (Dec 23, 2015), and to 3 percent (Feb 19, 2016).
  - Execution: Program had not been triggered as of reporting; judged to have reduced FX uncertainty.

### Macro-financial condition indices and implications
- Traditional MCI/FCI indices: suggest financial conditions eased since mid-2014, largely reflecting currency depreciation.
- Macro Risk Premium (MRP) indicator: incorporating intermediaries’ balance sheet data (and excluding exchange rate) has been increasing since mid-2014, indicating tighter balance sheets and reduced risk appetite.
- Higher MRP associated with moderation in credit growth; monetary tightening likely to further reduce banks’ risk-taking capacity and slow credit growth.

### Corporate and household sector vulnerabilities (summary and Box 2 highlights)
- Corporate sector:
  - Private sector corporate debt: 45 percent of GDP as of June 2015.
  - Foreign-currency funding: about 33 percent of total corporate debt.
  - Debt-at-risk (firms with ICR < 2): 30.1 percent of total sample debt (BanRep definition).
  - Fragile firms share: hovered at about 25 percent during the last three years (end-2014 data).
  - Sectoral debt-at-risk: Agriculture 36 percent; Real estate 39 percent; Retail 33 percent.
  - Staff analysis of largest 100 corporates: 5 percent of debt at risk (indicator was 40 percent in 2009).
  - Shock scenario approximating end-2015 (10 percent earnings increase and 30 percent depreciation applied to 2014 data): debt at risk increases to about 12 percent.
  - Central bank stress test (to June 2015) of FX-exposed subset: after 40 percent depreciation distressed firms would represent 3.2 percent of the commercial loan portfolio.
  - Oil sector: about 4 percent of total corporate loans; about half to oil industry suppliers and half related to Ecopetrol; capex cut by about 25 percent in 2016 for Ecopetrol.
- Household sector:
  - Household debt: 20.5 percent of GDP and 31.8 percent of disposable income.
  - Debt payments: about 9½ percent of disposable income.
- Banking sector:
  - Banks remain sound with robust asset quality and profitability indicators (ROA 3 percent; ROE 22 percent).
  - NPLs for all loan portfolios: 3 percent; coverage (provisions for NPLs): 154 percent.
  - Regulatory capital to risk-weighted assets: 17.2 (2013); 17.3 (2014); 16.9 (2015).
  - Nonperforming loans to gross loans: 4.0 (2013); 2.9 (2014); 2.5 (2015).

### Infrastructure agenda and financing
- 4G-PPP agenda:
  - First-wave projects allocated; construction phase started.
  - Development fund (FDN) facilitating financial arrangements with major banks and institutional investors; successful funding deals with global banks completed.
  - Sale of ISAGEN for about US$2 billion expected to help finance upcoming waves.
  - Capital expenditures will peak at around 1 percent of GDP in 2018.
  - Staff-calibrated DIGNAR model: positive growth yield that peaks at about 0.4 percentage points in 2019 and shows positive crowding-in effects on private investment.

### Outlook and projections
- Growth:
  - Staff projects growth to slow to 2.5 percent in 2016 and gradually increase over the medium-term (projections: 2017 3.0; 2018 3.7; 2019 4.1; 2020 4.3; 2021 4.0).
  - Potential GDP: 2016 3.4; 2017 3.4; 2018 3.6; 2019 3.7; 2020 3.8; 2021 3.7.
  - Output Gap: 2016 -0.3; 2017 -0.8; 2018 -0.6; 2019 -0.2; 2020 0.2; 2021 0.4.
- Current account:
  - Projected to decline to 6 percent of GDP in the reference year and gradually approach 3.8 percent of GDP in 2020.
  - Current account balance (percent of GDP): 2016 -6.0; 2017 -4.3; 2018 -4.2; 2019 -4.0; 2020 -3.8; 2021 -3.6.
- Inflation:
  - Acceleration continued in early 2016 but expected to reverse during the year due to further tightening and dissipation of weather-related food shock and pass-through; inflation expected to return to the target range by early 2017.
  - Headline inflation (CPI, end of period) projections: 2016 5.6; 2017 3.3; 2018 3.0; 2019 3.0; 2020 3.0; 2021 3.0.
- Credit and banking:
  - Ongoing monetary and financial tightening expected to moderate credit activity; credit growth projections (percent change): 2016 9.2; 2017 7.1; 2018 8.0; 2019 9.0; 2020 10.0; 2021 11.0.
  - Bank liquid assets would remain more than 2.5 times their liquidity needs as identified by their short-term liquidity risk indicator (IRL).

### Near-term fiscal adjustment and medium-term fiscal framework
- Near-term measures:
  - Expenditure freeze amounting to 0.7 percent of GDP affecting investment, the wage bill and transfers, while protecting key social programs.
  - Plans to bolster revenue collection by about 0.5 percent of GDP through tax administration efforts.
  - Under staff growth assumptions, further adjustments of around 0.3 percent of GDP would be needed to meet the headline deficit target.
  - Staff estimates a negative fiscal impulse of about 1.6 percent of GDP.
- Fiscal projections and debt:
  - Public debt will reach around 50 percent of GDP in 2016, decline over the medium term and remain sustainable.
  - Public debt (percent of GDP): 2013 37.8; 2014 44.2; 2015 50.6; 2016 49.9; 2017 49.0; 2018 47.9; 2019 46.1; 2020 44.4; 2021 43.2.
  - Public debt excluding Ecopetrol: 2016 45.2; 2017 44.5; 2018 43.5; 2019 42.3; 2020 40.6; 2021 39.4.
- Structural tax reform:
  - Central government oil fiscal revenue will decline from 3 percent of GDP in 2013 to near zero in 2016.
  - Absent structural tax reform, achieving the structural balance targets would require about 1.4 pp of GDP of primary expenditure cuts between 2017 and 2021.
  - Staff welcomes authorities’ commitment to seek approval of a structural tax reform this year (to be approved no later than December 2016 as indicated by authorities).

### Policies to protect financial stability and supervisory developments
- Key supervisory actions and powers:
  - Since December 2015 the supervisor (SFC) can impose higher capital and liquidity requirements on individual institutions with higher risk profiles.
  - Laws granting independence and legal protection of the supervisor came into effect in January 2016.
  - Laws awarding further regulatory powers over holding companies of financial conglomerates are before Congress.
- Liquidity and funding developments:
  - Government moved cash deposits to the central bank (single-treasury-account, CUN), reducing deposits at the four largest commercial banks; banks sought longer-maturity deposits as replacements.
  - Increased competition for deposits and monetary policy tightening have raised funding costs, particularly for smaller entities.
  - Liquidity stress tests show no systemic funding concerns given bank liquid assets exceed identified needs by more than a factor of 2.5.
- Supervision and stress testing:
  - SFC is strengthening contingency plans, discounting access to credit lines, linking liquidity measurement with stress tests and corporate governance, and addressing high dependency on funding in some institutions.
  - Authorities advancing stress-testing techniques including DSGE and network models; linking real sector vulnerabilities to financial sector solvency, liquidity impacts and contagion assessments.
  - Pilot assessment of resolution framework (2015) identified additional powers needed for effective resolution.

### Risks, scenarios, and policy recommendations
- Downside risks (predominate):
  - Large near-term external financing needs, sizable current account deficit, sizeable corporate short-term external debt, and reliance on portfolio inflows pose vulnerability to a deterioration in market sentiment.
  - Global risks: weaker advanced-economy growth, uncertainties about the Fed’s next steps, asynchronous unwinding of unconventional monetary policies, and sharper-than-expected slowdown in China.
  - Sharp and persistent drops in oil prices could render parts of the oil industry unprofitable, drastically reduce production, and worsen corporate solvency in affected sectors.
  - Delays in the 4G infrastructure agenda would dampen demand and competitiveness.
- Upside scenarios:
  - Successful conclusion of peace negotiations and prompt approval of a structural tax reform could boost business confidence and capital inflows.
- Staff policy recommendations and assessments:
  - Continued prudent fiscal policy and adherence to structural deficit targets to facilitate adjustment.
  - Prompt approval of a structural tax reform is essential to help the adjustment without undue compression of public spending; a reform that improves progressivity and business competitiveness will help achieve strong and inclusive growth.
  - Further strengthening of banking supervision and maintaining a strong, well-supervised banking system to withstand downside risks.
  - Progress on structural reforms (including tax reform and infrastructure implementation) could improve medium-term growth and external financing prospects.
  - Close monitoring of corporate foreign-currency exposures and short-term external debt to limit amplification of external shocks.
  - Continue embedding Basel III elements and enhancing resolution frameworks; enact conglomerates law currently in Congress.

### External sector assessment (Annex I summary)
- REER and valuation:
  - Real exchange rate (REER) depreciated by 34 percent over the last two years.
  - EBA REER indicates a 15 percent undervaluation; staff places the current account norm in the -2 to -3 percent of GDP range.
- Current account and trade:
  - Commodity exports contracted by US$19 billion; oil exports fell from 8.4 percent of GDP in 2013 to 4.9 percent of GDP in 2015; projected 3.6 percent of GDP in 2016.
  - Exports shifted toward the United States and the Euro Zone (from US$2.4 billion to US$3.6 billion); exports to the region fell by almost US$3 billion.
  - Imports contracted significantly; demand for imports expected to continue contracting.
- Capital flows and IIP:
  - Gross FDI into oil and non-oil sectors contracted in 2015 by US$4 billion or 25 percent.
  - NIIP: -44 percent of GDP in 2015 (from -30 percent in 2014); valuation impact from depreciation accounts for 12 percentage points of the IIP deterioration in 2015.
  - Gross liabilities estimated at 95 percent of GDP in 2015; portfolio liabilities amount to 25 percent of GDP.
- Oil shock impacts (selected figures):
  - Fiscal oil revenues: 3.3 percent of GDP in 2013 to almost 0 in 2016.
  - Oil-related investment (US$ bn): 2013 9.6; 2014 9.2; 2015 6.2; 2016 (proj.) 4.4.
  - o/w FDI in oil sector (US$ bn): 2013 5.1; 2014 4.7; 2015 3.7; 2016 (proj.) 2.3.
  - Oil exports (US$ bn): 2013 32.0; 2014 28.9; 2015 14.2; 2016 (proj.) 9.1.
  - Peso depreciation (percent, periods shown): 2013 3.9; 2014 7.1; 2015 37.0; 2016 (proj.) 22.4.
  - Crude oil, spot price (US$): 2013 104.1; 2014 96.2; 2015 50.8; 2016 (proj.) 34.8.
- Policy implication: flexible exchange rates are important for adjustment; Colombia likely needs a stronger adjustment in domestic demand to facilitate current account correction.

### Financial integration, pension funds, and bank structure (selected)
- Portfolio shifts:
  - 29.4 percent (context: a sizeable portfolio shift towards investments in dollars increasing by 6 percentage points while peso assets decreased by 8 percentage points compared to 2014).
- Bank liabilities and asset structure:
  - Deposits and demand accounts: 84 percent of total liabilities.
  - Around 40 percent of those deposits are from large (100) institutional depositors.
  - Issuance of debt securities: around 10 percent of liabilities.
  - Money market operations: 5 percent of liabilities.
  - Loans: 91 percent domestic and 9 percent foreign.
  - Government bond holdings by banks: 99.6 percent domestic and 0.4 percent foreign.
- Profitability and resilience:
  - ROA: 3 percent; ROE: 22 percent; Net-interest margins: 58 percent; Non-net-interest margins: 42 percent.
  - Banks retain around 30-40 percent of earnings; some banks intend to increase capitalization levels further in 2016.
- Stress testing:
  - Staff shocks included a 20 percent earnings shock and 70 percent depreciation; corporate loans around 65 percent of bank balance sheets; stressed probability of defaults 25 percent; loss given default 60 percent.
  - Under adverse but plausible shocks, banking system solvency remains above regulatory minima though two banks with the lowest starting capital fall just below the 9 percent regulatory minimum.
  - Release of countercyclical provisions expected to absorb losses and limit risks to credit supply and economic growth.

### Social and key macro statistics (selected)
- Population (2015): 48.2 million.
- Urban population (2014): 76.2 percent.
- Life expectancy at birth (2013): 73.8 years.
- Gini coefficient: 2014 0.550; 2015 0.552.
- Unemployment rate (2015): 8.9 percent.
- Poverty rate (US$3.1 a day, PPP, 2013): 5.3 percent.
- GDP (billion of US$): 2013 380; 2014 379; 2015 292; 2016 254; projections to 385 by 2021.
- Gross international reserves (US$ billion): 2013 43.2; 2014 46.8; 2015 46.3; 2016 46.4; projected 51.5 by 2021.
- GIR to GDP (end-2015): 15.8 percent; GIR to broad money (end-2015): 35.8 percent.

*International Monetary Fund — staff summary of “Monetary and Financial Conditions in Colombia” (excerpts).*

### 1. Monetary and Financial Conditions in Colombia ________________________________________________7

### Monetary and Financial Conditions in Colombia

### Recent developments and macroeconomic performance
- Poverty rate declined to 24.1 percent in 2015 (from 24.6 percent in 2014).
- Gini coefficient declined to 52.2 in 2015 after being near 54 for three consecutive years.
- Real GDP growth moderated to 3.1 percent in 2015; staff estimates a small positive output gap in 2015.
- Inflation developments in 2015:
  - Headline inflation closed the year at 6.8 percent.
  - Core inflation ended at 5.2 percent.
  - Inflation expectations increased to 4.5 percent.
- Current account and external position:
  - Current account deficit widened to 6.5 percent of GDP in 2015.
  - International reserves broadly constant at US$46.3 billion.
  - External debt increased to 40 percent of GDP.
  - NIIP deteriorated to -44 percent of GDP.
- Financial conditions and credit:
  - Bank real credit growth slowed during the year but still exceeded 8 percent in real terms (y/y) in December.
  - Commercial credit growth faster, consumer credit growth slower; mortgage credit and house price growth remained brisk despite some moderation.
- Commodity shock and external environment:
  - Large decline in oil prices produced a much larger terms-of-trade shock than the regional average.
  - Weaker growth among key trading partners (notably Venezuela and Ecuador) and tighter external financial conditions (increased government bond spreads, smaller portfolio inflows).

### Monetary and financial conditions and policy responses
- Central bank actions:
  - Central bank started increasing the policy rate in September 2015 in response to increasing inflation expectations.
  - Cumulative 200 basis point spike in the policy rate (through the tightening cycle noted).
  - Policy rate increased to 6.5 percent in March (year not explicitly restated in the unit; presented as "this year" in text).
- Fiscal and structural policy:
  - Government cut expenditures early in 2015 by about 0.5 percent of GDP.
  - End-2014 tax reform yielded 0.5 percent of GDP, aiding compliance with the structural target on the central government deficit.
  - Expenditure reallocation program focused on school construction and housing subsidies.
- Foreign exchange intervention program (Colombia's Central Bank's Dollar Auction Program):
  - Start date: October 30, 2015 with subsequent adjustments.
  - Objective: Moderate disorderly increases in the exchange rate and provide FX market liquidity.
  - Modality: Auction of call dollar options for about US$500 million (about 1/3 of daily turnover); option strike price = average spot exchange rate at the previous day; sold through Dutch auctions.
  - Rule-based trigger: sale/exercise requires daily exchange rate movement to exceed a threshold vs 20-days moving average.
  - Trigger history: 7 percent (Oct 30), lowered to 5 percent (Dec 23, 2015), and to 3 percent (Feb 19, 2016).
  - Execution: Program had not been triggered as of reporting; judged to have reduced FX uncertainty.
- Monetary and financial conditions indices findings (Box 1):
  - Traditional MCI/FCI indices suggest financial conditions eased since mid-2014, largely reflecting currency depreciation.
  - A Macro Risk Premium (MRP) indicator that incorporates intermediaries’ balance sheet data (and excludes exchange rate) has been increasing since mid-2014, indicating tighter balance sheets and reduced risk appetite.
  - Higher MRP associated with moderation in credit growth; monetary tightening likely to further reduce banks’ risk-taking capacity and slow credit growth.

### Corporate and household sector vulnerabilities
- Corporate sector:
  - Bank loans remain main corporate financing source; foreign currency funding represents about 33 percent of total corporate debt.
  - Corporate debt modest by international standards, but “debt-at-risk” (firms with interest coverage ratio (ICR) < 2) amounts to 30 percent of total sample debt.
  - Debt indicators worsened mainly in the oil and airline industries; solvency problems remain contained.
  - Debt service capacity had improved for the largest 100 firms through end-2014, but gains partially erased by 2015 commodity price and depreciation shocks.
- Household sector:
  - Household debt at 20.5 percent of GDP and 31.8 percent of disposable income.
  - Debt-service capacity appears ample with debt payments representing about 9½ percent of disposable income.
- Banking sector:
  - Banks remain sound with robust asset quality and profitability indicators (Table 7 referenced).

### Infrastructure agenda and financing
- 4G-PPP infrastructure agenda:
  - First-wave projects allocated; construction phase started.
  - The development fund (FDN) facilitating financial arrangements with major banks and institutional investors; successful funding deals with global banks completed.
  - Sale of ISAGEN for about US$2 billion expected to help finance upcoming waves.

### Outlook and policy implications
- Growth and near-term outlook:
  - Staff projects growth to slow to 2.5 percent in 2016 and gradually increase over the medium-term, supported by the construction phase of the 4G agenda.
  - Main short-term adverse impact of the oil shock expected through investment; peso depreciation since mid-2014 expected to spur import substitution and support non-oil exports.
  - Current account deficit projected to decline to 6 percent of GDP in the reference year and gradually approach 3.8 percent of GDP in 2020.
- Inflation and monetary outlook:
  - Acceleration in inflation continued in early 2016 but expected to reverse during the year due to further tightening and dissipation of weather-related food shock and pass-through; inflation expected to return to the target range by early 2017.
  - Ongoing monetary and financial tightening expected to moderate credit activity as banks absorb credit losses and reduce risk-taking.
  - Reallocation of credit from consumption toward construction could underpin activity pickup from 2017 onwards.
- Policy recommendations and assessments implied by staff analysis:
  - Continued prudent fiscal policy and adherence to structural deficit targets facilitate adjustment.
  - Further strengthening of banking supervision and maintaining a strong, well-supervised banking system to withstand downside risks.
  - Progress on structural reforms (including tax reform and infrastructure implementation) could improve medium-term growth and external financing prospects.
  - Close monitoring of corporate foreign-currency exposures and short-term external debt to limit amplification of external shocks.

### Risks and scenarios
- Downside risks predominate, concentrated in external financing dynamics:
  - Large near-term external financing needs, sizable current account deficit, sizeable corporate short-term external debt, and reliance on portfolio inflows pose vulnerability to a deterioration in market sentiment.
  - Global risks include weaker advanced-economy growth, uncertainties about the Fed’s next steps, asynchronous unwinding of unconventional monetary policies, and sharper-than-expected slowdown in China—these could reduce risk appetite for emerging market assets and further depress commodity prices.
  - Sharp and persistent drops in oil prices could render parts of the oil industry unprofitable, drastically reduce production, and worsen corporate solvency in affected sectors.
  - Delays in the 4G infrastructure agenda would dampen demand and competitiveness.
- Upside outcomes:
  - Successful conclusion of peace negotiations and prompt approval of a structural tax reform could boost business confidence and capital inflows.

*International Monetary Fund — staff summary of “Monetary and Financial Conditions in Colombia” (excerpts).*

### Box 2. Corporate Sector Vulnerabilities

### Box 2. Corporate Sector Vulnerabilities

### Background
- Colombian private sector corporate debt and leverage have steadily increased from early 2000.
- As of June 2015 private sector corporate debt stood at 45 percent of GDP.
- Slightly more than half of total corporate debt is owed to domestic financial institutions.
- About 2/3 of corporate debt is peso-denominated.

### Corporate debt structure and trends
- Corporate debt is increasingly domestic and bank dependent.
- Corporate debt is largely peso dominated but some growth in US dollar exposure is noted.
- Chart source noted as: Source: BanRep.

### Fragile firms (central bank and staff findings)
- Definition: Firms identified as fragile if their ICR (interest coverage ratio) is less than 2 (BanRep Financial Stability Report, September 2015).
- Fragile firms hovered at about 25 percent during the last three years (based on end-2014 data).
- Debt of fragile firms (debt at risk) amounted to 30.1 percent of total debt in the entire sample.
- Sectoral concentration of debt at risk:
  - Agriculture: 36 percent of debt in that sector is owed by fragile firms.
  - Real estate: 39 percent.
  - Retail: 33 percent.
- Staff analysis of the largest 100 Colombian corporates:
  - Only 5 percent of debt is at risk.
  - Indicator was 40 percent in 2009, declining consistent with observed growth in profitability and still favorable external financial conditions.
- Data coverage caveat:
  - The S&P Capital IQ data used by staff covers only up to end-2014 and does not fully account for further depreciation and even lower oil prices faced in 2015 and early 2016.
- Shock scenario (to approximate end-2015 conditions):
  - Applied a “shock” in line with observed changes in earnings (10 percent increase) and depreciation shock (30 percent) to latest available 2014 corporate data.
  - Under this scenario debt at risk increases to about 12 percent.

### Stress tests and resilience
- Central bank stress test (to June 2015) of a subset of firms exposed to FX risk:
  - After 40 percent depreciation distressed firms would represent only 3.2 percent of the commercial loan portfolio.
- Conclusion from staff and central bank analyses:
  - Corporate balance sheets remain vulnerable to further adversity, but the impact appears contained based on available stress tests and large-firm analysis.

### Macro-financial implications of the oil sector conjuncture
- The oil sector represents about 4 percent of total corporate loans from the banking sector.
- Composition of oil-related loans:
  - About half of these loans are to oil industry suppliers.
  - The other half is related to government-owned oil company Ecopetrol.
- Implications:
  - Given the low direct portfolio exposure to oil and oil-related entities this implies relatively contained impact on bank losses (NPLs) and bank solvency from distress and default in this industrial sector.
  - No other significant financial stability impact or broader macro-financial implications would result from this direct oil–bank sector loan linkage.
  - Financial stability impacts could become more significant if downgrades in oil-sector entities were to result in downgrades for the sovereign and Colombian banks.
- Ecopetrol-specific developments:
  - Response to the oil shock has included a large reduction in investment and a shutdown of operations with higher marginal cost of production.
  - Capex will be cut by about 25 percent in 2016.
  - Ecopetrol has limited debt amortizations in the next three years, but a lower capex outlook will constrain near-term production outlook and weaken debt service capacity.
- Chart sources noted as: Sources: Bloomberg and Fund staff estimates.

*Source: Fund staff estimates; BanRep.*

### 0.7 percent of GDP through an expenditure freeze

### _cr16129 - 0.7 percent of GDP through an expenditure freeze

### Near-term fiscal adjustment and outlook
- Authorities plan an expenditure freeze amounting to 0.7 percent of GDP that affects investment, the wage bill and transfers, while protecting key social programs.
- Plans to bolster revenue collection by about 0.5 percent of GDP through tax administration efforts supported by strengthened technical and human resources at the tax authority.
- Under staff growth assumptions, further adjustments of around 0.3 percent of GDP would be needed to meet the headline deficit target.
- Authorities indicated possible additional cuts or reliance on the normal level of under execution to provide the remaining restraint.
- Staff encourages continued emphasis on tax administration, building on gains achieved in 2015, and stressed the importance of protecting execution of key social programs.
- Further fiscal restraint is expected from sub-national governments’ weaker spending after the 2015 election cycle.
- Staff estimates a negative fiscal impulse of about 1.6 percent of GDP.
- Public debt will reach around 50 percent of GDP in 2016, decline over the medium term and remain sustainable.
- Staff notes that the near-term stance is tighter than what would be allowed by the structural fiscal rule by around 1 percent of GDP.

### Structural tax reform and the medium-term fiscal outlook
- Central government oil fiscal revenue will decline from 3 percent of GDP in 2013 to near zero in 2016 (noted as 1 percent of GDP lower than anticipated during the last Article IV Consultation).
- Staff estimates that absent a structural tax reform, achieving the structural balance targets imposed by the rule would require about 1.4 pp of GDP of primary expenditure cuts between 2017 and 2021, leaving little room for social needs and the multi-year infrastructure plan.
- The tax expert commission’s report is closely aligned with recent technical assistance from FAD and will form the basis of the authorities’ proposal; staff welcomes the authorities’ commitment to seek approval of a structural tax reform this year.
- The structural tax reform is seen as essential to make the fiscal adjustment more balanced, less reliant on expenditure restraint, and to help cover expenses related to the completion of the peace agreement.
- Authorities reaffirmed commitment to the fiscal rule as the underlying fiscal anchor and to identify and include any potential peace-related expenses in the medium-term fiscal framework.

### Protecting financial stability
- The financial system has been resilient but requires continued vigilance.
- 1/3 of corporate debt is FX-denominated, heightening sensitivity to exchange rate moves.
- Sharp fall in commodity prices and increased corporate debt created pockets of vulnerability in specific industries (oil and airlines).
- Stress tests indicate that under standard earnings and depreciation shocks, banks’ solvency remains above regulatory minima for the large majority of banks; risks to credit supply and growth are low given large countercyclical provisions.
- Household balance sheet risks have risen marginally but remain contained.
- Key indicators:
  - Loan-to-value ratios: 51.4 percent.
  - Mortgage portfolios: 12.3 percent of total loans.
  - Bank liquid assets would remain more than 2.5 times their liquidity needs as identified by their short-term liquidity risk indicator (IRL).
- The supervisory authority (SFC) has taken actions to strengthen liquidity planning, management and stress testing capabilities and to intensify supervision of liquidity models and contingency plans.
- Since December 2015 the supervisor can impose higher capital and liquidity requirements on individual institutions with higher risk profiles; laws granting independence and legal protection of the supervisor came into effect in January 2016.
- Laws awarding further regulatory powers over holding companies of financial conglomerates are before Congress; prompt approval would expand ability to manage cross-border risks.
- Challenges remain in assessing risks from mixed conglomerates due to complex ownership and offshore structures where SFC reach is limited.
- Authorities plan to embed Basel III elements and enhance resolution frameworks; staff encouraged further communication to explain the peculiarities and strengths of the Colombian regulatory regime.

### Funding structure and liquidity developments
- In 2015 the government moved cash deposits to the central bank (single-treasury-account, CUN), reducing deposits at the four largest commercial banks; banks sought longer-maturity deposits as replacements.
- Increased competition for deposits and monetary policy tightening have raised funding costs, particularly for smaller entities.
- Liquidity stress tests show no systemic funding concerns given bank liquid assets exceed identified needs by more than a factor of 2.5.
- SFC selective actions in 2015 included strengthening contingency plans for foreign subsidiaries, fully assessing and discounting access to credit lines, linking liquidity measurement with banks’ stress tests and corporate governance, and addressing high dependency on funding in some institutions.
- Banks’ own liquidity stress tests were encouraged to include persistent shocks and macroeconomic variables and to evaluate implementation of a 90-day IRL.

### Structural reforms and infrastructure agenda
- Colombia faces structural bottlenecks that could hinder productive transformation away from commodities; weaknesses include ease of trading across borders (110th) and paying taxes (126th), primary education (105th), taxation on investment (131th) and employment (113th), and infrastructure (ranked 126th by WEF).
- The authorities’ structural agenda targets diversification and inclusive growth: a recently approved customs code, the 4G infrastructure agenda, and a plan to improve multi-mode transportation logistics including tertiary roads.
- Improvements in planning, reducing subsidies, simplification of import tariffs, identification of production clusters, and programs to expand school coverage and link training with firms’ demands are highlighted.
- The 4G PPP-based infrastructure agenda:
  - Capital expenditures will peak at around 1 percent of GDP in 2018.
  - Staff-calibrated DIGNAR model suggests a positive growth yield that peaks at about 0.4 percentage points in 2019 and shows positive crowding-in effects on private investment.
  - The model accounts for short-term demand impacts and offset factors (crowding out, taxation to cover fiscal contribution, real appreciation from increased demand for non-tradables).
- Public Investment Management Assessment (PIMA) indicates Colombia compares well regionally but could strengthen project selection processes.

### Staff appraisal and risks
- Colombia’s resilience to global shocks reflects very strong policies; despite a large terms-of-trade shock, Colombia posted one of the strongest GDP growth rates in the region and reduced poverty and inequality.
- Coordinated policy response should help achieve a soft landing provided no major new shocks occur.
- Growth will slow in 2016 in part due to a decline in investment despite the start of the 4G agenda; fiscal and monetary tightening will help align domestic demand with subdued national income and guide inflation expectations back to the target range, with headline inflation returning to the target band in early 2017.
- The peso depreciation will help boost exports and import compression will contribute to a decline in the current account deficit toward its medium-term equilibrium.
- Credit growth will continue to slow in 2016, supporting reallocation of resources away from commodities toward construction.
- Downside external risks have grown but should remain manageable; notable risks include a disorderly slowdown in China, reversal in capital inflows, weak conditions in neighboring countries, and further declines in oil prices.
- Flexible exchange rate, ample reserves, and the FCL provide buffers; stress tests reassure that the financial system would weather severe shocks, though continued vigilance is warranted as the corporate sector adjusts.

*Source: IMF staff report content provided in the input.*

### 33.      A prompt approval of a structural tax reform is essential to help the adjustment,

### _cr16129 - 33.      A prompt approval of a structural tax reform is essential to help the adjustment,

### Tax reform and fiscal framework
- A prompt approval of a structural tax reform is essential to help the adjustment, without leading to an undue compression of public spending.
- A reform that improves progressivity and business competitiveness will also help achieved strong and inclusive growth.
- The expert commission recommendations constitute a valuable blueprint which can be fine-tuned to specific revenue needs—including those stemming from the peace process.
- Staff welcomes the authorities’ commitment to incorporate all peace-related initiatives transparently in their medium-term fiscal framework.

### Medium-term outlook and growth agenda
- The medium-term outlook is favorable in the absence of further major shocks.
- The authorities’ 4G infrastructure agenda will support growth during its construction phase and once completed stands to ease an important growth bottleneck.
- Ongoing efforts to eliminate trade obstacles, streamline customs procedures and regulations, and foster innovation will support growth and economic diversification.

### Financial regulation and supervision
- Recent advances in financial regulation and supervision have underpinned the financial system’s resilience to changing global conditions; further actions will bring Colombia closer to international best practices.
- The financial system solvency and liquidity has remained strong amid less favorable external financing conditions, sectoral credit issues and changes in local funding conditions.
- Expansions in regulatory and supervisory powers have widened both information availability and the policy toolkit including of macro-prudential tools.
- Colombia should continue to move its regulatory framework closer to the latest standards by enacting the conglomerates law currently in Congress, adapting key Basel III elements and strengthening its resolution framework.

### Development plan and inclusive growth
- The development plan offers a useful roadmap of additional measures to foster inclusive growth.
- Improving access to quality education, streamlining subsidies and regulations, and expand the logistic network across the country would help improve labor productivity and better integrate all regions, unleashing agriculture and industrial potential.

### Exchange restriction recommendation
- 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.

*IMF staff report excerpt.*

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

### _cr16129 - 38.      Staff recommends that the next Article IV consultation takes place on the standard

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

### Recent economic developments
- Growth has slowed while the economy remained operating near its potential level.
  - Real GDP growth (selected projections and historical): 2013 4.9; 2014 4.4; 2015 3.1; 2016 2.5; 2017 3.0; 2018 3.7; 2019 4.1; 2020 4.3; 2021 4.0 (Table 6).
  - Potential GDP: 2013 4.2; 2014 3.9; 2015 3.6; 2016 3.4; 2017 3.4; 2018 3.6; 2019 3.7; 2020 3.8; 2021 3.7.
  - Output Gap: 2013 0.6; 2014 1.1; 2015 0.6; 2016 -0.3; 2017 -0.8; 2018 -0.6; 2019 -0.2; 2020 0.2; 2021 0.4.
- Demand composition and activity:
  - Consumption remained resilient, supporting GDP despite slowdown (Real GDP Growth and Contributions chart).
  - Investment slowed down considerably (Capital goods imports and confidence; Investment indicators).
- Inflation and prices:
  - Headline inflation (CPI, end of period): 2013 1.9; 2014 3.7; 2015 6.8; 2016 5.6; 2017 3.3; 2018 3.0; 2019 3.0; 2020 3.0; 2021 3.0.
  - Weather-related food shocks pushed inflation outside the target band.
- Exchange rate and commodity shocks:
  - The plunge in oil prices led to peso depreciation; oil prices tracked Brent/WTI closely.
  - Exchange rate (nominal Col$/US$, period average): 2013 1,868.9; 2014 2,001.1; 2015 2,741.8; 2016 3,356.5 (Table 5).
  - Crude oil, spot price (projections row in Table 6): 2013 104.1; 2014 96.2; 2015 50.8; 2016 30.8; 2017 34.8; 2018 41.0; 2019 44.5; 2020 47.6; 2021 49.4.

### External sector developments
- Terms of trade and trade flows:
  - Terms of Trade index deteriorated in 2015 (Terms of Trade Index and Oil Price figure).
  - Exports (f.o.b., US$ million): 2013 60,281; 2014 56,923; 2015 38,125; 2016 32,298; projections rise to 46,157 by 2021 (Table 2a).
  - Imports (f.o.b., US$ million): 2013 57,101; 2014 61,553; 2015 52,151; 2016 45,038; projections to 54,270 by 2021.
  - Fuel exports fell sharply: Fuel exports (selected values) 2013 32,011; 2014 28,885; 2015 14,224; 2016 9,083.
- Current account and financing:
  - Current account balance (US$ million): 2013 -12,326; 2014 -19,593; 2015 -18,925; 2016 -15,281; projections through 2021 show deficits around -13,979 by 2021 (Table 2a).
  - Current account balance (percent of GDP): 2013 -3.2; 2014 -5.2; 2015 -6.5; 2016 -6.0; 2017 -4.3; 2018 -4.2; 2019 -4.0; 2020 -3.8; 2021 -3.6 (Table 2b).
  - The current account deficit worsened in 2015 but remained financed mainly by strong FDI and portfolio flows.
  - Financial account balance (US$ million): 2013 -11,845; 2014 -19,836; 2015 -19,201; 2016 -15,281.
  - Direct Investment (US$ million): 2013 -8,557; 2014 -12,426; 2015 -7,890; with FDI increasingly directed to non-oil sectors.
- International investment position:
  - The international investment position became more negative in 2015 (IIP figure).
- Reserve and coverage:
  - Gross international reserves (GIR, IMF definition, US$ billion): 2013 43.2; 2014 46.8; 2015 46.3; 2016 46.4; projections 51.5 by 2021 (Table 2a).
  - GIR/GDP: 2013 11.4; 2014 12.4; 2015 15.8; 2016 18.3; projected decline to 13.3 by 2021.
  - GIR to short-term external debt plus current account deficit (percent): 2013 104.7; 2014 110.4; 2015 118.4; 2016 116.0; 2017 118.5; 2018 104.9; 2019 104.3; 2020 98.6; 2021 n.a. (Table 2a).

### Macroeconomic policies and public finances
- Monetary policy:
  - The central bank tightened monetary policy in the second part of the year (Policy Interest Rate figure; Intervention rate and other rates chart).
  - Central Bank intervention rule: would intervene in the spot market once the exchange rate is above 5 percent of its 20 day moving average; before December 23/2015 the rate was 7 percent.
  - Central Bank inflation target range: 2.0-4.0 (Table 5, memorandum).
- Fiscal stance and public sector balances:
  - Central government overall balance (percent of GDP): 2013 -2.3; 2014 -2.4; 2015 -3.0; 2016 -3.6; 2017 -3.3; 2018 -2.7; 2019 -2.1; 2020 -1.8; 2021 -1.4 (Table 3).
  - Combined public sector (CPS) balance (percent of GDP): 2013 -0.9; 2014 -1.8; 2015 -2.8; 2016 -3.2; 2017 -2.9; 2018 -2.3; 2019 -1.8; 2020 -1.5; 2021 -1.3 (Tables 3 and 4).
  - CPS non-oil structural primary balance (percent of GDP): 2013 -2.8; 2014 -3.4; 2015 -1.8; 2016 -0.2; 2017 0.0; 2018 0.5; 2019 0.9; 2020 1.0; 2021 0.9 (Table 3).
  - Total revenue (percent of GDP): 2013 16.9; 2014 16.6; 2015 16.2; projections around 15.0 by 2021 (Table 3).
  - Total expenditure and net lending (percent of GDP): 2013 19.2; 2014 19.0; 2015 19.3; projections declining to 16.5 by 2021.
  - End-2014 tax reform helped offset some decline in oil revenues and protect expenditure levels.
- Public debt dynamics:
  - Public debt (percent of GDP): 2013 37.8; 2014 44.2; 2015 50.6; 2016 49.9; 2017 49.0; 2018 47.9; 2019 46.1; 2020 44.4; 2021 43.2 (Tables 4 and 6).
  - Public debt excluding Ecopetrol: 2013 36.1; 2014 41.4; 2015 45.9; 2016 45.2; 2017 44.5; 2018 43.5; 2019 42.3; 2020 40.6; 2021 39.4.
  - Public gross financing needs: values shown in DSA and Table 10 (charts show rising needs in baseline scenarios).
- Debt sustainability (DSA baseline and scenarios):
  - Baseline scenario key values: Real GDP growth (2016–2021) 2.5; 3.0; 3.7; 4.1; 4.3; 4.0; Inflation (GDP deflator) 3.9; 3.6; 3.2; 3.1; 3.1; 2.8; Primary balance (percent of GDP) 0.5; 0.6; 1.1; 1.6; 1.8; 1.7 (Table 10).
  - Public Sector DSA indicates identified debt-creating flows and sensitivity to interest rate, growth, current-account, and depreciation shocks (Tables 9–12).
  - Change in gross public sector debt (cumulative): projections show a cumulative -7.4 (Table 9, contribution to changes).

### Macro-financial conditions and financial soundness
- Credit and bank sector:
  - Credit to the private sector (percent change, selected): 2013 12.1; 2014 14.7; 2015 15.5; 2016 9.2; 2017 7.1; 2018 8.0; 2019 9.0; 2020 10.0; 2021 11.0 (Table 5).
  - Bank asset quality and capital ratios (Table 7): Regulatory capital to risk-weighted assets 2013 17.2; 2014 17.3; 2015 16.9; Nonperforming loans to gross loans 2013 4.0; 2014 2.9; 2015 2.5; 2016 2.8; 2017 2.8; 2018 2.9; 2019 3.0.
  - Liquidity indicators: Liquid assets to total assets 2013 9.2; 2014 7.5; 2015 8.6; Liquid assets to short-term liabilities 2013 14.2; 2014 12.1; 2015 13.9.
- Asset prices and credit gaps:
  - Local asset prices rapidly declined (Stock Market Indices and Government Bond Yield figures).
  - Government debt yields increased (10-year bond yields, Col$ and US$).
  - Housing prices growth moderated amid a slowdown in mortgage credit (Housing Price Index and Mortgage Credit).

### Reserve coverage in international perspective
- GIR metrics and cross-country comparisons (Figure 5 and Table 2a):
  - GIR to GDP (end-2015) and GIR to broad money (end-2015) shown for many countries; Colombia's GIR to GDP end-2015 15.8 percent; GIR to broad money end-2015 35.8 percent (Table 2a and Figure 5).
  - Reserve coverage remained strong by multiple metrics despite pressures.

### Social indicators
- Demographics and social outcomes (Figure 6 and sidebar):
  - Population (million), 2015 48.2.
  - Urban population (percent of total), 2014 76.2.
  - Life expectancy at birth (years), 2013 73.8.
  - Gini coefficient, 2014 0.550; 2015 0.552.
  - Unemployment rate, 2015 (percent) 8.9.
  - Poverty rate (US$3.1 a day, PPP), 2013 5.3; Extreme poverty (US$1.9 a day, PPP), 2013 2.5.
  - Physicians (per 1,000 people), 2010 1.5; Adult illiteracy rate (ages 15 and older), 2011 6.4; Net secondary school enrollment rate, 2013 73.8; Access to water (percent of population), 2015 91.4.

### Key summary statistics (selected)
- GDP (billion of US$): 2013 380; 2014 379; 2015 292; 2016 254; projections to 385 by 2021 (Table 2a).
- Gross international reserves (billion of US$): 2013 43.2; 2014 46.8; 2015 46.3; 2016 46.4; projected 51.5 by 2021.
- Current account (percent of GDP): 2013 -3.2; 2014 -5.2; 2015 -6.5; 2016 -6.0; 2017 -4.3; 2018 -4.2; 2019 -4.0; 2020 -3.8; 2021 -3.6.
- Public debt (percent of GDP): 2013 37.8; 2014 44.2; 2015 50.6; 2016 49.9; 2017 49.0; 2018 47.9; 2019 46.1; 2020 44.4; 2021 43.2.

*International Monetary Fund staff estimates and projections as presented in the source content.*

### Annex I. External Sector Assessment

### Annex I. External Sector Assessment

### External position — overview and valuation
- Staff assessment: external position appears weaker than implied by fundamentals while the economy is adjusting to a new equilibrium.  
- Real exchange rate (REER) depreciated by 34 percent over the last two years.  
- EBA estimates vary widely: EBA REER indicates a 15 percent undervaluation, while EBA ES and EBA CA current account norm estimates differ; staff view places the current account norm in the -2 to -3 percent of GDP range.  
- The EBA CA norm estimate may be biased upward because it does not account for sizable repatriation of profits and reflects a relatively low ratio of proven oil reserves to production.

### Current account, trade composition, and recent adjustment
- Current account deficit in 2015 is significantly higher than EBA ES and EBA CA methodology norm estimates; limited quantity adjustment to the REER depreciation so far.  
- Commodity and non-traditional exports contraction drove the widening CA deficit:
  - Average oil prices fell from 104 in 2013 to 51 in 2015.  
  - Commodity exports contracted by US$19 bn.  
  - Oil exports: 8.4 percent of GDP in 2013 to 4.9 percent of GDP in 2015; projected 3.6 percent of GDP in 2016 (Annex II).  
- Non-traditional exports have begun to shift away from slow-growing regional partners toward the United States and the Euro Zone:
  - Exports to the United States and the Euro Zone increased from US$2.4 billion to US$3.6 billion (period shown).  
  - Exports to the region fell by almost US$3 billion.
- Imports contracted significantly; demand for imports expected to continue contracting as a result of the depreciated exchange rate and additional fiscal adjustment.  
- Valuation effects: the exchange rate depreciation reduced the US dollar value of GDP in 2015, accentuating the deterioration in CA/GDP.

### Capital flows, FDI, and international investment position (IIP)
- Gross FDI into both oil and non-oil sectors contracted in 2015 by US$4 billion or 25 percent.  
- Portfolio flows fell from record levels in 2014; other gross capital inflows also dropped in 2015.  
- International investment position:
  - NIIP reached -44 percent of GDP in 2015 from -30 percent of GDP in 2014.  
  - Valuation impact from the depreciation accounts for 12 percentage points of the IIP deterioration in 2015.  
  - Gross liabilities estimated at 95 percent of GDP in 2015, of which 51 percentage points correspond to FDI.  
  - Portfolio liabilities amount to 25 percent of GDP (heightening vulnerability to global financial volatility).

### Impact of the oil shock and macroeconomic adjustment (Annex II)
- Fiscal and external impacts of the oil price decline:
  - Fiscal oil revenues projected to fall from 3.3 percent of GDP in 2013 to almost 0 in 2016.  
  - Oil-related investment (US$ bn): 2013: 9.6; 2014: 9.2; 2015: 6.2; 2016 (proj.): 4.4.  
  - o/w FDI in oil sector (US$ bn): 2013: 5.1; 2014: 4.7; 2015: 3.7; 2016 (proj.): 2.3.  
  - Oil exports (US$ bn): 2013: 32.0; 2014: 28.9; 2015: 14.2; 2016 (proj.): 9.1.  
  - Public debt (% of GDP): 2013: 37.8; 2014: 44.2; 2015: 49.6; 2016 (proj.): 49.9.  
  - o/w effect of depreciation on public debt: 2013: 1.0; 2014: 3.1; 2015: 5.5; 2016 (proj.): 1.4 (percentage points).  
  - Peso depreciation (periods shown): 2013: 3.9; 2014: 7.1; 2015: 37.0; 2016 (proj.): 22.4.  
  - Crude oil, spot price: 2013: 104.1; 2014: 96.2; 2015: 50.8; 2016 (proj.): 34.8.  
  - EMBI Spread: 2013: 179.4; 2014: 182.2; 2015: 294.0; 2016 (proj.): n.a.
- Cross-country perspective (Chile, Colombia, Peru):
  - Timing and magnitude differ: Colombia’s oil price decline began in 2014Q2 and was sharper (about 40 percent in 5 quarters) versus copper declines in Chile and Peru (45 percent over 18 quarters).  
  - REER and current account responses:
    - Colombia experienced a sharp and fast real depreciation of around 18 percent (data through 2015Q3).  
    - Chile’s REER depreciated by 5 percent over its adjustment; Chile closed much of its current account deficit.  
    - Peru had a minor real appreciation of about 6 percent; current account deteriorated slightly from 2 percent to 4 percent of GDP.
- Policy implication from cross-country experience: flexible exchange rates are important for adjustment; Colombia likely needs a stronger adjustment in domestic demand to facilitate current account correction.

### Consumption dynamics and determinants of durable consumption
- Durable goods consumption was pronounced during the expansionary phase in Colombia and Chile and is expected to slow significantly in Colombia as adjustment continues.  
- Regression estimates (dependent variable: durable consumption; sample: 2003Q3-2015Q3):
  - Income: 0.03  
  - Lagged REER: -0.16 ***  
  - Credit growth: 0.15 ***  
  - Interest rate: -0.20 **  
  - House prices: -0.04  
  - Consumer confidence: 0.06 ***  
- Interpretation: depreciation, increasing interest rates, and slowing credit are expected to weigh on durable consumption in 2016.

### Macrofinancial stability highlights (Annex III introduction)
- Financial system and macrofinancial linkages:
  - Financial system grew 4.72 percent in real terms in 2015 despite shocks.  
  - Credit institutions (banks, financial companies, cooperatives) grew 7 percent real in 2015.  
  - Financial assets were 1.56 times GDP in December 2015, compared to 1.45 times in 2014.  
  - Credit as a share of GDP increased from 44.13 percent in Dec-14 to 49.16 percent in Dec-15.  
  - Financial access/inclusion: 75 percent of all adults in households have access to some type of financial products.  
  - In December 2015, mandatory pension funds’ investments in domestic public debt represented 49.6 percent of total investments, followed by investments in dollars.
- Banking sector performance and vulnerabilities:
  - Banks have performed relatively well; NPLs remain low and well provisioned.  
  - Funding conditions have become more challenging but are manageable.  
  - Corporate vulnerabilities under adverse shocks could lower bank capital, credit, and economic growth but are not judged to be systemically impactful.  
- Regulatory and supervisory progress:
  - Continued enhancements in risk-based and financial conglomerate supervision.  
  - Ongoing work on financial integration and strengthening the AML/CFT framework.

*Source: _cr16129 - Annex I. External Sector Assessment (IMF staff annexes and accompanying figures).*

### 29.4 percent. Compared to 2014, there was a sizeable portfolio shift towards investments in

### _cr16129 - 29.4 percent. Compared to 2014, there was a sizeable portfolio shift towards investments in

### Portfolio shifts and currency composition
- 29.4 percent.
- Compared to 2014, there was a sizeable portfolio shift towards investments in dollars increasing by 6 percentage points while peso assets decreased by 8 percentage points. This was in the main due to valuation effects from depreciation.
- Pension funds to shift assets overseas ... in part due to valuation of USD denominated assets.

### Bank liabilities and asset structure
- Deposits and demand accounts constitute 84 percent of total liabilities.
- Around 40 percent of those deposits are from large (100) institutional depositors, mainly from fiduciaries, other entities, government and pension funds.
- Around 10 percent of liabilities come from issuance of debt securities.
- 5 percent of liabilities come from money market operations (usually short term).
- On the asset side:
  - Loans: 91 percent domestic and 9 percent foreign.
  - Government bond holdings by banks: 99.6 percent domestic and 0.4 percent foreign.

### Profitability, asset quality and provisioning
- Bank profitability remains robust with ROA (3 percent) and ROE (22 percent) unchanged from 2014.
- Net-interest margins: 58 percent.
- Non-net-interest margins: 42 percent.
- NPLs for all loan portfolios: 3 percent.
- Coverage (provisions for NPLs): 154 percent.
- As growth slows in 2016, profitability will be more adversely impacted from higher general provisions as NPLs rise; however robust (general and countercyclical) provisioning practices in Colombia mean NPLs are expected to remain manageable.

### Stress testing and macrofinancial impacts
- Staff stress tests: under adverse but plausible earnings and depreciation shocks to corporate profitability and debt service, the banking system solvency remains above regulatory minima though capital buffers are lower.
- Two banks with the lowest capital starting positions fall just below the 9 percent regulatory minimum.
- The shock undertaken involved:
  - 20 percent earnings shock and 70 percent depreciation,
  - corporate loans were around 65 percent of bank balance sheets,
  - stressed probability of defaults of 25 percent and loss given default of 60 percent to determine credit losses and NPLs.
- The release of countercyclical provisions is expected to absorb losses and limit risks to credit supply and economic growth.
- Authorities are advancing stress-testing techniques including DSGE and network models, and linking real sector vulnerabilities to financial sector solvency, liquidity impacts and contagion assessments.

### Capital buffers and voluntary strengthening
- Colombian banks usually retain around 30-40 percent of earnings.
- SFC powers and risk-based supervision can enforce capital and liquidity strengthening, including restriction of dividend disbursements.
- Authorities introduced greater loss-absorbing Basel III-type hybrid (debt-to-equity) instruments to enable voluntary capital strengthening.
- Some banks intend to increase capitalization levels further in 2016.

### Supervision, regulation and conglomerates
- Risk based supervision (RBS) is being consolidated with deeper risk-led inspections, monitoring and assessment of internal controls.
- The SFC is carrying out forward-looking thematic stress tests on vulnerabilities from:
  - (i) direct and indirect impact related to Oil and oil related industries;
  - (ii) impact of El Niño on agricultural and commercial and microcredit loan portfolios;
  - (iii) Commercial loan portfolio impacts from sustained depreciation;
  - (iv) payment capacity deterioration of housing and consumer loans.
- SFC is broadening RBS methodology to brokerage firms, pension funds, trust companies and securities issuers and developing tools to identify systemic, country and interest rate risk on the banking book from financial conglomerates activities.
- The law awarding regulatory powers over holding companies of financial conglomerates will enable SFC and BanRep to identify and better monitor regulated and unregulated parts of financial conglomerates through improved regulatory data capture. This would cover:
  - 21 financial conglomerates that represent 86 percent of Colombian financial system assets and 125 percent of GDP.
- The law provides powers to restructure conglomerates and enable authorities to impose additional systemic capital add-ons to better address cross-border risks.
- Mixed conglomerates (financial and non-financial activities) remain partly outside supervisory perimeter; enhanced monitoring of intra-group flows between regulated and unregulated entities should be undertaken involving the SFC and the Superintendencia de Sociedades (SS).
- The SFC’s 2016 regulatory project will collect asset and liability information, asset quality indicators, profit, solvency, investments and securities information in different currencies for cross-border subordinated entities.
- The expansion of Colombian groups abroad: 215 subordinated entities in 21 Latin American and Caribbean countries represent 29 percent of total Colombian financial system assets.

### Pilot assessment of resolution framework
- In 2015 Colombian authorities volunteered to undertake a pilot self assessment under the Key Attributes of Effective Resolution for Financial Institutions; Colombia is the first emerging market country to undertake this assessment.
- Key recommendations for Colombia include:
  - (i) the need for additional powers to transfer assets and liabilities to a private sector buyer or bridge bank;
  - (ii) additional powers to enable timely resolution based on early determination of non-viability of financial institutions;
  - (iii) the power to override shareholders consent.
- Authorities indicated willingness to publish the Detailed Assessment of Observation Report.

### Financial integration initiatives (Pacific Alliance and MILA)
- Since 2011 the Presidents of Chile, Colombia, Mexico and Peru have met regularly to advance the Pacific Alliance (PA) agenda.
- Identified needs to foster capital market integration in the PA:
  - Greater recognition of issuers and of the types of instruments, so that the initial placement can be made by issuers in the 4 countries of the PA.
  - Allowing the free marketing of investment funds authorized in any of the member countries of the PA.
  - Improving the treatment of investments of the Pension and Severance Fund Management Companies (AFP) in assets or products of the region so that AFP investments in securities, instruments or funds of the PA have the same treatment as for local investments.
  - Reviewing the tax and exchange treatment to seek efficiencies among the countries of the PA.
  - Continued PA countries support and further development of the private-led Integrated Latin America Market (MILA) initiative.

*Source: SFC.*

### 14.      Colombia has consolidated a comprehensive risk based supervision scheme of AML/FT

### 14.      Colombia has consolidated a comprehensive risk based supervision scheme of AML/FT

### Overview
- In 2017, the IMF will assess the money laundering and terrorist financing prevention system against Colombia’s compliance and implementation effectiveness of the 40 FATF Recommendations.
- The SFC is currently leading an inter-institutional project aimed at reaffirming the important work undertaken in recent years regarding the reinforcement of the AML/FT regime.
- Current regulatory projects intend to improve compliance, as well as deepening, strengthening and consolidating the legal framework for the prevention and control of ML/FT.

### Evolution and scope of the supervisory framework
- The original mid-90’s system of prevention of money laundering SIPLA, has evolved into a more comprehensive system called SARLAFT.
- SARLAFT engages all entities under surveillance of the SFC to design and implement a Money Laundering and Financing of Terrorism Risk Management System, that permits the adequate identification, measurement, control and monitoring of this risk.
- The scope of this system has migrated from a strict compliance system to a risk-based supervision scheme, which promotes an anti-money laundering culture and anti-terrorist financing activities.

### Outcomes, regional influence, and ongoing work
- Colombia has consolidated a comprehensive risk based supervision scheme of AML/FT for financial institutions that is a reference in Latin America.
- The current Colombian legal system has earned international recognition, and has served as a referent for other countries such as Costa Rica, Guatemala, Honduras, Panama and soon in Ecuador.
- The SFC-led inter-institutional efforts and regulatory projects aim to deepen, strengthen and consolidate prevention and control mechanisms for ML/FT.

*Source: _cr16129 - 14.      Colombia has consolidated a comprehensive risk based supervision scheme of AML/FT*

### 15.      Further strengthening of inter-institutional coordination mechanisms is an expected

### _cr16129 - 15.      Further strengthening of inter-institutional coordination mechanisms is an expected

### Inter-institutional coordination and AML/FT supervision
- The Superintendencia Financiera de Colombia (SFC) expects to strengthen and encourage memorandums of understanding to share relevant information with national authorities, including:
  - Ministry of Justice and Law
  - Attorney General's Office
  - Ministry of Foreign Affairs
- The SFC expects to share information with international organizations, such as:
  - CCICLA
  - UIAF
  - UNODC
  - GAFILAT
  - the Central American Council of Superintendents of Banks
- Colombia has received support from the U.S. government through agencies including the Department of Justice, the FBI and OFAC.

### Economic outlook and macroeconomic adjustments
- Growth and shocks:
  - The economy grew 3.1 percent in 2015.
  - Colombia was hit by a sharp decline in the terms of trade since 2014, a severe supply shock from El Niño, weaker growth among trading partners (notably Venezuela and Ecuador), and tighter and volatile financial conditions.
- Exchange rate and external position:
  - Exchange rate flexibility has been the main shock absorber; the peso depreciated significantly.
  - The current account deficit widened to 6.5 percent of GDP (last year) and is projected at 6 percent of GDP for 2016.
  - In dollar terms, the current account deficit is projected to decline from USD19 billion in 2015 to USD16 billion in 2016.
  - Financing: the deficit is expected to remain comfortably financed by FDI and portfolio inflows.
- Inflation and monetary policy:
  - Inflation breached the upper bound of the target range of 2-4 percent in 2015 and continued to increase in 2016.
  - The central bank started increasing the policy rate in September 2015 to contain temporary inflation pressures and anchor inflation expectations.
  - Inflation is expected to return to target in 2017 as supply shocks recede and pass-through from depreciation fades.
  - A rules-based contingent FX auction program was introduced in October 2015; the mechanism has not been triggered yet.
- Fiscal impacts of oil price decline and policy response:
  - Oil-related revenues declined from 3.3 percent of GDP in 2013 to 0.1 percent in 2016.
  - Interest payments increased 0.7 percent of GDP due to currency depreciation.
  - The total shortfall between 2013 and 2016 was 4 percent of GDP, absorbed by:
    - higher non-oil related revenues of 1.5 percent of GDP (a tax reform was approved in December 2014),
    - spending cuts of 1.2 percent of GDP,
    - a cyclical increase of the deficit allowed by the fiscal rule of 1.3 percent of GDP.
  - Central Government fiscal deficit targets and outcomes:
    - Target/Outcome: 3 percent of GDP in 2015.
    - Target/Outcome: 3.6 percent of GDP in 2016 (authorities remain committed to making additional adjustments if needed).
  - Structural tax reform: the government is preparing a structural tax reform to be submitted to Congress in the second semester of the year and to be approved no later than December 2016.
  - Public debt:
    - Central Government’s net debt grew from 35 percent of GDP in 2014 to 40 percent expected in 2016.
    - Debt is projected to decline gradually to reach around 29 percent of GDP in 2024.

### Financial sector resilience and reform agenda
- System-wide soundness:
  - The financial sector is described as sound, liquid, profitable, well provisioned and capitalized, with sufficient buffers to cope with shocks.
  - Stress tests by the central bank and Bank Superintendency indicate limited impact on capital adequacy ratios and liquidity of credit institutions under scenarios of lower growth, exchange rate depreciation, lower oil prices and external financial tightening.
- Regulatory developments:
  - Authorities are finalizing implementation of FSAP recommendations and moving toward Basel III best practices.
  - Since December 2015 the supervisor has authority to request higher capital and liquidity buffers for individual institutions with higher risks.
  - A law to grant more power to regulate and supervise financial conglomerates is being discussed in Congress.
  - The Central Bank has tightened regulation to limit currency mismatches and extended it to conglomerates, and has imposed liquidity requirements at a consolidated level.
- Specific indicators and exposures:
  - Corporate and household debt have increased but remain low by international standards.
  - The share of foreign currency denominated corporate debt is one third of total corporate debt.
  - Banks’ exposure and currency mismatches are contained by stringent regulation.
- Resolution regime assessment:
  - In October 2015, the FSB, the IMF and the World Bank assessed Colombia’s bank resolution regime against the “FSB Key Attributes of Effective Resolution Regimes for Financial Institutions” (KA).
  - The pilot assessment found that Colombia has strong powers to manage weak and failing financial institutions but the resolution regime has room for improvement; authorities are planning to implement the recommendations.

### Structural reforms and development agenda
- Government program and priorities:
  - The development plan law Plan Nacional de Desarrollo 2014–2018 outlines three pillars: peace, equity and education, implemented through social mobility, rural transformation, and improved competitiveness and infrastructure.
- Infrastructure and trade competitiveness:
  - Significant progress on infrastructure with the 4G PPP program and tertiary roads projects.
  - Other reforms to boost non-traditional exports include a new simplified custom status, tariff reform, education and human capital measures, and closer cooperation with business to leverage free trade agreements.

*Source: Excerpt from COLOMBIA STAFF REPORT FOR THE 2016 ARTICLE IV CONSULTATION—INFORMATIONAL ANNEX (April 18, 2016).*

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_Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2016/_cr16129.pdf_