Typical street scene in Santa Ana, El Salvador. (Photo: iStock)

Typical street scene in Santa Ana, El Salvador. (Photo: iStock)

IMF Survey : Drop in Oil Prices Poses Challenges for Colombia

June 8, 2015

  • Supportive policies cushion growth impact of oil price collapse
  • Medium-term rebound expected, despite external risks
  • Key challenges: raise non-commodity revenues, foster inclusive growth

The sharp drop in oil prices poses significant challenges to Colombia’s near-term outlook, but strong economic policies are expected to moderate the growth slowdown in 2015, said the IMF in its annual assessment of the Colombian economy.

(photo: Bloomberg GDA Photo Service)

Oil worker in Barrancabermeja, Colombia. The country is adjusting to lower oil prices, says the IMF (photo: Bloomberg GDA Photo Service)

Annual Health Check

A subdued outlook for investment, especially oil-related, and private consumption and a tightening of planned public spending will cause growth to slow to 3.4 percent in 2015, which would still compare favorably with most other countries in the region.

However, the medium-term outlook is favorable, with growth projected to bounce back gradually to around 4¼ percent by 2018, the report said.

“Colombia is now undergoing an adjustment to lower oil prices,” said Valerie Cerra, the IMF’s mission chief for Colombia. “But the authorities have built significant policy buffers, which will help moderate the impact of the oil shock on the economy.”

“In addition, the authorities’ efforts to implement key economic and structural reforms will help maintain growth momentum over the coming years,” added Cerra.

Healthy but slowing growth

Last year, the economy grew by 4.6 percent, boosted by domestic demand. “Strong economic activity supported historically low unemployment rates and increased labor market formality,” noted Cerra.

As inflation returned quickly to the midpoint of the 2-4 percent target band (from a low level in 2013), the IMF welcomed the central bank’s decision to increase interest rate to 4.5 percent. The central government fiscal balance was broadly unchanged from 2013, and met the structural balance target.

In the second half of 2014, Colombia confronted a severe oil price shock—oil is Colombia’s top export. The IMF expects growth to slow to 3.4 percent in 2015, which is still high relative to many peer countries. Given their flexible exchange rate regime, the authorities have allowed the peso to depreciate, which will help cushion the impact of the shock. Over time, stronger growth in nontraditional exports will help support economic activity and reduce the trade deficit.

The recent rise in inflation above the inflation target band is expected to be temporary and inflation expectations remain well-anchored, reflecting the strong credibility of the inflation targeting regime.

Positive outlook

Colombia’s prospects are favorable. Growth is projected to rise over the medium term to about 4-4½ percent. Inflation is expected to remain within the target band, as the authorities are committed to adjust the policy rate when needed to keep inflation expectations anchored.

But external risks have intensified over the past year, warned the report. A further decline in commodity prices would create additional strains on the economy. And the country remains exposed to potential volatility in financial markets as the normalization of U.S. monetary policy nears, and trade with partner countries could be affected by their lower growth prospects.

“The authorities have ample policy buffers to counteract the negative effects of any shocks,” pointed out Cerra. “Colombia also has a comfortable level of international reserves, reinforced by its access to the IMF’s Flexible Credit Line, which provides insurance to countries with very strong policies and track records.”

Strong policy management is key

Colombia’s very strong policy framework—which includes a structural fiscal balance rule, an inflation-targeting regime, a flexible exchange rate, and effective financial supervision and regulation—will help preserve the policy space to respond to adverse conditions and facilitate economic and financial stability.

The structural fiscal rule includes an adjustment for cyclical oil price changes, which will partially shield expenditures from the oil price shock. The authorities have also taken action to minimize the fiscal impact of lower oil revenues by passing a tax reform in 2014 and announcing some reductions in planned expenditures this year. “By demonstrating their commitment to the fiscal rule and responding nimbly to changing economic conditions, the authorities should be able to reinforce confidence and support private investment,” Cerra noted.

The IMF report also welcomed the formation of an expert tax commission to consider a broad range of options for tax reform. The fall in oil prices increases the urgency of mobilizing nonoil revenues to achieve the planned deficit reduction under the fiscal rule, while protecting important social and infrastructure programs. Reform objectives should include simplifying the existing tax structure, increasing progressivity, broadening the tax base, and facilitating private investment by ensuring international competitiveness. Large revenue gains can also be achieved by enhancing tax administration.

The report described a sound and stable financial sector, with high profitability and low exposure to oil financing. The authorities have made good progress on implementing the recommendations in the IMF’s 2012 Financial System Stability Assessment and are addressing risks from financial conglomerates operating in Central America. The IMF also supported measures to foster financial deepening and inclusion through the implementation of a movable property registry and financial education programs.

Fostering inclusive growth

The authorities’ structural reform agenda—highlighted in the national development plan—targets an inclusive environment to support sustainable growth. The plan includes measures to tackle the still elevated rates of inequality, youth unemployment, and informality and strengthens the social safety net for the poor. The ongoing peace process presents another opportunity to strengthen social cohesion, build institutions, and improve competitiveness.

The government has also launched an ambitious infrastructure investment program in partnership with private enterprises and financial institutions, and has been working vigorously to establish the supportive regulatory, fiscal, and financial environment. The first wave of projects has been successfully awarded and the program stands to shore up medium-term growth and encourage other private investment. With strong macroeconomic fundamentals, a good business environment, and the appetite of private partners to provide financing, Colombia is well placed to accomplish the infrastructure program.