There really isn’t much difference between the Colombia of Ernesto Samper’s government and the Colombia of Andres Pastrana’s government-except, of course, for credibility and hope.
It seems, at least, that hope inspired six million voters to give Andres Pastrana a clear mandate to lead. Hope has been at the center of serious attempts for a peace dialogue to stop the decades long guerrilla war, which is said to knock at least 2% off GDP growth each year. And hope appears to have propelled an opposition-led Congress to work with the chief executive.
After moving into office in August, Pastrana introduced a major legislative initiative called “Change to Build Peace,” a $38.8 billion development plan aimed at jump-starting the economy and building the foundations for civil peace by lowering interest rates, boosting exports and reviving the construction industry. The four-year plan seeks to increase economic output by 5.1% from 1998’s GDP rate of under 2%. It also aims to halve inflation, bringing it down to about 9%.
Initially, the president’s team has been aiming to reduce the fiscal deficit from over 4% of GDP last year to 2% of GDP in 1999.
The cooperation between government branches has produced needed reforms, but Congress did hesitate on the issue of raising taxes. To finance the plan, Pastrana had originally targeted major spending cuts and a tax increase by as much as $1 billion in 1999. Yet Congress whittled down the increase to $600 million, making some observers believe that the relationship between the chief executive and the nation’s legislators will be tested frequently.
Lowering interest rates even more, in fact, is one of the most crucial issues the government faces. Said David Yanovich, executive vice president of investment banking at Corporacion Financiera del Valle SA: “The economic reactivation depends critically on the descent of interest rates.”
But it will not be easy. At the time of this writing, real interest rates were hovering around 14.5%-the highest since the banking crisis of the early 1980s. The rate for the government’s 90-day treasury bills, which is the rate that commercial banks use for making personal loans, was 36%. The central bank intends to reduce it to 27% by June.
“Two aspects do not allow a prompt reduction in interest rates,” said Juan Carlos Botero, research director at Suvalor in Medellin. “The first is the fact that there are still some financial institutions facing problems in their (financing) gap. This forces them to search the market to borrow money at desperately high rates, thus increasing the average. The second aspect, recently introduced, is the Brazilian devaluation, which will stir the ghost of devaluation around other Latin American countries like Venezuela-an important Colombian commercial partner.”
To view the challenge in perspective, Corredores Asociados research director Juan Carlos Gonzalez said, “Such high interest rates have produced the most prolonged recession in the last 50 years.”
The high interest rates and the increased taxes, aggravated by the weakened capital markets and the collapse of commodity prices, may worsen the recession in the short run.
According to official estimates, prices for commodities should remain depressed throughout this year, which is not good for Colombia. Its four largest exports are commodities: oil, coffee, coal and gold. Unemployment is another negative. In January, the government reported that unemployment was 15.7%, the highest in the last 22 years.
Some encouraging signs are emerging, however.
For one, foreign direct investment remains strong, with the financial sector receiving most of it. In the first quarter of 1998, foreign inflows either through portfolio positions or direct investments (excluding the oil sector) shot up 95% over the first quarter of the year before, to $1.2 billion. Spain led the FDI category, sinking $375 million into the country. What’s more, it looks as if Congress will finally approve an amendment to Article 58 of the Constitution, which would give unconditional indemnity to national and foreign companies in case of expropriation.
Colombia was the only country in the hemisphere that did not guarantee such compensation unconditionally.
According to Enrique Gomez Pinzon, director of the Colombian government trade bureau in Washington, the provision applied only to “exceptional cases” and in fact has never been invoked. Still, the current government has recognized that guaranteeing unconditional compensation could attract more FDI, which is the most efficient way to strengthen the nation’s foreign reserves. Last year, the central bank spent more than $350 million in reserves to defend the currency from falling more than the allowed 27%.
“Arguments in favor of this step are overwhelming,” said Carlos Caballero of the state investment corporation, Coinvertir. “Colombia can’t afford to maintain this potential hindrance to investment. It has certainly constituted a grave impediment for small and medium-size foreign companies that are not willing to take the risk or pay such a high cost for insurance.”
A second point in the nation’s favor is the continued growth of private pension funds. In 1998 the value of those funds grew 84%, to $2.04 billion in total. Private pension fund affiliates grew by 16.4% to 2.9 million.
Colombian salaried workers can opt for either the state-run social security program or a private fund.
The decision by Moody’s Investor Services in December not to downgrade Colombia’s credit rating was another positive development, assuring the country of relatively lower financing costs. After spending weeks reviewing the country’s fundamentals, Moody’s cautioned against the nation’s fiscal deficit and large current account imbalances, but said in a statement that “Colombia’s dependable payment record continues to support an investment-grade rating.” It also praised the nation’s strong institutional framework and sound economic policies that, until very recently, have sustained growth for more than two decades.
Colombia is also in the initial stages of developing a derivatives market, which in the long term promises to foment a deeper and more mature economy through stimulating capital markets growth, but which so far has been depressed due to the high interest rates. “As interest rates go down, we expect the capital markets to recover,” said Yanovitch. “There are several securitizations and bond emissions going on that should start to reactivate the demand for financial assets.”
Yet, for all the positives, it is still too early to celebrate total liberation from the recent past. Commercial banking and the savings and mortgage corporations have been rattled by high interest rates. Authorities have indicated that past-due loans surged 76% in the 12 months ended December 25 to 11.2% of all loans outstanding, which is a record high for the decade. That number may rise further, given the tax increases of the Pastrana government.
“The problem has reduced profits for financial entities by way of greater provisioning and less interest income,” said Gonzalez. Other statistics demonstrate that as of November 1998, the financial sector had registered accumulated losses of $713 million for the year, which compares to 1997 year-end profits of $823 million. Of the total 34 institutions, 18 posted losses, twice the number as in the previous year.
The government’s bank rescue agency, Fogafin, invested a reported 800 billion pesos ($514 million) to finance government takeovers of financial institutions in 1998. The savings and loan rescue agency, Fogacoop, intervened in at least 40 corporations last year and reportedly had to insure more than 660 million Colombian pesos. One of those takeovers involved the nation’s second-largest savings and mortgage corporation, Granhorrar SA, which was seized by the government in October after its owners could not meet their own debt obligations. The government spent nearly $100 million in insuring Granhorrar depositors alone.
Commented Suvalor’s Botero on the savings and mortgage corporations: “They are perhaps the most affected group in the financial sector.
The main concern about their situation is the mismatch between the short maturity of borrowing and the long term of loans, which in an environment of rising interest rates-like the one we experienced during last year-produces considerable economic losses.”
Gonzalez added that at the end of last year, 93% of the deposits in the savings and loan system were short term, while 79% of the system’s total loans were long-term mortgages.
Moody’s, meanwhile, considers the trade balance of key importance to the nation’s banking system, and says it is subject to significant downside risk going forward, due to continued weakness in commodity prices, the questionable stability of Colombia’s oil sector, and the dim prospects for economic growth in the Andean region.
Betting on the Future
Since early November, the central bank has been allowing more cash to flow into the system by lowering bank reserve requirements and expanding its repurchase agreement operations.
Those moves may spell disaster for the savings and mortgage companies (CAV). Last year, aside from the Granhorrar case, there were at least four announcements of CAV mergers with banks or conversions into banks. “In the future,” said Yanovich, “the CAV system seems to be doomed and the financial system will be dominated by big banks with a variety of products and services. In the end, the foreign banks have emerged as market leaders and have consolidated their positions, providing safety in times of crisis.”