COLOMBIA SKIRTING RECESSION

C O N F I D E N T I A L BOGOTA 001270

SIPDIS

EEB/IFD/OMA FOR ASIROTIC; TREASURY FOR AJEWELL

E.O. 12958: DECL: 04/17/2019
TAGS: ECON EFIN PGOV CO
SUBJECT: COLOMBIA SKIRTING RECESSION

REF: BOGOTA 7

Classified By: ECONOMIC COUNSELOR LAWRENCE J. GUMBINER FOR REASONS 1.4
(B) AND (D)


1. (C) SUMMARY: Colombia's economy has slowed dramatically as
a result of falling international demand for exports, a
decline in investment, and weak domestic consumption. GDP
growth for 2008 fell to 2.5 percent after reaching a high of
7.5 percent in 2007. The final quarter of 2008 registered
negative 0.8 percent growth and the 2009 outlook now hovers
near zero percent. A reduction in revenues has the GOC
issuing more debt in world markets and carefully considering
an IMF line of credit. Inflation remains mild as the Central
Bank has quickly cut interest rates and the GOC launches a
USD 25 billion infrastructure spending program, but increased
debt and impending pension system obligations could stretch
Colombia's fiscal stability in the future. END SUMMARY.

Bad Economic News Piling Up
--------------

2. (SBU) On March 27, the GOC revised its 2008 GDP growth
figures downward, cutting official growth from a previously
reported rate of 3.5 percent to 2.5 percent. The final
official figure for 2008 represents the weakest expansion
since 2002, and a dramatic drop from the record high 7.5
percent growth registered in 2007. In the final quarter of
2008 GDP actually contracted in 0.8 percent, the first
quarterly decline since 1999.


3. (SBU) A trickle of bad economic news since then has
further dimmed the outlook for 2009. Industrial production
has fallen for six straight months and retail sales have
declined for the last five. Colombian exports have dropped
13 percent year-on-year amid weak demand in the U.S. and
Venezuela, Colombia's largest trading partners. Meanwhile,
foreign direct investment was down 27 percent in the first
quarter of 2009, with non-energy investment falling 59
percent. As a result the GOC has lowered its official 2009
growth projection for a second time to between 0.5 percent
and 1.5 percent from the original 5 percent estimate in
mid-2008.

GOC May Seek IMF Credit
--------------


4. (C) Finance Minister Zuluaga told EconOffs privately April
16 that he expects 2009 growth to end at close to zero
percent and possibly go negative if economic conditions in
Venezuela or the U.S. worsen. Zuluaga also blamed lower
commodity prices, particularly oil, for eroding GOC revenues
and complicating the fiscal outlook as the 2009 budget was
predicated on USD 50/barrel oil prices and 3 percent growth.
(NOTE: On April 7, the Finance Ministry increased its target
central government budget deficit from 3.2 percent of GDP to
3.7 percent--a roughly USD 1 billion increase in the deficit.
The same day the GOC announced it would increase external
borrowing by USD 740 million this year to fill the gap and
introduce a 2010 budget that cut nominal public spending by
approximately USD 1 billion over 2009. END NOTE.)


5. (C) In the face of falling revenues, Zuluaga admitted the
GOC would increase indebtedness, either with international
credits or going directly to debt markets. Zuluaga said the
GOC, despite public pronouncements to the contrary, is
carefully considering an IMF line of credit as a precaution
following the Fund's March decision to relax loan conditions.
He added, however, that any final decision would have to
handled quickly and with appropriate care as it could send a
negative signal and erode confidence. Zuluaga confided that
President Uribe, despite the potential political cost, was
taking a "flexible" approach on the issue.

Infrastructure & Rate Cuts to the Rescue?
--------------


6. (C) In the mean time, the GOC is implementing a USD 25
billion public infrastructure investment plan to create jobs
while the Central Bank expands the money supply with lower
interest rates. The GOC has announced that infrastructure
spending is the only area of the national budget that will be
spared spending cuts and is moving quickly to request bids on
almost a dozen large projects this year. Zuluaga admitted to
us, however, that such investment will create relatively few
new jobs (adding that housing is the only realistic sector
for large increases in employment). Rather, he suggested the
true economic benefit would be the eventual boost to
competitiveness.


7. (C) Separately, the Central Bank has aggressively cut its
benchmark interest rate 3 percentage points since December
2008 to a three-year low of 7 percent. Lending and
consumption have yet to recover. Local analysts, such as
Fedesarollo Senior Advisor Guillermo Perry, tell us they
expect rates to drop further and end the year around 5
percent. Business leaders such as National Association of
Industries President Luis Carlos Villegas blame interest
rates of 10 percent last year for quickening the fall of the
Colombian economy by quashing consumer spending and fueling a
rapid appreciation of the peso that harmed key export
industries such as textiles, cut flowers, bananas and coffee.
Nevertheless, Zuluaga, who is a voting member of the Central
Bank Board, asserts that further interest cuts would do
little to stimulate the economy in the short run. He
suggested instead that a recovery would come only when
domestic and international consumer confidence stabilized,
reinvigorating consumption and investment.

Glimmers on the Horizon
--------------


8. (C) Zuluaga, Perry and other analysts do point to a few
silver linings in the economy they believe will shield
Colombia from a severe recession similar to 1998-99 or
perhaps skirt a technical recession altogether. First,
annualized inflation remains mild at 6.5 percent and many
experts are optimistic the Central Bank will meet its 5
percent target for 2009. Second, international reserves are
high and the GOC continues to have success with recent
international bond issuances, including one April 14 in which
USD 1 billion was placed at a one-half percent discount of
the previous premium. The bonds were three times
oversubscribed. With the latest issuance, the GOC expects to
have 2009 outlays covered, but may have to return to the
markets to cover 2010 shortfalls if revenues remain weak.
Third, foreign direct investment, while off recent highs, is
still coming in at an annualized rate of USD 6.4 billion--the
fifth highest total ever. Minister Zuluaga cautioned that
although he expects recovery in 2010, it will likely be weak
with GDP growth no higher than 2 percent.

Impact to Long-Term Fiscal Sustainability
--------------

9. (SBU) The weak Colombian economy stands to exacerbate
Colombia's longer-term fiscal challenges and public pension
obligations. Reforms over the last decade have postponed
some of Colombia's public pension and health insurance
burden, but GOC costs are projected to more than double to
4.3 percent of GDP over the next two decades. Local experts
including Perry and National Association of Financial
Institutions President Sergio Clavijo emphasize that further
reform, including of labor benefits, is needed soon to avoid
permanently weighing down the public sector with
unsustainable costs and fiscal deficits. Most note though
that such important reforms will be significantly more
difficult, if not impossible, in the foreseeable period of
economic stagnation and rising unemployment.
BROWNFIELD