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