Colombia: With the back against the wall: S&P cuts Colombia's outlook to negative on its cliff-hanging, BBB- rating
March 27, 2020 (Investorideas.com Newswire) Amid a widespread revision of S&P to sovereign profiles of oil-exporting countries across the world (17 in total), the agency announced that it cut the Colombia's outlook from stable to negative on its BBB- rating. Thus, the country will walk on thin ice in the coming months/quarters due to the increased risk of losing the Investment Grade status that it gained back in 2010. In general, the government now faces a tough scenario to maintain the fiscal accounts on a sustainable path in the middle of an extraordinary shock, that requires to devote more resources to avoid a larger negative effect on economic activity from the partial paralysis of the private activity. As pointed out by S&P, ratings on Colombia reflect its track record of prudent macroeconomic management, which implies that structural measures to increase revenues will have to be taken to avoid losing the investment grade status in the next 12-18 months. Recall that the other major agencies still rate Colombia at BBB (Fitch with negative outlook, Moody's with stable).
- In the statement, S&P cited the current global outlook marked by the pandemic and the decades-low crude prices, emphasizing that this new scenario entails additional pressures to the country's external liquidity profile, the ongoing fiscal adjustment process and growth prospects. Before citing details of the rationale, we see this decision as a warning to the government for it to take adequate and structural policy actions that strengthen the fiscal position of the country and continue to decrease the dependence of oil-related revenues. In fact, the agency mentioned that "a timely and adequate policy response by Colombian authorities could facilitate a macroeconomic adjustment to limit the negative impact of the external shocks".
- While this is undoubtedly negative news for Colombia, we think that in a backdrop of ineludible pressures and demands (as the current one), incentives of policy makers, Congress and overall decision-makers have a greater probability to be aligned in order to carry out the structural adjustments and reforms. Colombia walked through a similar, although not as critical scenario, back in 2015-16 after the initial plummeting of oil prices, to which it responded with a comprehensive tax reform to partially offset the declining government revenues (the main measure of the bill was a 3pp increase in the VAT). For naming a few, there are pending structural reforms in the labor, pensions, tax and capital markets fronts, some of which are currently being structured (but maybe put on hold amid the COVID-19 crisis).
- However, this warning by S&P may weaken the position of the government to face the current public health situation, and the economic sudden stops that come from the recently-declared nationwide quarantine, specially considering the high informality rate of the labor market (46.5% in the main cities, with most of them depending on a day-to-day income). Thus, the fiscal efforts from the government to face the crisis must be precise, as a strong increase of the debt burden should be avoided in order to preserve the Investment Grade status from S&P. Hence, recall that the government is financing the shock-absorbing fiscal package of 1.5% of GDP with savings of stabilization funds (see note), but further spending requirements and support to the vulnerable population stand as a non-negligible risk to debt dynamics in the short term.
- Beyond the fiscal profile, S&P emphasized on the weakening of the external liquidity position of Colombia, caused by the shocks of the COVID-19 and the lower oil prices. This deterioration "reduces its capacity to absorb additional external shocks, such as a prolonged global economic slowdown or further tightening in external financing conditions". The agency mainly focuses on a specific metric, which is the ratio of gross external financing needs, to the sum of Current Account Receipts and usable foreign reserves, that currently sits at 100%, according to the statement.
All-in, the main takeaway from S&P's decision and the language of the statement is that the government needs to carry out comprehensive measures to avoid strong fiscal slippage in the coming years, despite the tough challenge marked by the major weakening of global and local conditions. As mentioned in the statement, the government needs to carry out adjustments in the coming 12-18 months to avoid an outright cut of the sovereign rating and, thus, the loss of the investment grade status. We think that the MoF team, headed by Alberto Carrasquilla, is well equipped and experienced to perform such adjustments. That said, the current political scenario (marked by polarization and despite our view of potentially aligned incentives) and the rapid deterioration of local conditions due to the COVID-19 stand as major risks.
Local assets could react negatively to this tomorrow and in the coming days, as our model of theorical sovereign rating based on 5y CDS levels of several countries, currently places Colombia in the BBB- notch.
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Daniel Velandia, CFA
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