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- IMF staff concluding statement of the 2023 Article IV mission on Colombia.
USA / COLOMBIA – The new administration took office in August 2022, with social equity and climate at the center of its agenda. Against a backdrop of high inflation and elevated fiscal and current account deficits, monetary and fiscal policies are being appropriately tightened, facilitating the needed transition towards more sustainable and inclusive growth. The approval of the 2022 tax reform, the prudent 2023 Financing Plan, the reaffirmation of the inflation target and the associated tightening of monetary policy are especially noteworthy and consistent with Colombia’s very strong policy implementation.
The balance of risks around the outlook remains tilted to the downside, albeit somewhat moderated by a less gloomy global outlook. As such, macroeconomic policies should continue to be tight to prioritize a durable reduction in inflation and external imbalances. Prudently advancing key structural reforms, coupled with a continually strengthened communication strategy, will be essential to boost productivity, enhance inclusiveness, and ensure a gradual and well-sequenced transition to a greener and more diverse economy.
Global conditions remain challenging. Following the pandemic, Russia’s war in Ukraine led to sharply higher global food and energy prices and contributed to a hardening of global financial conditions during 2022, with negative knock-on effects on many emerging and developing economies. Global growth and commodity prices are projected to moderate this year, reflecting the effects of policy tightening, although risks remain tilted on the downside. These developments have put the focus of the global policy debate on the need for tight macroeconomic policies to decisively bring down inflation, anchor inflation expectations, and safeguard hard won credibility, while also attending to social needs.
Despite these challenges, the Colombian economy outperformed expectations in 2022, growing at one of the fastest rates among emerging economies. Benefiting from an effective policy response to the pandemic and highly favorable terms of trade, Colombia’s economy is estimated to have expanded by 8 percent last year and is currently operating above potential. The strong output growth was largely driven by private consumption, reflecting pent-up demand from the pandemic, buoyant bank credit, and recovery in employment levels, although unemployment among women and the young remain elevated. More recent high-frequency indicators show insipient signs that the economy is starting to cool and domestic demand is starting to moderate.
At the same time, internal and external imbalances have also widened. Against a backdrop of robust domestic demand, high commodity prices, and weather-related shocks, headline inflation reached 13.3 percent year-on-year in January 2023, with core prices rising by 9.8 percent over the same period. Despite favorable terms of trade and robust non-traditional export growth, the current account deficit widened from 5.6 in 2021 to an estimated 6.3 percent of GDP in 2022. Importantly, the higher current account deficit, which also reflects increased profit transfers abroad, was financed by remarkably strong FDI, which more than doubled from 2021 to 2022.
Sovereign spreads, as measured by 5-year Credit Default Swaps, stand near 270 basis points and have fallen from earlier peaks reflecting evolving external and domestic conditions. In 2022 international reserves remained adequate and the central bank did not intervene in the FX market. The IMF’s Flexible Credit Line (FCL) provides additional external buffers and enhances market confidence.
Against this backdrop, macroeconomic policies are being appropriately tightened. The central bank reaffirmed its commitment to reaching the inflation target by end-2024 in its communiques and raised the policy rate continually from 1.75 percent in September 2021 to 12.75 percent in January 2023. Based on one-year ahead inflation expectations, monetary policy is now well into a tightening stance. Following a period of strong policy easing, fiscal consolidation is gradually underway.
The central government’s overall deficit is estimated to have narrowed to 5.5 percent of GDP last year, compared to 8.2 percent of GDP in 2021 (excluding privatization proceeds), and 3 percentage points of GDP above the fiscal rule target, underpinned by buoyant revenues and expenditure discipline. Improvements, however, were more limited for the consolidated public sector deficit, which includes the deficit of the Fuel Price Stabilization Fund (FEPC), which rose due to the decision to freeze fuel prices between January and June 2022.
The financial sector remains liquid and well-capitalized, with policy actions helping to moderate strong credit growth. Private credit expanded by about 17 percent in 2022, driven mainly by strong consumer loan growth. Recent data point to some moderation in credit growth, reflecting in part tighter macroeconomic policies and regulatory changes, with consumer loan quality deteriorating somewhat in late 2022. Loan-loss coverage, however, remains strong, owing to the proactive supervisory actions that raised provisioning and capital buffers. As such, capital adequacy and liquidity remain ample and well above regulatory levels.
Shifting down a gear: Transitioning to a more sustainable growth path
The Colombian economy is undergoing a necessary transition towards a more sustainable growth path. Output growth is projected to slow markedly in 2023 on account of tighter macroeconomic policies, a slowing global economy, and higher global borrowing costs. This necessary cooling of the economy would in turn gradually bring inflation towards the central bank’s target by end-2024. External imbalances are also expected to narrow amid tightening policies, and credit growth is projected to moderate further.
The balance of risks remains tilted to the downside. Adverse external risks remain elevated, as global financial conditions could tighten more sharply than anticipated with negative knock-on effects on commodity prices, capital outflows and domestic demand. Domestic risks cannot be discarded; special care will be needed to manage and communicate the sequence of reforms, and ensure that macroeconomic policies are sufficiently tight to bring inflation towards its target and effectively reduce the elevated fiscal and external imbalances. Maintaining a sustained track record of very strong policy implementation, including by continuing to adhere to the fiscal rule and the inflation targeting framework, would help support Colombia’s resilience and capacity to respond to shocks.
The envisaged fiscal adjustment for 2023 is welcome, with higher revenues also supporting inclusive goals. The Financing Plan for 2023 targets a central government overall deficit of 3.8 percent of GDP; better than the deficit implied by the fiscal rule and a significant improvement following the pandemic-related stimulus of previous years. The deficit reduction will be underpinned by the 2021 and 2022 tax reforms and high oil revenues, making space to expand social spending while continuing to reduce FEPC’s deficit (about 2.6 percent of GDP in 2022). The envisaged consolidation path would also support a reduction in inflation and external imbalances and is another reflection of Colombia’s very strong economic policies.
Beyond 2023, the Financing Plan envisages a path that is fully in line with the fiscal rules, demonstrating a commitment to comply with the very strong fiscal framework. It would be worth considering further improvements in fiscal balances over the fiscal rule path, as this would further reduce financing needs and borrowing costs, strengthen the convergence of public debt to its medium-term anchor, create buffers against downside shocks, and bolster the credibility of the fiscal policy framework. To ensure the medium-term fiscal consolidation path is consistent with an expansion of social spending, policies will be needed to continue to gradually remove distortive fuel subsidies, reduce budget rigidities, and ensure permanent spending is financed with permanent revenue sources and windfall revenues are saved (in line with the fiscal rule).
Continued vigilance and effective communication will be required to durably reduce inflation to its target. Further hikes in the policy rate may be needed depending on the evolution of factors including actual inflation, inflation expectations, and demand conditions.Based on currently available information, a tight monetary policy stance will need to be maintained beyond 2023. Effective communication, emphasizing that monetary policy will remain tight and data-dependent to achieve its target, remains key to reduce uncertainty, anchor expectations, and maintain central bank credibility. The exchange rate should continue to be allowed to adjust flexibly to shocks, as it appropriately has been, as long as financial stability is not compromised.
Financial stability risks need to continue to be carefully monitored. Continued strong oversight and proactive supervisory actions, including to raise provisioning and capital buffers if and as needed, remain necessary to maintain buffers and improve banks’ preparedness in the event of a further deterioration in credit quality, especially in the consumer sector. In addition, it will be important to continue to closely monitor the rising indebtedness of households as growth moderates. Going forward, as further progress is made in enhancing data coverage, expanding the macro and microprudential toolkit could serve a complementary role to the robust supervisory oversight. Recent enhancements in monitoring the exposure of conglomerates to Central America is welcome; these linkages would require continued close oversight in collaboration with host country supervisors
Structural reforms: Gearing up for a more equitable, and greener economy
A well-designed and executed energy transition and export diversification plan is vital to secure medium-term sustainability and resilience. The objective of reducing Colombia’s reliance on oil and coal is commendable. A successful transition would require developing a well-communicated and gradual plan that balances the energy needs of the domestic economy and its foreign exchange generation capacity with the transition of the global economy to a low-carbon one. This transition would need to be complemented with efforts to diversify Colombia’s export base through measures that strengthen the investment climate and bolster human capital, openness to trade, and competitiveness.
Prudently advancing structural reforms within Colombia’s very strong policy frameworks can foster a successful and durable transition to a more equitable and greener economy. The government’s recently unveiled four-year National Development Plan (NDP) defines a roadmap to boost equity and security, with emphasis on eradicating extreme poverty and hunger, reducing large regional disparities, achieving total peace within Colombia, and protecting the environment. The NDP also envisages a greater role for government in increasing financial inclusion and rural development as well as improving the coverage and progressivity in the pensions and healthcare systems.
Implementing the NDP carefully and prudently, in close consultation with relevant stakeholders, will be essential to preserve fiscal and financial stability, and ensure that economic incentives are well aligned. As social safety nets are expanded, better targeting social spending will ensure that public resources reach Colombia’s most vulnerable households. Communication of reform efforts has been helpfully strengthened; continuing to improve coordination in messages will further support consumer and business confidence in the Colombian economy.
IMF Communications Department
