Itaú BBA - COLOMBIA – Medium-Term Fiscal Plan highlights fiscal challenges

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COLOMBIA – Medium-Term Fiscal Plan highlights fiscal challenges

June 19, 2018

We see the need for additional fiscal measures, likely in the form of a new tax reform.

In its recently published Medium-Term Fiscal Plan (MTFP), the Colombian government maintained the fiscal deficit target for this year and expectedly raised its deficit targets thereafter. The revision is in line with a recently released recommendation by the Fiscal Advisory Council, which loosened fiscal targets given a larger than expected output gap. In fact, the 1.8% GDP growth recorded last year was inferior to 2.3% incorporated in the 2017 MTFP, resulting in the output gap being close to 0.4% larger than anticipated last year. Meanwhile, the government now works with better expectations for oil price for this year (USD 67/barrel vs. USD 55/barrel previously). The administration also made a marginal increase to oil production forecasts from 840,000 barrels per day to 844,000. We estimate these revisions mean some USD 1.6 billion in additional revenue, mostly coming from the revision to prices. Looking ahead to next year, a further activity pick up to 3.4% is expected, but is far below the 4.0% forecasted in last year’s MTFP. Overall, we see that the MTFP remains optimistic regarding the assumed path of fiscal consolidation, which means there will be need for additional fiscal measures in coming years, likely in the form of a new tax reform.

We believe the fiscal deficit target for 2018 (3.1%) is achievable on the back of higher oil prices, but challenges remain ahead. The central government’s fiscal deficit forecast for this year was unchanged from the 2017 MTFP, and implies a narrowing from the 3.6% deficit recorded in 2017. The corresponding structural deficit would be 1.9% of GDP, in line with the 2017 result. The anticipated higher oil prices means the government expects oil revenue to increase to 0.6% of GDP this year (doubling from the 0.3% of GDP in 2017) and to 1.2% in 2019.

Next year, the administration anticipates an additional narrowing to a 2.4% fiscal deficit (1.8% in structural terms) as the output gap persists. We are more conservative on our expectation for the pace of fiscal consolidation, as we see the nominal balance at 2.7% of GDP in 2019. Our lower growth forecast compared to the MTFP (3.2% vs. 3.4%) poses a revenue risk that would not be fully offset by our slightly more optimistic oil price forecasts for this year (Itaú: USD 71/barrel vs. MTFP: USD 67/barrel). In this context, the expected deficit reduction by the authorities would demand a significant moderation in expenditure (as a fraction of GDP), which also appears challenging in the current political environment (considering, for instance, expenditure pressures related to the peace deal implementation). Going forward, the MTFP also delayed the arrival to the 1% of GDP long-term target to 2027, five years later than previously envisioned on the back of a wider output gap.

The upcoming administration will face a tradeoff between living up to the roadmap set by the current fiscal authorities, and keeping key campaign promises demanding tax reductions. A transitory measure to cope with the need for fiscal consolidation and lower taxes could be to adjust the fiscal rule, relaxing short-term fiscal deficit goals (a strategy considered during the campaign). We note this would likely be read negatively by rating agencies, risking Colombia’s investment grade status.

Credit rating agencies have noted the likely need for measures to increase permanent sources of revenue (tax reform) or reduce expenditure. At the close of 2017, S&P cut Colombia’s credit rating to “BBB-” with a stable outlook despite the previous tax reform. The main reasons were the expenditure inflexibility and a higher debt level. Fitch recently affirmed its credit rating at “BBB” with a stable outlook due to favorable improvement in terms-of-trade. Meanwhile, Moodys (Baa2, negative outlook) believes that even with its expected growth pick up this year and the next, it would be insufficient to revert the central government debt path in coming years. At the same time, the agency expects the new government will adhere to market-friendly macroeconomic policies and in this context, waiting until next year to analyze the country’s conditions and pronounce about its credit rating. 
 

Miguel Ricaurte
Carolina Monzón 



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