Navigating Colombia’s economic terrain

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On this episode of Market Points, Scotiabank Colpatria Head Economist, Sergio Olarte, and Senior Economist, Jackeline Piraján, discuss how the dynamic economic landscape in Colombia evolved over 2023. They lay out their main concerns and expectations for 2024, including the potential for a healthy deceleration in GDP growth. Let’s get started. Here’s Sergio Olarte.

Sergio Olarte: Hey, Jackie, thanks for joining me.

Jackeline Piraján: Thank you for the invitation.

SO: Let’s dive right into it. First of all, I think it’s important to talk about the recent developments in politics. Conventionally, investors typically think that Latin America was stricter in terms of institutions. But definitely we have a lot of differences. So how the institutions in Colombia compared to those, for instance, in Peru, Argentina and Venezuela, for instance? Well, actually, we have the whole different institutions and the checks and balances are a bit different and I think works very well in Colombia. So today we want to share our thoughts on how these checks and balances and how the division of power are working in Colombia and in Colombian political environment. We know, as some of our listeners consider, that in the past this topic was top of mind for analysts when making investment decisions, but at the same time sometimes it becomes less important.

So why not Jackie first, you can take all us down the way back to the end of 2022. What was going on in Colombia and what were investors key concerns?

JP: Well, Sergio, I think that we all agree that markets have become more volatile. I mean, higher interest rates, right? But I think that in Colombia particularly, we have seen some developments in recent years that are important display of how we got here. And I will say that by the end of 2022, the main concerns about Colombia was around the political scenario. Remember that we had presidential elections and by this time we elect the leftist candidate, Gustavo Petro, and he will be our president for the period between 2022 and 2026. And I think that by this time, fears of the unknown dominate the market sentiment. And in that regard, remember that when Petro started the presidency, he started with massive support in the Congress. It was very easy to pass a very huge tax reform. The new president also announced a very ambitious agenda, talking about pension reform, health reform, labour reform, but also talking about making radical announcements, for example, in terms of the energy transition. All of these announcements increase a lot, the volatility in domestic markets. And remember that by this time our exchange rate surpassed the 5,000 mark. Also, for example, our COLTES operated well above 14%. So I think that this was the main concern by the end of 2022.

SO: Thanks for the overview of that market turmoil. I remember it very, very clearly, but I think many, many things have changed afterwards, right? So, what was these things that have changed since December 2022?

JP: Well, I think that 2023 was a year in which institutional framework in Colombia proved to be very robust. First of all, we have to highlight that the central bank continued pursuing an independent monetary policy. As you know, we maintained elevated monetary policy rates for the whole 2023. We maintain our flexible approach in terms of the exchange rate, which is also a very good institution that we have in Colombia. The government also said they respect the fiscal rules and in fact they are complying with that. And in terms of politics, I think that checks and balances remain in place. And despite the ambitious agenda, we know that Congress demonstrated that radical changes are not easy to pass. As you remember, in the first quarter, the government tried to pass the health reform and it almost broke the political coalition they had at the beginning of the government. So, I think that we know right now as we were feeling during 2023, that in Colombia we have very robust institution and that bring some better scenario for our domestic assets in that regard. Also, we saw that for example, support for the president and the approval rating decreased a lot and it turned in our regional elections that demonstrate very low support for the government’s party. If you remember, in the presidential elections in 2022, almost 50% of the population vote for Petro. A little bit more because he is now our President. But in terms of GDP, around 60% of GDP areas in Colombia vote for president Petro. While in regional elections, we have support of around 80% of GDP, that didn’t vote for the government parties. So, I think that we have a huge change by the end of the year. And I think that it is proving that people want results. They have low patience and at the end it demonstrates that checks and balances are in place and that the government needs to negotiate to make any change. We think that, because the support for the government has decreased in these main areas of the country, a lot of the risks that we faced at the beginning, by the end of 2022 when the Petro government started, have reduced. So all in all, we feel that it is important to appreciate the political power structure in Colombia.

So, Sergio, in your view, what works well about the division of power?

SO: I think that’s a terrific question. I think that’s key. First of all, we have three different powers, mainly. The presidency, that makes the decisions on the budget and they spend money and they make things happen with the government institutionally. But also the President can just present before Congress what he or she wants to change, so he has, or she has real impact. But then in Congress there is a process. Normally, it takes for big reforms at least two years to pass through Congress, and they decide the short- and long-term legislation. So, the president needs to negotiate with Congress, needs to negotiate with the different parties within the Congress. And then finally, the court, especially the constitutional court, defend the Constitution. So, they have the last word. If they decide that the law that the President wants to pass through Congress and finally the Congress accept it is not constitutionally right, is not complying with the Constitution, then it’s over. So in Colombia, definitely politics matters and it’s very strong. Overall, we feel that political framework is strong in Colombia and is not the main concern anymore or at the moment at least, although still there is some ideas in credit risks because the president wants still to change many, many things. We now are more focused on the macroeconomic landscape, what’s going on with the main variables, and this means that we need to talk about the economy, recovery and inflation for last year and that year that has just started.

So, Jackie, what factors fueled such a steep recovery in 2022 and what issues has this created for the economy today?

JP: Yes, Sergio, I think that, as you mentioned, we have to be very aware about the political agenda. But let’s turn to talk a little bit more about the economy. And I will say that in terms of economic activity, the post-pandemic recovery was very strong. Atypically, and sustainably strong. If you remember, when Colombia started the reopening policies, we reached pre-pandemic levels of economic activity in mid-2021. And in 2022, services were booming, basically a frenzy of consumption from domestic demand, households traveling, going to concerts, going to spend on services and it was kind of fueled by, first of all, the sentiment that we were free again, also the fiscal support that we have from the government. So especially holidays, subsidies, low interest rates. And I think that all of these end up in very appropriate conditions to fuel inflation to high levels. That said, we were very happy because in Colombia we consume a lot during 2022. But the reality was that this consumption wasn’t that healthy. At the end we used a lot of credit. Make a picture in your mind of a car, when we accelerate the car and maintain a very high speed probably we will end up burning the car. It is not sustainable and it is more difficult to react to something atypical when we are in this fast speed. So, in terms of reaction, all of this frenzy of consumption led the central bank to respond, increasing rates. And in 2023, we maintain their very high interest rates. On average 13% for the year. By the end of the year, they started an easing cycle. But at the end, what they wanted to do is control the inflation.

Inflation, I will say that had some sources. The first source when they’re reopening was the scarcity of some goods due to all of this noise that we have international bottlenecks, in their supply chains and everything of that. While in terms of demand, we also put under pressure the demand for those durable goods. The second source of inflation was food inflation. And I think that it was a combination between the economic recovery because massive events need food to provide to the consumers. But it was also a result of the situation of the war between Russia and Ukraine. And all that happened with international prices in the commodity space. And at the end, we saw the services inflation took some relevance in explaining this high inflation in Colombia. Because as people prefer to consume, but interest rates were very high. They like to reduce consumption in durable goods, but prefer to buy some lower sticker services, for example, going to a cinema, to a restaurant, and at the end, continued fueling the services sector and services inflation. At the end of 2023, as you remember, we had the reading of inflation. By the end of the previous year, we saw that inflation decreased from around 13% to 9.3% by the end of 2023. This is the headline inflation, by the way. And we saw the core inflation services prices remain elevated. Inflation was very sticky and we ended up with a core inflation well above 10%. 10.3% or something like that. In that sense, there is a challenge in Colombia. We have index in goods that is probably impacting some of these prices. But I think that 2023 was a year of transitions, transitions towards more sustainable economic growth, transition towards a more sustainable inflation convergencey path towards the target range and just absolutely the services component in inflation is important.

SO: Yes Jackie, absolutely. I think the services component inflation is very, very important right now, I think is not only in Colombia, it’s around the world. We have seen that issue in Canada, in the U.S., in Europe. It’s kind of like after pandemic, we all became like millennials, you know? We don’t want any more houses or cars. We like experiences, so we consume a lot of services. And that just pushes up the prices for the inflation measurement, right? So that is what happened around the world, but also in Colombia. And as you mentioned before, definitely what is more sticky right now and it’s going to be stickier down the road, it’s this part of the inflation. In fact, if you just divide the services inflation and goods inflation with this inflation that it’s affected by the FX, by the exchange rate, you can see that tradable goods, goods inflation is definitely going down. For instance, for December last year, the prices of cars went from 20% at the beginning of the year to 3% in December last year. So, these kinds of goods are just helping inflation to go down because of lower prices internationally, but also lower demand. While services inflation is no longer increasing, but definitely is not decreasing fast enough because as you said, last year was the year of the concerts in Colombia. We had Roger Waters, we had a lot of domestic artists and the stadiums were full and the prices were very, very high. So that will take longer to decrease. But definitely inflation is in an acceleration mode, not as in the rest of the peers. For instance, in Peru, in Chile or in Brazil, even in Mexico, that inflation is close to target already. Colombia is three times above target. Why? Because what you just mentioned, it’s indexation effects.

JP: Well, I think that in terms of inflation, remember that Colombia has a special mechanism, that is indexation. In terms of how it works is basically that we set some prices based on previous inflation or previous decisions about the increase of the minimum salary. For example, if you are a homeowner, you can set the rent accordingly with the previous inflation. So, in 2023, homeowners were allowed to set rent fees to increase around 13%. But in 2024, they are allowed to set rent fees an increase of around 9.3%, which was, in fact, the previous inflation.

SO: Yes. And also in Colombia, we didn’t increase the gasoline prices as the rest of the world. It took much longer. So last year what we had was an increment of 44% in gasoline prices, which made it more difficult to decrease. However, for 2024, we think those components are starting to vanish and we are confident that inflation first ended last year below 10%, 9.3%, so pricing down the market, which is very good. But also we think that tradable goods and lower demand will help inflation as a whole, the headline inflation, to return closer to target, not just to the target, but closer to the target by the end of the year. So, I think in that sense, the central bank can start to ease our static and will continue easing the monetary policy rate. So, on December last year, specifically in December 19, the Central Bank of Colombia decided to start an easing cycle after a long hiking cycle post-pandemic. So, they went very gradually from 13.25% to 13%, just sending the message that most concerns about inflation are gone and they are going to start easing monetary policy rate and go gradually to a long run frame in terms of interest rates and inflation. Though, we expect that this easing cycle continues, but the speed of the easing cycle will highly depend on how the inflation deceleration happens, especially for the first half of this year. But it’s not only the core problem inflation and monetary policy rate.

We have other topics to talk about, and I think one of them is definitely the fiscal accounts. So how prudent is the government fiscal plan right now?

JP: Sure, Sergio. And I think that all of this is connected. I think that in 2021-22 and post-pandemic era, we observed some good behaviour from the fiscal point of view. The fact that we grew very above our potential GDP fueled also the possibility of having higher tax collection. And in that regard, we saw how the government at the end reduced fiscal deficit from the 5.3% in 2022 to something around 4.3% in the previous year. And despite that we have had this correction, I think that the fiscal topic should be in this spotlight in 2024. Why? Because as we expect, Colombia probably will continue with the slow economic growth pace, growing around 1.8% in the year. Probably the government won’t find that a comfortable scenario to raise taxes. So, they will find probably a budget constrain this year. And at the end, we have to remember that we are in front of a new government in which the political agenda is around social benefits and social programs and they want to increase the social spending a lot. I don’t know if you remember, but what was usual for Colombia was having an investment in spending around 17% of GDP, 15% of GDP, which was very low. But right now, what the government intends is to increase fiscal expenditures in the overall to 25% of GDP, which is huge. And in that sense, it sounds a little bit difficult to make this kind of agenda, given that they are now expecting a more moderate tax collection. So let’s see what happens there. What we have to highlight for our audience is that they are very committed with their fiscal rules. So, in the approach that we have with fiscal authorities, they say that if they have to reduce expenditures because they don’t have enough money to spend, they will do that because they respect this institution and they think that it should be the main mantra for 2024. Just be confident that the government will comply with the fiscal rules. But in the meantime, we could have some volatility. And in terms of volatility, probably in the meanwhile, we are waiting for those kind of positive announcements. Probably sometimes we could find a report from the tax institution saying that they don’t collect what they expect or that probably the government is fully insured in having some tax collection. For example, from all of these lawsuits or what they promised in the budget. And at the end I think that we have to be very careful with this kind of news, follow what is the response from the government, if they adjust the expenditures according with the expected tax income or not. But in the end, critical points are, for example, if they increase or not diesel prices, if they adjust some_­  plans in terms of the reforms, how much cost there is reforms, how they respond to any change in the economy in terms of the fiscal side. But for all of the rest, we also have to say that, for example, credit rating agencies such as Fitch and Standard & Poor’s have said that we have low probability to be, again, investment grade in terms of long-term foreign debt. And I think that it is pointing us that all carries a process. So, in terms of the fiscal side, I think that it could be more challenging for the government this year, but we have to be vigilant of what happened with the reaction that they have to these potential shocks. So, we for sure have to be aware on what’s happening with their reforms, how much it costs, what is the financial distress around it. And the recovery was too fast, so levels of fiscal support from the government will be important.

However, some investors are concerned that long-term growth could be gradual for many years. What is your take on that concern?

SO: I think there’s a lot of things to analyze here. First of all, the outlook for the short- and long-term trend, it’s important to pay attention to understand that levels matter. It is not only that we grew 7.3% in 2022, then we decelerate a lot in 2023 to, let’s say, 1.1%, no. Levels matter. How is our production going? And I think since the recovery from pandemic that we lost a lot of production, was too fast. For instance, we grew in 2021 more than 11%, and we recovered the level pre-pandemic by third quarter of 2021. And then in 2022, we continue this spectacular growth. So, we overheated somehow. Let’s put it that way. If you are training for a marathon and you are already kind of trained, if you continue to run and do hard with to yourself, you will end up with some injuries. So, we need to take it down to breathe a bit. And that’s exactly what, in my opinion, happened in 2023. Of course, that’s costly. There are some sectors that happen to have a hard time and other than not, but in the end, macroeconomically, I think it was very good and we need it to happen. How we knew that we were overheated, over trained, in the example of the marathon? It’s because inflation picked up. We had an external imbalance, historically high. Normally our external imbalance is around three percentage points of GDP. Well, last year we doubled it. We had 6% of GDP current account deficit. So, we needed to just again, slow down a bit and that helped to just correct our imbalances, actually. And the current account deficit went from 6% of GDP to less than 3% of GDP last year and inflation started to go down. So, we are not in a crisis. We are in a healthy deceleration and returning to a path that is sustainable for the long run. What’s important that the investment part of the economy recovered fast enough, otherwise it can be hurtful for the long run growth. But definitely we needed 2023 and actually with the interest rates so high around the world, the liquidity for emerging markets is slowing down. So, we don't have anymore of this kind of infinite liquidity that there was money for all of us all the time. No, not anymore. People are highly indebted. So new money with these new high interest rates around the world means that we need to be careful and invest our money very, very carefully. But interestingly enough in Colombia it normally happens that we are lagging the rest of the peers. So, we think that after the political elections in South America, Brazil, Chile, Peru, Mexico, we can see some of the behaviour in the productivity in the GDP that has happened first with the peers. For instance, Brazil or Chile. First, they are status quo. We are keeping our status quo. And second, last year we decelerate, Brazil and Chile have already done that and they are in recovery more sustainable. I think with the easing cycle starting by December and inflation going down, we can expect some of that recovery this year in 2024. Of course, it will be gradual. We think we can grow between 1.5% and 1.8%, but it’s a recovery anyways.

So having said that, I think there are a lot of topics still to pay attention, at least for the short run. So, Jackie, what would you pay attention to in the first quarter of 2024?

JP: I think that we have to recommend paying attention to inflationary trends for sure and how the GDP part reacts. At the end, all of these stories is about taking the economy towards a more sustainable economic growth path and achieve the inflation targets. So, I think that we have to be very aware of how those inflationary trends react. I will say that in the first quarter of 2024, probably we will see the strongest adjustment in the inflation to the downside. And remember, as we mentioned before, in Colombia something especially happens and that’s indexation effects. We used to set prices based on previous prices. That said, rent fees, all of these labour-intensive services are very attached to the minimum wage increase and everything of that. And if you compare in 2024, indexation forces are lower compared with what we have in 2023. Basically, remember that for example, rent could increase around 9.3% this year versus the potential increase that we had in 2023 of 13%. So, we have lowering indexation there. We also have lower indexation in terms of those potential services attached to the minimum wage and minimum wage increased 16% in 2023. And right now is increasing 12%. So, I think we will prove how hard is this inflationary trend in the first quarter of this year. So, in that sense, I think that it will be also very interesting to see how is the reaction from the central bank in that regard. Let’s see if they increase the speed in the easing cycle. While in terms of economic GDP, the main question here is if we achieve the right landing or if the economic hold falls short of the long-term trend. As we mentioned before, households decreased consumption a lot in 2023. And I think that we have to see if they react to lower rates. Also, if investments improve after the regional elections. And I think that the critical point of evaluating Colombia is not only inflation, but as we mentioned, the GDP growth. And if we achieve this right landing, I would say.

But in the overall, we are very constructive about Colombia and optimistic about it’s economic potential. But we must acknowledge some of the key risks. What could you tell us, Sergio, about key risks ahead of 2024?

SO: Yeah, I think it’s important to see what can go wrong in Colombia, even though we are just constructive with the economy this year. But I think we need to differentiate the market perspective and the real economy perspective. From the market perspective, definitely, the easing cycle from the central bank will be key. How fast they can cut interest rates. And we need to pay attention if inflation surprises up. That is the main risk for markets at that moment, because that means the central bank cannot cut as fast as we think. Interest rate going from 13% in December to 7% this December. But also from the real economy side, I think we need to be aware that we have a different type of government and there is a lot of tension among the whole sectors facing their government policies. So, this fight can affect definitely the growth and the government expenditure can be lower down the road. And oh of course, there is another big thing here that can affect especially investment in the rural areas, which is the violence that has increased in Colombia, especially in the rural areas. Because the government, in my opinion, hasn’t spent enough to keep these areas under control. So that can increase the uncertainty for some investors and decrease the investment side of the economy. So, I think that’s very, very, very important. So, summing up, in my opinion, we need to be very, very careful on how GDP can recover a bit, how fast. Secondly, if inflation continues the down growth in 2024 and maybe speed up a bit. And third, how fast the central bank is going down in terms of the interest rates.

JP: Yes Sergio, from my perspective I think that as we talked at the beginning of the podcast, I think that the market has compressed almost all of the risk premium on Colombia in terms of the political scenario. So for me, high risk probably is when we start to talk about, again, all of this agenda reform. Maintaining this following basically what could be the outcome of this discussion if either could have the up fiscal pressure for the government or not, and also monitor what happens with their fiscal plan. We haven’t had yet the publication of the financial plan, but let’s see what happens in probably February or March when they used to release this publication. But in the meanwhile, just to clarify, the government continues with the traditional issuance scheme. The on the run bonds remain the same that we observed in 2023. So, for now we did not have changes in that regard. And finally, just to make emphasis in that question about the right lending, is Colombia achieving the right landing? Is inflation going down to the target range in the monetary policy horizon or not? And I think that those are my critical points to follow in terms of risk.

Well, thank you, Sergio, for joining today. It was a very interesting chat. It was a pleasure.

SO: The pleasure was mine. And we have a message from the sales team. Please don’t hesitate to reach out to your Scotia sales representative for a little more colour on trade ideas for 2024.

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