COLOMBIA: MODEST ECONOMIC GROWTH THROUGH 2002

Created: 3/16/2000

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Intelligence Report

PtKific arki ljm" American Analysts

Colombia: Modest Economic Growth2

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DATE:5

The Pastrana administration has taut the groundworkoderate recovery from the deep recession last year. The economy will growercent instrengthen slightly in the followingBogota1 stays the course on economic policy end exports remain healthy.

The administration Is committed to sound economic policy, but politically sensitive austerity measures wilt be watered down or delayed by Congress, which could undermine investor confidence.

The economy's likely growth rates are too modest to sharply raise per capita Income or to substantially reverse jumps In unemployment and poverty last year.

poor security situation wUI prevent growth from exceeding the recent historical average of about 4percent The government estimates that the economic cost of the insurgencyercent of GDP per year, so rapid progress in peaceubstantial dividend.

On theurge in violence would slow growth but not ignite another recession unless the administration simultaneously abandoned sound economic policy and the external environment for trade and financing turned unfavorable.

Successful Implementation of Plan Colombia will reinforce recovery prospects. The plan 's economic strategies embrace the policies that are key to sustained growth, end its peace components address ihe critical security concerns that deter investment and commerce.

At the same time, an improving economy will bolster President

Pastrana's political support and supply budgetary resources needed to carry out the plan. Even In the best case, however, the budget will be constrained by the need for fiscal

AHAm-*ni l

Economy To Recover Gradually From Worst Ever Recession

Tbe Colombian Government, in its recent loan agreement with the IMF, forecasts thai

GDP will increaseercentercentercent in

lowly improving growth wouldtrengthening of the nascent

recovery from Colombia's worst recession everfell by about

5 percenthe first year-on-year decrease' The social

consequences of the recession arc immense:

Unemployment soared to more thanercent in the third quarter fromercent at tbe end

The recession wiped out gains made inn poverty reduction. After falling throughout most of the decade, the rate ofincome insufficient forasic foodsharply9 to more thanercent, about where it was

The government's targets are optimistic, and the economy will growlower rate unless the administration makes rapid progress on its economic agenda and exports are unusually strong. Local and foreign private-sector analysts are generally less sanguine than the government andore modest2 percent this year, for example. The per capita outlook is not encouraging:

opulation growth rate ofercent, per capita GDP growth will be minimal

er capita GDP will still be about what it wasven if the government's higher growth forecasts are correct. I

Successful implementation of Plan Colombia will boost the economy because the plan's economic, fiscal, and financial strategies embrace the sound policies already advocated by the Pastrana adnunistration. At the same time, an improving economy will increase support forpublic is most concerned about unemployment and other economic issues, accordingariety ofsupply tax revenues needed to fund Bogota's contribution to the plan.l

' See APLAConfidenbeJragiU Rtcovtiy Viulit Way. bul Viotncr Umiis Economic PoKnnal. H

<;ood Fiscal ud Monetary Policies Underpin Growth Prospect*

The Pastrana administration's clear comrnilment to responsible economic policy is helping to restore investor confidence, which waned during the Samper era aad hit bottom last August when international credit rating agencies stripped Colombia of its mvestment-gradc status. The challenges arc significant, but Bogota has started to take steps to address the root causes of Colombia's economic problems:

The administration has made improving Colombia's fiscalriority, but its deficit-reduction efforts were thwarted last year becauseecession-induced drop in tax revenue and unforeseen spending require men Is, such as rebuildingevastating earthquake in Quindio Department in

The government has eased monetary policy and shored up ailing banks to foster an expansion of credit, which dried up last year because of the recession. The financial system's loan portfolio contractednd it suffered losses equivalent toercent of GDP.

Deficit Reduction Will Proceed, Slowed by Opposition. The Pastrana administration will build on momentum fromhen it passed an austere budget0aw to reform the pension system for local governments. The administration also signed an agreement with the IMF in which it pledged to gradually reduce its fiscal deficit, whichercent of GDP last year. Reforms necessary to meet deficit-reduction goals are politically sensitive, however, and will be watered down or delayed as Congress takes up key legislation beginrung onarch:

Regulation of territorial expenditure will improve control of the fiscal balances of departments and municipalities, which are generally profligate and highly indebted. Opposition to new oversight will nsc as local elections approach in October.

Constitutional reform of territorialrequires an amendment that roust be passed by two consecutive Congressionallimit the mandated transfer of federal revenue to local governments The administration has hacked away from freezing transfers in real terms and nowlight increase to make this unpopular reform more palatable; local governments arc as reluctant to give up the gravy bain as they are to suffer increased regulation.

Tax and pension reforms will raise government revenues and improve the solvency of the state pension fund, which has unfunded liabilities that exceed GDI'. Both reforms are widely unpopular, unions plan to protest pension benefit reductions and higher retirement ages.

unistration will also push forward with the privatization of public assets, from which it expects to raise almostillion thisthat are critical to reducing the fiscal deficit. Bogota's privatization efforts stalled last year and will continue to face the same obstacles, which will cause delays or lower bids:

The weak economy has reduced foreign investors' enthusiasm for the sale of state assets, especially those that are losing money, such as the electrical generation company TSAGEN.

Insurgent violence directed at companies up for sale has likewise dampened investors' interest. In the past year, insurgents have downed morelectrical towers belonging to transmission company ISA partly to protest its pending privatization.

Political wrangling, regulatory changes, and judicial challenges have caused repeated setbacks in the privatization timetable. Concerned about layoffs, workers have been particularly active in their attempts to derail the sale of public companies.

interest rates and exchange rates wu1 stabilize, The Central Bank and Finance Ministry will work to keep interest rates near their current levels, which are close to record lows. Monetary authorities will increasingly use interest rates to control inflation, free from the need to defend the peso's exchange rate band:

Inflation fell toercent last year, tbe lowest rate inears. As long as inflation remainsenerally downward trend, the Bank will be able to keep interest rates low.

Tbe Bank last September floated the peso rather than raise interest rates to relieve pressure on the exchange rate band, which had been under steady attack despite two devaluationsmonth span. The move was widely praised by financial analysts. The peso strengthened after it waswas nohas since remained fairly stable.

ueeung Banting Setter Reform t*

emerging morttu, wtach compVti Coionbii'* reform ettoeti favorably to ibe tfloro of nine oOier developing countries (

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The Financial System Is on ihe Long Road to Recovery. The government has made considerable progress in shoring up the shellshockcd financial system and will continue with the difficult job of getting weak institutions back on their feet so they can resumeclosing them, if they are beyond help.1

State-owned financial institutions are in far worse shapethose in the private sector, and most will be sold off. Even relatively strong private banks are still trying to clean up their balance sheets, however, so credit expansion will be cautious at best. To encourage new credits, the government will provide loan guarantees to reluctant lenders and assistance to troubled debtors. The total cost of cleaning up the financial system will be spread out over several years but is still significant- estimates rangeercent of GDP. Colombia is receiving loans from the World Bank and Inter-American Development Bank to help cover some of these cosUt.p

Export Engine Humming But Running Low on Gas

Tbe government says that exports will lead therevenues increasedercent last year, largely because of higher oil prices, helping to restore economic growth. Nevertheless, strong export growth will be problematic given volatile prices for Colombia's leading exports, oil and coffee, and near-term supplyBogota is trying to overcome:

The administration is sweetening contract terms for foreign investment in the exploration and production of oil. The successidding round this year is critical to the industry's long-term survival. Oil production peaked9 atarrels per day and is beginning to decline; without new discoveries, the country couldet oil importerortunately for Colombia, the revenue impact of lower production will be reduced as long as prices remain high.

The government is working with growers to boost Colombia's coffee production, which declined inecause of aging plantations, inefficient fanning,eries of natural disasters. Bogota has also broached output limits with Brazil, the world's largest coffee producer, to push up sagging prices.

Tbe administration will continue to promote exports by putting pressure on its trading partners to grant improved market access, which it sees as key to boosting nontraditional products. Bogota will continue its multifaceted approach toward the United States, its most important trading partner, particularly by requesting parity with the Caribbean Basin Initiative and expansion of the Andean Trade Preferences Act. Colombia will seek accession to NAFTA under the next USafter approval of Planincrease exports and to encourage local producers to become more competitive. The government is also lobbying the European Union for trade benefits as part of EU economic support for Plan Colombia.

Security Problema Shackle Ecoaomlc Poaaibilitic*

Even If the administration successfully pursues sound economic policies and exports are strong, Colombia's economic growth will be constrained for the foreseeable future by the poor security situation. Tbe government estimates thai the economic cost of the insurgencyercent of GDP per year. This includes direct costs, such as loss of life and property damage from insurgent attacks, as well as indirect costs such as foregone investment.

Until the security situation improves, Colombia will not reach the high growth rates that developing countries need to achieve substantial improvements in social welfare. Tbe Inter-American Development Bank warns that latin America must doubleercent growth rate or risk falling behind in global economic development.

Therelear consensus in Colombia that insurgent violence is an obstacle to sustained growth. Business elites, once relatively isolated from the insurgency, are uicrcastngly affected in multiplekidnapping, lower investment, higher costs, and reduced international competitiveness. The public is sensitized to the costs of the violence and roundly rejects attacks on the country's economicurge in violence would slow growth but not ignite another recession, however, unless Bogota simultaneously abandoned sound economic policy and tbe external environment for trade and financing turned unfavorable

The government, die business sector, and tbe insurgents all agree in the abstract on the need for ecoDc*riic growth, job creation, and social development. Nevertheless,evelopment model acceptable to all that achieves these goalslobal framework will be elusive and potentially unsettling to the economy:

The government has little- maneuvering room in which to satisfy insurgent demands Backpedaling on fiscal austerity, privatization, or free trade wouldlunge in investor confidence.

The business sector says that it is willing to invest inmore taxes for social development, forconditions this on an end to the violence

Leaders of the Revolutionary Armed Forces of Colombia (FARC) claim to be opcnininded about economic models, but the group'skidnappings and attacks on energyreflect its Marxist ideology and history of rural banditry. They say that peace must follow, not precede, economic growth. P

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