ISABELANA 2

IMF

Colombia : Review Under the Flexible Credit Line Arrangement

Press Release; and Staff Report
Author/Editor:International Monetary Fund. Western Hemisphere Dept.

Publication Date:May 22, 2019   Free .pdf  Download of complete document with graphics Here  946 KB

Summary:  Colombia’s recovery is gaining momentum on the back of strong domestic demand, with a wider current account deficit. As a key external shock, migration flows from Venezuela accelerated in 2018 and by end-December 1.5 million migrants were estimated to live in Colombia.

Risks to global growth and financial stability are tilted to the downside and have increased somewhat relative to the last FCL approval according to the April 2019 WEO and GFSR. Given the importance of oil exports and non-resident holdings of local-currency bonds, Colombia remains exposed to lower global growth, including indirectly through lower oil prices, and a sudden reversal in investor sentiment.

Colombia weathered last year’s financial and oil market volatility well, however, as evidenced by stable spreads and local currency bond yields.

  • Series:Country Report No. 19/141
  • Publication Date:May 22, 2019ISBN/ISSN:9781498316309/1934-7685
  • Stock No:1COLEA2019003Price:$18.00 (Academic Rate:$18.00)
  • COLOMBIA REVIEW UNDER THE FLEXIBLE CREDIT LINE ARRANGEMENT

EXECUTIVE SUMMARY

Colombia’s recovery is gaining momentum on the back of strong domestic demand, with a wider current account deficit. As a key external shock, migration flows from Venezuela accelerated in 2018 and by end-December 1.5 million migrants were estimated to live in Colombia.

Risks: Risks to global growth and financial stability are tilted to the downside and have increased somewhat relative to the last FCL approval according to the April 2019 WEO and GFSR. Given the importance of oil exports and non-resident holdings of local currency bonds, Colombia remains exposed to lower global growth, including indirectly through lower oil prices, and a sudden reversal in investor sentiment.

Colombia weathered last year’s financial and oil market volatility well, however, as evidenced by stable spreads and local currency bond yields.

Policies: Colombia continues to have very strong policies and policy frameworks. The authorities have been proactively accumulating reserves through a market-based mechanism that allows the exchange rate to remain the first line of defense against external shocks. The financial regulatory framework is being further strengthened by the implementation of the Conglomerates Law and Basel III capital and liquidity standards.

To accommodate spending pressures associated with migration, the authorities decided to use flexibility within the fiscal rule to modestly relax the deficit target in a well defined manner starting in 2019 while safeguarding the medium-term fiscal anchor.

Flexible Credit Line (FCL). On 25 May 2018, the Executive Board of the IMF approved a two-year arrangement for Colombia under the FCL in an amount equivalent to SDR 7.848 billion (384 percent of quota). The authorities stated their continued intention to treat the arrangement as precautionary and no change in access levels is being sought during this mid-term review. They are committed to the exit strategy communicated during the 2018 approval and see the reserve accumulation program as an important step in preparing for a phased reduction in access to Fund resources under the FCL, risks permitting.

Qualification. In staff’s assessment, Colombia continues to meet the qualification criteria for access to FCL resources as specified under the Executive Board decision on FCL arrangements (Decision No. 14283 – (09/29), adopted on March 24, 2009, as amended).

Staff therefore recommends completion of the review under the FCL arrangement.

May 3, 2019 COLOMBIA 2 INTERNATIONAL MONETARY FUND Approved By Aasim M. Husain (WHD) and Zuzana Murgasova (SPR) This report was prepared by a team comprising Hamid Faruqee (Head), Emilio Fernandez-Corugedo and Frederik Toscani (all WHD), Andrew Swiston (SPR) and Farid Jimmy Boumediene (MCM). Cristina Barbosa and Danjing Shen provided excellent assistance.

CONTENTS

  1.  RECENT DEVELOPMENTS
  2. OUTLOOK AND RISKS
  3. POLICIES
  4. REVIEW OF QUALIFICATION
  5. SAFEGUARDS ASSESSMENT
  6. STAFF APPRAISAL
  7. Updated External Economic Stress Index
  8. FIGURES 1. Recent Economic Developments
  9. External Sector Developments_
  10. Recent Financial Developments
  11. Non-Resident Investors in Local Currency Government Debt
  12. FCL Qualification Criteria
  13. Reserve Coverage in an International Perspective
  14. External Debt Sustainability: Bound Tests
  15. TABLES 1. Selected Economic and Financial Indicators
  16. 2.Summary Balance of Payments (In millions of US$)
  17. 3.Summary Balance of Payments (In percent of GDP)
  18. Operations of the Central Government
  19. Operations of the Combined Public Sector
  20. Monetary Indicators
  21. Medium-Term Outlook
  22. COLOMBIA INTERNATIONAL MONETARY FUND -Financial Soundness Indicators
  23. Indicators of External Vulnerability
  24. Public Sector Debt Sustainability Analysis – Baseline Scenario
  25. Public Sector Debt Sustainability Analysis – Composition of Public Debt and Alternative Scenarios
  26. External Debt Sustainability Framework
  27. Indicators of Fund Credit
  28. COLOMBIA 4 INTERNATIONAL MONETARY FUND CONTEXT

1. Colombia’s macroeconomic policies and policy framework remain very strong. Upon taking office in August 2018, President Duque’s government re-iterated its commitment to policy continuity and maintaining Colombia’s strong macroeconomic policy framework. Fiscal policy remains anchored over the medium term by the structural deficit rule and monetary policy decisions under the inflation targeting framework delivered inflation close to target, with well anchored inflation expectations, in 2018. The flexible exchange rate continues to be the primary mechanism of adjustment to external shocks.

2. The FCL arrangement provides valuable insurance against external tail risks. As noted in the April 2019 WEO and GFSR, global risks are tilted to the downside. Given the importance of the oil sector for the Colombian economy and the elevated share of non-resident holdings of domestic government bonds, Colombia remains exposed to the materialization of external risks, including a sharp correction in the price of oil or a general risk-off episode in financial markets. Against this backdrop, the FCL continues to provide a cushion of international liquidity and a signal of the strength of the Colombian economy and policy frameworks, contributing to Colombia being well-shielded from EM financial volatility in 2018, as evidenced by stable sovereign spreads and local currency bond yields.

3. Colombia has been the main recipient of migrants from Venezuela, leading to fiscal pressures. Following a sharp acceleration in inflows during 2018, 1.5 million migrants from Venezuela resided in Colombia as of December 2018, according to Migracion Colombia. The authorities’ commitment and efforts to provide humanitarian support such as health care and education to migrants will result in net fiscal costs for Colombia that will likely peak at around ½ percent of GDP in 2020 according to staff’s baseline estimates.

The net costs should gradually decline, as migrants integrate into the economy and associated gains in their economic output rise over time. In response to the substantial near-term spending pressures, the Fiscal Rule Consultative Committee (FRCC) recommended on March 29th to use flexibility within the fiscal rule to modestly relax the headline deficit target over the next few years. Market reactions to date have been muted.

RECENT DEVELOPMENTS :   Growth picked up in 2018 while external imbalances widened. GDP growth strengthened to 2.7 percent in 2018 from 1.4 percent in 2017, supported by stronger private consumption, and a modest investment pick-up.

With demand-driven growth spurring imports while non-oil exports remained sluggish, the current account deficit increased to 3.8 percent of GDP. Inflation has been stable around the 3 percent target since 2018Q1 and inflation expectations remain well-anchored.

NPLs started to decline in 2018H2 and domestic banks have become increasingly willing to lend as the economy and investment recovers.

The financial sector remains sound. Banks remain well capitalized with provisions stable at approximately 130 percent of NPLs and Tier-1 and regulatory capital having been raised to 13.2 percent and 18.9 percent of risk-weighted-assets (RWAs) respectively.

The central government reduced its deficit in 2018 as mandated by the fiscal rule. Consistent with the fiscal rule, the central government’s headline deficit narrowed to 3.1 percent of GDP in 2018 from 3.6 in 2017. Government debt increased modestly to 51.8 percent of GDP, primarily driven by an increase in the value of foreign currency-denominated debt in peso terms.

OUTLOOK AND RISKS: Despite external headwinds, growth is expected to strengthen further this year, while the current account deficit is projected to remain elevated. Notwithstanding a slowdown in global growth, staff projects growth to rise to 3.6 percent this year, driven by continued strength in consumption and an investment rebound. High-frequency indicators for early 2019 corroborate a further pick-up in growth.

Key investment supports include implementation of 4G infrastructure spending, improved corporate balance sheets and investment-friendly tax reform. Inflation should remain near target despite possible temporary factors, given favorable indexation dynamics and continued slack.

But with strong domestic demand, the current account deficit is projected to remain elevated. While the current account deficit is being comfortably financed by stable foreign direct investment and robust portfolio inflows from a more diversified 1 See 2019 Article IV Report for Colombia for a comprehensive discussion of recent economic developments.

INTERNATIONAL MONETARY FUND investor base: the projection for broadly unchanged deficits over the medium term would imply a modest build-up in net foreign liabilities.

Global risks remain skewed to the downside amid high policy uncertainty, posing external sector risks to Colombia.

  • Current account: As noted in the April 2019 WEO and GFSR, lower global growth—amid a further escalation in trade tensions and downside risks in systemic economies, including an increase in policy uncertainty—poses risks to Colombia’s exports, including indirectly through lower oil prices (with oil exports in 2018 amounting to one-third of total exports). The downside risks to global growth have increased somewhat relative to the time of the approval of the current FCL while the risk of lower oil prices is broadly similar. Colombia: Update on Global Risks
  • Capital flows: Financial conditions facing emerging markets (EMs) tightened in mid-2018 as several EMs underwent turmoil, then eased in early 2019 as prospective policy tightening by systemic central banks was delayed or reduced. While capital flows to Colombia have remained robust, the potential remains for a sharp deterioration in market sentiment, which could result in a rapid tightening in global financial conditions or a generalized risk-off episode. In addition to the gross external financing requirement of about 13 percent of GDP .
  • Colombia remains exposed to external financial conditions via nonresident participation in the local bond market, which rose to an all-time high in 2018 (7.9 percent of GDP or 26 percent of the total holdings), although increased diversification of the investor base has reduced concentration risk and a continued lengthening of average maturities has reduced roll-over risks.
  • The government has already met its external borrowing plan for 2019 with oversubscribed Eurobond issuances in October and January. Source: IMF staff estimates.

COLOMBIA INTERNATIONAL MONETARY FUND  Correlation of risks:

The balance of payments could be affected through multiple channels if negative external shocks materialize simultaneously. In 2009 and 2015, oil prices declined, demand for non-oil exports weakened, and EM financial conditions tightened together. This led to lower oil revenues, non-oil exports, and reduced private capital inflows. In this context, given the current account deficit, a large fall in oil prices could also negatively affect capital inflows.

This correlation of risks is consistent with previous staff analysis finding a strong positive relationship between commodity prices and capital inflows in Latin America.  Capital flows-at-risk analysis suggests that while the baseline outlook is for continued robust portfolio inflows, substantial net outflows could occur in the case of a tail risk scenario.

Colombia – Vulnerability to Capital Account Shocks

  • The updated External Stress Index (ESI) shows that the external conditions Colombia faces under the baseline are broadly similar to those at the time of the FCL approval. A tail-risk scenario continues to imply a significant deterioration in conditions relative to the baseline.  See Regional Economic Outlook, Western Hemisphere: Tale of Two Adjustments (April 2017).
  • This is proxied by simultaneous two-standard-deviation shocks to oil prices, U.S. Treasury yields, and EM sovereign spreads. See Staff Report for the 2019 Article IV Consultation for Colombia, Annex IV. Model baseline, 2019Q2 One standard deviation shock Two standard deviations shock
  • Frequency Distribution of Net Portfolio Inflows (Percent of GDP, capital-flow-at-risk approach) Sources: Haver Analytics; and IMF staff calculations and estimates.
  • Private Capital Inflows and the Oil Price (percent of GDP) Sources: IMF, International Financial Statistics; Haver Analytics; and IMF staff calculations.

COLOMBIA 8 INTERNATIONAL MONETARY FUND

The Updated External Economic Stress Index,  ESI, shows that the estimated impact of tail risks in the adverse scenario remain about the same as at the time of the FCL approval last year. The external ESI summarizes Colombia’s external shocks and exposures to these shocks.

It was initially presented in the staff report for the June 2015 FCL arrangement. The methodology is explained in “Flexible Credit Line—Operational Guidance Note,” IMF Policy Paper, July 2018. The index is based on four major variables which capture external risks for Colombia: the level of the oil price (a proxy for oil exports as well as oil-related FDI); U.S. real GDP growth (a proxy for exports); remittances, and other inward FDI; and the emerging market volatility index (VXEEM) and the change in the 10-year U.S. Treasury yield as proxies for risks to equity and debt portfolio flows, respectively.

The methodology and weights are unchanged from previous Colombia FCL reports. These unchanged weights, which were formulated when Colombia’s oil exports-GDP were higher and external liabilities to nonresidents were lower, do not fully capture the more recent reduced exposure to current account shocks nor increased exposure to capital account shocks, but the results would be broadly similar with updated weights.

The adverse scenario reflects external risks from global policy uncertainty and a global growth slowdown. In the adverse scenario, policy uncertainty or protectionism combined with a rise in risk premium are assumed to lower U.S. growth by 0.75 percentage point. Oil prices are assumed to fall 28 percent with respect to the baseline due to weak global growth, in line with the risks currently priced into futures markets.

Stress in financial markets due to policy uncertainty is assumed to increase the VXEEM by two standard deviations, and a decompression of term premia is assumed to trigger a 100bps increase in 10-year U.S. Treasury yields. The assumed shocks to the oil price, VXEEM, and yields are unchanged compared to the 2018 FCL approval, while the 0.75 assumption for the U.S. growth shock was lowered from a 1.5 percent shock in the 2018 FCL approval, bringing it into line with the latest scenarios used for the World Economic Outlook.

Overall, the updated ESI is now significantly stronger than at the time of the FCL approval last year, but is projected to fall towards a similar level under the baseline and under the tail risk scenario.

COLOMBIA INTERNATIONAL MONETARY FUND :. On the domestic front risks are broadly balanced. Heightened uncertainty in Venezuela adds to fiscal risks for Colombia.

The number of migrants is projected to reach 2½ million by end 2020 in staff’s baseline projection, with spillovers in terms of public spending for Colombia. But there exists substantial uncertainty around migration flows depending on how the Venezuela crisis evolves.  A high migration scenario could result in additional near-term fiscal costs of around ½ percent of GDP relative to the baseline.

A failure to mobilize tax revenues in the future could lead to large cuts in social and investment spending, adversely affecting growth and poverty reduction. Lower-than-expected subnational and private investment are a risk to the 2019 growth forecast.

On the upside, 4G infrastructure investment could proceed more quickly than expected.

POLICIES:  The authorities are further strengthening the policy framework and building policy space to ensure Colombia’s continued resilience to external shocks.

  • Reserve accumulation: Reserves remained adequate in 2018 at 118 percent of the ARA metric (130 percent excluding a commodity buffer). In a proactive step, in September 2018 the Central Bank announced a program to accumulate reserves as part of the authorities’ efforts to enhance the economy’s resilience to external shocks and prepare for a gradual reduction in FCL access in the future, risks permitting. The program’s market-based mechanism has allowed reserve accumulation without disrupting the smooth functioning of the foreign exchange market, while permitting the flexible exchange rate to remain the primary mechanism of adjustment to external shocks. As of April 2019 the Central Bank has purchased close to US$2.9 billion since last October.
  • Financial sector supervision: The financial supervisor is implementing the Conglomerates Law and Basel III capital and liquidity standards, in line with previous staff advice. These standards ,  See 2019 Article IV Report for Colombia, Annex III.  The program involves monthly auctions of “put” options allowing market participants to sell U.S. dollars to the Central Bank at the previous day’s market rate during any period when the dollar weakens against the peso below its 20 business-day moving average. See 2019 Article IV Report for Colombia, Annex IV for a detailed description of the program.   The purchases include US$1.9 billion through the market-based program and a US$1 billion direct purchase from the treasury at the prevailing market rate on February 1. This was a one-off transaction to monetize the proceeds of a Eurobond issued shortly before that date. COLOMBIA  INTERNATIONAL MONETARY FUND will be gradually introduced over a four year period (Feb. 2020–Feb. 2024). The measures should further strengthen the regulatory framework.
  • The 2018−22 national development plan (NDP) should strengthen competitiveness and governance. The plan is focused on measures to improve productivity growth, such as providing firms with incentives for technology adoption, improving human capital and reducing skills mismatches (most prominently, by pushing forward a new national qualification system) and expanding access to credit for SMEs and start-ups. The authorities are also focused on closing infrastructure gaps and reducing transport costs, including by pushing ahead with an ambitious 4G investment agenda. These measures should boost Colombia’s external competitiveness and help lay the foundation for higher medium-term exports. The NDP also includes welcome initiatives to improve the efficiency of the state and fight corruption.
  • Fiscal policy remains anchored by the fiscal framework and should place public debt on a declining path. The authorities’ medium-term fiscal framework (MTFF) requires reducing the structural deficit of the central government to 1 percent of GDP over the medium term. Given the large migration shock and its attendant fiscal costs, a modestly relaxed headline deficit path has been defined for a fixed period with a pre-specified ceiling on the deviation in the budget deficit, but the structural deficit objective remains unchanged as a medium-term anchor. The new headline deficit path implies higher deficits in 2019 and 2020 but lower deficits from 2023 to 2024 relative to the 2018 MTFF.9 Notwithstanding these revisions, adhering to the fiscal rule will keep public debt on a declining path over the coming years. In the baseline, public sector gross debt is projected to steadily decline from about 51 percent in 2018 to around 40 percent of GDP by 2024.10 In that context, durably raising tax revenues as a share of GDP, aligned with the authorities’ policy intentions, would help build fiscal buffers and minimize the risk of slower debt reduction while avoiding cuts in public investment and social spending that would adversely affect inclusive growth.
  • The moderately expansionary monetary stance is appropriate in the near term. With inflation close to target, anchored inflation expectations, weak credit growth, and the prevailing negative output gap, monetary policy should remain accommodative to safeguard the recovery and insure against heightened downside risks. If the recovery in credit and GDP materializes as 8 See 2019 Article IV Report for Colombia for further details on the regulatory changes.
  • The revised deficit path also includes a reassessment of the economy’s cyclical position which was deemed to be stronger relative to the 2018 MTFF, implying lower headline deficits between 2019 and 2026. 10 See 2019 Article IV Report for Colombia, Annex II for a discussion of the Debt Sustainability Analysis (DSA). COLOMBIA INTERNATIONAL MONETARY FUND 11 projected, the Central Bank can shift to a tightening bias towards the second half of the year to move monetary policy to neutral territory.
  • The authorities reiterated their intention to continue treating the FCL arrangement as precautionary and to gradually reduce access to Fund resources, risks permitting. The authorities continue to view external risks as elevated, in particular a possible sharp tightening in global financial conditions and a renewed decline in oil prices and continue to value the precautionary liquidity buffer provided by the FCL. The authorities see implementation of the Conglomerates Law and convergence to Basel III as well as continued adherence to the structural balance rule as important steps to further build resilience. They remain committed to the exit strategy communicated at the time of the 2018 FCL approval and see the reserve accumulation program as an important step in preparing for an eventual and gradual reduction, risks permitting, in FCL access.
  • REVIEW OF QUALIFICATION Staff’s assessment is that Colombia continues to meet the qualification criteria for an FCL arrangement. Colombia maintains very strong economic fundamentals and institutional policy frameworks, with an inflation-targeting regime and flexible exchange rate, fiscal policy anchored by a well-defined medium-term fiscal framework, and financial system oversight based on a sound regulatory and supervisory framework.
  • Moreover, Colombia has a sustained track record of implementing very strong policies and the authorities remain committed to maintaining such policies going forward. Specifically:
    • Sustainable external position. Overall, staff assesses the external position to be sustainable, based on the external assessment conducted for the 2019 Article IV consultation.
    • The current account deficit widened to 3.8 percent of GDP in 2018 and is expected to remain around that level in the medium term. Under staff projections, the estimated current account gap of 1.8 percent of GDP in the EBA current account approach implies it is moderately weaker than implied by fundamentals and desirable policies.
    • The external balance sheet is sustainable given sizable nondebt-creating capital inflows. Moreover, staff’s debt sustainability analysis projects external debt to be broadly stable over the medium term near its end-2018 level of 47 percent of GDP and to remain manageable even under large negative shocks. Going forward, the authorities remain committed to allowing the flexible exchange rate to serve as the primary mechanism of adjustment to external shocks, which should limit the risk of episodes of unsustainable external deficits.
    • The press release announcing the reserve accumulation program explicitly noted that one purpose was to prepare for a possible reduction in FCL access. See “The Board of Directors of Banco de la República Announces Program of Accumulation of International Reserves (28 September 2018).” 12 See 2019 Article IV Report for Colombia, Annex I.
    • Capital account position dominated by private flows. Capital account flows in Colombia are predominantly private. Public flows accounted for only around 25 percent of Colombia’s direct, portfolio, and other asset and liabilities flows on average over the last three years. Capital flows have been mostly in the form of net flows of foreign direct investment (FDI) and portfolio investment (averaging 2.8 and 0.6 percent of GDP, respectively, over 2016–18). Stable funding sources—especially FDI—are expected to continue to finance the bulk of the current account deficit in the medium term.
    • Track record of steady sovereign access to international capital markets at favorable terms. Colombia has had uninterrupted access to international capital markets at favorable terms since the early 2000s. The cumulative amount of external bonds issued by the sovereign between 2014 and 2018, is equivalent to more than 500 percent of Colombia’s Fund quota. In addition, cumulative non-resident acquisition of peso-denominated sovereign bonds during the period amounted to over nine times quota.
    • The three major credit rating agencies all continue to assign an investment grade rating to Colombia.  Sovereign bond spreads have performed in line with spreads on similarly-rated countries, remaining below the aggregate EMBI-Global spread.
    • A reserve position that is relatively comfortable. Colombia’s reserves have exceeded 100 percent of the ARA metric in each of the last three years, with end-2018 coverage estimated at 118 percent of the metric including a commodity buffer, and 130 percent excluding the commodity buffer.
    • Coverage is also adequate according to other traditional metrics (Figure 6). Based on projected ARA metrics, the reserve accumulation currently being undertaken by the authorities will help maintain these strong external buffers in terms of reserve adequacy over the medium term.
    • Sound public finances, including a sustainable public debt position. In recent years, the strong fiscal framework and moderate levels of public debt helped Colombia absorb the oil price shock of 2014–15 through a combination of expenditure restraint and revenue measures. Notwithstanding an increase in public debt in the wake of the oil price shock, debt has stabilized in recent years, and staff assesses it to be sustainable with high probability, including under alternative scenarios and encompassing consideration of potential contingent liability realizations.
    • The authorities are committed to fiscal sustainability by adhering to their structural deficit target as an anchor that will place public debt on a declining path. The current use of flexibility within the fiscal rule to address the costs of migration from Venezuela is understandable to avoid crowding out key public investment and social spending. The well defined adjustment to the fiscal rule—in terms of the trigger, size, and duration—is welcome and is not expected to appreciably alter Colombia’s debt dynamics.
    • Low and stable inflation in the context of a sound monetary and exchange rate policy framework. Colombia has maintained single digit inflation since 2000. Monetary policy has been set to help keep inflation close to target in most years, with inflation expectations becoming more well-anchored. Fitch and Moody’s assign (equivalent) ratings of BBB and Baa2, respectively. S&P assigns a rating of BBB-.  After the oil price shock and subsequent currency depreciation led to a temporary deviation in inflation in 2015–16, the central bank tightened policy to guide inflation back to target. Monetary policy easing from late 2016 to early 2018 was compatible with moderating inflation, and with inflation at target and inflation expectations well-anchored, policy has appropriately been on hold since April 2018. The authorities remain committed to their inflation targeting framework and flexible exchange rate regime.
    • Sound financial system and absence of solvency problems that may threaten systemic stability. Financial system solvency and liquidity has remained strong notwithstanding credit issues in specific sectors. As of September 2018, the banking system’s capital adequacy ratio stood at 18.9 percent, well above the regulatory limit, and other financial soundness indicators are well within adequate ranges (Table 7). While NPLs increased in the past few years, they declined in the last quarter of 2018 and are expected to further decline as the economy continues to recover. The 2019 Article IV mission did not find significant solvency risks or recapitalization needs. According to periodic central bank stress tests, the banking sector remains robust to adverse macroeconomic shocks.
    • Effective financial sector supervision. The authorities are taking measures to further strengthen the supervisory framework. They are bringing capital and liquidity standards into line with Basel III, including definitions of risk-weighted assets and regulatory capital, and the size of capital conservation and additional risk buffers for domestic systemically important banks (D-SIBs), with a phased introduction over 2020−24 to minimize any adverse impact on the supply of credit. The authorities remain committed to heightened supervisory vigilance during the transition period to Basel III. In addition, a capital requirement for operational risk for banks is expected to be introduced, with a decree outlining the specific details to be published in Q4 2019.
    • The authorities are also implementing the conglomerates law (approved in September 2017), which should enhance the effectiveness of supervision over cross-border banking groups, including capital adequacy requirements at the group and subsidiary levels, and guidelines for conflicts of interest within financial conglomerates.
    • Data transparency and integrity. Colombia’s macroeconomic statistics continue to meet high standards and are adequate to conduct effective surveillance. Colombia remains in observance of the Special Data Dissemination Standards (SDDS), and the authorities publish relevant data on a timely basis.
    • Track record. Colombia has a sustained track record of implementing very strong policies, grounded in staff’s assessment that all relevant criteria were met in each of the five most recent years. The authorities also remain firmly committed to maintaining such policies going forward. 16. Colombia has a very strong institutional policy framework. Fiscal sustainability and the independence of the central bank were enshrined in the Constitution in 1991. Effective financial regulation and supervision, with major reforms in the wake of the 1999 crisis, have provided a robust policy framework to ensure financial stability. Regarding the cyclicality of policies, Colombia  achieved a smooth adjustment to the 2014−16 oil price shock through effective monetary and fiscal policy responses, as described above.
    • Colombia’s government effectiveness indicators continue to improve. The World Bank’s government effectiveness score improved from -0.3 in 2000 to 0−0.1 in 2017, converging to the regional average, and most other governance indicators have also improved substantially. Behind this, the authorities have combined strengthening of the legal framework for governance and transparency with wider access to information and organizational changes to improve governance (IMF, 2018, Box 2).
    • Colombia has been invited to become an OECD member, having introduced reforms on labor standards, the justice system, corporate governance of state-owned enterprises, anti-bribery issues, and trade practices. Progress in implementing the governance agenda has been noted by the OECD15 and going forward, it is important for the government to continue to strengthen implementation of governance and anti-corruption measures.

SAFEGUARDS ASSESSMENT Staff has completed the safeguards procedures for Colombia’s 2018 FCL arrangement. On February 7, 2018, Deloitte Colombia (the external auditor) issued an unmodified audit opinion on Banco de la República’s 2017 financial statements, which are published.

Staff reviewed the 2017 audit results and discussed them with Deloitte. No significant issues emerged from the conduct of these procedures. Since then, the 2018 financial statements have been published with an unmodified audit opinion.

STAFF APPRAISAL  Colombia continues to benefit from the FCL arrangement. The FCL has contributed to Colombia weathering last year’s emerging market financial market turmoil well and continues to boost confidence in Colombia’s very strong policy framework. The volatility in oil markets in late 2018 highlighted that an oil price shock remains an important risk, as is a shock to risk premia in emerging markets.

Downside risks to global growth and financial stability have increased somewhat over the past months. In that context, the FCL provides important insurance against tail risks.

The authorities’ commitment to maintaining very strong policies and policy frameworks is welcome. The authorities’ proactive step to accumulate reserves will help maintain reserve adequacy metrics near current levels and underscores their commitment to the exit strategy communicated during the 2018 FCL approval. Implementation of the Conglomerates Law and Basel III capital and liquidity standards will further strengthen the regulatory framework. Fiscal policy remains anchored by the structural balance rule while the modest adjustment to the headline deficits targets is understandable given the additional spending due to exceptional migration  See: “OECD countries agree to invite Colombia as 37th member” and.  “OECD Integrity Review of Colombia. “

    • Inflows. Staff welcomes adjusting the deficit targets in a well-defined manner under the strict conditions outlined by the FRCC and welcomes the FRCC’s recommendations to revise the fiscal rule’s contingency framework to handle exceptional shocks in the future, which should avoid situations where the deficit target is modified after the occurrence of a shock. Going forward, reforms to raise tax revenue would help to rebuild fiscal space while meeting future spending priorities.
    • In staff’s view, Colombia continues to meet the qualification criteria for access to FCL resources. The IMF Board assessment of the recently-completed 2019 Article IV consultation noted Colombia’s accelerating economic recovery in a setting of very strong policy frameworks. Colombia has a track-record of very strong macroeconomic policies, anchored by its inflation-targeting regime, flexible exchange rate, structural fiscal balance rule, and effective financial system regulatory and supervisory framework. The authorities remain committed to maintaining such policies going forward.

Staff therefore recommends completion of the review under the FCL arrangement for Colombia Figure 1. Colombia: Recent Economic Developments Sources: Departamento Administrativo Nacional de Estadísticas (DANE); La Fundación Para la Educación Superior y el Desarollo; Banco de la República; Haver Analytics; and IMF staff estimates.

Monetary Policy Rate and Inflation Expectations (In percent) Gap between real ex ante policy and real neutral rate Inflation expectations over next 24 months Policy rate Headline inflation rate Monetary policy has been moderatly accomodative since early 2018 with inflation and inflation expectations at target.

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