Colombia: Sovereign rating downgraded to junk but public debt is expected to remain sustainable

Event

On 20 May 2021, the rating agency S&P lowered Colombia’s long-term sovereign rating from investment grade to speculative grade. The downgrade came following the abandonment of fiscal reforms in the beginning of May due to violent nationwide protests. The credit rating agency assumed that public finances would not be fixed quickly enough and that public debt would remain above 60% of GDP in the medium term. Fitch Ratings followed on 1 July 2021 and downgraded the country's long-term sovereign credit rating to junk. The credit rating agency also highlighted the deterioration of public finances and reduced confidence around the government capacity to credibly place debt on a downward path. A country is deemed to have lost its investment grade status when two or more major agencies put the country´s sovereign rating below investment grade, which is now the case for Colombia. As a result, some investors will be compelled to sell their government bonds. Furthermore, borrowing costs could become more expensive for the Colombian public sector while capital flight could occur. Also, some domestic companies could be downgraded alongside the sovereign downgrade and face higher borrowing costs.

Impact

Violent nationwide protests broke out on 28 April 2021 after President Iván Duque introduced a tax bill. The tax bill sought to increase tax revenue via higher income taxes and increased value-added tax rates – both sensitive areas. Moreover, the tax bill was badly timed, amid a third Covid-19 wave. The president backtracked and withdrew the tax bill following protests. Furthermore, Finance minister Alberto Carrasquilla – seen as the architect of the tax bill – resigned, which did not prevent violent protests to keep going on locally, but the high levels of violence from the beginning of the unrest  receded. Therefore, protests are expected to eventually wane over time. That being said, episodes of local violent unrest might pop up in the coming year and locally spiral out of control. 
Furthermore, the withdrawal of the tax bill severely weakened the position of the president and meaningful reforms will be difficult, especially ahead of the 2022 presidential elections. Hence, despite expected new fiscal measures, the public debt – at an elevated 63% of GDP end 2020 – is likely to increase in the coming year even though economic recovery is underway. That being said, public debt is not expected to increase to unsustainable levels, even in the medium term. Moreover, Colombia has a good reputation amongst investors given it has not defaulted since the 1930s, a sharp contrast to most Latin American countries.

Colombia’s short-term political risk classification remains in category 3/7 with a stable outlook given its adequate level of foreign exchange reserves (9 months of import cover in May 2021) and moderate short-term external debt. The medium- to long-term political risk rating is in category 5/7 with a negative outlook given the elevated levels of the external debt and of the external debt service to current account revenues ratio. The business environment risk rating (category F/G) has a positive outlook since an economic recovery of 5% is expected this year after the deep recession of -6.8% last year. That being said, the downgrade of the sovereign debt by the rating agencies and the impact of rising interest rates in the USA could pressurise the exchange rate and business environment risk rating. Furthermore, if (violent) protests pop up again nationwide and if the ongoing Covid-19 wave that started in the end of March 2021 spirals out of control, economic recovery could be hurt and business environment risk rating would also be pressurised.

Analyst: Jolyn Debuysscher – J.Debuysscher@credendo.com