Public Information Notice No. 99/114

Public Information Notice: IMF Concludes Article IV Consultation with Colombia

December 29, 1999

On December 20, 1999 the Executive Board concluded the Article IV consultation with Colombia,¹ and approved a three-year extended arrangement in an amount equivalent to SDR 1.957 billion (for further details, see press release number 99/63).

Background

For several decades, Colombia achieved significant economic progress with steady and strong economic growth and good balance in its external accounts. In recent years this performance has given way to slow growth and widening economic imbalances. To a considerable extent, the deterioration has been the result of unsustainable fiscal policies, external shocks, and a difficult internal security situation. The weak fiscal policies reflected the introduction earlier in the 1990s of new expenditure programs and a constitutionally mandated system of revenue transfers to the territorial governments. After taking office in August 1998, the Pastrana administration took several measures in an effort to address the difficult fiscal situation; these included spending cuts, a widening of the VAT base, higher fuel taxes, and stronger tax enforcement. Despite these measures, the nonfinancial public sector deficit rose to about 4 percent of GDP and the current account deficit widened to near 6 percent of GDP. The financial sector was beginning to show clear signs of distress by late 1998.

The recession intensified in 1999; the unemployment rate rose to a record 20 percent in September, while inflation fell to 9½ percent (from nearly 18 percent a year earlier) and the current account deficit came down sharply. The fiscal position deteriorated markedly during the first half of 1999, largely as a result of weak tax collections and higher outlays on interests, wages, and pensions. As market sentiment toward Colombia remained unfavorable, the peso came under repeated pressure, and on September 27, the central bank allowed the currency to float.

To head off a system-wide crisis in the financial sector, the government has introduced several measures since late 1998, including programs to assist savings and loans institutions, financial cooperatives, and mortgage holders; recapitalize viable private banks; and deal with the serious problems of the public banks through restructuring, recapitalization, and eventual divestment.

Executive Board Assessment

Directors noted that, after several decades of sound economic management and strong economic growth, Colombia's economic and financial situation had deteriorated in recent years. Directors observed that the weak performance resulted mainly from growing fiscal imbalances, adverse external shocks, and a difficult internal security situation. They commended the authorities for the corrective fiscal and financial sector restructuring measures taken recently to begin to address the situation, and endorsed Colombia's medium-term economic program.

Directors emphasized that substantial fiscal consolidation, the implementation of the financial sector restructuring plan, the pursuit of the flexible exchange rate, and the acceleration of other key structural reforms will be critical in helping to restore the strong economic growth necessary to promote employment and alleviate poverty.

Directors welcomed the authorities' ambitious medium-term fiscal consolidation plan. They emphasized the importance of a strong commitment to tax reform and tax enforcement, and observed that efforts under way to improve tax collection and strengthen tax administration—combined with measures aimed at broadening the value-added tax and income-tax bases—should help to achieve the fiscal objectives of the program.

Several Directors expressed concern about the distortionary nature of the financial transactions tax, and encouraged the authorities to phase it out as the revenue situation improves. They recommended that territorial government tax reform be enacted expeditiously to enforce reforms of the revenue-sharing system. Directors supported the authorities' intention to exercise firm control over non-interest expenditure, while protecting the gains in social spending that have been achieved in recent years.

Directors welcomed the program's emphasis on streamlining Colombia's system of fiscal decentralization, as well as the plans to help deal with the underfunded liabilities of the public pension systems. The efforts to strengthen control over the finances of territorial governments with debt servicing problems were also welcomed.

Directors considered that the authorities' decision to float the peso was appropriate, and supported their intention to follow a transparent foreign exchange market intervention policy so as to further contribute to a recovery of confidence. They were generally supportive of the reduction in central bank interest rates over the past few months, in light of the easing of inflationary pressures, but recommended that caution be exercised with regard to further steps in that direction until confidence is restored and until such steps can be supported by a stronger fiscal position.

Most Directors considered that inflation targeting could provide a transparent and credible framework for guiding monetary policy in Colombia, and encouraged the authorities to proceed with the implementation of such a framework. Some Directors noted, however, the need to ensure that the necessary preconditions for such a framework to be successful are in place before its adoption. In this regard, some Directors emphasized the need to ensure the operational independence of the central bank.

Directors commended the authorities for their prompt action to strengthen the financial system as it came under increasing stress. They noted that the financial system restructuring strategy was sound, but that important challenges remain in executing the strategy for the public banks, the mortgage sector, and the recapitalization program for private banks, adding that close vigilance is warranted in the period ahead. Directors welcomed the amendments to the banking law that were adopted earlier this year, but noted that a strengthening of supervisory practices will be required. They emphasized the need for tight control over the operations of public banks in the period until they have been divested.

With regard to other structural reforms, Directors endorsed the authorities' plan and policies in the areas of privatization, foreign direct investment, and private sector involvement in infrastructure projects, which hold out the promise of creating a more efficient private-based economy. A few Directors noted that labor market reform was not being vigorously pursued at this time, and urged the authorities to keep this issue on the agenda to help provide further impetus to the recovery.

Directors pointed to the challenges and risks facing the authorities' economic program, including the unsettled security situation, the possibility of a slower-than-expected recovery in economic growth, and the difficulties that might arise in securing political support for the government's reform agenda, as well as the program's heavy reliance on privatization proceeds. In this regard, Directors were encouraged by the political support evidenced by the passage of the tight budget for 2000, and by the authorities' intention to adopt additional measures, if needed, to ensure that their economic objectives remain achievable.

Directors welcomed the authorities' decision to take the necessary steps to accept the obligations of Article VIII, Sections 2, 3, and 4 of the Articles of Agreement by the end of the Extended Arrangement, and encouraged them to proceed quickly to achieve this.

Directors also noted that the provision of data to the Fund was adequate for surveillance and welcomed the authorities' intention to continue working with the Fund staff to improve the economic databases.