Public Information Notice No. 01/36

Public Information Notice: IMF Concludes Article IV Consultation with Colombia

April 12, 2001

On March 28, 2001, the Executive Board concluded the Article IV consultation with Colombia.¹

Background

Colombia's economic performance deteriorated markedly in the last half of 1998 and during 1999 due to a combination of external shocks and a weakening of confidence. The external shocks included deterioration in the terms of trade and the effects of the turbulence in international financial markets in the aftermath of the Asian and Russian crisis. The weakening of confidence was related to the worsening of the internal security situation, and uncertainty in the face of continued deterioration of public finances and clear signs of stress in the financial sector. Real GDP growth fell to 0.5 percent in 1998 and was negative by 4.3 percent in 1999, and the combined public sector deficit widened to 5.5 percent in 1999 from 3.8 percent of GDP in 1998. Unemployment rose to 20 percent.

To deal with these problems, the authorities designed a three-year stabilization program based on fiscal consolidation, exchange rate flexibility (the peso was floated in September 1999), and structural reforms. The structural program included measures to strengthen expenditure control in the public sector, privatization, and financial sector restructuring. In December 1999, the Fund approved a three-year extended arrangement in support of the Colombian government's program.

Economic conditions have since seen a notable improvement. Inflation ended 2000 below 9 percent, and real GDP grew at nearly 3 percent based on a strong recovery of exports and some rebound in domestic demand. The external current account improved to a surplus of 0.2 percent of GDP due to higher export receipts and a moderate recovery in imports. The combined public sector deficit was reduced to 3.4 percent of GDP in 2000 because of higher oil revenues and lower expenditure, and despite a court-ordered increase in public sector wages and a deteriorating financial position of the public pension systems. The conditions in the financial sector improved in 2000 with the help of a restructuring and recapitalization program implemented by the authorities. The government's privatization plans fell short of its objectives, but the rest of the structural reform program progressed about as envisaged.

The government's program for 2001 aims to sustain the recovery. Growth is projected to increase to near 4 percent and inflation to fall further to 8 percent. The external position is projected to remain strong with debt falling slightly in relation to GDP. The fiscal program for 2001, which is critical to achieving these objectives, calls for the nonfinancial public sector deficit to fall to 2.6 percent from 3.5 percent of GDP in 2000. This is to be achieved through expenditure reduction and a strong tax effort—drawing on the tax package that was recently approved by congress—to compensate for a projected decline in income from the petroleum sector. Most of the financing of the fiscal deficit is being secured from external sources. Monetary policy in 2001 will be implemented under an inflation-targeting framework and the exchange rate will continue to float.

Executive Board Assessment

Directors commended the authorities' efforts to achieve fiscal consolidation, financial sector restructuring, and structural reforms, as well as the central bank's adoption of an inflation-targeting framework for monetary policy. These policies have provided an essential underpinning to the economy's recovery from the 1998-99 recession. Directors supported the authorities' determination to persevere with and, where necessary, reinforce these policies to address the challenges that Colombia continues to face. They considered that the main economic challenges are to place the fiscal accounts on a sustainable footing, reduce the high level of unemployment, and further strengthen the financial system.

Directors commended the authorities' fiscal efforts to date and noted that the outcome would have been more favorable had it not been for the need to absorb the costs of court-ordered wage increases. At the same time, they considered that further measures are needed to attain a sustainable fiscal position. Directors noted that the recent fiscal adjustment has been aided by factors that may not be sustainable—such as higher than projected oil revenues and lower public investment—and by revenues from some taxes that are distortionary. Moreover, fiscal pressures could emerge from a number of sources, including costs related to the pension system and achievement of a lasting peace, as well as uncertainties relating to oil revenues and other developments in the world economy. Overall, Directors considered that the preservation of a sound fiscal situation should be central to the authorities' economic efforts. Without the necessary action on the fiscal front, there will be undesirable upward pressure on interest rates, external financing will be more difficult to arrange than otherwise, and policymakers' options in responding to shocks will be excessively constrained.

Against this background, Directors looked forward to the creation of a commission that would propose a comprehensive plan to improve the efficiency of the tax system and make it less distortionary. They considered it important to phase out the financial transactions tax and the new customs service charge. While understanding the complexity of the issues involved, Directors regretted the delay in submitting the fiscal responsibility law and the second-generation pension reform to congress, and urged the authorities to act expeditiously in these areas. They attached particular importance to the pension reform. Reform of the health care system is also needed. More generally, Directors encouraged the authorities to continue reducing the size of the public sector, including through privatization of public enterprises.

Directors were concerned about the rapid increase in unemployment, which at present levels could contribute to social tensions. They considered that the authorities' various initiatives, including the creation of short-term jobs, training programs, and incentives for education, could help in addressing this critical problem. More fundamentally, however, Directors noted that a successful attack on unemployment will require the correction of distortions in the labor market, such as high payroll taxes, and greater flexibility in the terms of employment.

Directors welcomed the central bank's commitment to continue lowering inflation. They noted that this commitment will be harder to meet the greater the reliance on backward indexation of wages and prices, which they considered should be avoided. Directors encouraged the central bank to continue studying the various transmission mechanisms of monetary policy with a view to refining the inflation-targeting framework.

Directors commended the authorities' resolute actions in dealing with loss-making public banks and strengthening the banking system. Capital adequacy levels have risen and problems with nonperforming loans have diminished. They welcomed the authorities' efforts to strengthen the mortgage institutions, and generally supported the measures to help spur activity in the housing and construction industries. Directors noted that maintaining a healthy banking system could have benefits for the fiscal situation in that it would avoid possible restructuring costs. It would also increase the authorities' room for maneuver in the conduct of monetary policy by increasing resilience to exchange and interest rate changes. Directors appreciated Colombia's efforts to combat money laundering.

Directors noted that the external current account deficit has been reduced substantially in the past two years, partly as a result of higher oil prices, but also reflecting the authorities' prudent policies and the depreciation of the peso under the floating exchange rate regime. They welcomed the progress already made by the authorities in securing external financing for 2001, which is especially important given recent uncertainties about near-term developments in external markets. At the same time, Directors urged the authorities to stand ready to deal with the effects on the program of a weakening of external demand and possible adverse developments in the terms of trade.

Directors commended the authorities' determination in pursuing their adjustment and reform policies despite the difficult domestic security situation. They noted that confidence will strengthen if the security situation improves, welcomed the resumption of the peace process earlier this year, and wished the authorities much success in their efforts.

Directors noted Colombia's participation in the Special Data Dissemination Standard and encouraged the authorities to improve the quality of data, especially on public domestic debt.

Directors also encouraged the authorities to take the necessary steps to accept the obligations of Article VIII, Sections 2, 3, and 4 of the Articles of Agreement.