29 Mar 2023
I arrived in Colombia with some trepidation. In the weeks preceding my trip, leftist President Gustavo Petro’s proposed reforms to the health and pensions system had taken a heavy toll on the country’s bonds and currency, given the major fiscal cost they entailed. A subsequent cabinet reshuffle, which saw the removal of ministers who opposed the health reforms, added to the pressure by stoking fears that the market-friendly minister of finance, José Antonio Ocampo, could be the next casualty.
In both cases, I gained comfort from the various meetings I had. Health reforms appear very likely to be watered down significantly, which will reduce the fiscal burden on the government, and all meetings relating to pension reforms pointed to them being much less extensive/costly than feared. As for Ocampo, it seems unlikely he will be pushed out or step away from the important job of implementing the reform programme in a way that is consistent with the country’s fiscal rules (a point that Ocampo stressed repeatedly during my visit).
Colombia’s finances are already benefiting from last year’s tax reforms, with revenues rising to boost the country’s fiscal position, helped also by a big uptick in oil revenues last year. But for investors in local debt, a combination of disappointingly stubborn inflation – partly reflecting rising food prices (exacerbated by heavy rain and mud slides at the start of the year) – and relatively resilient (albeit slowing) economic growth weaken the outlook over the short-to-medium term. A lingering positive output gap (above-potential production rates) is also a factor likely to force the central bank to keep rates higher for longer. Fortunately, however, the anticipated demand drag on Coltes (government bonds) relating to pension reforms appears less serious than feared, with the creation of a public savings fund acting as an offset to the diversion of contributions away from the private pension system into the public pay-as-you-go system.
Longer term, policymakers and officials are focused on energy security concerns and the need to address the energy transition. This should see more investment in renewables and the development of Colombia’s vast untapped offshore gas reserves. I also learned that issuance of green or sustainable bonds is on the cards to fund capital expenditure on energy transition-related projects. For instance, investment in the energy transition is set to account for a quarter of overall capex at the country’s energy giant Ecopetrol1. We think this should prove interesting for investors looking to make a meaningful impact on the energy transition.
I have noted before how parts of Latin America have been leading the way on green, social, sustainable and sustainability linked bond (SLB) issuance. While I was encouraged to learn of plans to issue a sustainable Eurobond, I believe Colombia would benefit from issuing a sustainability linked bond relating to deforestation. Reversing the trend on deforestation is a concern policymakers will need to address, particularly in the context of the country’s Nationally Defined Contributions. Upcoming EU regulation on deforestation & forest degradation (EUDR) – under which buyers of certain commodities (many of which are important exports for Colombia) will need to provide evidence that these are “deforestation-free” - adds a further sense of urgency here. Uruguay’s recent SLB issuance could provide a useful template to follow and could offer a very interesting opportunity for debt investors.
Peru has had a tough few years, politically and economically, as we touched on here. Recently, violent protests erupted after ex-President Castillo’s impeachment and imprisonment, only to be followed by a truckers’ strike and then road blockades as protestors called for the removal of President Boluarte. All of this increased the prospect of early elections being called while also forcing the large – and economically important – Las Bambas1 copper mine to suspend its operations. Moody’s revised its outlook to negative while bond investors watched on as political risk rose and the economic outlook darkened.
Fortunately, my trip to the country left me optimistic that it is moving past this tumultuous period. Protests have receded and appear unlikely to pick up again in the short term, pushing the prospect of early elections into 2024 or even 2025; Boluarte and her cabinet – which includes a highly credible minister of finance – are widely expected to remain for the time being. Political risk is moderating – at least in the short-to-medium term – and growth has bounced back quickly. The government also has room to implement some limited stimulus measures since the fiscal balance is well anchored.
All of this points to a brighter outlook for the country’s local bond and FX market. The sol is also enjoying a short-term boost in the form of the annual tax payment season, which sees locals selling dollars and buying the sol to settle their tax bills.
The trend is also positive on the inflation and monetary policy front. Like many central banks in Latin America, Banco Central de Reserva del Perú (BCRP) reacted to rising inflation last year, and this has paid off. Officials from both the government and the BCRP see inflation falling back to 3% by the end of this year, helped by the fact that – unlike Colombia and Chile – Peru does not have a positive output gap and fiscal stimulus measures have been quite limited. The BCRP has now finished hiking and I believe it has room to start cutting rates. A further positive for the country’s local currency bond market is that a very large cash buffer makes new issuance unlikely. In addition, the central bank has been buying back debt (soberanos) to boost market liquidity. However, another withdrawal from the pension fund system remains a risk to watch closely.
Regarding green bond issuance, despite very broad investment plans, I noted a relative lack of green investments due to limited planning capacity. The knock-on effect of this is that there are not enough green projects available to package into a potential green bond. Given the significant risks and challenges that climate change poses to the Peruvian economy, the country could benefit from exploring ways to address these issues and establish a presence in the green bond market as regional peers have done. However, we note that Peru is likely to issue a Euro-denominated social bond later in the year.
1 This is not a buy, sell or hold recommendation for any particular security.