Jul 6, 2021
Following S&P’s downgrade of Colombia to high yield at the end of May, Fitch followed suit at the start of July, also moving the country to BB+ (stable outlook). Here we discuss recent events, the market’s reaction to these, and why we still see significant positives for investors in the country’s debt.
As we discussed in May, the market expected this downgrade; Fitch had repeatedly voiced its concerns about the challenging fiscal adjustment needed against a backdrop of tight political constraints. Like the S&P downgrade in May, the timing was more of a surprise than the action itself, even if the rationale for the decision boils down to the same concerns that we outlined in May.
Since the earlier, more ambitious, fiscal reform plan was withdrawn after it triggered protests, the authorities have presented a medium-term fiscal plan. But this only served to highlight the fiscal challenges facing the country and the difficulty the constrained government will have in righting the ship before the election early next year. For instance, the fiscal plan still pencilled in a large deficit for next year, of 7% of GDP.
After S&P’s early move, Fitch was fully expected to follow - hard currency sovereign bonds were already trading in line with BB+ peers - so the market reaction in the aftermath was very muted. Furthermore, since active (rather than passive) investors own a large share of these, the extent of forced selling should be limited.
Unlike S&P, Fitch also downgraded Colombia’s local currency rating to BB+. However, since the sovereign still retains two investment-grade local currency ratings (Baa2 and BBB- from Moody’s and S&P respectively), there is not an immediate risk of the country’s local currency debt exiting the Bloomberg Barclays Global Aggregate Index. More broadly, we think the downgrade was fully priced in.
Fiscal challenges aside, we think Colombia has a number of strengths that are significant positives for investors in its debt: a large buffer of foreign exchange reserves; unconditional access to a flexible IMF credit line; a flexible exchange rate regime; and strong, independent economic institutions. The government also has a clear climate action strategy and strong ESG credentials.
Given this, we do not foresee any more downgrades further into high-yield territory in the near term, and we continue to hold exposure to Colombian assets in our portfolios.
Furthermore, if price action mimics that seen when markets like Brazil and South Africa lost their hard currency sovereign investment-grade rating, a fully priced downgrade could well be the trigger for outperformance from here, in our view.
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