Rating Action: Moody's changes Colombia's outlook to negative from stable, affirms Baa2 ratings

Global Credit Research - 03 Dec 2020

New York, December 03, 2020 -- Moody's Investors Service, ("Moody's") has today changed the outlook on the Government of Colombia to negative from stable. Concurrently, Moody's has affirmed Colombia's long-term local and foreign-currency issuer and senior unsecured debt ratings at Baa2 and foreign-currency shelf senior unsecured ratings at (P)Baa2. The short-term local and foreign-currency issuer ratings were also affirmed at Prime-2 (P-2).

The outlook change to negative reflects risks that the economic and fiscal effects of the coronavirus shock, which Moody's identifies as a social risk under its ESG framework, may leave a lasting impact on Colombia's fiscal strength and its overall credit profile. Following a sharp deterioration in debt metrics in 2020, Moody's expects that fiscal adjustment will start in earnest in 2022 with results contingent upon a tax reform that will be discussed in 2021. In the absence of material fiscal consolidation, government debt metrics are unlikely to significantly improve over the medium term, resulting in a weaker fiscal profile than that of Baa2-rated peers.

The affirmation of Colombia's Baa2 rating is supported by the government's track record of prudent macroeconomic policies that support the economy's capacity to sustain shocks. Moody's notes that external vulnerability risks have remained contained despite the external shock experienced in 2020 -- which included a decline in oil prices. The current account deficit has narrowed and a large portion of it is still financed by FDI, with the flexible exchange rate acting as an adjustment mechanism and international reserve buffers providing strong coverage. Moody's also considers that the government's funding strategy has been effective in minimizing financing risks by diversifying funding sources and limiting increases in borrowing costs.

Colombia's foreign-currency long-term bond and deposit ceilings remain unchanged at A3 and Baa2, respectively. The foreign-currency short-term bond and deposit ceilings remain Prime-2 (P-2). The local currency long-term bond and deposit ceilings remain A2.

RATINGS RATIONALE

RATIONALE FOR CHANGING THE OUTLOOK TO NEGATIVE FROM STABLE

Moody's expects that the pandemic will lead to a GDP contraction of 7.2% in 2020 and weigh on government revenue. Combined with the additional government spending measures implemented in response to the pandemic's health and economic fallout, Moody's forecasts the fiscal deficit will come close to 9% of GDP, contributing to a material 15 percentage point increase in the general government debt-to-GDP ratio to 67%, above the 'Baa' median of 61% of GDP. The decrease in government revenue will weigh on debt affordability with the interest-to-revenue ratio rising to 13% in 2020 from 10.8% in 2019 -- again higher than the 7.8% 'Baa' median. Moody's expects government finance ratios to continue to deteriorate in 2021 even with GDP growth of about 4.5%-5.0%.

The trajectory for Colombia's debt metrics will be contingent on how successful government efforts are in delivering a thorough fiscal adjustment program over the coming years. Preexisting conditions related to a narrow tax base for the central government and a rigid expenditure structure will complicate the fiscal consolidation process. The extent to which a tax reform proves effective in raising revenue on a permanent basis will be a major factor influencing Colombia's fiscal prospects and its credit outlook. In this respect, although the government has been able to broaden its coalition in congress, rising social pressures in the aftermath of the pandemic and political considerations related to the 2022 elections represent challenges that the authorities will have to manage as they seek to achieve substantive progress on the revenue front and move to address rigidities on the spending side.

RATIONALE FOR THE RATING AFFIRMATION

Colombia's Baa2 rating is supported by a track record of macroeconomic policies that support the economy's capacity to withstand shocks and the adjustment that has followed these episodes. Colombia's policy response to the 2014-16 terms-of-trade shock contributed to Moody's view prior to the pandemic that key credit metrics -- e.g., debt ratios, economic growth -- would improve over time. The quality of macroeconomic policymaking is recognized by the sovereign's qualification for a Flexible Credit Line (FCL) with the International Monetary Fund (IMF). The FCL was expanded this year to $17 billion and will contribute to the funding of the government's larger financing needs while still providing supplementary coverage for balance of payments risks. Moody's notes that this ability and willingness to conduct prudent policymaking will be tested by the magnitude of the pandemic's economic and fiscal shock.

Moody's assessment of relatively contained external vulnerability risks also supports Colombia's credit profile. A floating exchange rate has contributed to the adjustment of the external accounts with foreign direct investment continuing to provide a sizable coverage of the current account deficit. The country has been able to accumulate foreign reserves, which currently amount to about 20% of GDP. Reserves, which provide strong liquidity coverage of upcoming external debt payments, are boosted by Colombia's access to the IMF's FCL, which provides an additional $12 billion of liquidity support on top of Colombia's $55 billion foreign exchange reserves.

Colombia's liability management practices have minimized financing risks, allowing the government to limit the deterioration in debt affordability metrics. Following an initial spike of cross-border borrowing costs, external market conditions have improved and Colombia's funding costs are now lower than at the beginning of the year. Conditions in the domestic market have improved as well. The return of nonresident investors, after outflows were reported in March and April, allowed the government to issue its first 30-year local bond, contributing to improving its domestic debt profile. The government has diversified its funding sources with increased resources coming from multilateral institutions, including a $5 billion drawdown from its FCL at very favorable terms.

ENVIRONMENTAL, SOCIAL, GOVERNANCE CONSIDERATIONS

Environmental risks for Colombia are related to its exposure to physical climate risk in the form of flooding and extreme precipitation caused by the La Niña weather phenomenon that can affect the agricultural sector. Additionally, given the high share of hydrocarbons in exports, Colombia is exposed to carbon transition risks over the longer term.

Social risks are material for Colombia. Despite progress in poverty reduction achieved over the past two decades, persistently high levels of rural-urban income inequality could be a potential source of social unrest. Colombia faces moderate challenges in the provision and quality of education, housing, health and safety and access to basic services. Additional risks related the implementation of the peace agreement with the FARC and the large influx of Venezuelan migrants into Colombia adds pressure to the government's fiscal balance because of higher social spending, although in both instances there could be medium term positive effects on the economy by supporting increased investment and productivity. Moody's also regards the coronavirus outbreak as a social risk under its ESG framework, given the substantial implications for public health and safety.

Governance considerations, including issues such as rule of law and control of corruption, inform Moody's view of Colombia's moderate institutional framework. The government maintains a strong track record of effective fiscal and monetary policymaking.

GDP per capita (PPP basis, US$): 15,334 (2019 Actual) (also known as Per Capita Income)

Real GDP growth (% change): 3.3% (2019 Actual) (also known as GDP Growth)

Inflation Rate (CPI, % change Dec/Dec): 3.8% (2019 Actual)

Gen. Gov. Financial Balance/GDP: -2.4% (2019 Actual) (also known as Fiscal Balance)

Current Account Balance/GDP: -4.2% (2019 Actual) (also known as External Balance)

External debt/GDP: 42.7% (2019 Actual)

Economic resiliency: baa1

Default history: No default events (on bonds or loans) have been recorded since 1983.

On 30 November 2020, a rating committee was called to discuss the rating of the Colombia, Government of. The main points raised during the discussion were: The issuer's fiscal or financial strength, including its debt profile, has materially decreased.

FACTORS THAT COULD LEAD TO AN UPGRADE OR DOWNGRADE OF THE RATINGS

Given the negative outlook, a rating upgrade is unlikely. The outlook could return to stable if Moody's were to conclude that the measures the authorities will implement over the coming years will prove effective in delivering a material increase in government revenue while simultaneously addressing expenditure rigidities, elements that over time would lead to sustained fiscal consolidation and declining government debt ratios. Rising government revenue would also help improve debt affordability. Bolstering institutional aspects of Colombia's fiscal policy framework, in particular elements that allow the fiscal rule to more effectively support debt sustainability, would also be credit positive.

Colombia's rating could be downgraded if Moody's were to conclude that fiscal consolidation efforts are unlikely to lead to the stabilization and eventual reduction of government debt ratios, as this would leave Colombia with lower fiscal strength relative to peers. Additional negative pressure would emerge if the country were to become more reliant on external debt inflows to finance the current account deficit, or if increasing external imbalances lead to a weakening of the country's external liquidity buffers.

The principal methodology used in these ratings was Sovereign Ratings Methodology published in November 2019 and available at https://www.moodys.com/researchdocumentcontentpage.aspx?docid=PBC_1158631. Alternatively, please see the Rating Methodologies page on www.moodys.com for a copy of this methodology.

The weighting of all rating factors is described in the methodology used in this credit rating action, if applicable.

REGULATORY DISCLOSURES

For further specification of Moody's key rating assumptions and sensitivity analysis, see the sections Methodology Assumptions and Sensitivity to Assumptions in the disclosure form. Moody's Rating Symbols and Definitions can be found at: https://www.moodys.com/researchdocumentcontentpage.aspx?docid=PBC_79004.

For ratings issued on a program, series, category/class of debt or security this announcement provides certain regulatory disclosures in relation to each rating of a subsequently issued bond or note of the same series, category/class of debt, security or pursuant to a program for which the ratings are derived exclusively from existing ratings in accordance with Moody's rating practices. For ratings issued on a support provider, this announcement provides certain regulatory disclosures in relation to the credit rating action on the support provider and in relation to each particular credit rating action for securities that derive their credit ratings from the support provider's credit rating. For provisional ratings, this announcement provides certain regulatory disclosures in relation to the provisional rating assigned, and in relation to a definitive rating that may be assigned subsequent to the final issuance of the debt, in each case where the transaction structure and terms have not changed prior to the assignment of the definitive rating in a manner that would have affected the rating. For further information please see the ratings tab on the issuer/entity page for the respective issuer on www.moodys.com.

For any affected securities or rated entities receiving direct credit support from the primary entity(ies) of this credit rating action, and whose ratings may change as a result of this credit rating action, the associated regulatory disclosures will be those of the guarantor entity. Exceptions to this approach exist for the following disclosures, if applicable to jurisdiction: Ancillary Services, Disclosure to rated entity, Disclosure from rated entity.

The ratings have been disclosed to the rated entity or its designated agent(s) and issued with no amendment resulting from that disclosure.

These ratings are solicited. Please refer to Moody's Policy for Designating and Assigning Unsolicited Credit Ratings available on its website www.moodys.com.

Regulatory disclosures contained in this press release apply to the credit rating and, if applicable, the related rating outlook or rating review.

Moody's general principles for assessing environmental, social and governance (ESG) risks in our credit analysis can be found at https://www.moodys.com/researchdocumentcontentpage.aspx?docid=PBC_1133569.

At least one ESG consideration was material to the credit rating action(s) announced and described above.

The Global Scale Credit Rating on this Credit Rating Announcement was issued by one of Moody's affiliates outside the EU and is endorsed by Moody's Deutschland GmbH, An der Welle 5, Frankfurt am Main 60322, Germany, in accordance with Art.4 paragraph 3 of the Regulation (EC) No 1060/2009 on Credit Rating Agencies. Further information on the EU endorsement status and on the Moody's office that issued the credit rating is available on www.moodys.com.

Please see www.moodys.com for any updates on changes to the lead rating analyst and to the Moody's legal entity that has issued the rating.

Please see the ratings tab on the issuer/entity page on www.moodys.com for additional regulatory disclosures for each credit rating.

Renzo Merino Vice President - Senior Analyst Sovereign Risk Group Moody's Investors Service, Inc. 250 Greenwich Street New York, NY 10007 U.S.A. JOURNALISTS: 1 212 553 0376 Client Service: 1 212 553 1653 Yves Lemay MD - Sovereign/Sub Sovereign Sovereign Risk Group JOURNALISTS: 44 20 7772 5456 Client Service: 44 20 7772 5454 Releasing Office: Moody's Investors Service, Inc. 250 Greenwich Street New York, NY 10007 U.S.A. JOURNALISTS: 1 212 553 0376 Client Service: 1 212 553 1653

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