Will Colombia's Santos slay fiscal deficit dragon?

* Central government fiscal deficit seen 4.4 pct in 2010

* Santos backs “fiscal rule” to limit government spending

* Bond market wants discipline after free-spending Uribe

BOGOTA, Aug 9 (Reuters) - Wall Street has greeted Colombia’s new President Juan Manuel Santos as a champion of the markets who promises to improve the country’s finances by reining in the central government’s chronically high deficit.

But investors will watch closely for proof that Santos, who was sworn in on Saturday [ID:nN07219451], is serious about clamping down on the structurally high spending that has mired Colombia’s credit rating in junk bond territory for more than a decade.

The deficit, estimated at 4.4 percent of gross domestic product this year, has pumped up borrowing costs and helped spur Colombia's peso currency COP=RR to a two-year high that has the local export sector howling for relief.

A “fiscal rule”, proposed by the outgoing administration of Alvaro Uribe and embraced by Santos, tops the new government’s reform agenda. It would oblige the state to save money and cut debt during boom-times in order to have the reserves needed to run countercyclical spending policies when the economy slows.

The market also embraces Santos’ plan to use oil and mining royalties to build infrastructure projects nationwide and feed a savings account to be established overseas in order to ease upward pressures on the peso.

But some say that Santos, who has a 75 percent popularity rating, should be bolder in trying to drive long-sought-after pension and tax reforms through Congress.

“I just don’t think that Santos is being ambitious enough,” said Patrick Esteruelas, analyst for Latin America at the Eurasia Group consultancy in New York. “Now that he has unequivocal backing across the board and very strong political cards to play, this is the time to be ambitious.” <^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^

Santos’s main policies [ID:nN02274482]

Political risks in Colombia [ID:nRISKCO]

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The central government fiscal deficit is expected to widen this year to 4.4 percent of GDP from 4.2 percent in 2009. Santos’ team aims to cut it to 1.5 percent within four years.

Colombia’s economy grew a sturdy 4.4 percent in the first quarter after a 0.8 percent expansion last year. But Esteruelas is concerned that Santos is counting too much on growth and windfall oil and mining revenues to meet his fiscal goals.

“A heavily earnmarked budget, a highly distorted tax system and a bankrupt healthcare system lie at the heart of Colombia’s fiscal problems,” Esteruelas said.

Colombia’s central bank expects an economic expansion this year of 3.5 percent to 5.5 percent. Growth forecasts elsewhere in South America vary widely for 2010, from a likely recession in Venezuela to an expected boom of 6.5 or more in Brazil, the region’s powerhouse.


In 2003, the first full year of Uribe’s rule, Colombia’s deficit was 4.4 percent, the same as 2010’s projection. Economists fault him for not doing more to reduce the shortfall during the country’s 2005-2007 commodities bonanza.

The ex-president was criticized for high spending meant to shore up his popularity as he tried and failed to change the constitution to allow him to run for a third term this year.

Colombia’s finances have also been hurt over the last year by a trade embargo with neighboring Venezuela, imposed by leftist President Hugo Chavez in protest of Bogota’s close military alliance with Washington. Santos and Chavez will meet on Tuesday to try to normalize relations. [ID:nN08229870]

Uribe has based his career on defeating the Marxist rebels who killed his father in a kidnapping attempt in the 1980s.

Technocrat Santos is known for a less personalized political style but vows to preserve Uribe’s basic policies.

Investors are meanwhile piling into Colombia’s oil and mining sectors, emboldened by increased security brought by Uribe’s U.S.-backed crackdown on leftist insurgents.


One pension and tax reform proposal after another was watered down by Congress during Uribe’s eight-year rule. And a health care law, aimed at keeping the system solvent, was recently struck down by the Constitutional Court.

Colombia’s new finance minister, Juan Carlos Echeverry, wants to move informal workers onto the tax rolls and cut the proportion of unregistered businesses in half over 10 years.

His first big test in Congress will be to pass the “fiscal rule”, which is aimed at cutting the central government debt from 39.4 percent of GDP in 2010 to 28.4 percent in 2020. The market hopes to see the bill become law before year’s end.

Reform of Colombia’s mining and oil royalties system and a bill aimed at stopping the bleeding of public health sector finances will also be part of Echeverry’s initial push.

The peso on Wednesday ended at 1,822.65 per U.S. dollar, its strongest in two years. Policymakers are being pressured by the business community to do something about the situation.

Exporters, who earn dollars but pay their costs in pesos, say they are having to lay off workers as profits get hit.

“The fiscal reform initiatives in the pipeline will go a long way in containing peso appreciation pressures,” JP Morgan said in a recent note titled, bullishly, “New administration to take the fiscal imbalance bull by the horns.” (Reporting by Hugh Bronstein)