May 23, 2018 / 3:16 PM / 5 months ago

Colombia faces challenge to avoid debt downgrade, whoever wins vote

BOGOTA (Reuters) - With Colombia’s oil revenues flagging and its economy struggling to regain momentum, whoever wins its presidential election faces a challenge to retain the country’s investment grade credit rating, with precious little room for maneuver.

Colombian presidential candidate Gustavo Petro speaks to supporters from the Liberal Party during a meeting at a hotel in Bogota, Colombia May 22, 2018. REUTERS/Henry Romero

Colombians go to the polls on Sunday in an election pitting right-wing frontrunner Ivan Duque against second-placed Gustavo Petro, a leftist former guerrilla and ex-mayor of Bogota.

With several other candidates taking part, the race to replace President Juan Manuel Santos at the helm of Latin America’s fourth-largest economy will almost certainly go to a second round in June.

While Petro’s pledges to hike taxes on the rich and raise social spending have unsettled some investors, there are concerns that even Duque’s more business-friendly agenda of cutting tax rates may worsen the existing budget gap.

“If the government doesn’t show fiscal consolidation in the first six months ... Moody’s and Fitch downgrade us,” said Munir Jalil, chief economist at Citibank. “Investors will leave and generate a serious balance of payments problem.”

Colombia’s $324 billion economy is only tepidly recovering from a series of setbacks during Santos’ two terms.

Gross domestic product growth is projected to reach 2.7 percent this year from 1.8 percent in 2017, but that remains below potential. Economists are concerned the recovery could be stymied if consumers are spooked, external shocks roil the economy or inflation surges.

Whoever wins the presidency faces the difficult task of pushing unpopular fiscal changes through a divided Congress - including an overhaul of the pension system - while bolstering sluggish growth.

Anything less and Colombia risks losing its investment grade, economists say, barring many foreign investors from holding its debt and driving up borrowing costs.

Foreign investment funds are the largest holders of local public debt, with about $25.5 billion, or 26.4 percent of the total.

Fitch ratings agency maintained Colombia’s BBB rating with a stable outlook this month but warned it will be tough to achieve next year’s budget deficit target of 2.4 percent if additional measures are not taken. The deficit is forecast at 3.1 percent this year.

In December, S&P downgraded Colombia’s credit rating to BBB-, one notch above junk, and in February Moody’s revised its outlook to negative from stable. Colombia relaxed its deficit targets on May 9, a move Moody’s said could affect its rating.

Under multi-year budget targets, the new government must still lower the fiscal deficit by 2022 to 1.5 percent.

That is no easy feat given costs associated with a 2016 peace accord with Marxist FARC rebels as well as promised spending by candidates on health and education.

“The next government is, in economic terms, more important than the previous three because of the fiscal constraints we’re in,” said Hernando Zuleta, director of economic development studies at the University of the Andes.

FUNDING HOLE

Duque is a protege of former President Alvaro Uribe, who presided over record foreign investment, a buoyant economy and soaring stock market during his 2002 to 2010 administration.

A former Inter-American Development Bank official with around 42 percent support in opinion polls, Duque has promised to streamline taxation, reduce the tax burden on companies and households, slash evasion by 50 percent, exempt capital goods imports and abolish duties which distort markets.

He says tax cuts will help foster growth but investors worry how he will fill the revenue gap.

Petro, on the other hand, wants a complete tax overhaul to raise duties on dividends and wealthy people and companies, while reducing the burden on families and eliminating loopholes used by the rich.

Investors question if that will be sufficient to pay for his education, health and urban infrastructure plans.

Petro, who has around 30 percent support in opinion polls, also plans to gradually eliminate oil, coal and gas extraction and replace them with clean energy - something economists say would leave a massive funding hole.

Opinion polls in Colombia are historically unreliable and centrist Sergio Fajardo and center-right German Vargas, polling at around 16 percent and 7 percent respectively, are also both in with a shot of reaching the run-off.

Regardless of who wins, most agree the new president will have to diversify the economy away from its reliance on oil revenues, which fell 40 percent in the last three years because of weak prices and declining volume.

    Exports slid from about $62 billion in 2012 to $38 billion last year.

The mining and energy sector, once a darling of foreign investors, has lost its luster as shifting environmental rules, delays in obtaining permits and local community resistance leave many projects stuck on paper.

“The next government has to promote tax competitiveness in the (oil) sector ... and guarantee the stability of legal and economic conditions,” said Marcela Vaca, general director of oil company GeoPark in Colombia. “Only then will companies that bet on Colombia be able to continue investing.”

But Congress will not make reform easy.

The new legislature elected in March, while majority right-wing, reflects Colombia’s polarization following the FARC peace accord, as the left emerges as a political force. A Petro triumph would be particularly complicated.

“There would be gridlock if we have a president with an agenda that is contrary to Congress and the courts,” said Jaime Trujillo, Baker McKenzie’s director for Latin America. “It would be a highly conflictive and highly inefficient government.”

(For a graphic on elections in Latin America click tmsnrt.rs/2rAQ4l1)

Reporting by Helen Murphy and Nelson Bocanegra; Editing by Julia Symmes Cobb, Daniel Flynn and Rosalba O'Brien

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