Slowing economic growth, rising macroeconomic policy risks

Colombia has benefited from investor confidence in recent years, given its inflation-targeting strategy and lower inflation levels than regional peers; its flexible exchange rate, which provides some room to manoeuvre to absorb external shocks, and its rule-based fiscal policy. This has provided some degree of macroeconomic stability. However, the slow recovery after the suspension of the fiscal rule during the pandemic led to a significantly deteriorating medium-term fiscal outlook, which was one of the key drivers of the loss of Colombia’s investment grade status.

Colombia’s macroeconomic environment remains challenging. Real economic growth is expected to slow down after the exuberant results of 2021-2022. While economic activity surprised on the upside in 2022 on the back of strong private consumption, fueled in turn by pent-up savings and robust bank credit, there are already signs of exhaustion: private consumption recorded its first sequential contraction since Q2 2020, household savings are declining and real bank credit continues to decelerate from its mid-2022 peak. We expect the slowdown in the US and the global economy, high inflation, tighter global and domestic financial conditions and heightened policy uncertainty to weigh on activity going forward. That said, the announcement of a 16% increase in Colombia's minimum wage for 2023 might bring some support to economic activity. We expect real GDP growth to decelerate significantly to +1.5% in 2023 and stabilize around +3% over the period 2024-2026.

The minimum wage increase above inflation and significant currency depreciation have resulted in extensive pressures on prices. We expect inflation to moderate in the 2023 but remain elevated throughout the year, only approaching the inflation target in 2024-2025. The authorities reacted to inflationary pressures later than neighbouring countries such as Mexico. Given high inflation prints, a further unmooring of inflation expectations and high policy uncertainty, which has hit investor confidence, we expect monetary policy to remain tight.

According to the World Bank’s Ease of Doing Business survey, Colombia ranks third in Latin America (67 of 190 worldwide), losing its second place in the region to Mexico (with Chile ranking first). Yet, shortcomings remain in the areas of rule of law, trading across borders, enforcing contracts and paying taxes.

In terms of political risk, Colombia is undergoing a policy change following the presidential elections in June 2022 that saw a left-wing president - Gustavo Petro - elected for the first time. The main concerns for investors are the business-averse economic policy under president Petro, which includes an increasing role of the state in the economy with a more progressive tax regime and higher social spending, as well as rising inflationary pressures associated with the challenging global economic conditions.