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Summary of "Colombia: Mind the fiscal gap"

Core Content

This document provides an analysis of Colombia's fiscal situation, focusing on recent changes to the 2019 budget bill, the outlook for fiscal targets, and the prospects for tax and pensions reform. It is authored by Luiz Eduardo Peixoto from the Latam Economic Research team at Banco BNP Paribas Brasil SA.

Main Points

Budget Adjustments

• Congress has approved a 1.2pp of GDP increase in expenditure in the 2019 budget bill, bringing it closer to 2018 levels.
• This increase is offset by a reduction in the federal government's interest bill of similar magnitude.
• The changes align with Colombia's fiscal rule, based on moderately optimistic GDP and oil price scenarios.

Fiscal Targets Outlook

• The government is expected to meet the 2018-2019 fiscal targets, despite potential challenges.
• There is a risk of disappointment in tax revenue growth due to current investment and consumption tax exemptions.
• A budget cut may be necessary in 2020 if fiscal targets are not met or if tax revenues fall short.

Tax Reform Prospects

• Structural tax reform is unlikely in the short term, as coalition partners have rejected key proposals.
• The Duque administration is now promoting tax reform as a means to fund spending, but significant opposition remains.
• The Funding Law bill is expected to be submitted to Congress within two weeks, though details remain unclear.

Tax Reform Measures

• The proposed reform includes:
  • Reducing VAT deductions (likely to have a +1.4% of GDP fiscal impact, but medium probability if watered down)
  • Lowering the corporate income tax rate to 32%, with a -0.4% of GDP impact and high probability of implementation
  • Broadening the tax base to include 4-5 million people, with a +0.4% of GDP impact and low probability
  • Tackling tax evasion (targeting a 10% annual reduction, with a 0.2% of GDP impact in the first year) and high probability
  • Eliminating sectoral tax deductions (which cost COP 16bn annually), with medium probability of being targeted if reform is diluted
• The financial transactions tax is unlikely to be included due to difficulty in approval.
• Capital repatriation with tax discounts is highly probable and may have a 0.2-0.5% of GDP impact.

Pensions Reform

• Pensions reform is a key concern for rating agencies.
• The current system has low coverage (around 25%) and high subsidies, indicating a need for reform.
• A positive sign would be progress on pensions reform, which could help stabilize public finances.

Fiscal Outlook

• Primary surplus of 0.5% of GDP is expected for 2018, helping reduce debt levels.
• Foreign ownership of local debt is a concern, requiring caution in fiscal management.
• Meeting fiscal targets is crucial to avoid a credit rating downgrade, as rating agencies are concerned about reliance on oil revenues.

Key Information

• Current expenditure in the 2019 Congress bill is 15.7% of GDP, up from 14.7% in 2018.
• Interest expenditure is 5.0% of GDP, up from 4.8% in 2018, indicating a reduction of 1.2pp.
• Investment is 3.7% of GDP, down from 3.9% in 2018, reflecting a reduction of 0.4pp.
• Total expenditure (excluding interest) is 19.4% of GDP, up from 18.7% in 2018, with an increase of 1.2pp.
• Tax evasion and loopholes are estimated to reduce potential tax revenues by 30% to 40%.
• VAT exemptions account for 6% of GDP, a key area for reform.
• Public pension expenditure is 5% of GDP, with demographic pressures expected to increase the need for reform in the coming decade.

Conclusion

Colombia's fiscal position is relatively strong, with a primary surplus expected for 2018. However, sustainable fiscal management requires structural tax reform to address loopholes and evasion, which currently undermine revenue potential. The government's fiscal conservatism and budget adjustments are seen as prudent, but political resistance may hinder deeper reforms. The Funding Law bill is a critical step forward, though uncertainty remains. Pensions reform is also a key area for long-term fiscal stability. Overall, the risk of a rating downgrade is low if fiscal targets are met and reforms are implemented.

Legal Disclaimer

• This document is non-independent research and may be subject to conflicts of interest.
• It is intended for professional clients and is not investment research under MiFID II.
• No liability is accepted for any reliance on the information contained in this document.
• Performance data is hypothetical and not indicative of future results.
• The document does not constitute a prospectus or public offering and is not intended for retail investors.
• Confidentiality is required, and reproduction or distribution is prohibited without prior consent.