On July 1st Fitch downgraded Colombian sovereign debt to junk status, weeks after S&P did the same in May. Colombia’s fiscal situation has deteriorated substantially during the pandemic as the government adopts aggressive stimulus spending in the face of collapsing revenue and a stalled tax reform. Colombia’s general government debt to GDP has nearly doubled from a decade ago, with the government forecasting its debt levels to reach 69.2% of GDP in 2021. The downgrade reflects a lack of confidence from Fitch in the effectiveness Colombia’s revamped fiscal plan and the pending tax reform which will be introduced this month.

Watered-down tax reform leaves Colombia with a degraded fiscal outlook

Our View

Further downgrades of Colombian debt by ratings agencies have been built into market expectations since May, with S&P’s downgrade and the government’s withdrawal of the original tax reform. For this reason, we expect to see a limited and transitory impact on Colombia’s borrowing costs and foreign exchange rate relative to the impacts seen after S&P’s downgrade. The downgrades reflect a degrading overall fiscal situation in Colombia for the coming years. The loss of investment grade by both S&P and Fitch also eliminates an important check on Colombia’s fiscal balance, which previously pushed the government to strive to maintain investment grade status. We do not expect Colombia’s investment grade to be restored in the medium term. 

Business Implications

Firms should expect a transitory deterioration of the exchange rate because of the announcement by Fitch. Future ratings changes by Moody’s could further depreciate the peso, in a similarly limited and transitory manner. We forecast the exchange rate to average 3,670 pesos in 2021. Due to the underlying fiscal situation, Colombia will likely require a reliance on further debt accumulation and new fiscal reforms in the medium term, in addition to the one planned for this month. Firms should prepare for continued risks and uncertainty stemming from Colombia’s degraded fiscal situation.

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