Colombia - Country Outlook

COLOMBIA

The Economist Intelligence Unit

Country outlook

COUNTRY VIEW

After winning re-election in May 2006, the president, Alvaro Uribe, will remain in power until 2010. In spite of a strengthened popular mandate and a working majority in Congress, his political capital is diminishing. Reported links between several of Mr Uribe's congressional supporters and the demobilised Autodefensas Unidas de Colombia (AUC) will tarnish the president's reputation and detract from the legislative agenda. Despite some improvements, public security will remain poor, particularly in some rural areas. A negotiated end to the conflict with the Fuerzas Armadas Revolucionarias de Colombia (FARC) is unlikely. The Economist Intelligence Unit expects Mr Uribe to retain a prudent economic policy. GDP growth will slow gradually, but remain solid, averaging 4.5% in 2007-08. The current-account deficit will widen to 2.4% of GDP in 2008, but will be fully financed by strong investment inflows.

Domestic politics: Mr Uribe, who began a second four-year term in August 2006, will face significant challenges in the forecast period. Although he won a comfortable victory in the May 2006 election and holds a congressional majority, his political capital is diminishing in the wake of a Supreme Court investigation into links between some of his supporters and the AUC. Although this is unlikely to trigger an institutional crisis, the investigation will tarnish the president's reputation and detract attention from the legislative agenda. Governability is likely to deteriorate, as the unity of the president's congressional alliance is vulnerable and the investigation will exacerbate rifts within the ruling coalition. Conclusive peace negotiations with the largest guerrilla group, the FARC, are unlikely in the forecast period; the ongoing military offensive may further weaken the FARC, but we do not envisage that the group will be defeated militarily. Low-profile talks with the smaller guerrilla group, the EjÐ"©rcito de LiberaciÐ"Ñ-n Nacional (ELN), will continue and have a better chance of success. However, the security situation will remain fragile in the rural areas affected by the conflict and by violence related to the drugs trade and the criminal networks it has spawned.

International relations: Maintaining strong ties with the US will remain Colombia's foreign policy priority, as this brings important political and economic benefits. The administration of the US president, George W Bush, regards the Uribe government as one of its closest allies in Latin America. Although the concessions offered to the paramilitaries--several of whom are wanted in the US on drug-trafficking charges--as part of the demobilisation process are sources of unease in the US, we expect the US to fulfil its military aid commitments for drug-eradication and counterinsurgency efforts in 2007-08. From 2008 the US government will come under increasing pressure for a reduction in military aid. The US and Colombia signed a free-trade agreement (FTA) with the US in 2006. Ratification is expected in the Colombian legislature in 2007, but there are risks that the treaty could be defeated in the US Congress. Non-ratification would not prompt a diplomatic rift, but could have serious economic consequences if the existing preferences are allowed to expire. Renewed diplomatic spats between the Colombian and Venezuelan presidents are possible, but with both presidents now in office until 2010, they will have an incentive to maintain working relations.

Policy trends: Disciplined macroeconomic policies during Mr Uribe's first term helped to improve the public finances, reduce inflation and boost growth, and policy is expected to remain broadly unchanged in Mr Uribe's second term in office. The country's stand-by loan arrangement with the IMF was not renewed following its expiry in November 2006, but the government will continue to focus on reducing the public debt (which at around 45% of GDP remains one of Colombia's main weaknesses), strengthening the financial sector and keeping inflation within the official target range. The public finances have benefited from recent high oil prices, and the government will seek to cushion them against projected falling oil revenue and a possible future deterioration of external conditions by improving the flexibility of public spending. This will involve efforts to scale back transfers to regional governments--which accounted for 4.9% of GDP in 2005--and to simplify the tax system. Maintaining current levels of financial support from the US (which largely funds the anti-drugs effort) will be a high priority. The government will also seek greater private investment via trade integration initiatives and infrastructure concessions, the sale of some remaining assets in utilities, banking and energy, and a more attractive regulatory environment. Active liability management will lower the foreign-currency composition of public debt by switching to more domestic borrowing, helping to reduce exposure to currency fluctuations.

International assumptions: Although growth in the world economy (at purchasing power parity exchange rates) is expected to decelerate from an estimated 5.4% in 2006 to an average of 4.8% in 2007-08, our baseline forecast is for external conditions to remain supportive for Colombia. Still-high energy prices in 2007-08 will support Colombia's fiscal and external accounts, helping to offset the negative impact of declining oil production. Our forecast of sustained global economic growth is subject to downside risks. In the US, which currently purchases 40% of Colombia's exports, there is the risk of a recession, which would damage Colombia's growth prospects and external position. In addition, there is a growing risk of a hard landing in China or a slowdown in India, which together account for around one-half of global growth. This could prompt a marked decline in commodity prices, hurting Colombia's extractive industries and export and fiscal revenue. However, there are also upside risks to the global assumptions; if China engineers a soft landing, Indian growth continues to accelerate and