US embassy cable - 05BOGOTA221

C O N F I D E N T I A L SECTION 01 OF 02 BOGOTA 000221 
 
SIPDIS 
 
STATE PLS PASS USTR 
 
E.O. 12958: DECL: 01/05/2015 
TAGS: ECON, ETRD, EINV, EAGR, PGOV, CO 
SUBJECT: COLOMBIA'S ECONOMY IN 2004 LOOKED STRONG, BUT... 
 
Classified By: Ambassador William B. Wood, reasons 1.4 (b) and (d) 
 
 1.   (C)  Summary:  While the Colombian economy posted 
positive results in 2004, the sustainability of such 
performance is still in question.  On the macroeconomic side, 
growth reached almost 4 percent; IMF targets for the budget 
deficit, inflation, and reserves were either met or exceeded; 
public indebtedness declined to less than 50 percent of GDP; 
exports and imports both increased over 15 percent; foreign 
direct investment increased over 70 percent; the stock market 
surged forward buoyed by investor confidence; and 
unemployment, while still in double digits, declined.  Behind 
the good news, however, lurked structural problems that 
threaten the longevity of the recent recovery: basic "guns 
vs. butter" pressures on spending; an inability to address 
key pension and fiscal reforms; failure to position the 
country for optimum gains under an FTA; and the government's 
susceptibility to special interests, be it exporters 
clamoring for protection from exchange risk or industries 
unwilling to face competition under an FTA.  While there are 
signs that the Government wants to take the steps necessary 
to overcome these problems, there are also signs that it may 
not be able to completely resist sectoral pressures.  End 
Summary. 
 
The Positive Numbers 
 
2.  (U)  The Colombian economy continued its recovery in 
2004.  Growth will be somewhere in the 3.5-3.8 percent range, 
just shy of the projected 4 percent and in keeping with 
2003's 3.7 percent growth.  The GOC met the 2.5 percent GDP 
target for the budget deficit (thanks in large part to record 
oil revenues) and inflation, at 5.5 percent, was the lowest 
in 49 years and met the IMF program target. The peso 
appreciated 12 percent in 2004 in real terms, allowing the 
Central Bank to increase reserves 30 percent to USD 13 
billion, but also generating considerable concern among 
exporters.  The peso's appreciation also helped total 
indebtedness drop to less than 50 percent of GDP, and allowed 
the GOC to switch the composition of the debt more heavily 
towards domestic sources.  Despite the appreciation, exports 
grew over 20 percent in 2004, outstripping import growth of 
15 percent.  Export growth was greatly aided by price 
increases for coffee, oil and coal that helped offset the 
effects of the peso's appreciation.  Non-traditional exports 
also posted their largest increase since 1999. 
3.  (U) Investor confidence, both foreign and domestic, also 
increased.  The stock market grew by almost 50 percent for a 
second straight year - the second best performance of any 
world market monitored by Bloomberg.  Foreign direct 
investment increased over 70 percent from 2003, led mostly by 
increased investment in extractive industries.  Large 
multinationals, such as ExxonMobil and Telefonica returned to 
Colombia and regional investors from Brazil bought up the 
national airline and a local steel mill. 
 
4.  (SBU) While at 12.5 percent, unemployment is down from 18 
percent when President Uribe took power, many see its 
persistence as the single biggest threat to President Uribe's 
popularity.  While the numbers at the end of the year show 
improvement, the year has seen spikes as high as 17 percent 
and the average at 14 percent. Central Bank economists note 
that unemployment is a lagging indicator, but after 2 years 
of strong positive growth, the government is still waiting 
for a decline to single digit levels. 
 
The Underlying Dark Clouds 
 
5.   (C)  The Uribe government faces structural issues that 
need to be addressed if the current economic recovery is to 
yield sustainable results.  These include a need to 
rationalize spending and tax collection and shoring up the 
social security system (whose trust fund ran out in 2004). 
Government attempts to fix the problem via law in 2002 and 
public referendum in 2003 either failed or were watered down. 
 Attempts in 2004 to pass these reforms also failed. The 
result, the GOC has cut back on some spending, but has not 
been able to rationalize its collections (which at 20 percent 
of GDP are already higher than the Latin American average). 
Colombia's tax rate, at 38.5 percent is high, as is its VAT 
at 16 percent.  The tax base has also grown from 400,000 to 1 
million since 2002 thanks to stopgap reforms, but a more 
systemic reform has been impossible.  According to central 
bank officials, the fiscal situation could be summed up 
easily: constitutionally mandated transfers to the regions 
take up 5 percent of GDP; another 5 percent of GDP goes to 
security; 5 percent for social security and pensions; and 5 
percent for debt payment.  Thus, the government runs out of 
collections (20 percent of GDP) before it can even pay for 
its basic operations or key social programs. 
 
6.  (C)  Under the Uribe Administration, budget items for 
security have increased 46 percent.  Although Congress wants 
more money for social programs, Uribe plans to continue 
funding security items first, then social programs.  Uribe,s 
policy is bent on fixing the ship, not just plugging holes. 
2004 began with Colombian security forces stationed in every 
municipality throughout Colombia, an environment not seen in 
over 40 years.  According to the the Colombian Vice 
President's Human Rights Office, 2004 ended with a 41 percent 
decrease in displacements of Colombian citizens.  Key 
indicators, such as kidnappings and murders have also 
decreased by over 50 percent since Uribe came to power. 
The security mission is working. 
 
7.  (C)  The FTA with the US will offer Colombia important 
new opportunities, but the GOC's inability to resist sectoral 
pressures and get its economy ready for greater competition 
could reduce these benefits.  The GOC began the FTA 
negotiations thinking it could use  narco-terrorism to seek 
special treatment.  The Colombians tried to raise this 
argument at the highest levels, but failed to win support for 
it.   Subsequently, during the sixth round of FTA 
negotiations, the GOC took a positive step and began to 
negotiate, but we are still far from closure on key sectors 
such as intellectual property and agriculture. Both of these 
sectors are fearful that an open market will fatally damage 
their businesses. 
 
8.  The GOC is facing a difficult challenge.  While President 
Uribe's commitment to fully take advantage of an FTA is 
unquestioned, the steps his government needs to take require 
goring many of the oxen of his key supporters.  The GOC 
recognizes the need to modernize both its agencies and 
Colombia's economy and infrastructure to prepare for an FTA. 
To that end, they have begun to focus on what they call the 
"internal agenda"- a series of initiatives designed to 
increase Colombia's competitiveness.  To date, however, there 
have been no concrete proposals put forward, a testament to 
the difficulty of balancing the many sectoral interests 
involved.  Many of these changes require legislation and 
President Uribe has no political party to exert discipline on 
the Congressional ranks.  President Uribe must also  change a 
protectionist mind-set not only in the business sector but in 
much of the government's bureaucracy. 
 
9.  (C) The recent GOC decision to provide subsidies to 
flower and banana exporters to counter the negative effects 
of the peso's 14 percent depreciation reflects the 
government's susceptibility to internal pressure.  A 
mechanism to protect other politically powerful agricultural 
groups is also under design according to the Minister of 
Agriculture.  These efforts have drawn criticism for favoring 
a select few rather than the many, but the GOC continues to 
believe in such support mechanisms. 
WOOD