US embassy cable - 05BOGOTA2634

UNCLAS E F T O SECTION 01 OF 03 BOGOTA 002634 
 
SIPDIS 
 
E.O. 12958: DECL: 03/18/2010 
TAGS: BEXP, ECON, EFIN, CO 
SUBJECT: UPDATED INPUT FOR ICRAS PROCESS 
 
 
1.  Summary: The 2005 ICRAS draft contains out of date 
information on the political, economic, and security 
situation in Colombia.  Below, post provides an accurate 
update for input to the ICRAS process.  End Summary. 
 
2.  Expected Payments Performance Overview:  In 2003, the 
economy grew at 3.9%, but it was due only in part to higher 
commodity prices (although marginally ) coffee prices were 
depressed in 2003).  Investor confidence did increase in 
2003.  This was a result of significant improvements in the 
security situation of Colombia, and also due to the optimism 
surrounding the beginning of President Uribe,s 
administration.  This increase in confidence has accelerated 
and investment has increased apace. 
 
3.  Foreign direct investment (FDI) increased by almost 50 
percent in 2004, demonstrating a renewed interest and 
confidence in Colombia.  In addition, the Colombian stock 
exchange was the best performer of the exchanges tracked by 
Bloomberg, with over 100 percent growth over the past two 
years.  Domestic investment has also increased, leading to a 
7 percent increase in industrial output in 2004. 
 
4.  The Central Bank maintains an inflation targeting policy 
that has been very successful in bringing inflation into 
check.  In 2004, the inflation rate was 5.5 percent, the 
lowest in 49 years, and is targeted for 5.1 percent in 2005. 
The appreciation of the peso relative to the dollar is due to 
investment inflows, balance of trade surpluses, improved 
prospects for the economy, and global trends. 
 
5.  The report is incorrect in asserting that Uribe,s lack 
of robust party support in congress is a major roadblock to 
his agenda.  The same congress recently amended the 
constitution by large majorities so Uribe could run for the 
Presidency again.  An informal Uribe block has coalesced and 
may form into a party soon.  Certain elements of his agenda 
have not been approved by congress (fiscal, pension reform), 
but there is a concern that the post-congressional election 
period is the target window for passage.  But, his agenda has 
moved forward and Colombia is better off as a result. 
Uribe,s budgets have moved through congress and congress has 
agreed with Uribe on important strategic shifts in budgetary 
allocations that have contributed to the dramatic improvement 
of the GOC,s war on illegal armed groups. 
 
6.  The report incorrectly describes the status of Uribe,s 
re-election campaign.  The constitutional amendment was 
passed through congress, but must be reviewed by the 
Colombian court system, especially the Constitutional Court. 
Recent polling shows Uribe would likely win re-election, if 
he is able to run.  His most recent approval rating in 
independent polls is well over 70 percent and stable. 
 
7.  The report incorrectly characterizes the security 
situation.  The security situation is dramatically better, 
for example, now than it was in 1999, when Colombia last held 
a &C-& ranking in the ICRAS model.  Colombians now use 
intercity roads.  The illegal armed groups have been cleared 
from major cities; the military campaign is chalking up 
success with few setbacks.  The external debt trend is 
favorable, and the security situation much more so. 
Colombia's unbroken record of not having defaulted on 
sovereign debt and good reputation for implementing economic 
reforms ) when viewed against the 1999 &C-& ranking 
warrent more than a "D" rating. 
 
8.  The statement that foreign exchange availability could 
become a problem is also incorrect unless, there are dramatic 
changes to the prices of key exports such as petroleum or 
flowers.  Colombia,s diverse traditional export sector is a 
strong generator of foreign exchange.  In addition, foreign 
direct investment is strong in Colombia, and will become 
stronger over the short- to medium-term, thanks to a new free 
trade agreement with the U.S. 
 
9.  While there is a lack of clear resolution to the internal 
conflict in Colombia, the situation has not looked as 
positive in several years ) certainly more positive than in 
1999 (the last time Colombia held a &C-& rating), when the 
FARC controlled a large swath of the country during thge 
government's failed attempt to negotiate a peace settlement. 
 
10.  Foreign Debt Service Burden ) D minus Rating:  The GOC 
has adopted an aggressive policy of switching from 
predominately foreign-denominated debt to domestic debt.  The 
GOC will also use approximately USD 1.25 billion of reserves 
(currently at USD 14.35 billion) to prepay debt with the IDB. 
 Colombian exports, especially non-traditional exports, are 
increasing, indicating that the debt service as a percentage 
of foreign exchange receipts will continue to drop from a 
high of 51.2 percent in 2002 to 29.3 percent in 2004 to 
levels in the low 20,s within the next 18 months. 
 
11.  On March 2, the GOC announced it will abandon the 
capital control decree put in place in December of 2004. 
Post assesses as unlikely the possibility that the GOC will 
implement new capital controls to slow the appreciation of 
the peso.  Colombia,s finance minister has made recent 
public statements calling these controls &useless8. 
Completion of an FTA will improve the inflow of foreign 
exchange over the forecast period and should improve, to a 
greater extent, Colombia,s FX to external debt ratios. 
Concerning the report,s figure noting debt service as a 
percentage of foreign exchange receipts, post suggests that 
the improvement from 51.5 percent in 2002 to the current 29.3 
percent would present more a mitigation than a continued 
constraint of the factor. 
 
12.  Balance of Payments Adjustment Capacity ) D Rating: 
Colombian exports have increased by 20 percent a year since 
the Uribe administration came to power in 2002.  Increases 
have not been based solely on the increased price of major 
commodities such as oil, coal, and coffee, but also on a 
diversification of the export base into non-traditional 
products other than commodities.  Post suggests Colombia,s 
exports will continue to increase in 2005 and beyond, not 
decrease as described in the report.  Given the high prices 
of oil and coffee, and increased exports to Venezuela, 
Colombia,s trade surplus for 2004 was far in excess of the 
USD 95 million mentioned in the report.  Trade figures for 
January through October 2004 show a USD 897 million trade 
surplus.  In addition, the report makes no mention of the 
FTA, which should enter into force during the forecast period. 
 
13.  Macroeconomic Environment ) C minus Rating:  The GOC 
dramatically exceeded its IMF-mandated fiscal deficit target 
of 2.5 percent, turning in an impressive 1.2 percent deficit. 
 The GOC is committed to privatizing remaining state 
enterprises or opening them to competition from the private 
sector. 
 
14.  Political/Social Constraints ) D Rating:  On the 
ratings chart, number 35 lists the ranking of &Relations 
with the United States8 as a &D8 rating.  A strong case 
can be made that Colombia is the United States' strongest 
political ally in Latin America.  Colombia is certainly our 
strongest ally in the region on the war against drugs and 
terrorism.  Colombia supports U.S. policy in the region, even 
at the price of generating considerable political friction 
with the growing number of region's left-leaning leaders. 
Colombia is the third-highest recipient of U.S. foreign 
assistance in the world, and the program enjoys broad 
bipartisan support in Congress.  Colombia has the most 
successful extradition relationship in the world with the 
United States, and is part of the Coalition of the Willing in 
Iraq.  The Uribe administration is a strong supporter of 
counter-narcotics and counter-terrorism efforts and is a 
strong ally of the U.S. in international fora.  We are also 
currently negotiating an FTA with Colombia, which will 
strengthen our economic ties and provide stronger guarantees 
for U.S. investors.  Post would suggest that this be ranked 
at least a &C8, if not more. 
 
15.  Vulnerability to Foreign Exchange Crisis ) D Rating: 
Post disagrees with the statement that, &(Colombia,s good 
liquidity is supported, in large part, by capital controls on 
shot-term investment.8  While Uribe did issue a decree to 
impose a tax on short-term capital transactions, this decree 
will soon be abandoned.  Even so, the capital control program 
had a very limited effect on the Colombian market. 
 
16.  Banking System ) D Rating: Progress is being made on 
the privatization of Bancafe.  The GOC is preparing for the 
sale of Bancafe by splitting off poorly performing assets and 
liabilities, including some pension liabilities, for 
liquidation.  The stronger Bancafe will then be privatized. 
Virtually all lending banks have made record profits due to 
reforms earlier in the decade and the growing economy.  The 
system appears sound with no major bank in trouble except the 
newly created entity taking Bancafe,s bad loans. 
 
17.  Legal System ) D Rating: In 2003-2004, the GOC cleared 
up existing trade and investment disputes with U.S. 
companies.  The GOC also presented legislation before the 
Colombian congress to guarantee conditions for foreign 
investment.  The &E8 rating for contract enforcement and 
dispute resolution (number 49) cannot be justified.  The 
legal system is slow, but it works.  The private sector has 
generally not complained of corruption in appeals courts or 
higher courts. 
 
18.  Foreign Exchange Availability - D minus Rating:  The 
&F8 ranking for Foreign Exchange Controls (number 53) seems 
harsh.  Remittance flows and increases in FDI have caused a 
net positive inflow of foreign currency, leading to a 15 
percent appreciation of the peso over the last year.  Exports 
are increasing at a 20 percent annual rate, driven in large 
part by a billion dollar-per-year growth in exports to the 
U.S.  This will increase as the U.S.-Andean FTA comes into 
effect during the forecast period. 
 
19.  The limited exchange control had marginal impact on the 
amount and types of transactions.  The GOC has announced it 
will abandon this limited capital control regime.  The peso 
is a freely floating currency and individuals can change 
money with the central bank, commercial banks, 13 official 
money-changing houses, or on any local market via several 
thousand regulated exchange professionals. 
 
20.  Business Climate ) C minus Rating: Post would add that 
the central bank,s tenacious inflation targeting policy had 
more to do with meeting the inflation target than the 
appreciation of the peso. The security situation is also far 
better than it was in 1999.  In addition, Colombia's stock 
market index has been one of the best performing indices over 
the past two years, although the report correctly points out 
that it is undercapitalized.  The GOC has greatly improved 
its new business registration regulation.  It now takes, on 
the average, 2 days to register a new business. 
 
21.  Comment:  In summary, it appears the ICRAS rating is for 
a pre-2003 Colombia.  Foreign debt is a much smaller burden 
going forward due to Colombia taking advantage of market 
conditions to reduce its debt burden.  ForEx reserves are 
high.  The Colombia of 2005 is dramatically improving the 
legal system, sharply reducing narcotics production and 
exports, opening its trading system, and welcoming the 
increased foreign investment.  There are no serious 
challenges to these processes in the political system. 
WOOD