After Peace, Colombia Will Still Struggle

6 MINS READApr 7, 2016 | 09:30 GMT
A man sits in La Macarena, a town in Colombia's Meta department, on Feb. 23.
Forecast Highlights

  • A peace deal with the FARC will make Colombia more secure, but it will not end violence or drug trafficking in the country.
  • Low commodity prices will continue to hurt the economy and prevent Colombia from achieving the full benefits of peace.
  • A weak peso, greater stability, business-friendly policies and borrowing will enable the country to weather its economic downturn.

Colombia is at a historic juncture. After 52 years of fighting, the country is on the verge of a peace agreement with the Revolutionary Armed Forces of Colombia, known as the FARC. But the deal will solve only some of Colombia's problems, which extend well beyond security. With oil prices low and likely to stay that way, Colombia has already entered one of its periodic busts, and the government will have to manage sluggish growth and a deteriorating economy. Amid this tough situation, the FARC deal – and related talks with the National Liberation Army (ELN) – will open up the ruling Social Party of National Unity to criticism from its opponents.

But from an investor's point of view, Colombia's straitened circumstances may be a boon. Thousands of militants will soon demobilize, the peso will depreciate, and state-owned energy firm Ecopetrol will likely sell some of its assets. The government will have to navigate the next few years carefully, implementing policies to deal with the secondary effects of low oil prices, including fewer infrastructure improvements, government austerity measures and a wider-than-normal trade deficit.

The Bust

When global oil prices fell in 2014, Colombia's trade balance quickly worsened. In 2013, the country had a slight surplus of $2.2 billion, but by 2015 it had a deficit of nearly $16 billion. This can largely be accounted for by the Colombian economy's heavy reliance on hydrocarbons, which accounted for 66 percent of export revenue by value before the downturn. Colombia is no stranger to commodity booms and busts — its fortunes were once determined by the cyclical prices of coffee, which composed 70 percent of Colombian exports by value in the mid-1950s. But in some ways, the latest commodity bust is different. In the 2000s, China's massive economic growth drove commodity prices up around the world, and the Colombian government became heavily reliant on extractive royalties. By 2013, around 25 percent of central government income came from hydrocarbons-related royalties. Colombia did not follow the example of neighboring Venezuela, where oil accounts for more than 90 percent of exports, and its public finances are stable enough that it can cut some spending and take on additional debt to weather the drop in oil prices.

Even though Colombia will not come apart at the seams like Venezuela, the economic downturn will jeopardize the Social Party of National Unity's chances for victory in the country's 2018 elections. Colombian President Juan Manuel Santos will need to tread carefully. The Colombian economy has continued to grow despite the drop in oil and mineral prices, albeit at a much slower rate than in previous years. The country's gross domestic product grew by just 3.1 percent in 2015, compared with 6.6 percent in 2011, near the height of the global commodity boom. The president's resulting loss in popularity may be compounded by his negotiation with the FARC, which is likely to reach a conclusion at least a year ahead of the presidential vote. Politically unpopular concessions to the FARC, combined with the economic decline, could cost Santos' party votes in the coming elections and potentially open up spaces for competitors to make gains either in the legislature or in the race for the presidency itself. If the FARC talks result in immunity for FARC leaders, or if the rebels receive automatic congressional seats as part of a deal, the ruling party's popularity could suffer in the coming years.

Weathering the Storm

With no end in sight for low oil and mineral prices, one of Colombia's options to make up for budget shortfalls will be to attract additional investment into other sectors. Fortunately, it can rely on some capital inflows because its peso is weak relative to other major global currencies, such as the dollar. Areas such as real estate, tourism and Colombia's limited manufacturing base could garner additional investments. State-owned oil company Ecopetrol may manage the downturn and increase its cash flow by selling off assets, such as the infrastructure in the Cartagena Refinery. This would offer further investment opportunities for international energy firms.

Colombia's ability to attract investments lies primarily in its growing political stability, relative ease of doing business and low wages compared with other potential investment destinations. The FARC demobilization will add to Colombia's stability by splitting the group up and drastically lowering the risk of politically motivated violence. However, the nation's backlands remain relatively underdeveloped, with poor infrastructure and little heavy industrial activity; most economic activity is instead concentrated in urban areas of the Andean core and a few specific ports, including Buenaventura, Barranquilla and Cartagena. This disparity will mean that investment is still most likely to flow into isolated manufacturing activities, agriculture or the extractive sector.

In the meantime, Colombia's security problems will not disappear. The nature of the recent peace agreement makes it likely that many — if not the majority — of low-ranking FARC members will not be immune to prosecution for crimes committed during the conflict. They will find it difficult to reintegrate, and many may turn to criminal activities. The same will likely be true of the ELN. In particular, the cocaine-producing centers of Putumayo, Cauca, Narino, Meta, Caqueta, Norte de Santander and Choco will likely continue to operate as before. And the insurgents and organized crime groups based in those areas will continue to extort private businesses nearby. Moreover, without the unifying command of either the FARC or ELN, isolated former militants engaged in crime may fight among themselves. The resulting sporadic outbursts of violence could have spillover effects on businesses investing in hydrocarbons, minerals and agriculture.

Colombia's near future will bring slower-than-desired economic growth and political change. A successful peace agreement with the FARC will push insurgency to historic lows, but the potential for criminal violence will remain in areas where the insurgents have historically held sway. Overall, though, Colombia will move toward further economic development and experience fewer criminal and insurgent threats to the state.

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