NEW YORK--(BUSINESS WIRE)--Victory for incumbent Juan Manuel Santos in Colombia's presidential election sets the stage for further peace talks with FARC rebels. An eventual peace settlement would be credit positive in the medium term but could add to spending commitments, meaning revenue enhancement would be a key element of fiscal consolidation.
President Santos beat challenger Oscar Zuluaga in Sunday's run-off vote. Attempts to end the decades-long conflict were the main point of contention and the outcome allows Santos to continue peace negotiations with the FARC. These began in November 2012 and have so far seen agreement reached on three of six areas of discussion. Earlier this month, the government announced it had held exploratory talks with the ELN, Colombia's second largest guerrilla group.
Successful peace agreement and implementation could be a medium-term positive for Colombia as it could potentially lift the country's growth trajectory, but it would not necessarily have immediate ratings implications. The conflict's impact on investment and economic performance has steadily fallen over the past 10 years as government forces have driven the rebels out of the most economically productive parts of the country. We forecast real GDP growth of 4.6% in 2014 and 4.7% in 2015 and medium-term growth prospects remain favourable compared with several 'BBB' ratings peers.
However, implementing a sustainable peace agreement could also increase spending commitments in the context of a rigid expenditure profile. It could, for example, require further spending on agriculture, infrastructure, and social development. Security spending may also have to be maintained to deal with organized crime violence even if a formal peace settlement is concluded. The authorities already face fiscal rigidities due to commitments made to support the agricultural sector following protests and strikes by farmers in 2013, pension and health costs, and transfers to regional governments.
Meanwhile, eventually phasing out the Financial Transactions Tax and scheduled lapsing of a wealth tax could further constrain Colombia's relatively low revenue base (we expect central government revenues to peak at 17.1% of GDP to meet the 2014 fiscal deficit target of 2.3% of GDP). If revenue loss cannot be offset through increased formalisation and tax-collection efficiency, then the narrow revenue base, rigid expenditure profile, and spending pressures will constrain further fiscal consolidation and policy flexibility.
Improving external accounts and positive government debt dynamics underpinned Fitch's decision to upgrade Colombia to 'BBB' from '??' last year and credible and consistent policies have given the sovereign capacity to withstand shocks. Improvements in growth prospects and reduced fiscal rigidities could support Colombia's creditworthiness and help improve credit metrics in relation to ratings peers. Stronger governance indicators would also be credit positive.
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