NEW YORK--(BUSINESS WIRE)--Fitch Ratings has revised the Outlook on Colombia's ratings to Negative from Stable and affirmed its Long-Term Foreign Currency Issuer Default Rating (IDR) at 'BBB'. In addition, Fitch has affirmed the issue ratings on the senior unsecured foreign currency bonds at 'BBB' and the country ceiling at 'BBB+'.
Fitch has downgraded Colombia's Long-Term Local Currency (LTLC) IDR to 'BBB' from 'BBB+'. The Rating Outlook is Negative. The issue ratings on Colombia's long-term senior unsecured local currency bonds have also been downgraded to 'BBB' from 'BBB+'. The Short-Term Foreign Currency (STFC) IDR has been affirmed at 'F2' and a new Short-Term Local Currency (STLC) IDR of 'F2' has been assigned.
KEY RATING DRIVERS
The downgrade of Colombia's LTLC IDR to 'BBB' from 'BBB+' reflects the following key rating drivers:
In line with the updated guidance contained in Fitch's revised Sovereign Rating Criteria dated July 18, 2016, and as part of a broader portfolio review, Fitch concluded that the credit profile of Colombia no longer supports a notching up of the LTLC IDR above the LTFC IDR. This reflects Fitch's view that neither of the two key factors cited in the criteria that support upward notching of the LTLC IDR are present for Colombia. Those two key factors are: (i) strong public finance fundamentals relative to external finance fundamentals, and (ii) previous preferential treatment of LC creditors relative to FC creditors.
Assignment of STLC IDR
The assignment of a STLC IDR of 'F2' to Colombia is consistent with Fitch's approach to assigning ST ratings by using its LT/ST Rating Correspondence table to map the STLC IDR from the LTLC rating scale. According to Fitch's Rating Definitions, the Fitch Rating Correspondence Table is "a guide only and variations from this correspondence will occur".
However, variations to this approach are rare in the case of sovereign ratings. Colombia's STLC is derived from the mapping to its revised LTLC IDR of 'BBB' and was assigned as part of the portfolio review referenced above.
The revision of the Outlook to Negative reflects the following key factors:
Colombia's current account deficit reached 6.4% of GDP in 2015, thus increasing the country's vulnerability to changes in investor sentiment and external financing conditions. Fitch forecasts the deficit to narrow to 5.8% in 2016 and decline gradually in 2017 and 2018 balancing low, albeit recovering, oil prices and lower oil production against a narrower income account deficit, and continued COP weakness. Current account deficits could average 5.3% of GDP in 2016-2018, well above the 'BBB' median of 1.6%.
As FDI could finance only half the current account deficit, external indebtedness will remain high over the forecast period. Increased external borrowing in recent years and the COP depreciation took external debt to 37% of GDP in 2015. Gross and net external debt compares unfavourably to 'BBB' peers in terms of current external receipts (CXR) after the sharp correction in oil exports since 2014. Colombia's net external debt could increase to 48% of CXR in 2016, more than double the 20% 'BBB' median.
In spite of expenditure containment and cuts, and generation of non-oil tax revenues, the complete loss of the central government's oil income (3.4pp of GDP between 2013 and 2016), rising interest payments and expenditure rigidity will result in a central government deficit of 3.9% of GDP in 2016, up from 3.1% in 2015. At the general government level, Fitch estimates the deficit could increase to 3.5% in 2016, above the 2.5% median of rating peers.
A higher deficit and the COP's sharp depreciation have negatively impacted debt metrics, as general government debt rose to an estimated 46.5% of GDP in 2015, above the 'BBB' median of 40%. Fitch considers that debt is likely to remain elevated over the forecast period given the gradual pace of fiscal consolidation, sluggish growth and limited COP appreciation pressures. Deft liability management has improved currency, refinancing and interest rate risks. General government debt maturities will average 2.4% of GDP in 2016-2018, below rating peers.
Colombia's ratings balance its flexible and credible policy framework, improved external buffers and a record of macroeconomic and financial stability against high commodity dependence, limited fiscal flexibility and structural constraints in terms of low GDP per capita and weak governance indicators.
Colombia's track record under its inflation-targeting regime, significant exchange rate flexibility, and a sound banking system have underpinned its capacity to absorb external shocks and maintain broad macroeconomic and financial stability. Nevertheless, annual inflation rose to 8.6% in June still reflecting the pass-through of COP depreciation and the effect of El Nino on food and energy prices. After a 275 basis points (bps) increase since September 2015, Fitch expects that monetary policy will remain focused on bringing inflation down in line with the target range of 3+/-1% and support the reduction of external imbalances.
External buffers remain adequate, as international reserves stand at USD47 billion. Moreover, the International Monetary Fund (IMF) and Colombia recently extended the Flexible Credit Line (FCL) for two years and increased it to USD11.5 billion (24% of current international reserves) to reduce risks related to the weaker oil price outlook and increased participation of non-residents in the local market. Risks related to the increase of private external debt are partly mitigated by its medium- and long-term structure, the use of hedging instruments, natural hedges and continued financing availability.
Growth reached 3.1% in 2015 reflecting external financing availability, government programs and increased public regional and local spending. Fitch expects growth to average 2.3% in 2016 reflecting tighter monetary policy and weaker public spending, before recovering to 3% and 3.5% in 2017 and 2018, respectively, on the back of higher oil prices and the full year execution of the 4-G infrastructure program.
Fiscal policy flexibility is constrained by a narrow revenue base, a rigid expenditure profile and limited fiscal savings. Fitch's base case is that the government will introduce and obtain congressional approval for a revenue positive tax reform by the end of 2016. It is difficult to judge the final outcome, but a net positive revenue measure and its successful implementation are critical to compensate the loss of oil-derived revenues (from an already low revenue base) and replace expiring taxes in 2018.
Colombia has made important progress towards reaching a peace agreement with the FARC with the conclusion of negotiations and a plebiscite process expected in the coming months. The implementation of a peace agreement could provide a confidence boost in the short term and medium- to long-term benefits (i.e. with investment in energy and agriculture) that could increase growth prospects. In the near term and, given the wider fiscal deficit, such an agreement would highlight the importance for the government to rebuild its revenue base to accommodate required investment without jeopardizing fiscal consolidation.
SOVEREIGN RATING MODEL (SRM) and QUALITATIVE OVERLAY (QO)
Fitch's proprietary SRM assigns Colombia a score equivalent to a rating of 'BB+' on the Long-Term FC IDR scale.
In accordance with its rating criteria, Fitch's sovereign rating committee decided not to adopt the score indicated by the SRM as the starting point for its analysis because, while the SRM output migrated to 'BB+' from 'BBB-', in the committee's view this is likely to be a temporary deterioration.
Fitch's sovereign rating committee adjusted the output from the SRM to arrive at the final LT FC IDR by applying its QO, relative to rated peers, as follows:
--Macroeconomic: +1 notch, to reflect Macroeconomic policy consistency and credibility, and a flexible exchange rate regime have underpinned Colombia's macroeconomic and financial stability, and its capacity to adjust to external shocks.
Fitch's SRM is the agency's proprietary multiple regression rating model that employs 18 variables based on three year centred averages, including one year of forecasts, to produce a score equivalent to a LT FC IDR. Fitch's QO is a forward-looking qualitative framework designed to allow for adjustment to the SRM output to assign the final rating, reflecting factors within our criteria that are not fully quantifiable and/or not fully reflected in the SRM.
The main factors that could lead to a downgrade are:
--Failure to reduce the fiscal deficit and stabilize the government's debt burden;
--Persistence of large external imbalances;
--Persistence of macroeconomic imbalances that undermine the credibility of the policy framework.
The Rating Outlook is Negative. Consequently, Fitch's sensitivity analysis does not currently anticipate developments with a high likelihood of leading to a positive rating change. Future developments that could individually, or collectively, result in a stabilization of the Outlook include:
--Faster than anticipated reduction in Colombia's current account deficit;
--Reduced fiscal deficits leading to improved debt trajectory;
--A higher growth trajectory that supports improved debt dynamics and reduces Colombia's income gap with higher-rated sovereigns.
--Fitch assumes that oil prices average USD35 in 2016, and rise to USD45 in 2017 and USD55 in 2018.
--Fitch assumes that authorities will undertake fiscal policy measures to confront the oil shock and lower growth.
Additional information is available on www.fitchratings.com
Country Ceilings (pub. 20 Aug 2015)
Sovereign Rating Criteria (pub. 18 Jul 2016)
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