Colombia’s Underperformance To Continue

Colombia is struggling with low oil prices, a sluggish economy, a very weak currency, and rising inflation. While Colombia has a good track record with regards to policymaking, we think the poor fundamental outlook will keep its assets in the underperforming camp.

POLITICAL OUTLOOK

President Santos began his second and final 4-year term in 2014, and one of his major goals is to conclude peace talks with the FARC rebels. In September, the two sides made enough progress to commit to a March 2016 deadline for signing a final agreement. Press reports suggest a major breakthrough will be announced this week regarding the treatment of victims of the long-standing conflict, which has been one of the major sticking points.

Local and regional elections in late October saw many posts (including Bogota mayor and several governorships) go the right-wing Cambio Radical (CR). Vice President Vargas Lleras hails from CR, and is widely expected to run for President in 2018. The overall results were disappointing for Santos’ center-right Partido Social de la Unidad Nacional. On the other hand, leftist Polo Democratico Alternativo suffered a big defeat in losing the mayoral race in Bogota.

Regionally speaking, relations with Venezuela could improve, now that the opposition now controls the National Assembly there. The two countries had a spat this past summer, when Venezuela closed several border crossings and deported thousands of Colombians. Lastly, the controversial sale of the government stake in power company Isagen has been cleared by the courts, and could help bolster foreign investment in the nation.

 

ECONOMIC OUTLOOK

The economy is still adjusting to lower oil prices. GDP is expected to grow 2.9% this year and 2.8% next year, the slowest rates since 2009. Retail sales have accelerating, helping to offset the drag from the external sector. However, higher rates are likely to crimp consumption moving forward.

Inflation is high and still rising. CPI rose 6.4% y/y in November, the highest since February 2009 and well above the 2-4% target range. Back in early 2009, the policy rate was just starting to come down from the 10% peak from H2 2008. PPI inflation is still accelerating, up 8.9% y/y in November. The central bank has hiked rates by 100 bp to 5.5% since September, and is widely expected to hike another 25 bp to 5.75% this week.

The external accounts have worsened. Exports are contracting around -40% y/y, but imports have not slowed as much. The current account gap is expected to widen to over -6% of GDP this year, and likely won’t improve too much next year.

Slow growth and declining revenues will put upward pressure on the budget deficit. The gap is seen widening to over -3% of GDP this year and nearly -4% next year. The fundamentals have deteriorated, and Colombia saw its implied rating slip a notch to BBB/Baa2/BBB in our last sovereign rating model update. In our view, Colombia no longer has upgrade potential and appears correctly rated at BBB/Baa2/BBB.

 

INVESTMENT OUTLOOK

The peso is the second worst performer in EM this year, -29% YTD against the dollar. This is behind only BRL (-31%). We believe COP underperformance will continue in 2016, as our EM FX model shows it is saddled with WEAK fundamentals. USD/COP made a new all-time high this week around 3378. From a longer-term perspective, there is an upward sloping channel on the weekly charts dating back to mid-2013. The top of that channel comes in around 3500, and it’s a pretty steep channel.

Colombian equities have underperformed within EM. MSCI Colombia is down -50% YTD, the worst in EM and compares to -18.7% YTD for MSCI EM. This underperformance should continue, as our EM Equity model has Colombia at an UNDERWEIGHT position currently.

Colombian bonds have underperformed this year. The yield on 10-year local currency government bonds is +173 bp YTD. This is behind only the worst performers Brazil (+354 bp) and Turkey (+264 bp). With inflation likely to remain high and rate hikes likely to continue, we think Colombian bonds will continue underperforming.