Colombia’s New Frontier

Uncertainty about succession to President Alvaro Uribe clouds economic outlook.

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As bankers and policymakers prepare to assemble for the annual meeting of the Inter-American Development Bank later this month, the location of the gathering — Medellín — speaks volumes about the political and economic transformation of the host nation, Colombia.

Just a few years ago, few foreign financiers would have dared to set foot in the city. Home to one of the country’s most notorious drug cartels, Medellín was plagued by kidnappings and ruthless violence. The government managed to largely subdue the cartels only to see Colombia’s leftist guerrillas and right-wing paramilitary groups muscle in on the drug trade and do battle with each other across much of the country. Death squads, jungle drug labs, politicians bought with drug money: All were routine in a nation that has been torn by violence for the better part of 60 years.

That Colombia can hardly be found today. The country has enjoyed an unprecedented economic boom in recent years, thanks to the tough security policies and pro-market stance of the government of President Álvaro Uribe. Since first being elected in 2002, Uribe has used billions of dollars in U.S. aid to crack down on drug-funded insurgents and regain control over much of the country’s territory. The greatly enhanced security, combined with the government’s fiscal discipline and business- and trade-friendly policies, has attracted a surge of foreign investment. The economy has enjoyed its strongest performance in 50 years, with growth jumping to a peak of 7 percent in 2007.

Today, however, the U.S.-led global downturn is threatening to undermine those gains. Colombia’s economy has slowed sharply, with growth easing to 3.4 percent in 2008, and it is expected to sink further this year because of sharp declines in the prices of oil products and other commodities that make up the bulk of the country’s exports. The Finance Ministry forecasts growth of 3 percent in 2009, but the central bank predicts a rate of just 1 percent, and Morgan Stanley estimates 1.5 percent. The Colombian peso, which, like many Latin American currencies, was riding high less than a year ago, has tumbled by 35 percent over the past eight months, to a rate of about 2,600 to the dollar.

Colombia’s dependence on trade with the U.S. and neighboring Venezuela is proving to be a double whammy. The American recession has hit exports hard, and political differences with the administration of President Barack Obama hold out little hope of any near-term improvement. Uribe negotiated a free-trade pact with the administration of president George W. Bush in 2007, but Obama campaigned against the deal because of alleged human rights abuses in Colombia’s war on drug trafficking, and ratification efforts have stalled. Venezuela’s economy, meanwhile, has taken a beating as a result of collapsing oil prices and the virtual cutoff of international financial flows because of the confiscatory policies of President Hugo Chávez.

“Colombia may be a relatively insulated country, but it will not be able to escape the ravages of the international credit crunch,” says Walter Molano, chief emerging-markets analyst for BCP Securities in Greenwich, Connecticut.

The country also faces rising political uncertainty as Uribe nears the end of his second term in 2010. The president has toyed with the idea of amending the constitution to run for a third term, but his popularity has dimmed in recent months, and several members of his conservative coalition are believed to be preparing their candidacies for an expected primary race late this year.

Like Colombia, most of Latin America has seen the economic outlook deteriorate sharply, a trend that will dominate discussions among policymakers and bankers at the IADB meeting. The region had resisted the global credit crisis better than many others through most of last year, but the sudden drop in demand from the U.S. and Europe in the fourth quarter and the sharp decline in commodity prices in the past six to nine months have dealt a severe blow to the area’s economies. The financial crisis has also hit home with a vengeance. The Institute of International Finance forecasts that the flow of private capital, which had buoyed the region in recent years, will drop to $43.1 billion this year, from an estimated $89.0 billion last year and a record $183.6 billion in 2007.

The IIF also predicts that the entire Latin American economy will grow by just 0.5 percent this year, down from 4.3 percent in 2008. Recession is hitting Mexico, which the International Monetary Fund projects will see output contract by 0.3 percent in 2009 under the pressure of declining trade with the U.S. Even Brazil, the region’s largest economy, is feeling the pinch. In January the IMF slashed its forecast for Brazilian growth this year by 1.2 percentage points, to 1.8 percent; that would be down from robust growth of 5.8 percent last year (see “Brazil: Where the Banks Grow,” page 70).

In Bogotá, Colombia’s capital, the government is taking advantage of its relatively strong fiscal position to increase spending in a bid to cushion the downturn. Finance Minister Oscar Iván Zuluaga laid out an economic program in January that includes infrastructure projects, social welfare programs and business lending. The government plans to boost spending on roads, housing and water and sanitation systems by 31 percent this year, to 5.7 trillion pesos ($2.2 billion). It will also nearly double the size of a welfare program that pays for better nutrition, education

and health care, called Familias en Acción, to cover 3 million people, up from 1.7 million currently. The aim is to “maintain employment generation and avoid a greater drop in the economy,” Zuluaga told Institutional Investor in a recent interview.

In addition to spending increases, the minister announced a total of $950 million in new credit lines for Colombia’s export bank to promote exports. He also boosted a guarantee fund for small business lending by $80 million, which is expected to increase bank lending in the sector by $500 million.

The government aims to support exports as well by expanding trade with China. In November, Uribe and China’s president, Hu Jintao, signed a treaty that commits the two countries to protect investments and eliminate double taxation. It is notable that at this year’s IADB meeting, China will be participating for the first time as a member since joining the development bank last year. “We need to broaden [market] access and diversify our exports, and one strategy is based on attracting Chinese investments,” says Eduardo Muñoz, Colombia’s ambassador to the World Trade Organization.

Although he acknowledges the heightened risks facing the economy, Zuluaga is upbeat on the outlook. “In this era of crisis, investment continues, exports are normal, and the devaluation of 14 percent in 2008 is lower than that of other countries,” he says.

The increased spending, combined with reduced tax receipts, will widen the government’s budget deficit by 0.6 percentage point, to 3.2 percent of gross domestic product, but Zuluaga says public finances are sound. Central government debt declined to 44 percent of GDP last year from 52 percent in 2002, and the country’s external debt — government and private sector combined — has fallen to 14.6 percent of GDP, from 20.6 percent in 2004.

The government took advantage of a thaw in global credit markets in January to issue $1 billion of ten-year bonds, which were priced to yield 7.5 percent, or 503 basis points over comparable U.S. Treasuries. Just one year earlier, Colombia paid 222 basis points over Treasuries on a similar issue.

The Finance Ministry has also secured a total of $2.3 billion in lending this year from the World Bank, the IADB and the Andean Development Corp. to help finance social programs, regional and sustainable development and financial system support.

Colombia’s banking system is relatively healthy, with capitalization levels averaging 14 percent — well above the 8 percent minimum required under the Basel global capital rules — and record profits that topped $1.69 billion last year. Colombian companies are “less exposed to derivatives and less leveraged in foreign currency than those in Brazil and Mexico,” says Francisco Aristeguieta, president of Citibank Colombia.

Still, a credit crunch is in the making. Growth in bank lending slowed to about 10 percent in November, from 28 percent two years earlier, according to the Colombian bankers’ association, Asobancaria. Wachovia Corp. and Bank of America Corp. were leading lenders to Colombian banks, but both have cut their credit lines sharply, local bankers say.

Business executives have turned cautious, although most continue to expect at least modest growth. “The economy is not shielded — the crisis arrived slowly, but it has arrived,” Mauricio Rodríguez, an economic analyst and founder of financial newspaper Portafolio, tells II. He still expects the economy to grow by 1 to 2 percent in 2009. “There is good dynamism of foreign investment and private investment,” explains Rodríguez, a director on several corporate boards and until recently rector of the Bogotá-based graduate business school Colegio de Estudios Superiores de Administración. “There’s concern but not alarm, not yet.”

That business leaders remain somewhat optimistic despite the global slowdown reflects the dramatic political and economic gains that Colombia has achieved under President Uribe’s leadership.

The rightist politician comes from a wealthy landowning family in Antioquia province, a mountainous agricultural region in northwest Colombia, of which Medellín is the capital. His father, a wealthy cattle rancher, was killed in 1983 during a kidnapping attempt by the Revolutionary Armed Forces of Colombia, or FARC, as it is known by its Spanish acronym.

Uribe trained as a lawyer and worked as a government official in Medellín and Bogotá before starting his career in politics with a brief stint as mayor of Medellín in 1982. He then served as a senator from 1986 to 1994 and as governor of Antioquia from 1995 to 1997. He was elected president in 2002 after campaigning on a promise to crack down on the FARC. He successfully enacted a constitutional reform allowing him to run for a second term, which began in 2006.

When he began his first term, half of the country was under control of the FARC and another, smaller leftist group, the National Liberation Army. Under a program called Democratic Security, Uribe increased the military budget, directed the armed forces to confront the leftist rebels and gave the U.S. a free hand to try to eradicate coca farming. Colombia receives some $500 million a year in U.S. support for the war on drug trafficking, making it the biggest recipient of U.S. military aid in the Western hemisphere.

The results of these efforts have been dramatic. In six years the security campaign has reduced the FARC forces to 10,000 from 18,000. Kidnappings dropped from some 3,500 a year to just over 700 in 2008, and the murder rate fell by about half nationwide. Today, fully two thirds of Colombia’s territory is under government control, including the triangle that encompasses the economic centers of Bogotá, Cali and Medellín.

“He cleaned up the area where 80 percent of the economy is produced,” says Juan Carlos Echeverry, chief of EConcept, an economic consulting firm in Bogotá. Improved public safety “changes where you can go,” says Citibank’s Aristeguieta. “Top talent is now happy to stay in the country.”

The security transformation was highlighted last July, when an undercover Colombian military operation tricked FARC forces and rescued former presidential candidate Ingrid Betancourt and other hostages who had been held captive for several years.

Security has come at a cost, though. Human rights groups criticize connections between government officials and military officers and right-wing death squads. More than 30 members of Congress, including Uribe’s cousin Mario, have landed in jail, accused of links with paramilitary forces that have terrorized the countryside. Hundreds of labor activists have been killed in recent years, many the apparent victims of right-wing paramilitary groups. Last fall Uribe fired 27 officers and soldiers, and later the head of the armed forces resigned, over cases in which poor people were lured away and killed, then dressed to make them appear as if they were rebels or criminals killed by the armed forces.

Uribe, who has a reputation as a workaholic and micromanager, has identified himself closely with the war on drugs and leftist insurgency. At a gathering in Lima, Peru, during the Asia-Pacific Economic Cooperation summit meeting in November, Uribe was asked how to fight terrorism. “The president of Colombia has to behave as a soldier,” he said, standing at attention. “I am a policeman in civilian dress. Determination, determination, determination is the key rule to fight criminals.”

The security gains have also been uneven. Colombia in many ways is two nations. One is centered in the banks and boardrooms of Bogotá, where business was booming before the global economy took a nosedive last fall. The other is a rugged terrain, crossed by three mountain ranges that divide cities from each other and slope down to vast jungles, where the government is rarely seen and where coca cultivation and trafficking still thrive. These two worlds intersect when the poor who are displaced by the drug war and the battles over land in the countryside crowd into urban slums and provincial towns.

Notwithstanding the shortcomings, Colombia’s security climate has improved enough to foster a dramatic rise in economic activity. The country’s GDP has nearly tripled since 2002, reaching some $222 billion last year, or $4,418 per person. On that basis, Colombia ranks as the sixth wealthiest Latin American country after Chile, Venezuela, Mexico, Brazil and Argentina. Investment, exports and tourist visitors have all doubled since 2002.

The growth of foreign investment, which was virtually unheard of in the 1980s and early 1990s, when drug barons like Pablo Escobar and the Ochoa brothers terrorized the country, has been particularly dramatic. Such investment grew from $2.1 billion in 2002 to $9 billion in 2007, before easing back to $8 billion in 2008, according to Proexport, a Colombian investment promotion agency. (In 2006, the latest year for which comparable data is available, Colombia and Ecuador each drew $6 billion in investment, Peru attracted $3.5 billion, while Venezuela suffered a disinvestment of $500 million, according to the World Bank and the United Nations Conference on Trade and Development.)

Foreign direct investment has been substantial enough to finance the country’s current account deficit, which is running at a rate of about 3 percent of GDP. In 2005, London-based SABMiller bought Bavaria, the country’s largest brewery, for $4.7 billion, a deal that sent foreign investment to an all-time high of $10 billion that year. In 2007, Switzerland-based Glencore International pledged $2 billion for a refinery in Cartagena, and the Brazilian construction company Votorantim Group acquired 52 percent of the Acerías Paz del Río steel plant for $490 million. Last year, Brazilian mining giant Companhia Vale do Rio Doce invested $300 million in a coal mine and exploration prospect owned by Cementos Argos.

The surge in investment, combined with strong prices for Colombia’s commodity products, has led to a steady rise in exports. Oil and oil products accounted for 26 percent of exports in 2008, contributing to a 20 percent increase in revenues, to $36 billion.

But with oil prices sinking below $40 a barrel, roughly one quarter of last year’s high, that bonanza is fast evaporating. Total exports are expected to drop to $31 billion this year, according to Morgan Stanley. Recessions in the U.S., Venezuela and Ecuador, Colombia’s three main markets, are sapping demand for the country’s commodities as well as other key exports, such as auto parts and clothing.

The weakness of trading partners has had a dramatic effect on Colombia’s economy recently. Industrial production fell 13.3 percent in November from a year earlier, and 9.2 percent in December. The global downturn is also expected to hit remittances from abroad, a direct, effective cash transfer to some of the country’s poorest people. Remittances totaled $4.5 billion in 2007, according to the IADB.

Uribe had been hoping to use a free-trade agreement with the U.S. to sustain growth, but the recession as well as political opposition from the new U.S. administration have stalled, if not derailed, that ambition. In opposing the trade pact during his campaign, President Obama, backed by U.S. labor unions and their supporters in Congress, alleged that Colombia has done little to stop the killings of hundreds of labor activists, many of whom are believed to be the victims of right-wing paramilitary groups, in recent years.

Colombian officials deny those allegations and insist that the government is vigorous in defending human rights. “We have a commitment to continue working for human rights and labor [rights], with or without a free-trade agreement,” WTO ambassador Muñoz tells II. “Today, the mortality rate for labor activists is half that of the population at large.”

Political uncertainty ahead of the May 2010 presidential election also clouds Colombia’s outlook. Uribe has hinted at running for a third term. Five million Colombians have signed a petition favoring a constitutional reform that would allow him to do so, pushing the matter to Congress, which could vote as early as this month to allow a referendum.

Opposition to a third term is building from foes and allies alike, who cite the need to uphold the rule of law and respect for the country’s political traditions. “All institutional arrangements in Colombia were made thinking about one-term presidents,” says Boris Segura, Morgan Stanley’s senior Latin America economist in New York. IADB president Luis Alberto Moreno, a former Colombian ambassador to the U.S. who is believed to have political ambitions of his own, in December told Bogotá’s El Tiempo newspaper, “I think he’s a great leader, but I don’t believe it is best that he continue in the presidency, even for him.”

Luis Carlos Villega, president of the national industrialists group known as ANDI, said in December, “The president should not seek a second reelection. It is not convenient for democracy.”

The next president, whoever he is, will face no small challenge in trying to sustain economic growth in the midst of a global recession and to keep insurgents and drug traffickers under control. But the progress made under Uribe in the past seven years offer hope that Colombia will continue to pursue a similar blend of economic and security policies, which may be the best reassurance the country can have in these uncertain times.

Says Guillermo Perry, research fellow with the Fedesarrollo policy think tank, based in Bogotá, “It is totally unthinkable that someone who won’t continue his policy will be elected.”

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