It's only been a month but so far Colombia's new president, Iván Duque, has got off to a good start. He has visited remote areas that have been ignored by successive central governments, made headway in a peace agreement with the ELN guerrilla group and taken a strong line on Venezuela. In an extremely busy LatAm election year – where leftist populist AMLO was elected in Mexico and the Brazilian presidential race has one candidate in jail and the other in hospital - Duque's presidency, alongside Chile’s election of Sebastián Piñera, stands out as a positive result for investors. Uday Patnaik, head of EM debt at Legal & General Investment Management, sees Colombia as a “temporary safe haven given the upcoming elections and future policy uncertainty in Brazil and Mexico and the impact on Uruguay from the likely meaningful slowdown in Argentina.”
Extractives the biggest winner
Duque supports traditional right-wing economic policies. He proposes cutting corporate tax rates to 27%, from 37% under President Santos. He also intends to reclaim greater fiscal flexibility by introducing counter-cyclical spending commitments, rather than adhering to Santos’s Fiscal Rule, which pledges to reduce the deficit to 1% of GDP by 2022. This should allow for a flatter growth cycle by releasing funds in economic downturns and saving more during growth periods.
On extractives, Duque will try to clarify the law around popular consultation votes, in which communities vote to decide whether to allow extractive projects in their municipalities. As it stands, they are legally binding. The biggest casualty has been Anglo Gold Ashanti, which saw its gold mine blocked from operating after a community vote in March 2017. There are 54 votes planned this year, according to the Ministry of Mines and Energy, which is causing huge uncertainty in the oil and gas and mining sector. A solution won’t be simple – the constitution says that communities can decide how to use their land while the Mining Code says that the national government has jurisdiction over the subsoil - but Duque wants to take steps to clarify the law.
"Duque hopes boosting extractive sector will increase tax revenues…"
He is also expected to rearrange the royalty structure so that more money goes to local governments. This should lead to an increase support for mining and O&G projects, which will improve tedious permitting process and reduce the risk that popular consultations will be held. The logic is simple: give locals a greater share of the profits and they will be more favourable to the projects. However, this may also see corruption rise.
Duque hopes boosting extractive sector will increase tax revenues. By clearing up regulation issues and bringing down taxes, he is seeking to spur investment and increase output. As shown below, oil, gas and coal output has stagnated since 2013. Correcting this give the government power to invest in other areas, such as security and education.
Security hard-line to boost economy
Duque has been fast-tracked to the presidency because of his backing by the controversial – and influential – ex president, Alvaro Uribe. Uribe – who ruled from 2002 to 2010 – is best known for upping the ante in the fight against the FARC and leaving a trail of human rights abuses, which are still unravelling today. Duque wants to re-instate some Uribista policies, such as aerial fumigation of illegal crops and forced substitution and eradication, rather than the voluntary model under Santos.
Organised crime is a drain on the economy. Beating it back will provide an economic boost to national and international investors, particularly for extractives projects which have to carry out complex risk assessments, often based around avoiding violence and corruption caused by organised crime. While increases in military spending and reinstating aerial fumigation will likely strike a blow to the flourishing illegal economy - coca production hit its highest rate in 30 years in 2017 - it may backfire by turning rural communities against the government, leading them into the hands of organised crime, and opening more fronts in the war on drugs.
"Organised crime is a drain on the economy…"
On the FARC peace, Duque pledges to modify the agreement without destroying it. This could mean restricting funding for rural socioeconomic development and implementing harsher penalties for former FARC members suspected of continuing criminal activity, particularly drug trafficking. Duque shouldn’t have a problem passing these alterations through Congress, but he may provoke some unintended consequences that will be bad for investors. For example, the changes could encourage demobilised FARC to take up arms, leading to an uptick in violence and a hard fight against dissident FARC groups and other organised crime groups. This is bad for everyone, and Duque would do well to resist calls from his mentor Alvaro Uribe to weaken the peace agreement. A strong peace is good news for investors.
Biggest risk comes from Venezuela
Duque doesn’t just have to worry about the guerrillas. Another challenge comes from Colombia’s belligerent neighbour, Venezuela. The economic and political crisis across the border is driving an unprecedented wave of illegal and legal migration into Colombia. According to the United Nations, more than 1.5 million Venezuelans have moved into neighbouring countries, most of the crossing into Colombia to stay to find work, as well as travelling on into Ecuador or Central America.
Arriving Venezuelans are increasing pressure on already-stretched public services and undercutting the wages on local workers. This will spread unrest and require decisive action from Duque, which could drain resources away from other spending areas. Furthermore, it brings an added security risk as desperate Venezuelans are recruited into armed groups, such as the ELN, which dominates the border region. Duque will take a harder line to migration as pressures increase from the public for the flow to be stopped. This may manifest itself in a harder border with increase military presence, deportations, or reduced public services for migrants. Each way, the migrant crisis presents a threat to social, political and economic stability, and if it continues to escalate, it will draw attention away from economic reforms.
Economic conditions strengthen Duque’s hand
Duque inherits an economy in good shape. Inflation is under control at around 3%, total government debt is 48.5%, which although high compared to the regional average of 40%, is less than Argentina (53%) and Brazil (83%), while the Colombian peso is steady against the dollar. Moreover, it is insulated from an economic collapse in the Southern Cone, where it does very little trade. Instead, it looks outwards, and trade mainly with the United States (32% of exports) and Panama (5.8%). Colombia’s export exposure to Brazil and Argentina is just 3.6%.
Most importantly, according to Patnaik “Colombia is being supported by relatively high oil prices, which should boost oil revenue and thus create fiscal room to potentially cut corporate income taxes and boost growth.”. It’s not to say there is no need for discipline. Patnaik adds that “markets will be looking for the government to reduce the budget deficit over the medium term.” However, Duque does not have to administer economic life support when he takes office. Instead, he can carry out his own security and tax reforms without too much external pressure. President Santos didn’t have this luxury in his final term when commodity prices tanked in 2014.
Additionally, Duque will find support for his ideas in a right-wing Congress. In the House, right wing parties, Democratic Centre, Radical Change and Conservative Party, have 49% (83/171 seats) of the votes and in the Senate they have 47% (50/107 seats). He shouldn’t have any trouble legislating, which is good for the economic outlook.
Investors have learned that the election of seemingly market-friendly leaders, think Pedro Pablo Kuczynski in Peru, doesn’t always work out as planned. However, just by avoiding Petro, the Duque victory has given a short-term boost to Colombian investments. If he can deliver on some of the plans outlined above, Colombia could reward international investors over the next five years.