THE BLOG
12/15/2014 11:26 am ET Updated Feb 10, 2015

Colombia's twin deficits

Geared towards what seems to be an uncertain landscape for the country, Colombia continues to prove to be a fragile economy, with serious structural complications in its core and what some may classify as an irresponsible fiscal policy. By the end of the current year, the economy hopes to reach an increase of nearly 5% in its GDP--27 basic points above its immediate neighbors and 25 above the world average--and although it appears to be overperforming, the truth is, the underlying stability is being threatened by major variables. Interest rates have increased over the year for inflationary controls, exchange rate levels have gotten out of the safe zone and next year's budget hasn't been accounted for completely. The country has leveraged its growth by maintaining a fiscal and current account deficit for some time now, rightfully earning the label of net debtor to the world. Interestingly enough, the positive performance will turn out to be null in the long term, as external shocks approach and our ever holding stability and resistance will tumble amid a shifting international landscape.

There's more to the story when examining the deficits, and the national budget for 2015 may fall short in its financing, hampering development plans and ultimately affecting stability. First, there's fiscal deficit; term used to designate when a nation's expenses exceed its revenue. According to the Ministry of Finance, the deficit for 2013 reached $8.8bn USD--2.4% of GDP--and expects to maintain similar levels for 2014. This deficit is likely to be partially financed through internal debt, as the Central Bank expects to issue nearly $15bn USD in TES--government bonds--for full year figures. This deficit, of course, isn't necessarily self-indulgent. A country may pursue stable levels of deficit in order to finance projects and fuel the economy by boosting spending.

That being the case, government spending must take into account obligations to debt service, issue that must be carefully addressed in order to maintain a healthy debt-to-GDP ratio. In Colombia, the external debt rose 15.6% for the first semester of the current year--when compared to the same period in 2013--, reaching a total debt of 24% of GDP. This debt-burden is expected to diminish, as the Finance Minister states, since immediate payments are mainly directed towards amortizations and are not interest based. So even though debt is partially being taken care of, fiscal deficit isn't changing any time soon, much less on the budget allocated for next year. A total of $108bn USD has been approved for 2015, where $59.5bn are destined for government spending, $23.5bn to debt and nearly $25bn for investments. There is a gap of nearly $6bn USD that hasn't been accounted for and is expected to rise sharply due to falling oil revenue given recent falls in the commodity prices. The government expects to fill this gap through additional taxes, although this has sparked heated debates amongst most sectors of the economy, which feel they are being asphyxiated with excessive taxation. Indeed, the planned tax reform would leave Colombia with the highest effective "government cut" in Latin America, a not at all positive sign for an already ailing economy.

Another deficit still lurks in the country's balance of payments, specifically in the current account. This account registers the inflows and outflows of the total value of goods and services, and for the first semester in 2014, registered a deficit of nearly USD $8bn, and as a GDP ratio, spiked from 3% in 2013, to nearly 4.4% in 2014 (a whopping 47% increase!). On one side, there is a deficit in the goods and services balance of USD $3.4bn--explained by higher imports than exports--and a net flow abroad deficit of USD $6.6bn--higher outflows from investments related to companies with foreign direct investment, as well as interest payments associated to debt titles--. On the other side, there is a positive but small surplus of USD $1.9bn in net current transfers--modest inflows from transfers related to worker remittances from abroad and minimal outflows derived from transferences abroad--. Now, a 1.4% increase--in terms of GDP--is a considerable amount under any means of measurement. The counterpart to the current account deficit, or rather, how it is financed, is through higher foreign capital inflows to the country and an increase in international reserves. Again, the capital inflows used to finance the deficit are registered as credit assumed by the country, hence the label of net debtor.

Economic literature states that the correlation between fiscal and current account deficits is known as twin deficits hypothesis. The theory suggests that there is a strong link between these phenomena, and judging from what was previously specified, there seems to be some reason to it. The fiscal or budget deficit has to be financed through internal or external debt. In Colombia, both foreign capital and internal debt pay for the budget deficit, as investment rises over the year, consequently increasing the current account deficit. The Ministry of Finance has asserted in its development plans that according to fiscal regulations, government spending must increase in a manner proportional to perceived revenue and not rely on debt, with a medium term view of reducing the deficit in the years to come. However, relying on the facts, this doesn't appear to be happening anytime soon.

According to the Central Bank's latest figures, foreign direct investment accrued figures for October 2014 suggest that investment has fallen nearly 6.26%, trend that is expected to steep dive in the months to come, as higher interest rates in the US would naturally lure capital back from emerging markets. A highly devalued currency and an underperforming local commercial environment--decreased external demand--are expected to maintain current exports levels low, which at the moment, won't serve as aid in the reduction of the current account deficit. There seems to be an insight hinting that the twin deficits are staying that way, given the fragile and uncertain economical outlook. Responsible fiscal management is a must, along with sound and plausible policies to fund development--no gaps in the budget--. Exports are in need of increasing and foreign capital must be destined towards sectors that foster development and employment--certainly not oil & gas, which by the way has decreased 3.17% in the current year--. Next year is paramount to Colombia's economy performance in both an international and local environment.