OECD Economic Outlook, Volume 2023 Issue 2

Colombia

GDP is expected to grow at moderate rates of 1.2% in 2023 and 1.4% in 2024 before picking up to 3% in 2025. High inflation, interest rates and policy uncertainty will weigh on domestic demand in 2024. The central bank has raised interest rates to a 25-year high to bring inflation under control. Headline inflation has started to come down and is projected to return to the 2-4% target range in the second half of 2025.

Monetary policy should avoid a premature easing to ensure continued disinflation and safeguard credibility. To ensure debt stabilisation and compliance with fiscal rules while securing fiscal space for an ambitious social reform agenda, it will be necessary to improve spending efficiency and public revenues. Further raising incentives for formal job creation by reducing non-wage labour costs and improving training could foster both productivity and equity.

Growth has slowed

GDP growth has slowed substantially since late 2022 and consumer and business confidence remain relatively weak. Investment has fallen sharply to below 18% of GDP compared to 22% on average during 2014-2019. High interest rates and policy uncertainty are the main factors weighing on investment. Moreover, financial conditions have tightened amidst rising cost of credit and more stringent lending criteria. Private consumption, a key driver of the strong recovery from the pandemic, has also weakened. So far, the slowdown has not yet been passed through to the labour market, where the unemployment rate is 1.5 percentage points below pre-pandemic levels.

Colombia: Inflation and banking indicators

Source: DANE; and BanRep.

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Colombia: Demand, output and prices

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Monetary policy tightening, with interest rates at 13.25% since May, has contributed to the decline in inflation to 10.5% year-on-year in October. Core inflation stood at 9.5%. Disinflation occurred despite significant increases in energy prices, especially fuel, and the pass-through of the 16% minimum wage increase in January into prices especially of services. The alignment of previously subsidised domestic gasoline prices to international prices mitigates the impact of global oil prices on Colombia’s public finances. The severity of the ongoing El Niño weather phenomenon, which could cause droughts that might result in food price pressures due to lower harvests, is expected to peak in early 2024.

The path of fiscal consolidation is uncertain

Fiscal consolidation is taking place but there are risks of non-compliance with fiscal rules. The planned budget deficits of 4.3% of GDP in 2023, 4.5% in 2024, and 3.5% in 2025 would be just within the limits stipulated by the fiscal rule. However, primary expenditure to implement the reform agenda in 2024 is higher than previously anticipated. In addition, oil, customs and tax revenues in 2023 are lower than expected. Moreover, fiscal plans incorporate cyclical and uncertain revenues, notably the collection of tax arrears via litigation, which amount to almost 1% of GDP in 2024 and 0.6% in 2025, according to the fiscal council. Under the current fiscal plans, debt would hover around 55% of GDP in 2033, compared to less than 50% before the pandemic. On the monetary side, a gradual easing of interest rates could start in 2024, assuming inflation will have fallen further and is on a durable path back towards its target, following other central banks in the region. Policy interest rates are projected to fall to 6% by the end of 2025.

Weak growth will continue well into 2024

GDP growth will remain below potential while monetary policy is restrictive. Growth will gradually pick up with the central bank’s easing cycle starting from 2024, although there is a significant lag in the pass through from the benchmark to lending rates. The speed-up in growth from the second half of 2024 will be especially driven by a rebound of investment fuelled by the relaxation of financial conditions. However, this will only make up partly for the earlier decline. Exports, which are currently dominated by oil, will remain subdued given a weak global economy and weak investment into production. Inflation will continue to gradually decrease, to around 10% by end-2023 and around 5% by end-2024, driven by tight monetary policy and weak domestic demand. Domestic risks include a breach of the fiscal rules and challenges to debt sustainability, particularly with high planned public expenses, and a more severe El Niño. On the upside, higher global oil prices could improve the fiscal position.

A strong macroeconomic framework would support the reform agenda

A continued commitment to the traditionally strong fiscal and monetary framework would support the government’s ambitious and fast-paced reform agenda. Improving spending efficiency and raising revenues, for example by reducing tax expenditures and exemptions, will also be needed to ensure compliance with the fiscal rules, debt stabilisation, and financing of the proposed health, pension, labour and education reforms and the energy transition. Reforms to reduce informality, which affects half of Colombian workers, should include lowering non-wage labour costs and improving the quality of training.