After a year of bad news due to the COVID-19 pandemic and its economic repercussions, Colombia’s fortune is finally improving: at the end of September, the IMF expanded Colombia’s credit line from USD 10.8 billion to USD 17.2 billion. The news is reassuring; it provides the country with liquidity, while also signaling IMF trust in Colombia’s fiscal structure.
Out of the augmented USD 17.2 billion, Colombia’s government is considering using USD 5.3 billion to avoid extra fees that could arise from the IMF’s special considerations on borrowing limits and payment timelines. These resources will play a key role in Colombia’s 2020 budget, for they will provide liquidity to strengthen economic recovery and cushion possible menaces in the short-term. Furthermore, the conditions on this credit line are truly favorable and flexible, giving Colombia the possibility to gather funds in a very comfortable manner.
Why does Colombia need money?
Like the majority of countries around the world, Colombia struggled in 2020. During the first quarter of 2020, Colombia’s economy grew by 1%; however, Colombia’s GDP contracted by 15.5% in the second quarter reflecting the economic slowdown caused by lockdowns. Fedesarrollo, one of Colombia’s most respected think tanks, conducts a survey on a monthly basis amongst the country’s financial institutions to forecast economic activity; respondents of September’s survey reported that Colombia’s GDP could contract up to 10% for the third quarter and almost 6% in the fourth quarter. The contractions are expected as 62% of Colombia’s total workforce in 2019 belonged to the informal economy. Most informal jobs are agricultural, making it impossible for workers to adapt “new normal” measures such as working from home.
As such, since July, the government has been easing lockdown measures to incentivize economic production. However, as many industries, especially informal ones, remain unproductive, many laborers will need governmental support to maintain a minimum standard of living. Moreover, Colombia needs liquidity to continue supporting the country’s industry. The IMF loan comes in to bolster several programs that incentivise the economy, some of which will provide credit lines to companies that have financial needs, allowing them to keep producing and keep people on payroll.
Credit conditions
IMF loans have a clear purpose: to aid member countries in times of crisis. In many cases, loans come with special commitments such as fiscal restructures. Normally, countries have to engage in behavior which the IMF deems desirable to receive a loan, but this is not the case with Colombia’s current credit line. Back in May, Colombia received approval of a Flexible Credit Line (FCL) – a special loan that has no additional commitments with the IMF. In other words, the country’s only obligation is maintaining interest rates.
FCLs are only given to countries with outstanding economic policies and signs of future stability in domestic finances, meaning that the IMF sees Colombia’s finances with good eyes. The interest payment of IMF FCLs varies depending on the amount borrowed and the time the country takes to payback. Since Colombia would only use USD 5.3 billion of the entire credit line (187.5% of the country’s quota with the IMF), the outstanding credit would not incur additional borrowing costs.
Depending on whether the Central Bank decides to increase the outstanding credit, Colombia could have to pay an extra 200 basis points, and further 300 basis points if outstanding credit remains over the 187.5% limit for three or more years. As for right now, the loan’s approximate cost is an annual interest rate of 1.6% (not including a refundable commitment fee of 0.6% which the IMF repays to the country if the country draws from the credit line), which Is incredibly favorable for Colombia. As its name indicates, this credit line is very flexible, making it ideal for Colombia in a time of crisis such as the one being experienced.
Why IMF instead of Debt Issuing?
As mentioned above, Colombia, like many other countries, needs liquidity right now. As any other nation, Colombia could have raised capital through taxes or by borrowing. Increasing taxes was a suboptimal option, hence the country looked towards credit options. Debt issuing is always an alternative governments contemplate when resources are needed. However, in this case, Colombia was better off by using the IMF’s help than by issuing government bonds.
This is due to two main reasons. Firstly, in the case that Colombia could pay the loan in one year, the yield of a bond for mentioned time period navigates around 2.55%; borrowing would be more expensive, if this option was chosen. Secondly, the price of government papers could be altered if the Central Bank increments the supply of bonds. The law of supply and demand would indicate prices fall if supply of government bonds in the open market increases. As bond prices decrease, yields rise.
In other words, issuing bonds would be counterproductive. Colombia’s Central Bank monetary policy is to incentivize the economy by making credit cheaper through interest rate cuts. If bond yields rise, the cost of credit could rise as financial institutions decide between lending money to the government through bonds, or issuing loans to companies and individuals. Aside from receiving capital at a lower interest rate, Colombia benefits from the IMF’s loan because the cost of credit stays low and economic recovery is fostered.
Overall Impact
The IMF requires countries which have received LCFs to maintain sound public finances and strong economic stability in order to maintain the credit line. As a result, for the next couple of years, Colombia will be incentivised (more like forced) to be austere, keep inflation low, and install effective economic policies. With augmented liquidity, Colombia will continue to contain the recession in a more effective manner than most of its South American peers; in fact, the IMF’s GDP growth forecast indicates that Colombia will outperform South America’s mean GDP growth for both 2021 and 2022. Although undergoing hardships, Colombia has some things to thank for before the year ends.
