Author: Ana Mara Montoya Durana, Bogot March 16th 2012

COLOMBIAN ECONOMIC ENVIRONMENT 1.1.1. GENERAL VISION

Colombias economy is relatively diversified by regional standards. The country is well endowed with natural resources, including oil, coal and natural gas; energy, manufacturing and services sectors are also of importance. Improved security combined with business-friendly investment rules led to a surge in foreign direct investment (FDI). The World Bank last Doing Business Report that measures 138 world economies shows that the Colombian economy has been improving principally in three areas: facility for the creation of an enterprise, tax reduction and facilities for tax payments and insolvency resolution. Colombia got the highest classification in 1 America Latina on foreign investment protection insolvency resolution . The 3rd edition of the annual LatinFinance Finance Ministry scorecard qualified Colombian minister finance minister who arrives in June 2010 on the first place. Colombia has the proper reforms oriented towards fiscal responsibility and infrastructure growth. The internal demand has been growing sometimes over 11%. The Latin Finance ranking incorporates currency appreciation, inflation management, fiscal behavior, independence towards political pressure, transparency and clarity in the communication to the markets, the 2 capital markets and financial innovation . Newsweek magazine declared in 2010 Colombia as the new star of the south : after multiplying foreign investment 5 times from 2002 to 2010 Colombia is learning how to manage the Dutch disease. The Colombian Central Bank Chief, Jose Daro Uribe said on February 2012 that the Colombian economy grew 4 between 5.6% and 6% in 2011 due to strong investment in energy sector and is predicted to grow 5 approximately 5% in 2012 supported by investment that continues at energy sector, public works related to reconstruction of large areas after the 2010 2011 floods, social housing construction and consumer spending. Colombia is part of the CIVETS, acronym that corresponds to Colombia together with Indonesia, Vietnam, Egypt, Turkey and South Africa. Following The Intelligence Unit of The Economist, the CIVETS economies are interesting for foreign investors due to projections of GDP increase around 4.5% annual for the next 20 years. This growth is over the estimation of G7 counties that is around 1.8% All of this countries have big and young populations from 240 million people of Indonesia to 46.9 million people of Colombia. These economies are diverse and doesnt depend on basic products and except Egypt maintain inflation under control. None has a high fiscal deficit despite it has grown after the last world financial crisis. Finally the CIVETS are economies that werent very much impacted by the global financial crisis due to their accurate policies a solid economical base.
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Economa colombiana, entre las mejores de Amrica Latina, El Mundo.com, 20 de Octubre de 2011 Schwartz, Karen The right moves, LatinFinance, Mar 1st 2012 3 Colombia becomes the New Star of the South, Newsweek Magazine, Jul 16th 2010 4 Central bank sees Colombia's 2011 GDP growth at 5.6% to 6%, Colombia Reports, February 13th 2012 5 Dan Molinski, Colombia targets inflation as economy booms, WSJ, January 20th 2012
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1.1.2.

ECONOMIC OUTLOOK

The economy expanded by 7.7 % in the third quarter of 2011. Demand-side growth is driven by private consumption and investment with the financial, commerce and mining sectors as the main supply side engines. The GDP has been growing constantly in the last decade from 1.7% in 2001, with a yearly increase of around 1% reaching percentages around 5% during the years from 2004 to 2006 and touching its highest level of 6.9% in 2007. The decline of 2008 and 2009 was related to the economical cycle as well as the impact of the World Financial crisis. The recovering of the growth has been outstanding since 2010 based principally on Gross Capital Formation followed by Consumer Spending. Those two variables have been determinant for Colombian economical growth during last decade.

Graph 1. Gross Domestic Product (GDP) Constant Prices 2005. Percentage annual variation % 25

20

15

10

-5

-10 2001 2002 2003

GDP GCF Imports

2004

2005

2006

2007

2008

2009

2010

Consumer Spending Exports GDP

Source: National Accounts, National Administrative Department of Statistics -DANE.

Unemployment policy: Supported by the economical growth, the unemployment rate has been descending from 15.52% in 2002 to levels around 11% and 12% between 2005 and 2009, and continues descending to 10.8 % in 2011. Unemployment is one of the most important goals for the actual government. The month to month variation got 9.8% on December 2011 and came around 9% since the last four months of this year. Graph 2. Colombia Unemployment rate. National Total

18 17 16 15 14 13 12 11 10 9 8 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 11,79 15,52 14,95 14,05 13,65 12,03 11,17 11,27 12,00

11,76 10,80

Source: National Household Survey, National Administrative Department of Statistics - DANE

Despite poverty has fallen since 2003, it remains high at 31% in 2010. The relatively slow response of poverty to growth is explained by a highly unequal income distribution: the Gini coefficient is the 7th highest 6 7 worldwide . The government goals are to reduce poverty to 22% in 2014 . For this purpose the actual 8 government created the Administrative Department for Social Prosperity that includes the National Agency for Overcoming Extreme Poverty-ANSPE.

Monetary and exchange rate policy: Colombias Central Bank is the only one in the region that is currently tightening monetary policy on concerns about rising inflationary pressures, rapid housing price increases on the backdrop of robust domestic demand. Three recent rate hikes elevated the monetary policy rate from 4.5 to 5.25 %. Consumer price inflation rose by 3.73 % during 2011, 0.7 percentage points higher than the middle of the central bank's target, range driven primarily by consumer demand and higher food prices, approaching the ceiling of the 2-4 % target range. The exchange rate has appreciated substantially in 2012, as FDI surged on the back of strong fundamentals and portfolio inflows resumed as global risk aversion

7 8

World Bank, Colombia Country Brief, 2011 Baj la pobreza en Colombia pero la desigualdad no, Portafolio.co, agosto 28 de 2011 Department for Social Prosperity at http://www.dps.gov.co/portal/default.aspx

receded. To reduce short-term fluctuations in the exchange rate, the Central Bank has re-introduced a dollar purchase program. As shown in the graph below the inflation has been historically controlled oriented to be around 3% during the last two years. Colombia has a serious and consistent monetary policy oriented to manage inflation in the actual growth context. The 2008 7.67% CPI over the middle target of 4% was properly managed at that time, remaining inflation into the target during 2010 and 2011. Graph.3. Consumer Price Index and Inflation Target 2000 2011 12,00

10,00

8,00

6,00

Inflation Target Consumer Price Index (CPI)

4,00

2,00

0,00 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011
Source: CPI: DANE. Inflation Target: Board of Directors Central Bank of the Republic of Colombia

Fiscal policy: Colombia exhibited a very good fiscal performance in 2011 thanks to high economic growth, favorable oil prices and tax reforms. The structural reform on the health system and the labor formalization as well as tax reform were part of fiscal government policy during 2011. Tax revenues-to-GDP soared in 2011 by 1.3 %, as a result of tax reforms and reduced evasion. Colombias fiscal institutions are strong and were further strengthened in 2011 through the approval of important fiscal reforms. Partly as a result of these reforms, all three major rating agencies (S&P, Fitch, Moodys) upgraded Colombia to investment grade in 9 2011 The government deficit as a percentage of the GDP has been descending from 4.1% in 2009 to 2.9% in 2011. During the last decade the deficit touch its highest level of 5.1% in 2002 descending annually in average of 0.4 percentage points until 2008.

Ibid, World Bank

Graph 4. Central National Government - CNG. Income, Expenses & Balance COL $ Bill. and GDP %

Income

Expenses

Fiscal Situation CNG

0,0 -1,0 -2,0 -2,3 -3,0 -3,4 -4,0 -4,6 -5,0 -6,0 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011
Source: Ministry of Finance and Public Credit, Republic of Colombia.

120 100 80 -2,7 -2,9 60 -4,1 -3,8 40 20 0

-4,2 -4,8 -5,1

-4,0 -4,5

International reserves: The international reserves have been growing constantly since 1999 as shown in Graph 5. and have more than double its amount from USD 14,947 million in 2004 to USD 32.400 million in 2011 a record for the country; 3.1 times the short-term external debt balance by original maturity and 2.1 times the repayments of external debt with residual maturity of one year. Graph 5. Annual Evolution Balance of Payments

30.000 25.000 20.000 15.000 USD Millions 10.000 5.000 0

-5.000 -10.000 -15.000 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010

International Reserves

Current Account

Source: Central Bank of the Republic of Colombia - Economic Studies Division.

Trade in Goods & Services: The commercial balance has been historically negative, affecting the GDP in around -3.5%. The principal commercial partners are U.S.A, followed by the European Union, the ALADI (Latin America Association of Integration), and China. Actually, Colombia has diverse in force free trade agreements with CAN (Peru, Ecuador and Bolivia), MERCOSUR (Argentina, Paraguay, Uruguay and Brazil), Chile, G2 Mexico, North Triangle (Honduras, st st Guatemala, El Salvador), Switzerland (Since 1 July 2011), Canada (Since 1 August 2011). Also Colombia has in execution free trade agreements with United States, European Union and EFTA (Switzerland, Iceland, Norway and Liechtenstein) is negotiating FTA with South Korea, Panama, Turkey and Australia and in the 10 future will negotiate with Japan and the Gulf Community . Foreign Investment: Actually Colombia has three in force bilateral agreements of investment with Peru, Switzerland and Spain, five in execution agreements with United Kingdom, South Korea, India, Belgium and China and is negotiating bilateral investment agreements with Kuwait, Japan and United Arab Emirates. By sector, in the period of January September 2011, the foreign direct investment was distributed as shown in the Graph 7., highlighting 36% of the foreign investment in manufacturing, 26% in commerce, restaurants and hotels, followed by 15% in mining and energy sector, 12% in transportation, storage and communications and 11% in others. Graph 7. Foreign Direct Investment in Colombia by sector January - September 2011 Transportation, Storage and Communications 12%

Mining and Energy Sector 15%

others 11%

Commerce, Restaurants, Hotels 26% Manufacturing 36%

Source: Central Bank of the Republic of Colombia - Economic Studies Division.

Colombia has healthy levels of international reserves, a Flexible Credit Line with the IMF, a flexible exchange rate, room to cut policy rates and moderate inflation rates. The deterioration of the external economical environment hasnt impact strongly the Colombian growth and the increase of the internal reserves. With the actual government policy is expected to get a better The GINI coefficient, space for investment in
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Colombian Foreign Affairs Ministry

infrastructure sector and policies oriented to increase the internal demand by the poverty reduction. Colombia is moderately vulnerable on the fiscal, in the case of lower oil prices, preventing this vulnerability the government has been promoting the natural gas exploration as well as energy investment both sectors oriented to increase the country energy exports.

COLOMBIAN SOVEREIGN DEBT

1.2.1. BACKGROUND Colombia has enjoyed in recent years a tradition of impeccable payments on its foreign debt, not only to commercial banks but also to bondholders in the active bond market of sovereign debt, which dominates since the eighties the scene of external financing economies for both developed and emerging economies. The country has gone through almost all debt crises of the twentieth century and so far this twenty first century, without any interruption of payments to commercial banks or bondholders. Such position was confirmed at the end of 1980s a time when major restructuring of bank debt through the issuance of Brady Bonds11 was done. A total of 17 countries totaling $ 170 billion got involved in that program, and Colombia did not issue a single one of them, despite maintaining several outstanding Eurobond issues and so commercial bank loans.

1.2.2. THE COLOMBIAN FOREIGN DEBT. EVOLUTION 2003 2011

The size of the Colombian external debt projected by the Central Bank of the Republic of Colombia by the end of 2011 is estimated at USD 73.466 million, a figure that represents a 93% increase for the period 2003 to 2011. Out of this previous total, it corresponds to the public sector USD 41.889 million and USD 31.577 million to the private sector, which means that the participation of the latter increased from 35.41% to 42.98% in the period. It is also observed in Graph 8 that the widespread availability of external credit that was being used by both sectors at the same pace until 2009, changes its trend in the last two years when the private sector gains share in front of the public one in these two periods.

11

Sachar-Brauer and Chen (2001), Brady Bonds.

Graph 8. Colombian External Debt Public vs. Private 2003 2011 (USD millions) 80.000 70.000 60.000 50.000 40.000 30.000 20.000 10.000 0 2003 2004 2005 2006 2007 2008 2009 2010 2011
Source: Central Bank of the Republic of Colombia COLOMBIAN EXTERNAL DEBT, Economic Studies Division. March 2012

PRIVATE PUBLIC

Graph 9. Colombian External Debt % of GDP 2003 2011

% GDP
45,00% 40,00% 35,00% 30,00% 25,00% 20,00% 15,00% 10,00% 5,00% 0,00% 2003 2004 2005 2006 2007 2008 2009 2010 2011
Source: Central Bank of the Republic of Colombia COLOMBIAN EXTERNAL DEBT, Economic Studies Division. March 2012

% GDP

The year 2003 was a critical year in the external front when the size of the country's external debt was above 40% of GDP, a situation that was successively attenuated to achieve stabilization, on indicators in a range slightly above 20% of GDP, a condition which confirms, at the end of 2011, a prudent use of these sources in front of a growing economy.

The composition of external debt by instrument, grouped into two categories, one being bonds and the other loans including commercial loans, long and short term bank debt and others, showed in the graph below, illustrates that the latter increased from USD 25.553 million to USD 48,199 USD million, representing an 88.62% from 2003 to 2011. Graph 10. Colombian External Debt-Loans vs Bonds 2003 2011 (USD millions) 80.000 70.000 60.000 50.000 40.000 30.000 20.000 10.000 0 2003 2004 2005 2006 2007 2008 2009 2010 2011
Source: Central Bank of the Republic of Colombia COLOMBIAN EXTERNAL DEBT, Economic Studies Division. March 2012

BONDS LOANS

But the most significant aspect to highlight is the 102% increase that had the bonds as a funding source, which have contributed to improve the profile of the Colombian external debt with a transformation of longer terms and lower rates as it will be described at the end of this apart. Graph 11, shown below, reveals that that country's foreign debt financed by bonds increased from USD 12.511 million in 2003 to a sum more than double or $ 25.267 million at the end of 2011. Graph 11. Colombian External Debt-Bonds 2003 2011 (USD millions)

BONDS
30.000 25.000 20.000 15.000 10.000 5.000 0 2003 2004 2005 2006 2007 2008 2009 2010 2011
Source: Central Bank of the Republic of Colombia COLOMBIAN EXTERNAL DEBT, Economic Studies Division. March 2012

BONDS

1.2.3 COLOMBIAN SOVEREIGN DEBT. BEHAVIOR: SPREADS AND RATINGS. 2003 2011
When it comes to talk about emerging market bonds the obligated reference is the EMBI Global composite, as calculated by JPMorgan, to represent the sovereign spread over U.S. Treasuries. The index was introduced in August 1999, and is the most comprehensive emerging markets debt benchmark. The Colombian sovereign spread, represented by the EMBI Global Colombia composite, is graphed in figure 1, for the time period from 2003 to 2011. The spread during this period has experienced two peaks and two bottoms, has come to a high of 722 on 02/13/2003, to a low of 93 on 06/21/2007, and computes an average price of 287.38 over the period shown. Peaks are explained by to two large shocks. The first one due to the election Lula da Silva as Brazilian President, who in earlier campaign, threatened to default on the Brazilian debt. The second one reflects the impact of the 2008 debt crisis. The Brazilian crisis had a severe impact on Colombian spreads, because the country was perceived with economic structural similarities to Brazil, nevertheless Brazilian spread reached a high of 2,500 basis points, while Colombias slightly reached 1,000 in September 2002 and started a notorious advance as Brazil committed himself to service the debt fully, achieving an exceptional 93 mark on 2007. Figure 1. EMBI Global Colombia composite 2003- 2011
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Source: Ultraburstiles S.A. Comisionista de Bolsa.

The 2008 economic crisis which was driven by a housing bubble, excessive debt leverage and the crash of the subprime debt market widened significantly spreads for emerging markets but the impact on Colombians, as shown in graph 1.2.5, though notable did not reached the peak of the period 2003 2011 and remained well below the 1,000 mark during the Brazilian crisis.

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EMBI: Emerging Market Bond Index

The period analyzed also exposes the lowest spread of 93 in mid 2007, which contrasts with the BB+ credit rating for Colombia by Standard & Poors, an speculative grade at that time (Table 1), but one to be traded for an investment grade economy. Table 1. Credit rating history of Colombia Effective on 16/03/2011 05/03/2007 S&P 24/05/2000 21/09/1999 21/06/1993 31/05/2011 19/06/2008 11/08/1999 09/06/1999 Moody's 18/12/1998 30/09/1998 15/09/1995 25/05/1995 04/08/1993 22/06/2011 Fitch 21/06/2007 10/01/2002 19/05/2000 Credit Rating BBBBB+ BB BB+ BBBBaa3 Ba1 Ba2 Baa3 Baa3 Baa3 Baa3 Ba1 Ba1 BBBBB+ BB+ BB+

Source: Corredores Asociados S.A. Comisionistas de Bolsa

Colombia is currently rated as an Investment Grade or BBB- with a stable outlook by Standard & Poors. Fiscal strength, organized financial planning and the countrys projected economic growth were the reasons that the risk assessment agency underlined on March 2011, when it upgraded Colombian sovereign debt. Fitch also rated Colombia as an Investment Grade or BBB-. In recent declarations to Reuters Gabriel Torres 13 one of the vice-presidents of Moodys mentioned a positive perspective for the country .

1.2.4 COLOMBIAN SOVEREIGN DEBT. ISSUES AND PRICING.

Current spreads over the US treasury bonds rate for five outstanding Colombian sovereign debt issues are shown in Table 2, reflecting higher prices and very low spreads 44,9 and 83,9 basis points (bp) especially for the shortest durations. Other spreads like 155,4 bp and 278,6 bp for bonds with maturities on 2020 and 2028 respectively are also a sign of active demand for Colombian debt in the market at the moment.

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A Moodys le entusiasma el panorama econmico de Colombia, Dinero.com, 4 de enero de 2012

Table 2. Colombian sovereign debt current spreads Issue COL28 COL16 COL13 COL20 COL14 Duration (yrs) 9,483 3,372 0,790 5,813 2,484 Maturity 3/9/2028 2/15/2016 1/15/2013 2/25/2020 12/22/2014 Coupon 11,85% 8,70% 10,75% 11,75% 8,25% Yield 4,24% 3,00% 1,21% 3,28% 1,46% Price 187,6911 120,845 107,75 158,75 118,275 Spread Over T-bills (bp) 278,6 315,9 44,9 155,4 83,9

Source: Ultraburstiles S.A. Comisionista de Bolsa.

While the markets were responding to the difficult situation in Europe in 2011, the Republic of Colombia successfully issued USD 2 billion in a new global bond with a maturity of 10 years in the international markets. The transaction faced a demand of USD 7.3 billion and a participation of 293 investor accounts from the US, Europe, Latin America and others and marked a 130 basis points spread over the US treasury bonds rate, which was the lowest ever seen in Colombian history. (See Table 3) But again at the beginning of 2012 the Colombian government repeated last year success, this time with a selling of USD 1.5 billion of bonds due 2041 to yield 4.96 with a 6,125% coupon rate, marked at 165 basis points over US T-bills as shown in Table 3. At the end, 165 investors participated for a total demand for the securities of USD 3.6 billion.

Table 3. Colombian sovereign debt latest issues Issue COL21 COL41 Ammount USD $ 2.000.000.000,00 $ 1.500.000.000,00 Maturity 07/12/2021 01/18/2041 Coupon 4,375% 6,125% Spread Over T-bills (bp) 130,0 165,0

Source: Ministry of Finance and Public Credit, Republic of Colombia.