Colombia's presidential election on 29 May looks set to be a two-horse race between leftist Gustavo Petro and centre-right Federico Gutierrez, as widely expected after the primary vote in March. Petro is well ahead in the polls and remains favourite to win, even being able to increase the size of his lead over Gutierrez, his main rival, while the other four candidates trail a long way behind.
That said, Petro seems unlikely to achieve the 50% needed for an outright victory, which would mean a run-off vote on 19 June against the second-placed candidate (most likely Gutierrez). At that point, things may not be so straightforward.
Whoever wins, however, they will take over at a difficult time as the deterioration in the external environment linked to Russia's war in Ukraine and higher global interest rates hit the economy, while a divided Congress may hamper reform efforts. That said, investors will be more nervous about Petro as he represents a greater threat to Colombia's economic institutions and macro stability.
Petro (of the Historic Pact party) has held a commanding lead over Gutierrez (Team Colombia) for some time now. According to the latest CNC opinion poll, Petro is on 38% of the vote to Gutierrez's 24%. Rodolfo Hernandez (Independent) is in third place, with 10%, and Sergio Fajardo (Hope Center) in fourth, with 7%. The remaining candidates (Ingrid Betancourt and John Milton Rodriguez) poll less than 1%. Other polls show a similar profile, although Petro's lead over Gutierrez varies.
Note that current president, Ivan Duque, elected in 2018, cannot run again due to the non-renewable four-year-term limit. Duque defeated Petro in that election, after a second-round run-off (54% to 42%).
If Petro wins, in his third bid for the presidency, he would become Colombia's first leftist leader, marking a dramatic shift in the country's political landscape – bringing hope for some, who see him as a vote for change (despite being part of the political establishment) and fears for others (a threat to macro stability and even to security).
That said, there are a few things to watch. First, the extent to which the presence of other candidates fragment the vote, although this may work more to the detriment of Gutierrez, and benefit of Petro, than the other way around. Petro is firmly identifiable as the left. Gutierrez may be competing with others for the traditional conservative vote.
Second, the May vote could still be influenced by the high level of undecided voters (averaging c10%, according to some polls). Capturing these, and tactical voting by supporters of the remaining candidates, could therefore still swing the vote in either Petro's or Gutierrez's direction – potentially meaning either Petro is able to secure an outright win (market negative) or that Gutierrez is able to close the gap sufficiently to force a run-off and raise hopes that he can overturn the deficit going into the second round (market positive); a third scenario, an outright win for Gutierrez in the May vote, seems unlikely at this stage.
If it goes to a second round, much will then depend on the winning margin and where the votes of losing candidates migrate to. If Petro wins by a narrower-than-expected margin, that will raise hopes that Gutierrez can overturn the deficit. Gutierrez should benefit from picking up the centre-right and traditional conservative vote and even wavering Petro voters who change their minds at the last minute on the prospect of such radical change. Petro, for his part, may pick up centre-left votes from Fajardo and Betancourt.
But Petro, if he is elected president – and, indeed, whoever wins – would, however, lack a legislative majority and have to deal with a divided Congress. Following the legislative elections in March, Petro's Historic Pact became the largest party in the lower house and second largest in the Senate, but fell short of a majority in both chambers. This may be some comfort to investors, but, as a divided Congress may help to block or dilute populist excess, it could also undermine governance and stifle reform prospects, which would also weigh on the investment climate.
Petro has campaigned on reducing income inequality and increasing social spending, and, while some of his aims may be laudable in a country marred by years of conflict and insecurity, it will be the way that he goes about it that matters for investors (and, ultimately, his chances of success).
Petro is reported to want to end oil exploration and cut the country's dependence on fossil fuels, and raise import tariffs, while his plans for land reform, tax reform, wealth redistribution and the redistribution of pension savings may cause alarm not just among the rich but among businesses and the middle class. He aims to raise US$10bn a year (2.8% of 2022 GDP) through, inter alia, levies on company dividends and offshore assets. Meanwhile, his monetary policy plans could also threaten central bank independence (a strong central bank has been a pillar of macro-stability over the past 20-something years). This includes possible changes to the objectives of monetary policy (or how the objectives are delivered), central bank board appointments and Erdogan-like views on high interest rates.
On the other hand, Gutierrez largely represents policy continuity, in a historically right-leaning pro-business country, albeit one in which inequality has grown and more people feel marginalised as the benefits of macro-stability accrue only to a few.
Whoever wins, the next President will take over at a difficult time as the deterioration in the external environment linked to Russia's war in Ukraine and higher global interest rates hit the economy. Higher inflation, higher interest rates and slower growth may make for a short honeymoon period. That said, investors will be more nervous about Petro, as he represents a greater threat to Colombia's economic institutions and macro-stability.
Real GDP growth is projected at 5.8% this year by the IMF, down from the Covid-induced bounce back of 10.6% last year, although marking an upward revision from the 3.8% expected in the October WEO (possibly due to higher-than-expected oil prices). Colombia is a (small) oil exporter (producing c750,000 barrels per day). Medium-term growth, however, remains at 3.4%. Growth this year may be helped by the better-than-expected out-turn for Q1, according to official data released this week (8.5% yoy versus 7.7% for the Bloomberg consensus) although that is before the impact of the Ukraine war, monetary tightening and any election-related uncertainty.
Consumer price inflation rose to 9.2% yoy in April, well above the central bank's 2-4% target range, and a 22-year high. This compares with just 5.6% in December.
The central bank has responded to the acceleration in inflation by increasing its policy rate by a total of 425bps in six hikes since its tightening cycle began in September 2021. The past three hikes have been 100bps each, with the most recent increase – as expected – coming at the board of directors' last meeting, on 29 April. This has taken the policy rate to 6%, although, with real interest rates still negative, further hikes are likely to be needed. This could pose a test for a Petro presidency.
Meanwhile, the consolidated public sector balance is expected to narrow to 4.4% of GDP this year, down from 7.2% in 2021, according to the IMF. The IMF projects a 2.1% deficit in 2023 and 1.3% in 2024. Helped by oil revenues, the consolidated deficit is narrower than the central government deficit, which is projected at 6.1% this year, down from 8.2% in 2021, and only falling to below 3% by 2025. Investors may worry, however, that a Petro presidency may seek a slower pace of fiscal consolidation, and that his fiscal plans could threaten debt sustainability.
Public debt jumped to 66% of GDP in 2020, after the pandemic, according to the IMF, an increase of 14ppts from 2019. Debt stabilised last year, at 65%, and is projected to fall to 61% this year and 59% in 2023.
However, external vulnerabilities present a key threat to macro-stability, with a reasonably large and persistent current account deficit (albeit projected to narrow from 5.7% of GDP in 2021 to 3.3% this year, on the back of higher oil prices, but to stabilise at 4% over the medium term) and high external financing needs (c14% of GDP) – reflecting high amortisation. This leaves Colombia vulnerable to swings in market sentiment and sudden stops, and exposed to higher refinancing costs. External debt ratios (external debt/exports and the MLT debt service ratio) are also high (c300% and c30%, respectively), although much of this is driven by the external debt of the private sector. International reserves (US$57.5bn at end-April, according to the central bank) are, however, comfortable, projected this year by the IMF at 8.4 months imports cover and 127% of its ARA metric.
Liquidity buffers are also reinforced by the IMF. The IMF approved another contingent credit facility, under its flexible credit line (FCL), for Colombia on 29 April. The new two-year FCL, amounting to US$9.8bn, is a successor arrangement to its previous US$17bn two year facility that was approved in 2020, under which it drew about 30%. The new FCL is Colombia's ninth such arrangement and the authorities intend to treat it as precautionary. It may be seen as prudent that the current government sought to renew the facility ahead of the election to provide an additional external buffer. The new facility is a bit less (cUS$2bn) than the undrawn amount of its previous one.
Meanwhile, the Colombian peso has remained relatively stable this year (appreciating by 1.1% versus the US dollar this year), although its performance has come in distinct phases – appreciation versus the US dollar through the first quarter, helped by higher oil prices, was reversed in late April (perhaps on the back of the CNC opinion poll on 21 April, which showed Petro's lead over Gutierrez growing to 14ppts). Still, COP has been the fifth best-performing EM currency on Bloomberg's currency ranker this year.
Fixed income implications
We do not have a recommendation on Colombian bonds currently.
Colombia (Baa2/BB+/BB+) has seen its dollar bonds weaken sharply this year, as with most in EM, with the yield on the 10-year rising by over 140bps to c6.6% (price down 15pts – and down 23pts since last September). This is due to the deterioration in external conditions, while a possible shift to the left under Petro could also begin to weigh on investor sentiment. In fact, that the bonds have matched the index (a total return on the '32s YTD of -14.8% versus -14.7% for the Bloomberg EM Aggregate Index) might even suggest that the election hasn't really been an issue thus far (or rather it is reflected more in the currency than external debt).
The yield on the COLOM '32s is 6.6%, with a z-spread of 383bps (and a cash price of cUS$76) as of cob 17 May (on a mid-price basis on Bloomberg). The spread has widened by c80bps this year. Indeed, in this sell-off, Colombia is now some 140bps cheap to the curve on our ratings versus spreads model. Moreover, Colombia's spread over Peru has also widened to c190bps on comparable '31s, compared with 100bps in the post-Covid period and a low of 30bps a year ago. Better-rated Peru is, however, close to fair value on our ratings versus spreads model, even though it too has its own political issues.
On the surface, such valuations may even begin to look attractive for Colombian bonds, as ability and willingness to pay are both strong, supported by a strong policy framework, but we think investors may defer decisions pending the outcome of the presidential election, and – if Petro does win – better visibility over policy implementation and, given the composition of Congress, prospects for governance. On the downside, leftist Bolivia's '30s yield 8.4% (z-spread 569bps).
Equity implications: Cheap versus oil peers
Colombia equities (IEQC Index) are up 7% ytd in total US$ return terms, driven by the 45% increase in the oil price (Brent) – at over US$100 per barrel, net exports of fuel equate to c10% of Colombia GDP. However, equities are down 11% qtd, driven by concerns over a tilt leftwards in political leadership (despite recent concerns over global growth, oil prices are still up 5% qtd).
Directionally, this performance is similar to most global EM oil exporter peers, eg in the GCC, and to regional LatAm peers, but, relative to both peer groups, Colombia has underperformed.
Trailing PB of 1.0x (for 12% ROE) is a 13% discount to the five-year median and forward 2022 PE of 9x (for 23% earnings growth and 5.9% dividend yield), a 32% discount to the five-year median. A return to the 10-year real effective exchange rate would imply over 20% upside to the FX rate.
These are substantially more discounted valuation multiples versus history than seen in global EM oil exporter peers, less so when considered alongside LatAm peers.
For global investors who can tolerate relatively low liquidity (average daily traded value over the past six months is merely US$32mn a day), Colombia equities look more attractively valued than oil exporter peers, ie political risk appears to be adequately reflected.
Relative to LatAm peers, particularly those driven by commodity exports like our favourite regional market, Chile, where its main export copper should have structurally higher demand growth than oil, because of the transition to renewable energy, Colombia’s investment case is less compelling.