Colombia reached an important milestone after its government agreed a peace deal with FARC, originally a Marxist-Leninist guerrilla movement fighting unequal land ownership that became a terrorist group living off a lucrative drug trade. The deal comes after 52 years of conflict, which claimed more than 220,000 lives and displaced more than 7 million people. The accord outlines a timetable for FARC militants to surrender their arms and reintegrate in society and stipulates reparations to victims of the conflict (e.g. by land restitutions). A transitional justice system for crimes committed during the conflict will be set up. FARC militants who committed or ordered atrocities but confess their crimes will avoid serving their sentences in jail. Instead they must perform community service projects for a period of up to 8 years. The government commits to rural development programs with the aim to address poverty and inequality (according to the IMF, Colombia’s Gini coefficient in 2015 was a high 52.2), whereas the FARC will eradicate drug crops. The government also agrees to widen the opportunities of political participation to smaller political movements (including a party that FARC may found, which would be guaranteed 5 seats in Congress for the 2018 and 2022 terms). The deal will be put to a national plebiscite on October 2nd.

The peacemaker…

It is by no means assured that the deal will be ratified in the plebiscite. Many Colombians would like to see that FARC members do time in jail and believe that the deal is too soft on them. This is understandable given the grave terror (murders, kidnappings and alike) that FARC unleashed against the population over the years. But to ask FARC to voluntarily be jailed for 20 years is like asking turkeys to vote for Christmas: it won’t happen. Alvaro Uribe, predecessor of current president Juan Manuel Santos and whose government during 2002-2010 basically defeated FARC in an all-out war, is leading the opposition to the accord. Mr. Uribe, whose father was killed by FARC rebels, portrays the deal as handing over Colombia to the chávismo FARC. It doesn’t help that Mr. Santos, a staid technocrat, is nearly as popular as Nicolás Maduro, president of neighboring Venezuela (a Gallup poll in May of this year puts it at just over 20%). Furthermore, FARC did not monopolize terrorism in Colombia. The ELN, a similar though much smaller outfit, still needs to find its way to the negotiation table. Even if the accord is ratified and the ELN is brought into the deal, there are many challenges ahead. Development projects in FARC-infested areas should gather pace quickly and security and justice be restored. Quick wins (for example, provision of basic infrastructure) are required to get the buy-in from the population, in our view.

We side with Mr. Santos and believe the peace accord offers Colombia a historic opportunity to improve the lives of poor Colombians (mostly the peasants that FARC claimed to fight for). Unfortunately, Colombia is facing economic headwinds due to the collapse in commodity prices since 2015, which could hamper its ability to invest in infrastructure and provide economic growth and funding for social support programs to lift its citizens out of poverty. Although the government has implemented sound macroeconomic policies, much work remains to be done. The IMF projects economic growth for this year at a still respectable 2.5%. For next year, growth of 3% is penciled in, slowly growing to 4% in the years thereafter. The table below shows historic data and forecasts for main macroeconomic indicators (source: Citigroup, July 2016):

Growth in 2012-2015 was underpinned by both private consumption (leading to a modest property bubble) and private investment (especially in the energy and mining sectors). The collapse in commodity prices led to substantial cuts in capex and a significant depreciation of the peso (now just under 3,000 pesos per dollar, a decline by about one-third). Unsurprisingly, due to the weakening currency and also because of El Niño (adversely affecting crops), inflation edged up, forcing the central bank to tighten monetary policy which obviously will dampen domestic demand. Despite a weak peso, exports have not picked up as Colombia’s neighbors are in poor shape (only Colombia’s border regions are benefiting somewhat from Venezuelan “food tourism”). Thus, the current account deficit remains elevated (also amplified because dollar-denominated GDP, derived from commodities, dropped), although it probably peaked this year and will decline to a more manageable 3.5% in the coming years. The so-called 4G infrastructure project (an USD 25 billion PPP initiative to build 8,000km of “4th generation” roads) is supporting the economy and is required to lay the foundation for long-term growth prospects. The fiscal balance deteriorated but the government is committed to the fiscal rule (a target structural deficit based on parameters for growth and oil prices defined by an independent committee) and is expected to achieve its structural balance target of 1% by 2022. Colombia’s external debt position worsened but not to alarming levels (just above 40%). The IMF recently approved a 2-year USD 11.5 billion Flexible Credit Line, which can be used in adverse economic scenarios (i.e. a new drop in commodity prices or retreat in financial markets, for example triggered by an economic slowdown in China or a Federal Reserve interest rate hike) and, thus, provides a buffer in tough times ahead.

As is the case for most emerging markets, Colombia needs to implement structural reforms to stimulate long-term economic growth. In Colombia’s case this includes broadening the tax base (to replace lost income from oil) and making it more progressive whilst at the same time maintain funding on social programs and improve (primary) education. We understand that a structural tax reform will be presented to Congress on October 10th. The 4G infrastructure projects are very important to improve competitiveness whereas there still is ample room to simplify/ease bureaucratic procedures and regulations for businesses. Land reform, in our view, is also important to develop agri-business. This may be somewhat contentious as a competitive agri-business requires relaxation of (foreign) land ownership (i.e. ability to own and operate large tracts of land to become a low-cost producer of grains). To be sure, the government has been working on these reforms and has made good progress, but more needs to be done.

We believe Colombia deserves (financial) support from the U.S. and EU in implementing the peace plan as the social and humanitarian gains for Colombia are huge. Public endorsement with financial commitments would be very welcome, in our view, so that the probability that Colombians seize this historic opportunity to vote for peace is increased. If the accord is ratified in the plebiscite, there will be no uncertainty who will be the next winner of the Nobel Peace Prize.