Finance Minister of the Year: Cardenas steadies the ship

On meeting Mauricio Cárdenas one isn’t immediately reminded of Margaret Thatcher. Or Mikhael Gorbachev. But Cárdenas acknowledges that he has something in common with these politicians (and other notable examples): a big gap between domestic and international perception and appreciation.

Colombia’s finance minister must be at times frustrated by the level of internal criticism of his handling of the economy, which has at times strayed into personal territory when opposition politicians question his credentials for the office of managing Colombia’s economy and financial system. Fortunately for Cárdenas – and Euromoney would argue Colombia – the country’s president, Juan Manuel Santos Calderón, backs his finance minister unstintingly.

Cárdenas, a Berkeley-educated former scholar from the Brookings Institution, was one of the first reappointments in Calderón’s cabinet after he regained power in the 2014 elections and the president often asks his finance minister to appear at Sesiones de Controle Político, at which Congress grills members of the cabinet on government policy.

Cárdenas is running late for his appointment with Euromoney – a preceding meeting of the cabinet, chaired by the president, runs over. When Cárdenas appears, his height (he is well over six foot tall and a shock of thick, more-pepper-than-salt hair adds to the commanding appearance) and jovial demeanour (created by a loud, confident, booming and warm voice) strike an equal impression.

But the appearance of bonhomie belies a flinty resolve to push Colombia’s economic success story to the fore. It’s for this reason that – despite laughing away questions about whether he is personally affronted by continuing criticism of his record – he must surely harbour some feelings of disappointment beneath the surface about the lack of domestic appreciation for his performance with the economy.

And there is political cause for Cárdenas and Santos to worry if the finance minister is underappreciated – this isn’t a vanity issue. The president has pressed hard for a peace agreement with the FARC rebels, expending a lot of political capital to reach an agreement announced on September 23. However the president and Cárdenas meanwhile have identified fiscal reform as a key challenge to keep the economy on track – and legislation is planned – but if the minister can “own” fiscal reform and lever his personal political reputation to navigate approval through Congress then perhaps both objectives can be achieved concurrently.

To this end Cárdenas has revamped his personal PR team and hired a new spin doctor to focus just on the financial press – to explain and defend Colombia’s and Cárdenas’ record. Fortunately the new hire, who started in August, has plenty of positive messages to use in the charm offensive: Colombia has responded impressively to the severe terms-of-trade shock it is facing as the price of oil plummets. The country is a large oil producer and in 2013 oil receipts accounted for 20% of total government revenues – and 55% of all exports.

Today, the oil sector provides just 7% of revenues. The collapse in the price of oil has had a direct impact on the Colombian peso – down by 23% this year and by almost 60% in the past 12 months.

"We have about $47 billion in reserves but we don’t think it’s wise to start using those unless we really know what the fundamentals are – and what are the new fundamentals"

Inflation has jumped, due to the pass-through effect of higher import prices, and now exceeds the upper bound of its target (4%) but – as yet – the central bank has not felt compelled to increase interest rates. Unlike other oil producing countries (such as Russia) and Latin American peers (such as Brazil) the stability in monetary policy points to well anchored expectations.

International investors are also calm: as CDS spreads and yields on sovereign debt have spiked elsewhere, Colombia has outperformed its peers – a big vote of confidence in the country’s macroeconomic management and a testament to the country’s structural fiscal discipline law.

The finance minister’s consistent articulation of his government’s commitment to adhere to fiscal constraints during the country’s stress test has often been credited as a key source of investors’ differentiation of Colombia amid weakening emerging markets.

And then there is the economy: the second quarter’s growth of 3.0% (year-on-year) surprised on the upside and July’s retail sales grew at 4.5% year-on-year, beating the consensus forecast of 3.0% and the average of 3.4% for the first half of the year. Although clearly moderating from growth rates of around 5.5% to 6% in previous years – the country is not only one of the quickest growing EM economies (above Mexico, Chile and Brazil and level with Peru) but confidently projecting that it will be the seventh fastest growing economy in the world this year.

Diversification away from oil and other commodities is providing a back-up engine: the government’s investment in the low income housing sector has led to a jump in construction (the sector grew by 8.7% in Q2 2015) and with the $50 billion “4G” series of road projects due to begin construction later this year – and boost GDP by up to 1.5 percentage points for the next four years – there is a very slim chance the country will flirt with the recessions that threaten much of the emerging market world. The country also continues to add jobs, with the employment rate rising 0.3 percentage points to 56.9% at the end of the first quarter, which is helping to buoy domestic consumption. In short, the economy is performing well nominally – and exceptionally well relatively.

Despite the country’s undeniably strong preparedness for this terms-of-trade shock Colombia is not out of the woods yet and there remains much to be done to prevent a deterioration in its fundamentals. One of the country’s biggest challenges is the increase in the current account deficit, which jumped to an uncomfortably high 6.9% of GDP in the first quarter of 2015.

Cárdenas wants to get that down under 5% as soon as possible and he says that ambition has been one of the reasons that the central bank (Cárdenas sits on the board of the central bank’s monetary policy committee) hasn’t intervened in the FX market despite the rapid depreciation in the peso.

The strategy is working – in the second quarter the current account deficit fell to 5.2% of GDP and projections for the year have lowered to around 5.6% of GDP. “The adjustment of the current account has been very fast because of the flexibility of the exchange rate,” says Cárdenas. “It is adjusting but it is still high – well above what is optimal or desirable.” Cárdenas admits the lack of intervention in the FX market is not due to philosophical reasons – the bank has been active in the past. He says it is more a reflection that the bank is waiting to see at what market valuation the currency will stabilize.

Unlike many other EM countries, there has been no attempt to even guide the market with an articulation from the minister of finance or the central bank about whether it feels the FX rate has overshot its fundamentals. Why not?

“There is always a big uncertainty about what the equilibrium exchange rate is,” says Cárdenas. “I asked the staff at the central bank to make a calculation to help us understand where we are now – whether or not there has been an overshooting of the currency – and the report they gave us suggests that the current exchange rate, at close to Ps3,000 to the dollar, is within the range that they would call a reasonable equilibrium value. And that is another reason [beyond the current account adjustment] we haven’t intervened. We have decided to see where the market settles before making a decision.”

Is the nonintervention also a practical acceptance that, as the strengthening dollar is a global phenomenon, the central bank could perhaps slow the depreciation but would ultimately end up at the same valuation in six months’ time, while having burned through billions of dollars of reserves – potentially leading to an even weaker end result?

“Absolutely,” he says. “We have about $47 billion in reserves but we don’t think it’s wise to start using those unless we really know what the fundamentals are – and what are the new fundamentals. There are two major sources of uncertainty: we have seen the dollar getting stronger globally so first we have to understand [in relation to depreciation of the peso] what is specific to Colombia and what is just due to the general strengthening of the dollar. Within the country-specific evaluation it is then very hard to decide what is permanent and what is temporary and that’s why we are letting the market adjust.”

He adds: “If we see something that is out of the ordinary and can not be explained by fundamentals then you can be sure we will intervene – but we haven’t seen that so far.”

Sticking with monetary policy, inflation has started to rise to levels (now 4.7%) that are making some on the central bank’s board uncomfortable. The last two meetings have seen split votes – with some keen to begin to increase rates to ensure that inflation is contained. Cárdenas is characterized as one of the more dovish members – emphasizing the need to maintain rates to foster growth and confident that the increase in inflation is a one-off pass-through event – but he acknowledges that persistently high inflation could lead to a change in expectations, weakening the hard-fought anchor.

“Well, clearly the August inflation figures were not a source of good news because inflation increased to 4.7% from 4.5%,” he says. “I think that everyone on the central bank’s board understands that the depreciation of the currency leads to a one-off increase in prices which does not necessarily mean that there will be greater inflation on a permanent basis – it’s just an adjustment in relative prices and should be a one-off. But that is one thing and the other thing is inflation expectations – what people think and how they are forming their expectations and whether they see the target we have set as credible. Those are the things that central bankers need to worry about and that’s the essence of the conversation.”

Cárdenas sees a flipside to current conditions: “I would say that given the economy will be growing below potential for the next [few] months, even years, the market should adjust itself in the sense that there will be fewer demand pressures. And with fewer demand pressures there will be less inflationary pressure. And that’s pretty much the debate and the central bank will do what it ultimately thinks is [needed] to keep inflation below the 4% target, which is the ceiling of the target and is very important to everyone – including the government.”

Colombia’s central bank is the least predictable of the five Latin American central banks that have inflation-targeting regimes (in a study of economists’ ability to predict policy actions) and Cárdenas says the central bank is not interested in adopting the current developed markets’ practice of forward guidance.

“The attitude of the board is to make its analysis based on today’s data and today’s circumstances and argue for the decision on the basis of what we see now,” he says. “We leave the future open. We rarely say what we are going to do in the future – we almost never say anything like that. We provide the fundamentals for the decision that has been taken in the specific month but not so much forward guidance.”

The bank is widely seen as enjoying independence in practice but is the presence on the board of the minister an institutional weakness?

“No. My own personal view is that the institutional arrangement that Colombia has is very effective because it combines independence – there are seven members of the board and the minister of finance is just one of them and the others are fully independent. So the decisions are very independent but the presence of the minister of finance helps in bringing information, perspectives and coordination with fiscal policy.”

Talking of fiscal policy, Cárdenas says that of all the metrics that are testament to Colombia’s strong response to the negative EM environment he is most proud of the country’s ability to reduce rapidly its dependence on oil for fiscal revenues while maintaining its fiscal goals.

“This year oil will account for about 7% of revenues [down from 20% in 2013] and so we have accommodated that shock and yet we are still going to have a relatively low fiscal deficit, of about 3% of GDP,” he says. “We have done that by anticipating the need for more revenues and making significant budget cuts.”

Cárdenas ushered through tax reforms in 2014 that essentially renewed taxes that were due to expire, extending those revenues until 2018, and some other minor tweaks. However, he also set in motion a committee to draw up structural fiscal reform that will widen the tax base and increase revenues.

Colombia’s tax receipts are low, at just 16% of GDP, and even without the fall in oil revenues Cárdenas says the country needed structural reform to increase that to around 18%, especially as it is mandated to lower the national debt in the medium term. Last year’s reforms were seen as a bridge to that structural change but with president Santos prioritizing a peace accord with the FARC rebels, doubts remain over whether the government has the political capital to enact widespread tax reform at the same time.

Cárdenas seems confident: “There is an independent panel that it going to provide its recommendations in November and we will use that to structure a bill to submit to congress and try and enact as soon as possible,” he says. Does he expect that tax bill to be approved and generating new revenues by 2018 (which would require adoption in 2017)? “Yes – and some could be earlier than that.”

Does he expect that the peace process could have an impact on tax reform?

“The peace process is essentially something that can happen at any time – and we have to be prepared for that scenario,” he says. “We don’t know how much it is going to cost. We know that whatever we agree to in the context of those negotiations is going to take time [to be implemented] – it is not going to be overnight. We will have to extend the execution of those commitments over a period of years so that we don’t compromise our fiscal sustainability.”

Cárdenas expects that there will also be a peace dividend to help offset the costs and points out that the government is already spending 1% of GDP on reparations to victims and land restitution that are commonly considered post-conflict expenditures.

What should Colombians expect from the new tax law? Cárdenas has been on record as saying that in his view tax collection should be neutral whereas government expenditures should be redistributive. But with the committee’s interim report pointing to an adoption of a more progressive taxation regime, has the minister’s view changed?

“I am convinced that in a society with the level of inequality that we have the state has a very active role in narrowing those inequalities – the market alone will not do it,” he says. “So I think we need a firm hand from the state and very specifically public finances can play a role in reducing inequality – its essentially what they do in Europe and it makes a difference. I also think that the most effective tool in reducing social inequality is through well-targeted social interventions – through government expenditures – that help people leave poverty.

“And I don’t think that taxes should be completely neutral – taxes can also help and some form of progressive taxation is useful, which is why we have favoured raising taxes on the rich. But at the same time as being progressive, the tax system also has to be competitive – you have to be able to produce a tax burden that doesn’t become an obstacle for investment and for the private sector to locate in Colombia. So we will have to think a lot about making sure our tax system is competitive and thinking more about redistribution through government expenditures.”

Cárdenas adds that enforcement is also critical: “There is so much tax evasion that with the same tax rate structure we could widen the tax base [by lowering informality] you could collect a lot more.” Cárdenas notes that informality has fallen following a 2012 reform to payroll taxes but more can be done.

Meanwhile, Cárdenas isn’t simply waiting for the new fiscal revenues. Given low government spend in Colombia – 21% of GDP last year – the room for cutting is small but Cárdenas has managed to reduce that level by one percentage point this year and will do so again next year – to 19% in 2016.

He describes the cuts as part of “intelligent austerity. We are making it possible for the private sector to substitute some of the expenditures we would otherwise do – for example by passing some infrastructure to the private sector and cutting capital expenditures by 10.5%. We are also forcing every entity of the national government – and there are 150 of them – to reduce their payroll and general services expenditures by a nominal 2.5%, which is more in real terms.” The result should enable the government to comply with its fiscal rules that allow for a 3% of GDP deficit this year and 3.6% next year (flexibility is built in to the rule in times of falling government receipts). Some argue  the rapid depreciation in the Colombian peso has also been favourable to the ministry of finance as a means of protecting the fiscal base – falling oil receipts are mitigated if the currency falls by a similar level to the oil price. However, Cárdenas shrugs off this as a motivation to  let the peso fall. “About 30% of our public debt is in dollars and so debt servicing costs go up [if the peso falls],” he says. “It is not that clear that the depreciation in the currency helps the public finances.”

He is also confident that the banking system and Colombian corporates are well placed to weather the depreciation. “We are not seeing major disruptions because the dollar debt of the private sector is limited to a few companies that also earn dollars – in the oil or mining sectors – and so the country has been able to absorb and accommodate the depreciation surprisingly well,” he says.

This robust response from the economy will be enhanced when the first of the 40 road projects starts construction at the end of this year. The “4G” programme was conceived over four years ago, and it was envisaged it would lift the country’s GDP growth to around 7%. Now it looks like it will push growth back to around 5% – the country’s development agency ANI predicts it will boost GDP growth by 1.5 percentage points during construction (up to 2020) and long-term inflation-free trend growth by half of that thereafter. In a region that is desperately looking to infrastructure to provide alternative long-term growth to commodities Colombia is an example of the benefits of long-term planning.

“It’s our best counter-cyclical policy – although I use that term loosely,” says Cárdenas. “It is a great coincidence that this is going to be available when we are having this negative shock – it’s one way to compensate. We have always needed these roads for long-term productivity reasons. It is now not only enhancing productivity in the long term but from a short-term point of view it’s a great way to stimulate the economy.”

The fact that the projects will be being built when the economy has some slack will also limit the crowding-out effect that had led some to question the levels of GDP growth attributed to the projects. With much of the finance being sourced domestically, the 1.5% rate was challenged by those who argued that other credits, which would otherwise have been financed, now would not be.

Cárdenas will not be drawn on whether he accepted the argument put to him by the head of the ANI, Luis Andrade, that the programme was fiscally neutral over the lifetime of the projects. However, he does believe that the fiscal commitment to supporting Colombian PPPS shouldn’t exceed 10% of GDP over a 30-year period.

As the payments are dependent on the performance of the assets, they are not categorized as debt but Cárdenas thinks exceeding the 10% rule would be fiscally irresponsible. The ministry of finance could not provide an exact running total of that percentage after accumulating the 4G project commitments but Cárdenas says it is nearing the 10% threshold – clearly constraining the country’s ability to conduct further PPP initiatives. “It’s not a legally enforceable limit,” he says. “It’s more an idea that I have based on the experience of other countries that are doing the same thing – we are still below that limit and I don’t think it is fiscally sound to go above it.”

The investment in infrastructure, led by the private sector, has seen the country’s investment rate come clear to 30%, which is a record that will be difficult to maintain. “It’s the highest level of investment in Latin America and keeping at that level will be a challenge because we are going to lose some of the investment that is associated with the energy sector due to the decline in oil prices,” he says. “Oil companies are going to be investing less – we have seen that with Ecopetrol – and it will be a big challenge to offset the energy investment.”

Given Cárdenas’ previous experience as minister of mines, just how does he see commodity and oil prices performing in the years ahead – is this a global cyclical or structural low?

“Rather than giving you a well-thought out answer based on global supply and demand I’ll give you the practical answer,” he says. “From the point of view of our [government’s] term, this is permanent. Our term ends in 2018 and we are not expecting any recovery in oil prices soon – certainly not to the level where prices were. Eventually, being optimistic, we could expect prices to go back to the $60 to $70 per barrel range, but not for our planning purposes.”

Mauricio Cárdenas’ fiscal credibility and investment plans have bolstered the country’s defences amid the emerging market rout, while boasting the best economic growth in the region.