Peace and Prosperity

November 15, 2016

If you’ve found the post-brexit drop in sterling alarming, spare a thought for the Colombians. Over the last two years the Colombian peso has dropped 40% against the dollar, as falling oil prices work like a chainsaw through the country’s export earnings. For Colombia’s new middle class, created by the economic boom that began at the start of the century, the recently-acquired taste for imported gadgets and foreign holidays is becoming prohibitively expensive. The end of the commodity ‘super-cycle’ also wreaked havoc with the country’s macroeconomic standings. The drop in exports has pushed up the current account deficit while the lower tax take has left the government with a large fiscal shortfall.

It all sounds pretty grim. Yet the depressing economic headlines hide an exciting opportunity for investors. For all of its problems Colombia has managed to avoid the economic travails of neighbours Brazil and Venezuela, both of whom are in severe recession and Colombia’s economy is growing at around 2.6% per year. The weak peso is stimulating rapid growth in other areas, such as manufacturing, which is growing at 6%, tourism and financial services. The initial boost from the depreciation will be sustained by profound structural changes, such as the peace process and the extensive infrastructure programme, which will boost the competitiveness of Colombian industry. It’s an economic transformation that is set to reward investors. And, best of all, UK investors who buy in now get a great discount. Even after sterling’s brexit fall, the Colombian peso is still 30% down against the pound since the start of 2013. That means now is a great time to pick up Colombian assets on the cheap.

Why Colombia?

Before we look at the specific sectors that will reward investors it probably makes sense to give a quick class in ‘Colombia 101’. For most of the 20th century Colombia’s economy was inward-looking and closed until a new constitution in 1991 opened up the country to international investors. Yet during the 90s Colombia was on the verge of becoming a failed state with its institutions struggling to cope with two, interlinked battles. One was against the guerrillas, the most notable being the Revolutionary Armed Forces of Colombia (FARC), who first took up arms in 1964. The other was against the cocaine smuggling drug lords, whose immense wealth and power undermined the ability of the state to provide security for its citizens.

It would be presumptuous to declare victory but Colombia has made great progress with both battles. Drug smuggling continues but by weakened smaller narco gangs that have far less ability to impact the wider population. Likewise the various guerrilla groups and paramilitaries have been diminished and now operate in the fringes of the country.

It would be presumptuous to declare victory but Colombia has made great progress with both battles…

The growing power of the state coincided with a massive boom in commodity prices. Higher prices combined with improved security meant that Colombia could finally start to take advantage of its natural resource bounty. In just six years oil production doubled, hitting 1 million barrels of oil equivalent per day (boe/d) from around 500,000 boe/d in 2004. International capital began to pour into Colombia. In the decade following 2003 foreign direct investment (FDI) multiplied by almost ten times, reaching $16billion in 2013, up from just $1.7billion. Throw in a demographic boom – Colombia’s population has increased by 25% since the turn of the century, and its little surprise that the economy has done well. In fact it has tripled in size since 2000, making it one of the standout performers in the region.

Of course when a country builds wealth from commodities, it is always going to be susceptible when the price falls. The drop in oil has been far more severe than anyone was predicting two years ago, yet Colombia has ridden out the storm with surprising resilience. One reason is that the country’s macroeconomic management has been extremely prudent. Debt was reduced during the good times, which has given the government some slack to borrow again during the bad times. At 55% of GDP today it looks a lot healthier than the 70% in neighbouring Brazil. The government was also careful to reduce external debt, which has prevented the type of balance of payments crisis that used to be the norm during Latin American slowdowns. The other reason for the resilience is that Colombia’s economy has a lot more going for it than just oil and coal. These other sectors now well-placed to benefit from Colombia’s economic transition and will reward brave investors who buy in now.

Made in Colombia

One of the interesting quirks of the Colombian economy is that while oil and coal dominated exports – accounting for almost 80% in 2015 – Colombia’s economy is surprisingly diverse. Manufacturing, construction and services all contributed more to GDP last year than any commodity.

Colombia’s manufacturers have had a tough time over the past decade. The huge inflow of commodity investment and export earnings pushed up the Colombian peso and made locally-made products less competitive both at home and abroad. It has since fallen 40% against the US dollar – the currency of Colombia’s main trading partner, the US – which gives an instant boost to manufacturers. That can already been seen in the breakdown of GDP growth during the first quarter of the year. With an expansion of 4.5%, the non-oil manufacturing outgrew the wider economy for the first time since 2007.

José Darío Uribe Escobar, general manager of the Colombian Central Bank, believes that the weaker peso will continue to have a profound impact. “The fall of the current exchange has a permanent component, which sends a powerful price signal to the economy. This change in relative prices will eventually change the productive matrix of the economy. In the same way that the period of high commodity prices shaped the Colombian economy, over the next few years we will see a change. There will be a shift to agriculture, manufacturing and services like tourism.” Of course it takes time for the impact to be felt. First a producer has to believe that the new currency level is stable and then build a new plant – so this is very much an ongoing story. “Indeed the tourist sector has been the quickest to respond to the price signals and hotel occupancy rates in the country are at record highs… I think it will take five to ten years to see the full impact in other sectors.”

Colombia’s producers will also benefit from other factors. The country’s improved infrastructure will have a huge impact on productivity. At present it costs as much to send a container of cargo from the capital city Bogotá, which sits at 2,600 metres in the Andes mountain range, to Colombia’s main Atlantic port of Barranquilla. Lowering transport costs will make Colombian manufacturers more competitive at home and abroad. The country’s ongoing demographic boom – the population is expected to hit 60 million in 2030 up from 49 million today – will help producers by both creating a larger local market and keeping a lid on labour costs.

Rebuilding Colombia

Colombia’s land transport infrastructure is terrible, consisting of almost no rail and crumbling single-lane motorways. In the Colombia’s defence, there is a good reason for the historical lack of infrastructure development. It is an enormous country – roughly the size of France, Spain and Portugal combined – that is divided by three long branches of the Andes. Swathes of dense jungle and extreme weather events, such as floods that wash away roads, don’t help either. Meanwhile, half a century of civil conflict removed the government’s appetite and ability to solve the transport problem.

The challenging geography means that a comprehensive road network would be too expensive for the Colombian government to finance on its own. So in 2013 it launched the ambitious ‘4G’ infrastructure programme and invited investors from the local and international private sector to build and finance the roads. The scale of the programme is enormous, with $50billion-worth of projects expected over the next decade.

a comprehensive road network would be too expensive for the Colombian government to finance on its own…

To begin with the programme was beset by problems. Challenges from communities, unwieldy bureaucratic procedures and uncertainty over financing models, meant that the first year or so were full of delays. This year, however, has seen significant progress. Construction has started on nine projects, worth around $12.5billion, while many more have been awarded. Now the teething problems have been sorted, the programme should pick up pace. For Alejandro Sanchez, Executive Vice President of Corficolombiana, the largest infrastructure investor in Colombia, the 4G programme has been a steep learning curve for the country’s financial institutions. “It has taken time for international and local players to get to know each other. Until now Colombia’s large financial groups were able to fund and develop most projects, so the country has not got a lot of exposure to international financial actors. But I think things will move faster from now on because both local and international players have learned from the process.” The impact for the country is clear. Journey times between cities are going to drop, helping to reshape Colombia.

El Dorado

Over the last few years most of Colombia’s extractive industries have seen the prices of the materials they produce fall. However, one bright spot has been the gold market, where the price has risen almost 30% since the end of 2015. Even before prices started to rise there was a change in the Colombian gold mining industry. One reason is the improving security situation. Colombia’s gold mining was particularly affected by the civil conflict and the narco gangs. That’s because, unlike coal or oil, which need complicated logistics to get the produce to market, the high value-to-weight ratio of gold means that it is a handy funding source for illegal groups. Indeed roughly 80% of Colombian gold production comes from illegal mines. There are also historical reasons. Pre-columbine society was mining gold, silver and emeralds long before the Spanish turned up. As a result many communities see gold mining as an ancestral right, and not an activity that needs to be sanctioned by the government in Bogotá.

But now the situation is starting to change. There has been a push from the government to encourage informal miners to register their operations and bring them up to the required standards. Colombia’s strengthened institutions are now better able to handle these issues, and have a successful case study in emerald mining, which is now far more formalised. Another factor is that military victories against the Farc have opened up gold-rich mining locations to legitimate investment. In 2000 the Farc had 40% of Colombian territory under its control, which restricted gold miners’ exploration efforts. As these huge swathes of Colombia are opened up to modern, efficient mining, the country’s gold output will soar.

Colombia’s National Mining Agency (ANM) estimates that gold production will increase by 30% over the next five years. Indeed Colombia is expected to become a top ten gold producer by 2021, up from 20th position today. That optimism is based on four major gold mining projects being developed, with combined proven resources of 6.5 million ounces and grades as high as 10.8 grams per tonne. Clearly starting a mine in a former conflict area comes with its own set of challenges but for the companies that get in first the potential rewards are huge.

A version of this article first appeared in MoneyWeek on the 9th of September.