Foreign demand for Colombia’s peso-denominated bonds has been a boon for a country struggling with low commodity prices. But for how long will market confidence stay high? Jacopo Dettoni reports.

Colombia bonds

Colombia’s push for peace, reforms and an economic life beyond oil, combined with the peso’s renewed signs of vitality in the currency market, has shored up foreign demand of its peso-denominated debt notes, known as TESs, over the past two years. Almost untouched by investors outside the country only a few years ago, foreign holdings of Colombian bonds spiked up to more than one-quarter of total outstanding TES notes, as shown by the latest figures from the country's finance ministry.

US-based asset management powerhouse Franklin Templeton led the charge, accounting for half of the foreign demand for TES bonds in 2016. If growing inflows of portfolio investment helped the government support ongoing fiscal and current account adjustments, they also increased the pressure on the Colombian authorities to deliver on key issues such as fiscal discipline and a promised peace dividend following congressional approval of the historic peace deal with leftist rebel group Farc in December 2016. 

“It all means that we have to [take care of] the economy,” says central bank governor Juan José Echevarría. “If that doesn’t happen, this capital will leave the country.”

A buying spree

Unlike Colombian shares, which continue to be hampered by low liquidity, TESs stand out at the heart of a dynamic domestic fixed-income market with an increasingly diverse base of participants. Foreign holdings of TESs grew to 64,083.7bn pesos ($20.8bn), or 26.2% of total outstanding TESs, at the end of May 2017, twice as many as the 32,206.3bn pesos (15.6% of the total outstanding TESs) of June 2015, finance ministry figures show. Only as recently as 2012 they failed to reach 2.5%.

Franklin Templeton alone, which started adding Colombian local currency bonds in early 2016, acquired TESs for 10,000bn pesos in the full year, making up 48% of the foreign demand and becoming the largest single foreign investor in TES notes, according to figures from local asset manager Alianza Fiduciaria. Other major investment names such as BlackRock, Pictet, Allianz and Aviva followed suit. Overall, foreign purchases rose to a record 21,000bn pesos in 2016, absorbing two-thirds of the new TES notes issued in 2016.

“Now that Colombia has reached a peace accord after 50 years of civil war, the country can unlock a lot of its economic potential,” says Michael Hasenstab, executive vice-president and chief investment officer at Templeton Global Macro. “It will be able to raise living standards through increased investment, particularly in infrastructure. Improving the power and transport sectors can significantly reduce supply bottlenecks and cut the costs of goods.”

Though not without hiccups, such as failing to secure a majority in a referendum held in October to uphold the peace agreements struck between president Juan Manuel Santos and Farc, the country’s commitment to the peace process culminated at the end of 2016 with congressional approval of the revised peace agreement. The International Monetary Fund estimates a peace dividend in the order of 0.5% of extra annual growth in the near term, which at least partially balances the loss of economic potential stemming from the end of the commodity boom. Medium-term economic potential is now rated at between 3% and 3.5%, below the average annual growth of 4.6% achieved amid very favourable external conditions between 2006 and 2015, but higher than the 2% achieved in 2016.

Institutional strength

Taking the long view, foreign investors are factoring in the quality of today’s Colombian institutions and their constant push towards reforms. It was fiscal reform that put Colombia on the map for foreign asset managers in the first place in 2013, when the finance ministry slashed the tax rate on capital gains on fixed-income trades from 34% to 14%.

“The Colombian sovereign debt market was already relatively big and liquid, but foreigners did not have access to it because yield after taxes was not attractive,” Juan Pablo Cordoba, CEO of the Colombian Stock Exchange, said at the Colombia Inside Out investment roadshow in London in June. “Slashing the tax rate to 14% made a real difference.”

These improvements in the regulatory environment caught the attention of JPMorgan, which began to increase the weight of Colombian debt notes in its Government Bond Index-Emerging Markets (GBI-EM) indices, a major benchmark for investors in emerging markets’ fixed-income area, “as a result of improved transparency and accessibility for international investors in the local TES market”.  

The central bank also played a key role in boosting the market’s credibility by sticking to its inflation-targeting approach, even in more recent times of severe economic slowdown.

“Colombia’s central bank has kept the country on track by tightening rates during much of 2016 to rein back inflation,” says Mr Hasenstab. Interest rates rose by 300 basis points between 2015 and the first half of 2016.

“That combination of sound fiscal and monetary governance combined with the start of a peace era, on top of already resilient growth, is creating an optimal investment opportunity,” adds Mr Hasenstab.

The hike in interest rates prompted the peso’s recovery. The Colombian currency rose about 13% against the US dollar after touching a historic low in February 2016, giving the TES market new momentum.

“From the beginning of 2016 through [to] April this year we did see substantial currency appreciation [in Colombia] and that adds to the total return you can get in bonds [in dollar terms],” says Jan Dehn, head of research at Ashmore Investment Management.

Adjustment needed

However, that phase is coming to an end as other economies in the region become more appealing. International enthusiasm for Colombia’s peace deal is likely to fade, opening up potential concerns over macroeconomic imbalances.

“Today, we don’t see Colombia as particularly attractive in peso bonds compared with other destinations in Latin America,” says Mr Dehn. “I think that investors are slowly beginning to realise the story of the whole [president Juan Manuel] Santos era is coming to an end. Right now we are more bullish on private, off-market opportunities than bonds.” 

Mounting foreign interest has pushed up TES valuation, with 10-year yields falling from more than 9% in February 2016 to 6.7% in the first week of July 2017. Today, investors can find better yields from Latin American local currency sovereign bonds in Mexico, Brazil and Argentina. The latter two are not investment grade, however.

At the same time, the market is becoming increasingly aware of Colombia’s need for further adjustments, first and foremost on the fiscal side.

“Last year’s fiscal reform helped bridge the financing gap in 2017 and 2018, but there will be either expenditure cuts to be made, or additional revenues to be found in the future,” says Samar Maziad, senior analyst at credit rating agency Moody’s, which has a Baa2 rating with 'stable' outlook on TES notes. Standard & Poor’s and Fitch both have a BBB rating with a 'negative' outlook.

The end of the bonanza petrolera, or oil boom, took a heavy toll on Colombia’s finances, drying up oil-related fiscal revenues worth up to 4% of gross domestic product almost overnight in what finance minister Mauricio Cárdenas called “the worst fiscal shock in our history”. A major reform was passed in December to raise billions in the coming years and make up for lost oil revenues. However well-received initially, the authorities soon realised that the reform would fall short in achieving the targets set by a fiscal rule adopted in 2011 aimed at shrinking the deficit to 1% by 2022.

In to stay?

While Colombia waits for new adjustments to materialise, foreign portfolio investment has played a key role in supporting an initial rebalancing of the country’s fiscal and current account deficits. With yields down from 2016 levels, they will not match last year’s record levels of TES purchases, but are not expected to pose a capital flight risk for the country.  

“Foreign investors will play a more regular role in the TES market in Colombia and we are seeing slower foreign demand this year,” says Felipe Campos Salazar, head of strategy and research at Alianza Fiduciaria. “We have already done a catch-up and from now on foreign holdings will grow to 35% of outstanding TESs in the good times, and fall to 20% in the bad times, but I don’t believe we will see oscillations beyond this range.”

Leading investor Franklin Templeton has in the past unwound its exposure to other emerging market sovereign debt gradually over a period of about three years, suggesting a limited risk of a sudden sell-off of its TES portfolio, according to an analysis by Alianza Fiduciaria.  

“We have already seen a lot of capital flight from emerging markets associated with the [US Federal Reserve] taper,” says Ashmore’s Mr Dehn. “Foreigners invested in Colombia right now are dedicated emerging markets guys. They are fairly comfortable about Colombia.”

This is reassuring, but with presidential elections due in 2018 and Juan Manuel Santos stepping down after winning two consecutive mandates, Colombia’s new leader will have to consolidate ongoing efforts to achieve peace and reboot the economy and state finances. Foreign bondholders will likely maintain their trust in Colombian institutions, alongside their concerns over macroeconomic adjustments. Their growing share of TES bonds makes them a group of stakeholders any new president could not ignore.

PLEASE ENTER YOUR DETAILS TO WATCH THIS VIDEO

All fields are mandatory

The Banker is a service from the Financial Times. The Financial Times Ltd takes your privacy seriously.

Choose how you want us to contact you.

Invites and Offers from The Banker

Receive exclusive personalised event invitations, carefully curated offers and promotions from The Banker



For more information about how we use your data, please refer to our privacy and cookie policies.

Terms and conditions

Join our community

The Banker on Twitter