Over the past three months, expectations around the potential benefits of the peace agreement between the Colombian government and the FARC have been significantly increasing among the investor community. Most recently, during the Pacific Alliance Summit on June 30, President Santos shared the results of a government-sponsored study on the impact of the peace dividend on Colombia’s GDP, which lifted spirits even higher.
According to President Santos, overall GDP is expected to grow by an additional percentage point in Colombia in the first year following the signature of the agreement, with some rural regions growing at above 10 percent. But are these growth expectations realistic, or should they be treated as a marketing device to attract investment into Colombia?
While it is true that the peace agreement will boost investment in some sectors and will create additional jobs in the economy, it is important not to underestimate the costs and difficulties associated with the execution of the peace agreement, as well as to consider whether the government will have enough fiscal capacity to address them.
The Economic Benefits from Additional Investment
After more than five decades of internal war, which has costed billions of dollars in terms of foregone investment, Colombia is now expecting to experience a boost in FDI as a result of the peace agreement with the FARC. Assuming the agreement is signed during the second half of 2016, the government expects that in 2017 FDI could amount to US$23 billion, almost doubling projected investment inflows in 2016.
Notwithstanding the direct benefits of greater investment through job creation, especially in the construction and oil industries, the peace agreement is expected to report much needed additional tax revenues for the government, which could amount to 4.8% of GDP as economic growth accelerates.
Opportunities in the construction industry
Investments in the construction industry are expected to expand by 10% on average during the first five years after the peace agreement. To make this happen, the government is planning to offer tax incentives to companies that get involved in infrastructure development and social service projects in underdeveloped areas or areas marred by the country’s 50-year armed conflict. According to FSG’s own estimates, these opportunities could translate into almost 4 percentage points of additional growth in the construction industry.
Opportunities in the oil industry
The oil industry stands to emerge as the top beneficiary – in dollar value terms – of the peace agreement as companies in this sector will now be able to expand their presence in commodity-rich regions previously controlled by the FARC, and also avoid costly protection measures and losses stemming from terrorist attacks to existing production facilities in other parts of the country.
According to El Tiempo newspaper, as many as 40 million barrels of oil have been lost to the bombings since the mid-1980s (the equivalent to almost two months of production at current levels). Under this scenario, the oil industry would gain approximately 1.5 percentage points of additional growth on average over the next five years.
The Cost of Transition to Peace
While the Colombian government has estimated that the total cost of the implementation of the peace agreement will amount to 0.3% of GDP, at FSG we believe that this estimate is miscalculating the costs associated with compensations to displaced victims, which could be equivalent to 1.4% of 2016’s GDP and disbursed over the next 10 years, as well as the cost of agrarian reform and rural reconstruction, which could amount to 2.4% of GDP. In fact, FSG considers that a more realistic scenario would situate the costs of the peace process at 0.8% of GDP per year.
Considering that Colombia’s current fiscal deficit is of 3.6% of GDP, the costs of transition to peace (0.8% of GDP) would enlarge this deficit to 4.4% of GDP, a number that is slightly lower than the 4.8% of GDP in expected additional fiscal revenues.
Indeed, FSG expects economic activity to accelerate over the next few years by an average of additional 0.45 percentage points per year between 2017 and 2019, which would bring down fiscal deficits substantially through higher tax revenue.
Overall, companies need to tame expectations about the potential dividends of the peace agreement as they make investment decisions in Colombia.
Meanwhile, multinationals need to pay attention to additional factors that could impact their profitability in the Colombian market, including a looming tax reform package that is expected to be discussed in Congress later this year that could place a higher fiscal burden on the private sector. Additionally, it is critical that multinationals notice that the government has not yet resolved another longstanding armed conflict with the ELN, which still controls some areas of rural Colombia, particularly in the north close to Venezuela, making investment in these regions still a risky endeavor.
Finally, as companies plan to expand into new markets, industries and customer segments in Colombia, it will be critical to identify and foster relations with potential strategic channel partners and design a joint go-to-market strategy before competitors do.