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Could the peace deal turn Colombia into an investment paradise?

After 52 years of war with the FARC rebel group, negotiations led by President Santos have finally manifested in a potential peace deal. With the upcoming referendum on the deal likely to succeed, all eyes are on how the end of the decades long conflict will impact the real economy.

Sep 30, 2016 // 12:37PM

Following the recently inked agreement, peace is now a distinct possibility for a country that has been ravaged by war, drug trafficking and terrorism for decades.

While Colombia’s fiscal and economic policy has been considered sensible and strong despite periods of instability and socio-political tensions, promise of a peaceful and prosperous future now means the country could become a favoured destination for foreign money.

This sentiment was reaffirmed on Tuesday by the US Treasury Secretary Jack Lew during his official visit to Bogota.

“Implementing the agreement, showing that Colombia has a stable future, I think will make Colombia a more attractive place for foreign investment,” Lew said after meeting with Colombian Finance Minister Mauricio Cardenas and President Juan Manuel Santos.

Colombia’s huge investment potential has been clear to major global banks and asset managers for some time now. The government’s economic policies have received praise from investors and observers for enabling it to successfully weather persistently low oil prices and creeping inflation through pin-point fiscal adjustments.

According to Carlos Gustavo Cano, co-director of Colombia’s Central Bank, fostering low and stable inflation is the organisation’s main priority, while adopting a floating exchange rate has been shown to be the “best mechanism for absorbing external shocks.”

The recent slowdown, mirroring that of other commodities-dependent economies like Russia and Brazil, manifested in a modest 2.0% year-on-year growth in the second quarter – well below the Central Bank’s target of 2.6% and even lower than the 2.3% forecast by independent analysts. In fact, it was Colombia’s worst second quarter since 2009.

But there has also been plenty of good news. Industrial manufacturing grew by 6%, while financial services and real estate have increased by 4.6% in the second quarter of this year. The social, community and personal services sector has also displayed positive signs during that period. According to Administrative Department of Statistics (DANO), six of the nine branches of social security have shown positive growth, with three outpacing the growth rate of the whole economy.

Nevertheless, key challenges stem from the demand to increase spending. Upwards of $40bn needs to be put into rural development and land reform, and the government intends to carry out substantial tax reforms that will put more pressure on the energy sector at a time of low prices.

Production levels, which have been persistently high at about 1 million barrels per day since 2013, have recently fallen to around 843,000. According to Jose Lloreda, the head of Colombia’s oil association, the industry will require up to $70bn worth of investment in the next 10 years just to stay afloat.

The deal with FARC ought to remove some of the stumbling blocks, including instability caused by regular attacks on oil infrastructure, and facilitate the implementation of tax reforms. It can also boost tourism, which can become a significant growth factor in the long run.

But, as Gustavo Rangel of World Bank points out, a lot will rest on the government’s ability to clear the deficit via interest and tax rate hikes without damaging the investment climate.

“The [FARC deal] will be positive for the country as it will facilitate approval of tax reform and development projects. It is unclear, however, if it will have long-term impact on the current investment boom, as a lot of these projects don’t have concrete tenders and costs may rise”, notes Rangel.

Still, in contrast with some of its Latin American neighbours, Colombia for now remains one of the most attractive emerging markets for investors. In August the country’s local-currency bonds were offering returns of 5.8% on average, the highest among all EMs. With 3.3% growth, the peso became the best performing currency in the developing world, while Goldman Sachs tips Colombia to have world’s biggest growth spurt - if price of oil rebounds.

One thing is clear: the government’s take on peace-time fiscal policy and the changing dynamics of the commodities market will make the next six months crucial for investor sentiment.

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