FILE COPY Report No. 3222-CO Economic Posibon and Prospects of Colombia (In Two Volumes) Volume 1: Main Report February 27, 1981 Latin America and Caribbean Regional Office FOR OFFICIAL USE ONLY Document of the World Bank This document has a restricted distribution and may be used by recipients only in the performance of their official duties. Its contents may not otherwise be disclosed without World FPank authorization. Currency Unit: Peso Exchange Rate Effective February 2, 1981 US$1.00 = Col.$51.45 CoI$1.00 = US$0.01944 Average Exchange Rate (Buying) 1975 1976 1977 1978 1979 US$1.00 = Col$31.202 Col$34.976 Col$36.923 Col$39.252 Col$42.587 Col$1.00 = US$0.03205 US$0.02859 US$0.02708 US$0.02548 US$0.02348 1980 US$1.00 = Col$ 47.283 Col$1.00 = US$0.02115 FOR OFFICIAL USE ONLY This report is based on the findings of an economic mission to Colombia in May 1980, composed of Messrs. George Gebhart (C4ief of Mission), Jos' SokQl (Economist) and Branko Grdjic (Statistician). This document has a restricted distribution and may be used by recipients only in the performance of their official duties. Its contents may not otherwise be disclosed without VVorld Bank authorization. ECONOMIC POSITION AND PROSPECTS OF COLOMBIA TABLE OF CONTENTS Page No. VOLUME I - THE MAIN REPORT Map Country Data Summary and Conclusions .......................... i - xiv I. Background ......... ................................ 1 Introduction ....................................... 1 Economic Developments in 1979 ....................... 5 Developments During 1980 ............................ 18 II. Development Issues and Strategy . .................. 23 Introduction .23 Major Sector Issues . . .26 1. Energy . .26 a. Electrical Power .28 b. Petroleum. 30 c. Gas .32 d. Coal .33 e. Other Energy Sources. 34 2. Manufacturing ..35 3. Transportation .. 38 4. Agriculture ................... ................. 39 5. The Social Sectors ............. .. .............. 41 III. Investment and Its Financing ....................... 43 Public Sector Investment ........................... 43 Financing Public Investment ......................... 48 Private Sector Investment and its Financing ......... 53 IV. Growth and Balance of Payments Prospects .... ........ 56 Growth Prospects .................................... 56 Balance of Payments Prospects ....................... 58 External Capital Requirements ....................... 62 Debt Management and Creditworthiness .... ............ 65 VOLUME II - STATISTICAL APPENDIX IBRD-3638RI 78~~~~~~~~~~~~~ 76 W ~~~~~~~~~~~~~~~~~~~~~~~OCTOBER 1974S A T-L A NT / C EOU AME N SOT AE rr~~~~~~~~~~~~~~~~~~~ D. 0,'a 'awI 4k /CORDOBA ~ 'DE V E N E Z SANTANDER( A OUIANANER J A AUCA U ~~~~~~~~~~~~~~~~~ E O ~~~~~~~R ISARALD_A' CADAS 0 .CAAA CUNDINAMARCA? dd BOGOTA ( 0c.11~ ~~~~~~r 0110,cni C A U C A 'IHUILA IA, N A R I N 0 V A U P E N Th 5 N~~~~~~~~~~~ 40~~~~~~~~~~~~~~/ 4 A M A Z 0 N A LO M Bi Al". ~ ~ ~ ~ ~ ~ ~ - Page 1 of 2 Pages COUNTRY DATA - COLOMBIA AREA POPULATION DENSITY 1,138,900 km (total) 26.7 million (estimate: mid-1980) 23.4 per km2 231,200 km2 (arable) Rate of Growth: 2.3% (from 1975 to 1980) 115.4 per km2 of arable land POPULATION CHARACTERISTICS HEALTH /1 Crude Birth Rate (per 1,000) 31 Population per physician 1,970 Crude Death Rate (per 1,000) 8 Population per hospital bed 620 Infant Mortality (per 1,000 live births) 98 DISTRIBUTION OF LAND OWNERSHIP (1971) INCOME DISTRIBUTION (1974) % owned by top 10% of owners 80.0 % of national income, highest quintile 54 % owned by smallest 10% of owners 0.2 lowest quintile 5 ACCESS TO ELECTRICITY ACCESS TO SAFE WATER /1 % of dwellings - urban 87.5 % of population - urban 73 - rural 13.2 - rural 46 EDUCATION LI NUTRITION /1 Adult literacy rate % 81.0 Calorie supply as % of requirements 102.0 Primary school enrollment 7 103.0 Per capita protein supply (grams per day) 52.0 GNP PER CAPITA IN 1979 j2: US$1.010 GROSS NATIONAL PRODUCT IN 1979 /3 ANNUAL RATE OF GROWTH (%. CONSTANT PRICES) US$ Min. % 1960-65 1965-70 1970-75 1975-78 1979 GNP at Market Prices 27,412 100.0 4.5 5.5 6.1 6.1 5.1 Gross Domestic Investment 6,465 23.6 1.8 8.1 0.6 13.2 6.9 Gross National Saving 6,993 25,5 2.1 10.8 4.6 22.3 13.0 Current Account Balance 596 2.2 - - - - - Exports of Goods, NFS 4,912 17.9 2.1 4.1 5.9 4.6 13.0 Imports of Goods, NFS 4,200 15.3 1.9 10.2 1.1 14.8 11.6 OUTPUT, LABOR FORCE AND PRODUCTIVITY IN 1975 Value Added Labor Force V.A. per Worker US$ Mln. % Mln. % US$ % of Average Agriculture and Mining 3,791 30.4 1.6137 25.4 2,349 119.3 Manufacturing and Construction 3,213 25.7 0.9911 15.6 3,242 165.0 Other 5.480 43.9 3.7484 59.0 1.462 74.4 Total Weighted Average 12,484 100.0 6.3532 100.0 1,965 100.0 GOVERNMENT FINANCE /4 General Government a Central Government (Col$ Mln) 7 of GDP (Col$ Mln) e/ of GDP 1978 1978 1975-77 1979 1979 1975-78 Current Receipts 117,895 12.7 13.4 140,211 12.0 11.1 Current Expenditure 44,901 4.8 8.4 63,597 5.4 5.0 Current Surplus 72,994 7.9 5.1 76,614 6.6 6.1 Capital Expenditures (direct) 13,287 1.4 1.6 13,630 1.2 1.0 /1 Between 1974 and 1978. /2 The per capita GNP estimate is calculated by the conversion technique used in the World Bank Atlas. All other conversions to dollars in this table are at the average exchange rate prevailing during the period covered. /3 Preliminary. /4 Estimated. 75 Consisting of Central Government, Departments and Municipalities. Data for the Departments and Municipalities for 1979 are not yet available. Page 2 of 2 Pages COUNTRY DATA - COLOMBIA MONEY, CREDIT AND PRICES 1974 1975 1976 1977 1978 1979 (Million Col$ Outstanding End Period) Money and Quasi Money 66,705 90,146 125,336 164,804 219,884 280,246 Bank Credit to Public Sector (net) 8,394 10,157 8,381 12,795 3,540 23,962 Bank Credit to Private Sector 94,927 119,507 153,558 194,993 252,912 317,122 (Percentages or Index Numbers) Money and Quasi Money as % of GDP 20.3 21.8 23.5 22.9 24.5 24.0 Consumer Price Index (7/54-6/55 - 100) 875.1 1,082.1 1,298.0 1,749.7 2,042.2 2,549.6 Annual Percentage Changes in: Consumer Price Index 25.2 23.7 20.0 34.8 16.7 24.8 Money and Quasi Money 30.3 35.1 39.0 31.5 33.4 27.5 Bank Credit to Public Sector 15.9 21.0 -17.5 52.7 -60.4 - Bank Credit to Private Sector 32.0 25.9 28.5 27.0 29.7 25.4 (Millions US$) MERCHANDISE EXPORTS (AVERAGE 1977-79) BALANCE OF PAYMENTS 1977 1978 1979 US$ Mln % Exports of Goods, NFS 3,404 4,059 4,910 Coffee 1,971 58.7 Imports of Goods, NFS 2,730 3.722 4,191 Major non-Coffee Agriculture 206 6.1 Resource Gap (Deficit - -) 674 337 719 Major Manufactured Goods 527 15.7 Petroleum Derivatives 136 4.1 Factor Service Income (net) -265 -295 -180 All Other Commodities 515 15.4 Interest Payments (net) (-185) (-171) (-141) Total 3,355 100.0 Other Factor Payments (net) (-80) (-124) (-39) Net Transfers 46 55 57 EXTERNAL DEBT, DECEMBER 31, 1979 Balance on Current Account 455 97 596 US$ Min Direct Foreign Investment 3 56 124 Net MLT Borrowing 192 72 703 Public Debt, lucl. Guaranteed, Total Disbursement (426) (361) (1,222) Outstanding and Disbursed 3,426 Amortization (-234) (-227) (-519) Capital n.e.i. (net) 162 391 -158 DEBT SERVICE RATIO FOR 1979 /3 Increase in Reserves (-) -852 -616 -1,265 % Gross Reserves (end year) /2 1,835.6 2,492.6 4,113 Net Reserves (end year) 1,829.6 2,481.8 4,106 Amortization of Public Debt 8.3 Net Interest on Public Debt 4.4 RATE OF EXCHANGE Total 12.7 December 31, 1978 IBRD/IDA LENDING, DECEMBER 31, 1979 (MILLION US$) US$1.00 = Col$41.000 Col$1.00 = US$ 0.02439 IBRD IDA December 31, 1979 Outstanding and Disbursed 838.4 21.5 US$1.00 - Col$43.980 Undisbursed 988.3 - Col$1.00 - US$0.02274 Outstanding Incl. Undisb. 1,826.7 21.5 /1 Preliminary data. 7T Official reserves only. /3 Ratio of debt service to exports of goods and all services. SUMMARY AND CONCLUSIONS Background i. The Colombian economy made considerable progress over the past quarter century. It evolved to a more integrated urban-industrial and services orientation, from a largely rural and agricultural base in the 1950s. The productive structure of the economy was broadened appreciably and output in both the agricultural and industrial sectors became more diversified. Greater reliance on foreign trade allowed the external sector of the economy to grow, with non-coffee exports, particularly exports of manufactured goods, expanding rapidly and the range of products sold abroad widening considerably. Public sector investment and output came to play a greater role in the economy, largely as a result of increased activity on the part of decentralized agencies and public enterprises. Financial and capital markets evolved pari-passu with the growing financial needs of the economy, and Colombia has become an active participant in international capital markets. Population growth has slowed since the mid-1960s, primarily because of a drop in the fertility rate. ii. In large part, these gains were the result of Government efforts to stimulate the productive sectors, provide the required economic and social infrastructure and establish an effective institutional base in the economy. In the 1950s and early 1960s, development policy favored import substitution, supported by high tariff protection, and the provision of economic infrastruc- ture by the public sector. It was during this period that the country's communication and transportation networks were largely completed and the trans- formation to a semi-industrial economic structure began in earnest. By the mid- 1960s, however, the prospects for further import substitution had diminished substantially and the country was in the midst of a period of high economic un- certainty, with economic activity and the balance of payments largely determined by developments in the world coffee market. After several years of erratic growth and rising unemployment, the authorities in 1967 adopted an outward- looking development strategy designed to reduce the economy's dependence on coffee and restore high levels of growth and employment. Export promotion policies, including periodic exchange rate devaluations and export tax rebates, were introduced and the authorities lowered tariffs somewhat and freed product and capital markets from controls as a means of raising efficiency and increas- ing the competitiveness of Colombian goods in external markets. iii. The economy responded strongly to the new strategy. Non-traditional exports expanded rapidly, providing the stimulus for growth and relieving the balance of payments constraint that had plagued the economy for many years. Real GDP rose by 6.4% p.a. between 1967 and 1974 and, with coffee falling to about 45% of merchandise exports from over 60% in the early 1960s, the economy became less susceptible to the vagaries of the world coffee market. By the mid-1970s, however, the economy was once again subject to a balance of payments constraint and lower growth, the result in part of world recession. At the same time, domestic inflation had accelerated in response to rising import prices and large Central Bank financed budget deficits, with the result that the Colombian peso became increasingly overvalued. Because of declining oil production the country faced an impending loss of self-sufficiency in petroleum, its primary energy source. - I i - iv. The Government introduced wide-ranging fiscal, monetary and trade reforms in late 1974 in an effort to increase productivity and get the economy back on the path to higher and more stable growth. Before these reforms were fully effective, however, the economy experienced a strong expan- sion in aggregate demand arising from a nearly fourfold increase in world coffee prices. This reversed the trend towards lower growth and employment and caused a turnabout in the balance of payments, but it also generated strong inflationary pressures. During each year of the 1976-79 period, the authorities had expected that the foreign exchange accumulation would be transitory, as coffee prices had been anticipated to fall. This potential for excessive short-term instability led the authorities to focus economic policy on stabilization rather than on development. Measures were taken to delay the monetization of export earnings, the exchange rate was allowed to appreciate and higher reserve requirements, including a 100% marginal requirement, were imposed to limit secondary credit expansion. Concurrently, fiscal expenditure, particularly public investment, was placed under restraint and import controls were relaxed, albeit only moderately so. v. While these measures prevented inflation from getting out of hand, changing economic conditions prevented them from being effective in reducing the rate of price increase to the lower levels prevailing in the early 1970s. Continued dollar earnings, both legal and illegal, by the private sector, sustained the expansion of aggregate demand through the entire 1976-79 period and resulted in continued reserve accumulation. This accumulation was largely the consequence of high coffee prices following unexpected Brazilian frosts of 1975 and 1979. A desire not to cripple domestic industry, combined with expectations that coffee prices would fall substantially during this period, led to a continued restraint on import expansion and by 1979 inflation was still in the 25% range. The authorities thus maintained intact the stabiliza- tion program throughout the 1976-79 period. Nevertheless, real economic growth continued at an annual average of about 6% per year. vi. While beneficial in some respect (the country's international reserve holdings had risen to the equivalent of 11 months imports of goods and non- factor services by the end of 1979, the public sector ran a current surplus averaging nearly 6% of GDP, boosted by the growth of revenues arising from the special exchange account, economic growth accelerated and unemployment fell), the foreign exchange boom had a somewhat negative impact in regard to development strategy because of the need to adopt policies oriented towards stabilization. For example, public investment was curbed, thereby delaying some badly needed additions to economic and social infrastructure. By lowering the rate of devaluation and delaying the conversion of export receipts to local currency, the authorities were able to moderate the growth of domestic demand, but at the expense of export expansion and diversification. Also, the trend towards freer product and capital markets was reversed in the interest of controlling credit expansion and price increases, thereby precluding any potential gains via increased efficiency in these markets. Economic Developments in 1979 vii. In many respects, 1979 was a pivotal year for the Colombian economy. The external sector continued to exert strong pressure on the money supply and aggregate demand, with the balance of payments registering an overall surplus of US$1,265 million for the year, equal to 4.6% of GDP. In part, this surplus - iii - was the result, as in past years, of higher receipts from coffee exports. However, other factors were also of importance. Relatively high interest rates in Colombia gave rise to increased private sector borrowing abroad and to delays in making payment for imports. Also, in anticipation of higher interest rates and lower availability of foreign financing later on, the Government borrowed heavily in international capital markets during the year to finance future development expenditures. An expansion in illegal exports, part of which was registered in the Central Bank through over-invoicing of exports, and part of which was registered as tourism and other export services, is thought to have contributed to aggregate demand growth and accounted for a substantial portion of the increase in reserve accumulation. The authorities undertook a policy of a gradual reduction in the growth of the money supply instead of a shock treatment to avoid the severe disruptive effects of the latter on economic growth and employment. As a result, govern- ment efforts to limit the monetary impact on prices were only partially successful despite a substantial reduction in Central Bank credit to the public sector, and the demand side causes of inflation remained a serious problem for the authorities. viii. Supply side factors began to exert greater upward pressure on prices in 1979. High interest charges pushed costs up, unit labor costs are estimated to have increased in excess of the inflation rate, and shortages of cement, building materials, steel, etc., helped to push up construction costs. The deteriorated state of rail and highway infrastructure, combined with large real increases in gasoline prices caused a sharp rise in transport cost. Retail prices of regular gasoline were increased by 30% in real terms in 1979. ix. Real GDP growth reached about 5% for the year. Manufacturing activity, which had grown by 7.1% p.a. between 1970 and 1978, rose by 5.9% and agricultural output, notwithstanding a 9% increase in coffee production, rose by only 3.9%. Construction activity, which was adversely affected by shortages and accelerating costs of building materials, low growth in public investment and an inadequate availability of mortgage funds during part of the year, fell by nearly 10%. Mining activity, heavily influenced by declining crude oil extraction, continued to fall. Of the remaining sectors, only transport and communications, public administration and the services grew in excess of total GDP. Gross fixed investment is estimated to have increased by 8% in real terms in 1979, almost exclusively the result of private investment in replacing machinery and in transport and other equipment; public investment is estimated to have fallen slightly in real terms. Net direct foreign investment more than doubled for the year, rising to US$124 million, mostly as a result of increased exploration by foreign oil companies. Primarily because of large real increases in the charges levied for public services and increased revenues from coffee tax and international reserve holdings, the public sector current account surplus is estimated to have reached 6% of GDP. x. By the fourth quarter of 1979, it had become clear that new policy directions were called for. Economic growth was slowing, and the distortions created by three consecutive years of tight controls over the economy were becoming excessive. Moreover, the credit restraints and capital market controls had been rendered largely ineffective as a result of widespread evasion and the increased expansion of the informal market, and Colombian products could no longer compete adequately in external markets. In response - iv - to these developments, the authorities began to consider adjusting the policies pursued during the previous years. By the year end, two major policy decisions had been taken. First, future expansion of the subsidized selective credit operations of the Central Bank, for years a major reason for base money growth, was to be limited to the amount of resources that could be captured for the purpose from private savings. In support of this policy, open market operations were initiated, with Central Bank bonds issued at market interest rates to finance these operations, and by year end had captured resources equivalent to 5.4% of the monetary base. The second policy decision was to advance the rate of currency devaluation. The main purposes of this were to prevent further deterioration of Colombia's competitive position in external markets and to eliminate (or at least reduce) the advantages of borrowing in external capital markets. 1980: A Year of Transition xi. In 1980 the authorities began adjusting the stabilization program to changing economic conditions. They expected coffee prices to fall sharply and imports of petroleum and other goods and services to go up substantially. This belief led them to adopt measures intended to ease the tight monetary policy without large risks of stimulating greater inflation. The 100% marginal reserve requirement was eliminated during the year and interest rates on time deposits and on the lending therefrom in commercial banks and development finance companies were freed from controls. The purposes of these were to permit a limited expansion of credit (average reserve requirements were raised to prevent too large an expansion) and to restore the competitiveness of time deposits vis-a-vis other financial market instruments. Short-term interest rates rose rapidly because of these measures, reaching a real level of 23.5%. It was also expected that more liberal interest rates would reduce the flow of savings into the extrabank market, thereby restoring the effectiveness of monetary policy, albeit at the cost of higher interest rates. As a result of the above and of open market operations which captured resources equivalent to 13% of the monetary base, the money supply growth was contained to 17% during the first 11 months of the year. The exchange rate was adjusted on the basis of a 16% annual increase, a 3% devaluation in real terms. Such adjustments were intended to discourage capital inflows, by eliminating the differential between domestic and international rates, and to improve the competitiveness of non-coffee exports. The concession contracts with petroleum producers were adjusted to provide incentives for increased production. The prices of petroleum products were increased substantially; regular gasoline prices were raised by 50%, from US$0.60 to US$0.90 a gallon. xii. Although most of these policy changes were in effect prior to mid-year, changing economic conditions did not allow for their rapid impact in rejuvenating the economy. Lower growth rates abroad and the inability of Colombian products to compete in foreign markets and particularly the weakening of the Venezuela market, severely limited the growth of exports. Industrial activity, hemmed in by sluggish demand, experienced a slowdown with output in the sector not likely to have increased by more than 3% in real terms. Agri- cultural output was affected by a drought, high incidence of disease and rising fertilizer costs. Construction permits declined in nominal terms because of rising construction costs and excess supply in the high income housing and office space markets. None of the other sectors of the economy, with the possible exception of public administration, evidenced any particular dynamism. v Consequently, it seems unlikely that real GDP growth exceeded 3%-4% in 1980, substantially below the economy's real growth potential of 6%, and unemploy- ment, which in 1979 reversed the declining trend of the prior few years, probably rose further. Inflation, however, was contained to a 26% annual increase despite large, unexpected increases in net Central Bank reserves arising from coffee earnings (most of the 1980 crop was sold on the futures market at prices significantly above the realized world market), services exports, gold purchases and short-term capital inflows. Although the current expenditures of most branches of government and the decentralized agencies rose sharply in 1980 as a result of wage hikes and employment increases, public sector savings were probably sufficient to cover 50% of public invest- ment. The higher charges levied for public services increased earnings on foreign exchange holdings and continued large revenues from the coffee tax supported the increased spending levels. xiii. With world coffee prices having fallen sharply over the past few months, the inflationary pressures on the Colombian economy from the external sector have begun to give way and a reversal of increased inflationary expec- tations has begun to take place. Consequently, it should be possible in the short run to shift more rapidly to development oriented policies without having to worry excessively about the effects of those policies on aggregate demand. The remnants of inflation arising from the cost side can be dealt with most effectively with import liberalization and increase in allocative and productive efficiency. It appears important that public investment be accelerated as rapidly as possible in order to relieve the energy and infra- structure constraints on growth that have emerged in recent years. With promulgation of the Plan de Integracion Nacional (PIN), the Government has proposed a new development strategy which emphasizes public investments in energy, transport and communications infrastructure while continuing the previous strategy's focus on export expansion and increases in economic efficiency. The reordering of priorities and programs required to achieve the ambitious PIN targets are substantial. Mobilizing increased domestic resources to finance its rapid execution remains a sine qua non for the country's future growth and development. Making the transition to the new development strategy without renewing inflationary pressures or letting the economy fall into a recession will require careful economic management. The authorities envisage that the PIN will produce a counter-cyclical stimulus to aggregate demand and restore the economy's higher growth path of recent years. However, the tradeoffs between the different government policies--growth, employment, trade, monetary and fiscal--will have to be given careful consideration as the transition takes place. Development Issues and Strategy xiv. Colombia faces a number of important development issues in the 1980s. Foremost among these is a potentially crippling energy shortage that could give rise to balance of payments constraints on growth in the latter part of the decade as a result of the need to import large amounts of crude oil. Deficien- cies in economic infrastructure, in particular in the transportation and communication sectors arising from nearly a decade of neglect, have begun to impinge on inter-regional trade and on the country's export prospects. The investments required to resolve these issues will place heavy demands on the country's development institutions, especially on the public enterprises, and - vi - a major effort to encourage savings will be required to prevent an escalation of inflation. An increasing proportion of the savings mobilized will have to be channelled to the public sector. To achieve the higher saving rates, it will probably be necessary to raise the tax burden and improve tax administra- tion, while at the same time increasing in real terms the charges levied by the public sector for the services it provides (national government revenues now amount to about 10% of GDP). Further relaxation of regulations governing the capital market could be expected to reduce market distortions and improve resource allocation, lessen the significance of the extrabank market, lengthen the term structure of lending and encourage private savings. Each of these would contribute to domestic price stability and help improve Colombia's competitive position vis-a-vis the rest of the world. This would, in turn, revitalize the export sector, thereby reducing the country's dependence on coffee and providing a much needed supplement to domestic demand. The limited size of the domestic market plus prospects for slower growth, over the next few years at least, in the more developed nations, has highlighted the impor- tance of maintaining demand growth at adequate levels through export expansion. xv. The recently promulgated PIN sets forth the Government's strategy for achieving its development goals, which include maximum economic growth, improved distribution of income and greater welfare for all Colombians, through a more efficient use of resources. The PIN proposes a quantum jump in public invest- ment, with emphasis on transport infrastructure and energy development, to strengthen the base of the economy; a continuation of export incentives with the objectives of supplementing domestic demand and reducing the country's dependence on coffee; and measures (including further import and capital market liberalization), designed to increase economic efficiency and raise institutional capacity. Economic decentralization, regional autonomy and the linking of regional growth centers are strategic objectives of the PIN directed towards uniting the country's several regional growth centers into a national market. Greater regional autonomy in tax collection and development program- ming is expected to raise the effectiveness of regional development efforts. The PIN also places emphasis on the promotion of both small scale and commer- cial agriculture as a means of diversifying and increasing exports, assuring adequate domestic food supplies, holding down inflation and contributing to the nutrition and welfare goals of the Government. Industrial policy is designed to provide clear and stable rules-of-the-game and adequate credit and infrastructure in order that private entrepreneurs may invest and expand output in an environment of certainty. Private foreign investment is to be encouraged because of its benefits in opening foreign markets to Colombian products, creating employment opportunities and bringing in new technology. The PIN also contains policies related to maintaining international competi- tiveness and for temporary tariff reductions on capital goods and raw materials. It does not include overall import liberalization policies, although it does suggest a review of the current import policies. The administration's approach to helping the poor takes on a new orientation in the PIN. Programs in health, education, nutrition, water and sewerage, etc., are to be better focused and integrated and selected low income and disadvantaged groups, including workers in the informal sector, children and unemployed youth, are singled out for special attention. Combined with extensions of the Integrated Rural Development (DRI) and National Nutrition (PAN) projects, the new direc- tions given to social programs are envisaged to raise the welfare of low income groups over the next several years. - vii - xvi. Given the prospects for slower growth of the world economy and the present stage of Colombia's development, the general strategy outlined in the PIN seems appropriate. The country's growing energy deficit and abundant domestic energy resources argue convincingly for the high priority given the investments in energy, and the likelihood of low growth of world trade and the limited domestic market suggest the propriety of integrating regional markets and promoting exports. Generating a significantly larger national market through the decentralization of economic activity, combined with infrastructure expansion and increased autonomy for outlying departments and municipalities, could be a time-consuming and costly endeavor, however. Nevertheless, the diversion of investment away from Bogota may result in the creation of new economic activity closer to international markets. The focus on youth in social programs seems to warrant broad support. Infant mortality rates are high, nutrition deficiencies and related health problems are widespread among Colombian youth, school dropout rates are high and unemployment among 15-18 year olds are nearly triple the national average. The emphasis on improving financial intermediation and raising economic efficiency appears well-founded, and the proposals for rationalizing agricultural and industrial sector develop- ment appear to attract the major constraints on growth in these sectors. xvii. While the PIN provided a good analysis of the development issues facing the country and sets forth general policy and program guidelines to resolve these issues, considerable additional work is required to define the specific policies necessary to bring off the Government's strategy. There are three major policy areas which will present difficult management problems for the authorities over the next few years. First, in order to reach the targets set for export growth, the fall in competitiveness of Colombian goods in external markets which occurred over the past several years will have to be recouped. The main emphasis in restoring and maintaining competitiveness properly lies in increasing productive efficiency and lowering costs. Both quantitative controls and tariff barriers have been reduced in recent years; however, they still remain high, particularly in the case of licensing requirements and other administrative controls. The Government's policy is to reduce these controls, but gradually so as not to unduly disrupt the industries involved. An alternative would be to revalue the peso; given Colombia's foreign exchange holdings, however, such a measure could increase contraband and affect industrial and export activities seriously. Substantial advantages in the way of increased efficiency and competitiveness would result from further import liberalization and elimination of administrative controls and should be vigorously pursued. Adjustment assistance might be considered in return for industry agreements on more rapid lowering of these barriers. A second area requiring careful policy management is the country's credit and capital markets. These policies over the past several years have been directed toward credit restraint as part of the Government's strategy of fighting infla- tion through demand reduction rather than through supply expansion. The measures (primarily high reserve requirements, interest rate ceilings, forced investment requirements, taxes on interest income and directed credit obliga- tions) used to achieve the Government's objectives generated serious distor- tions in financial intermediation, reduced the profitability of financial institutions in the official market and credit, a misallocation of resources through an inconsistent (and frequently changing) interest rate structure and speculative flows of capital abroad. The relaxation of controls over the - viii - official capital markets would eliminate most of these distortions, encourage saving and investment, and contribute considerably to lowering inflation. The measures taken early in 1980 are an important first step in this direction, but further actions, including elimination of all but the most essential interest rate ceilings, revision of forced investment and directed credit requirements, and the provisions of uniform tax treatment of capital assets, would appear called for. The third major area where policy actions are required is exchange rate policy. A continuation of the exchange rate adjust- ments undertaken in 1980 is advisable as a means of eliminating the differen- tial between domestic and international inflation. This should be accompanied by an opening of imports to avoid possible inflationary effects. xviii. In addition to these specific policy needs, there are two other important aspects of bringing off the development strategy that are expected to receive the authorities' attention in coming months. The first involves deepening the sector analyses to improve intersectoral coordination in planning and executing sector strategies and the second involves matters relating to financing the Plan. Given the ambitious investment program proposed in the PIN, a major effort will be required to mobilize the financial resources required for its execution. This is likely to require further tax measures to increase public sector savings. Major Sector Issues Energy xix. Colombia's energy balance is deteriorating rapidly, largely as a consequence of the country's heavy dependence on oil and its declining oil production. On the other hand, the country has extensive primary energy resources which can be tapped to provide for the nation's needs well into the next century. Resolution of the energy problem depends on the country's success in designing and undertaking a strategy to promote domestic energy availability, allocation and use. Such a strategy would need to include: energy pricing policies that rationalize consumption with energy resource availability; a least-cost program of investments in energy; and measures to assure the plan's rapid execution. Although planning and policymaking have improved substantially in some energy sector institutions in recent years, overall planning and coordination in the sector is still weak. A study initiated in 1980 by the National Planning Department is expected to provide the basis for improvement, overall planning and policy making in the sector. xx. Electrical power is Colombia's most economic conventional source of energy and installed hydro capacity is very cheap in Colombia relative to other countries. Its expansion is constrained, however, by insufficient domestic financial resources, and sector planning, coordination and regulation require further strengthening. Pending decisions within the sector are expected to provide Interconexion Electrica S.A. (ISA), which has been charged with planning sector development, with sufficient plant ownership to enable it to fulfill its responsibilities. Electricity rates are programmed to increase sharply in real terms in coming months, to provide additional savings in the sector. Nevertheless substantial external and domestic borrowing will probably be required by several electric companies if they are to carry out their investment programs. - ix - xxi. In mid-1980, the government raised the prices paid producers for basic and incremental crude oil to levels which should provide adequate incentives for private companies to expand production. Retail gasoline prices were raised twice during the year; however, they still do not reflect the opportunity costs of imports and the increases have had only a minor impact in curbing demand growth. Subsidizing petroleum product prices has drained ECOPETROL's (the State Oil Company) finances and limited its exploration and other investments. Further increases in retail prices are called for, as is careful planning of ECOPETROL's investment program. Colombia has a large supply of proven natural gas reserves. While incentives for further explora- tion may not appear adequate, priorities for use of the gas have yet to be established and investment is at a standstill. The use options include: residential use in Medellin and Cali, which would require building a pipeline to those areas from the north coast; production of ammonia and urea and the production of methanol. Each of these projects would require costly investments. xxii. Colombia's coal prospects are considered very good. Reserves are abundant, and some known deposits, particularly the El Cerrejon deposit in the Guajira peninsula, are of large size and easily accessible. CARBOCOL, the Government coal agency, has been preparing projects for both domestic consump- tion and export. Its major project, El Cerrejon-North, is to be carried out in joint venture with INTERCOR (an Exxon subsidiary) and will probably be initiated in 1981, with exports beginning in 1986. Long-term sale contracts are necessary to justify so large an investment. Furthermore, exports of coal from this project figure heavily in Colombia's balance of payments picture later in the decade and its prompt execution is important. Coal projects devoted to domestic use (e.g. substitution for oil) are expected to receive careful scrutiny to assure least cost energy development, and further analysis is expected before choices amongst the many coal options are made. Increased private sector involvement will be necessary to develop these resources rapidly. Colombia is thought to have geothermal potential and exploration for uranium is underway. These are considered long term prospects, however. Gasohol production is another long term possibility, as is coal liquefaction. Without doubt, the most compelling task facing Colombia during this decade is that of developing domestic energy resources and encouraging rational energy use. xxiii. Colombia's manufacturing sector makes an important contribution to the economy and to employment creation. However, capacity constraints and technological obsolescence of capital equipment have become an increasing factor in affecting sector growth. High protection has led to inefficiency in many manufacturing subsectors. The temporary reduction of import tariffs on capital goods imported and the need to expand capacity and replace technolo- gically obsolete equipment appears to have stimulated industrial investment in 1980. With further improvements in capital market operations, reduced import protection and a continuation of the exchange rate and trade measures (along the lines noted above), investment could be expected to accelerate, efficiency to increase and the competitiveness of Colombian goods in external markets to rise again. Transport costs are high and service unreliable because of the deteriorated state of sector infrastructure. Derailments and delays are frequent on the railways because of the poor condition of the track and a high proportion of the rolling stock is out of commission. because of inadequate maintenance and lack of spare parts. The country's highways are in poor condition because of inadequate maintenance and rehabilitation. Transport sector planning is expected to consider both the setting of priorities and the establishment of sector policies. The PIN sets forth what seems to be a well-balanced program of investments. Policy needs to include the pricing of transport services, the energy implications of transport development, the establishment and enforcement of load and weight controls, and guidelines for sector financing. Agriculture is a key sector of the economy in terms of its participation in GDP and employment, its contribution to exports, its significance for the Government's nutrition and welfare programs and its role in combatting infla- tion by assuming adequate domestic food supplies. Commercial export agricul- ture has benefitted from intensive research programs over the past several years and productivity gains have been impressive in those crops. However, productivity remains low on small farms, which predominate in Colombia, and consequently the incomes of small farmers are low. Raising productivity on these farms will require improved farm technology and remuneration and stable demand for this product. Research and extension are to be directed more towards resolving the problems of small farms, farmer access to purchase inputs such as fertilizer and pesticides is to be increased and public support to on-farm investments is to be expanded. Although considerable progress has been made over the past several years in raising welfare levels through social sector programs, the infant mortality rate is still in excess of 80 per thousand and an estimated one third of the population still lives at or below the poverty line. Execution of the "new social strategy" outlined in the PIN is expected to raise institutional capacity in the social sectors so that goals set forth in that document may be met. The Public Sector Investment Program xxiv. A substantial increase and redirection of public sector investment will be required in the next several years to carry out the development strategy outlined in the PIN. Over the 1980-85 period, such investment is expected to increase by about 12% in real terms. The petroleum, power, mining and transportation sectors are expected to account for the bulk of this investment, with 7%, 25%, and 10% respectively. Sizeable real increases in public investment are also expected in nutrition and health, small scale agriculture and industry, water and sewerage and education. Overall, public fixed investment is projected to average 9.2% of GDP during the 1980-85 period, and is expected to total Col$1,716 billion. xxv. Investments in energy will include several large hydroelectric projects to be initiated or completed during the period; some backup thermal capacity using coal-fired boilers; oil exploration and field development, plus some added refinery capacity; execution of the US$3.2 billion joint venture El Cerrejon coal project and possibly some additional coal and natural gas projects. Public investments in transportation and telecommunications are expected to involve substantial rehabilitation and maintenance of the railway and highway systems; additions to the rolling stock and the purchase of locomotives and spare parts for the railroads; construction of the Saboya/ Carare rail bypass on the line from Santa Marta to Bogota, selected highway and feeder road construction; improvements to the Rio Magdalena/Canal del Dique waterway; expansion and improvements at several major ports, and exten- sion of the telephone and telex systems to a large number of heretofore - xi - unserved rural areas. Most investments in the transport sector require prior decisions regarding energy development, therefore the maintenance of maximum flexibility in establishing priorities within the sector is expected. Invest- ments in the agricultural sector are to emphasize land improvements and irriga- tion facilities, increased agricultural research and extension, and agro- industrial projects. A large proportion of the investments to increase pro- ductivity and raise welfare will probably be undertaken via the DRI and PAN projects, which are programmed for expansion during the 1980-85 period. Mining sector investments (excluding those involving energy products) include the Government's participation in the Cerro Matoso nickel project, exploration for and mining of phosphate rock, and exploration for uranium, copper and bauxite. Projects to expand health care, nutrition programs and educational services and to extend them into additional rural areas will account for most of the public investment in the social sectors. xxvi. The total financial requirements of the public sector are projected to rise by 33% p.a. over the 1980-85 period and average 10.8% of GDP. Public sector debt payments are projected to increase by 25% p.a. during this period. Financing Public Investment xxvii. If the Government's development strategy is to be executed without undue financial difficulties or inflationary pressures, substantially greater financial resources will have to be mobilized from the domestic capital market by the public sector than was the case in the past few years. Tax administration will require strengthening, additional tax measures will be needed, full cost pricing of the goods and services provided by the Decentralized Agencies will have to be achieved, and restraint will need to be exercised on public sector current expenditures. Even with strong advances in these areas, however, considerable external and internal borrowing will still be necessary. xxviii. The current account surplus of the National Government is projected to average 2% of GDP (5.4% before transfers) during the 1980-85 period, compared with 3% p.a. on average in 1976-78, when the coffee boom and rapid international reserve accumulation produced large gains in revenues. Strong growth is expected in gasoline and sales tax collections and in customs revenues. The buoyancy of the income tax is expected to increase gradually as a result of tax administration improvements, increased coverage of withholding, the inflation indexing of deductions, and other measures becoming effective in the 1980 tax year. On the other hand, revenue transfers from the special exchange account are likely to decline, as coffee export receipts stabilize and earnings on international reserves fall, and could cause fiscal problems. Also, because of needed employment increases and expected wage adjustments, in addition to increased transfers to the rest of the public sector, current expenditures of the National Government are projected to grow by about 30% p.a. between 1979 and 1985. Consequently, some additional tax measures will be required. Consideration should be given to broadening the base of the sales tax, higher property tax rates and broader application of the presumptive income tax. The Decentralized Agencies will require substantially greater resources over the next several years, a larger proportion of which should be generated through increased charges for the products and services they provide. As a group, these agencies are expected to generate savings averaging 1.5.'o of - xii - GDP over the next few years, up slightly from the 1.4% of GDP registered in 1978, and up substantially from the 0.7% of GDP achieved in the 1976-77 period. Unless corrective measures are taken vis-a-vis those agencies which have recently begun to encounter financial difficulties, and unless efficiency in the use of resources is increased in the rest of the public sector, the projected level of saving might not be achieved. If the above measures are adopted, public sector savings could average about 6% of GDP during the 1980-85 period. An alternative would be to execute a smaller investment program and encourage increased private sector investment through proper incentives. Private Sector Investment and its Financing xxix. Industrial activity will have to expand rapidly over the next few years to provide the goods and services required by the growing economy and to provide employment opportunities for the expanding labor force. Industry also has important roles to play with regard to export growth and economic decentral- ization. The economic policy considerations noted earlier concerning protec- tionism, capital markets and exchange rates relate directly to the industrial sector and constitute an important part of industrial policy. There are other elements of industrial policy that deserve mentioning as well. Selective use of incentives via industrial parks and free trade zones is expected to encour- age industry to locate in outlying areas of high unemployment and low economic activity, as are credit and tax incentives designed for the same purpose. One policy currently in effect that would seem to merit a careful view of its justification is that forbidding private foreign investment in the three major metropolitan areas, given the considerable advantages of foreign investment, particularly technology inflow and external market entry. xxx. The critical factors in assuring adequate private investment over the next few years are the establishment of a stable economic environment and the provision of sufficient credit. With careful management of monetary, fiscal, and foreign trade policies along the lines described above, inflation should moderate steadily in coming months, and with consistent rules-of-the- game maintained during that period, investors can be expected to respond strongly. The credit policies mentioned above should encourage savings and lower interest rates, which, together with declining inflation, should promote lengthening of the term structure of lending. Thus, adequate access to financ- ing should be assured. In addition, the more favorable treatment of capital gains and the indexed re-evaluation of assets accorded by recent tax legisla- tion should substantially increase retained earning and encourage the purchase of company shares, thereby returning these as important sources of investment financing. Growth and Balance of Payments Prospects xxxi. The Colombian economy is projected to grow by 5.5% p.a. in real terms over the 1980-85 period. The leading growth sectors are expected to be manufacturing, transportation and communications, power and public administra- tion. Construction activity is expected to pick up strongly also, as a result of increased private and public investment. Gross domestic investment will have to expand to about 24% of GDP, up from 18% in the 1970s and 21% in recent - xiii - years to support this rate of economic growth. Public investment is expected to increase as a proportion of total investment because of heavy capital requirements in energy and infrastructure. To avoid too large an increase in foreign indebtedness, gross national saving would have to average 21% of GDP over the next several years. This is about the same level of savings achieved in 1978-79 when the coffee boom pushed up incomes, but significantly higher than that registered in the early 1970s. Balance of Payments Prospects xxxii. Colombia's balance of payments is projected to deteriorate somewhat in the early part of this decade, but then to recover in the latter half. Only modest export growth is expected over the next several years. Receipts from coffee exports will be affected by relatively low prices and by export volume limitations imposed by the new international coffee agreement. Slow growth of the world economy will probably depress non-coffee exports, despite the measures taken to raise the competitiveness of Colombian goods in external markets. On the other hand, imports are projected to expand rapidly. Petro- leum imports are expected to grow from US$570 million in 1979 to US$2,000 million in 1985, despite expected domestic price increases which would raise prices to international levels by 1982. In addition, the large increase in investment proposed for the 1980-85 period will induce a strong rise in imports. While under other circumstances the authorities could opt for slower growth and less pressure on the balance of payments, such a policy is constrained by a number of factors. First, the country has a large cushion of reserves and favorable access to international capital markets, rendering public acceptance of lower growth and higher unemployment unlikely. Second, many of the imports, particularly those for energy and industrial investments and the petroleum itself, are critical, as are the imports of raw materials and spare parts. The same is probably true for some of the imports needed for improvements to the highway and communications systems, and for inputs to the agricultural (fertilizer) and industrial sectors. Only a relatively small percentage of imports are consumer goods. xxxiii. Over the 1980-85 period, Colombia's current account balance of payments deficits are projected to average US$1,150 million, equivalent to 2.8% of GDP. This contrasts sharply with the US$596 million surplus registered in 1979, which was about 2.2% of GDP. By the late 1980s large coal exports and less dependence on imported oil should substantially improve the interna- tional payments balance again. Should Colombia's coal exports be delayed and additional oil discoveries not materialize, foreign exchange constraints might seriously reduce economic growth in the second half of the decade. In an effort to avoid this, Colombia's trade policy is expected to continue to favor exports. External Capital Requirements xxxiv. Gross external capital requirements, net of reserve drawdown are projected to total US$10.0 billion in current prices for the 1980-85 period, with an average annual requirement of approximately US$1,670 million. Of this amount, 31% or US$600 million p.a. will be needed for debt amortization and the rest to cover current account deficits. Private foreign investment should - xiv - provide about 12% of gross external financing. Multilateral and bilateral agencies are expected to provide US$660 million p.a. on average, about 40% of total external capital requirements, and the remaining US$800 million, or 48% of the total, is expected to come from private banks and suppliers' credits. Debt Management and Creditworthiness xxxv. Colombia's public external debt, repayable in foreign currency amounted to US$5.4 billion at the end of 1979, of which US$3.4 billion was disbursed and outstanding. By 1985, this debt is expected to rise to about 17% of GDP, from 13% of GDP at the end of 1979. The public debt service ratio is projected to increase to about 15% in 1985, from 9.6% in 1979. Projections past 1985 show Colombia's debt service ratio peaking at around 18% in 1990, as the country begins to pay off the heavy borrowing of previous years. Given the continuation of sound economic and financial management, Colombia is expected to maintain its creditworthiness through and beyond the 1980-1990 period. CHAPTER I BACKGROUND A. Introduction 1. The Colombian economy made considerable progress over the past quarter century. It evolved to a more integrated urban-industrial and services orientation, from a largely rural and agricultural base in the 1950s. The productive structure of the economy was broadened appreciably and output in both the agricultural and industrial sectors became more diversified. The economy grew more trade oriented, with non-coffee exports expanding rapidly, and the range of products sold abroad widening considerably. Financial and capital markets evolved pari-passu with the rest of the economy, and Colombia has become an active participant in international capital markets. Population growth has slowed since the mid-1960s primarily because of a drop in the fertility rate. Colombia's current (1980) population of 26.2 million is growing at a rate of 2.1% p.a., a considerable decline from a rate exceeding 3% just 15 years ago. 2. In large part, these gains were the result of Government efforts to stimulate the productive sectors and to establish an effective institutional base in the economy. Economic infrastructure was expanded rapidly, particu- larly in the 1960s, to support growth in the industrial and agricultural sectors and institutions were developed, e.g., the Agrarian Reform Agency (INCORA) in agriculture, the National Highway Fund (FONDO VIAL) in transpor- tation, and the Export Promotion Agency (PROEXPO) to encourage exports, etc., for the purpose of providing policies and programs needed by the expanding economy. The planning capability within the Government was increased substan- tially during this period, providing the basis for more effective public sector intervention in economic matters. 3. As a result of these developments, there has been significant improvement in the welfare of the poorest income groups in Colombia. Crude death rates have fallen by 50% since 1960, and life expectancy has risen from 53 years to 62 years in the same period. The mortality rate of children ages 1-4 1/ has declined from 17 per thousand to 9 per thousand since 1960. Enrollment ratios, another indicator of welfare, have increased substantially at all school levels since 1960, and by 1977, 91% of urban children and 65% of rural children aged 7 to 14 were enrolled in school. The poorest groups, including those in rural areas, have experienced the greatest increases in electricity and water services in recent years, and have benefited more than the average of the population from services of the national health system. The ratios of population to physician and hospital bed have declined by 24% and 9%, respectively, over the past two decades. A much broader segment of the population is covered by social security, which was practically non- existent twenty years ago. 1/ The infant mortality rate, estimated at 98 per thousand, is excep- tionally high for a country of Colombia's per capita income level, however. - 2 - 4. In spite of this progress, Colombia still remains largely under- developed, with a relatively small modern sector superimposed on a broad, traditional and economically poor base. The economy is still heavily dependent on coffee. Development has been concentrated in relatively few areas of the country, public services are not available to most rural residents or to a large percentage of urban dwellers, underemployment is high and income and wealth distributions are badly skewed. The coverage of health care is still deficient and adequate housing is not available to a substantial proportion of the population. Rapid migration to the three major metropolitan areas (Bogota, Cali and Medellin) has created serious urban development problems, with attendant social difficulties. And finally, in spite of the increase in per capita incomes over the past quarter century, an estimated 20%-30% of the population (5 million to 8 million persons) enjoys today only a minimum subsistence standard of living. 5. The Colombian economy continued to evolve favorably during the 1970s. Real GDP grew by 6% per annum on average; important structural changes occurred leading to a more open and diversified economy; and institutional improvements were substantial. In the first half of the decade, rapid expansion of non- traditional exports, particularly manufactured goods exports, provided the stimulus for growth. This increase in exports, which occurred in response to a shift in the late 1960s from a development strategy emphasizing import sub- stitution to one stressing export promotion, also relieved the foreign exchange constraint to growth that had plagued the Colombian economy for many years. As a result of its enhanced resilience to external shocks, the economy was able to weather the oil price increase and world recession of the mid-1970s with only a moderate reduction in growth 1/. 6. Since 1976 the economy has been subject to strong inflationary pres- sures, caused primarily by the world coffee boom 2/, and rising energy prices. Each year during the 1976-79 period, the authorities expected that the foreign exchange accumulation would transitory, as coffee prices had been expected to fall; consequently, economic policy was focussed on stabilization. The strong growth in receipts from coffee exports raised incomes and domestic demand, particularly in rural areas, and led to a rapid expansion in base money and credit. This coincided with a strong surge in contraband exports which contributed further to growth of domestic liquidity and demand. Although aggregate supply responded favorably, particularly in 1978 when real GDP growth exceeded 9%, it was unable to keep up with the growth in demand. Poor weather prevented sufficient growth in agricultural output; industry began to encounter capacity constraints; and tariff and quantitative controls precluded any significant expansion of imports, especially of consumer goods. 1/ Real GDP rose by 4.4% per annum on average during the 1974-77 period. 2/ A damaging frost in Brazil's major coffee growing areas in late 1975 caused a fourfold increase in world coffee prices. Another frost in 1979 also affected coffee prices. - 3 - of consumer goods. Consequently, inflation accelerated, reaching a peak annual rate of 45% in mid-1977. 1/ Although inflation has moderated somewhat since then, continued rapid international reserve accumulation resulting from high coffee prices and increased coffee export volumes, plus further growth in contraband exports and large capital inflows, sustained a continuous pressure on the money supply and thus on prices. 7. The Government's response to the accelerating inflation consisted of monetary and fiscal controls to slow the growth of domestic demand, combined with trade and exchange rate measures to reduce the growth of international reserves. A 100% marginal reserve requirement on sight deposits was introduced in early 1977 and maintained throughout the period. Reserve requirements on savings and time deposits were raised also, in an effort to further restrict credit. 2/ By requiring exporters to accept "certificates of exchange" redeem- able in 120 days (later reduced to 90 days) in lieu of full cash conversion of their foreign exchange receipts, the authorities sought to delay the monetiza- tion of foreign exchange earnings. Although the Banco de la Republica stood ready to discount these certificates immediately (at rates that varied from 6-8 percent during the period), most were sold in the open market at a slightly lower discount, or held to maturity. Consequently, this measure was helpful in restraining the growth of base money. At the same time the autho- rities permitted the exchange rate to appreciate vis-a-vis the currencies of the country's major trading partners in order to discourage exports and encourage imports. Together with the high domestic demand, which reduced the availability of goods for export, this policy was successful in limiting the growth of exports. On the other hand, high tariffs and quantitative barriers, which were lowered only slightly during the period, prevented a significant acceleration in imports. On the fiscal side, considerable restraint was exer- cised over public sector expenditures. In particular, public sector investment, most of which is carried out by decentralized agencies, was curbed by controls over National Government capital transfers which traditionally have financed a substantial proportion of such investment. 8. While these measures were successful in preventing inflation from getting out of hand, changing economic conditions prevented them from being effective in reducing the rate of price increase to the lower levels prevailing in the early 1970s. The reasons for this are several. First, world coffee prices failed to weaken as had been expected and international reserves continued to accumulated rapidly. Second, the existence of a large, and rapidly growing extrabank market affected the effectiveness of monetary policy in restraining credit. And third, cost factors, emanating from high interest rates, rising energy prices, and declining economic efficiency, became major contributors to inflation as the period progressed. 1/ The maximum monthly inflation rate was 6.0% registered in April 1977, equivalent to over 100% on an annual basis. Food prices rose by 10.5% that month alone. 2/ At the same time, however, subsidized credit to "priority" sectors of the economy was expanded sharply via rediscount windows of the Central Bank. This expansion of Central Bank credit was highly inflationary and at cross-purposes with the stabilization measures then in effect. -4- 9. The main casualty during the 1976-79 period of high inflation was the country's development strategy. This strategy, which emphasized export promotion as the engine of growth and as the means to lessened dependence on coffee, gradual liberalization of product and capital markets, and increased productive efficiency, was sidetracked in the interest of stabilization. The progress achieved in export expansion and diversification during the early 1970s was disrupted by policies permitting real appreciation of the exchange rate and by the diversion of exportable goods to domestic consumption as a result of the relatively high returns available on domestic sales. Capital market liberalization, which had been promoted by financial reforms in the late 1960s and early 1970s, was thwarted through an intensification of con- trols (interest rate ceilings, forced investment requirements, increased reserve ratios, selective credit measures, etc.) during this period. Import liberalization was not advanced significantly even though economic circums- tances seemed to favor such a policy. And finally, economic efficiency suffered for a variety of reasons, including a lack of competition from abroad, inefficient financial intermediation, ineffective capital markets and inadequate provision of economic infrastructure to support growth of the productive sectors, reduced technology transfer and low investment growth leading to high capacity utilization ratios in industry. 10. On the other hand, both the balance of payments and public finances consistently produced large surpluses throughout the 1976-79 period. By the end of 1979, net international reserves held by the monetary authorities had risen to the equivalent of nearly one year's imports of goods and non-factor services, a level unprecedented for Colombia. For three consecutive years 1/ 1976-78, the public sector current account surplus exceeded 5.5% of GDP, also unprecedented in Colombia. Employment expanded rapidly during this period, and unemployment in the four largest metropolitan areas declined to less than 9% in 1979, from over 12% earlier in the decade. The population growth rate fell gradually, but continuously, throughout the 1970s 2/, and per capita income rose by an estimated 3.4% per annum. 11. By 1979, Colombia's economic situation had changed and new policy directions were called for. The tight monetary and fiscal controls maintained over the previous three years had begun to impinge on growth and new constraints emerged to dampen the country's development prospects. Foremost among these were a rapidly deteriorating energy balance 3/, which promised a renewed 1/ The public sector also produced a large current surplus in 1975 (7.3% of GDP), primarily as a result of the 1974 tax reform. Public sector financial data for 1979 were not yet available when this report was being Drepared. 2/ The population grew by 2.3% during the 1970s, compared with a growth rate in excess of 3% in the 1950s and 1960s. The estimated population growth in 1979 was 2.1%. 3/ Colombia became a net energy importer in 1976, and by 1979 petroleum imports were absorbing nearly 12% of the country's receipts from exports of goods and non-factor services. -5- balance of payments constraint on growth by the mid-1980s, and a shortage of economic infrastructure, particularly in transport and communications, caused by inadequate public investment during previous decade and a half. In view of these developments, 1979 was a pivotal year for the Colombian economy. B. Economic Developments in 1979 12. In 1979, for the fourth consecutive year, the Colombian economy was strongly influenced by developments in the external sector. Higher prices and increased volumes for most of the country's major exports, combined with a sharp rise in both public and private capital inflows and only a modest increase in import payments, contributed to an overall balance of payments surplus equivalent to 4.6% of GDP. 1/ The resulting accumulation of reserves produced a strong increase in the monetary base and provided the wherewithal for a rapid expansion of credit. Government efforts to limit the monetary impact of the reserve accumulation were only partially successful and infla- tionary pressures intensified. Although growth of total agricultural output was above the historical average, the increase in basic food supplies 2/ was not sufficient to contain prices--as was the case in the second half of 1978. Consequently, inflation accelerated to almost 30% for the calendar year, com- pared with only 18% in 1978. This occurred despite rigid controls over secondary credit expansion in the official market and a severe fiscal con- straint, particularly with respect to public investment. The effectiveness of monetary policy in the face of the large international reserve accumulation was diluted by the already existing high degree of tightness in the monetary system and by the escape valve presented by the extrabank capital market. Measures were taken during the year to liberalize imports, and selective credit programs were expanded in an effort to increase the supply of consumer goods. Investment and Growth 13. Real GDP 3/ growth for 1979 is estimated at about 5%, with public administration, transport and communications and the service sectors register- ing advances in the 7% to 9% range (See Table 1). Manufacturing, which failed 1/ Contraband activities contributed to the balance of payments surplus. A portion of the foreign currency receipts from these activities enters into official channels through the "open" window of the Central Bank, labeled as tourism or other such services. The Colombian balance of payments estimates include an adjustment for certain contraband activities for which reasonable estimates are considered possible. 2/ Growth rates for some basic foodstuffs were: yuca, 1.8%; potatoes, 1.9%; platano, 2.0%; panela, 2.0%; vegetables, 0.8%; corn, 0.9%; cattle extrac- tion, 4.3%; and rice, 12.7%. While mainly for export, the latter two products are also important domestic consumption items. 3/ Preliminary estimate. Tabl 1 - CW0lUA: GROSS DuMTIC r IlJCT AT FACTOR cMO by SECTOR 1h 1970 lUcCS, 1960-1979 (In Iillions of 1970 Colombian Pesos) PrjeLinary 8stImate Growth Rate (Ave. Annual) 1960 1965 1967 1970 1975 1976 1977 1978 1979 1960-70 1970-78 1978-79 Gross Domestic Product at f.c. 71,902.4 90.351.4 99,668,3 119.796.9 163,399.2 170.226.3 178.325.7 193.996.6 203.696.4 5.2 6.2 5.0 Agriculture LI 24,305.2 27,833.6 39,249.9 34,244.8 44,066.4 44,905.0 46,096.5 50,161.0 52,104.1 3.5 4.9 3.9 Mining 1,862.0 2,267.2 2,209.0 2,528.0 2,240.7 2,145.9 2,063.8 2,154.4 2,130.6 3.1 7.1 -1.1 Manufacturing 11,698.1 15,388.5 17,000.4 20,976.7 30,030.7 32,037.7 33,386.8 36,182.4 38,305.2 6.0 1.2 5.9 Construction 3,114.6 3,526.3 5,010.1 6,530.0 7,795.9 6,686.2 7,067.0 7,205.3 6,494.7 7.7 8.3 -9.9 Electricity, goo wster 767.2 1,163.7 1,398.5 1,797.9 2,753.4 3,067.7 3,138.4 3,391.0 3.651.7 8.8 9.3 7.7 Transportation & comunication 4,767.7 6,488.2 7,028.6 8,881.1 14,085.3 15,076.1 16,232.7 18,148.4 19,453.4 6.4 7.7 7.2 Trade L2 11,279.8 15,047.0 16,262.7 20,760.2 29,487.8 31,698.2 33,724.4 37,675.7 39,237.2 6.3 5.4 4.1 Public adLinistration & defense 4,852.7 6,523.4 6,971.7 8,283.5 11,189.1 11,370.6 11,786.3 12,629.4 13,775.1 5.5 S. 9.1 Other branches /4 9,255.1 12,113.5 13,416.7 15,804.7 21,749.9 23,239.1 24,829.8 26,451.0 28,544.4 5.5 6.7 7.9 1I Includes fishing and hunting and forestry. /2 Composed of comerce and banking. finance and insurance. /3 Equals govarnment services. /4 Composed of house rentals and personal services. Source: Banco de la REpublica. to keep pace with total GDP growth during the 1974-78 period, 1/ rebounded with a 5.9% increase in output in 1979. The trade sector, (including commerce and banking, finance and insurance) grew at a rate somewhat reduced from that of the previous few years, primarily because of the relatively slow growth in private consumption and the effects of stabilization policies on banking and financial activity. Construction, the weakest sector of the economy in 1979, suffered a recession in which output is estimated to have declined by nearly 10%. This was the result of low public investment, a decline in the capture of financial resources by the Savings and Loan Associations and sharp cost increases for 'housing and other private construction which discouraged demand. Relative increases in interest rates paid by other savings instruments 2/ reduced the competitiveness of the constant purchasing power saving certifi- cates (UPACs) issued by the Savings and Loan Association, thereby limiting their lending activity, particularly during the second half of the year. Agricultural output, which still accounts for nearly 30% of Colombia's GDP and is of critical importance to price stability and exports, rose by 3.9% in real terms. Although increases occurred in the output of most crops (important exceptions being sorghum, cottonseed and potatoes), the major gains were in rice (12.7%), bananas (11.5%), soybeans (11.3%) and coffee (5.4%). Livestock production rose by 5.6% despite a sharp decline in registered exports of cattle and beef. The extraction of crude oil fell by 5.1% in 1979, bringing the level of production down to only 57% of the 1970 maximum. Domestic crude is presently covering only about 83% of domestic consumption. Open unemploy- ment in the four major cities rose slightly to 8.6% in December 1979, from 8.5% a year earlier and 8.0% at the end of 1977. 14. Gross fixed investment rose by an estimated 8% in real terms in 1979. almost exclusively the result of private investment in machinery and transport and other equipment. This was in response to the high capacity utilization and low replacement rates of the past few years which had left industrial capital in a somewhat deteriorated condition. Both private and public construction activity declined in 1979 for reasons mentioned earlier in this report. The lack of growth in private construction is particularly disturbing, given the unmet (mostly low income) housing needs in Colombia. Net direct foreign investment more than doubled in 1979, rising to US$124 million from US$56 million in 1978, largely as a result of increased invest- ment in the exploration for oil and other natural resources. Despite this increase, foreign investment constituted less than 2% of Colombia's gross domestic investment in 1979. Balance of Payments 15. The resource balance and current account surplus of the balance of payments reached US$719 million and US$596 million, respectively, in 1979, equivalent to 2.6% and 2.2% of GDP. (See Table 2.) In 1978, these ratios 1/ Manufacturing grew by 5.1% p.a. on average during this period, while GDP was growing at 5.5% p.a. 2/ Primarily the introduction of market determined interest rates on certi- ficates of participation and higher returns on certificates of exchange. -8 - Table 2 - COLOMBIA: BALANCE OF PAYMENTS, 1970, 1975-79 (in Percent of Current GDP) 1970 1975 1976 1977 1978 11 1979 2/ Exports of Goods and Nonfactor Services 14.1 16.4 18.2 14.0 17.8 17.9 (of which coffee) (6.5) (5.8) (8.5) (8.3) (8.9) (8.3) Imports of Goods and Nonfactor Services 16.2 15.4 15.1 10.6 16.3 15.3 (of which crude petroleum and derivatives) (-) (-) (-) (1.0) (1.1) (2.1) Resource Balance -2.1 1.0 3.1 3.4 1.5 2.6 Net Factor Services -2.5 -2.0 -1.8 -1.4 -1.1 -0.4 Current Transfers 0.4 0.4 0.2 0.3 - - Current Account Balance -4.2 -0.6 1.5 2.3 0.4 2.2 Net Public Medium and Long Term Disbursements 2.3 1.9 0.8 1.0 0.3 2.4 Gross Public Medium and Long Term Disbursements (3.3) (2.9) (1.8) (1.9) (1.3) (3.6) Amortization (-10) (-1.0) (-1.0) (-0.9) (-1.0) (-1.2) Direct Foreign Investment 0.5 0.2 0.1 0.2 0.2 0.5 Net Private Medium and Long Term Disbursements 0.6 0.4 0.1 - -0.1 0.4 Gross Private Medium and Long Term Disbursements (1.4) (0.8) (0.5) (0.3) (0.2) (0.7) Amortization (-0.8) (-0.4) (-0.4) (-0.3) (-0.3) (-0.3) SDR Allocation - - - - - 0.1 Other Capital n.e.i. 0.8 -0.9 1.2 0.8 1.9 -1.0 Capital Account Balance 4.2 1.6 2.2 2.0 2.3 2.4 Overall Balance - -1.0 -3.7 -4.3 -2.7 -4.6 Change in reserves (-increase)- (-1.0) (-3.7) (-4.3) (-2.7) (-4.6) 1/ Preliminary 2/ Estimated Source: Banco de la Republica and Bank staff estimates. - 9 - were 1.5% and 0.4% respectively. Strong growth in export receipts (24%), led by minor exports (42%), 1/ was the primary cause of the improvement in these accounts. In contrast to a rather conservative external borrowing posture in 1978, the public sector's gross borrowing (including publicly guaranteed) rose to US$1,036 million in 1979, a threefold increase over 1978. A large part of this borrowing, i.e., the US$600 million Chemical Bank loan, was undertaken in anticipation of new public investment initiatives (US$430 million) and to refinance some costly prior borrowing (US$170 million) by the State Oil Company (ECOPETROL) and the State Agricultural Marketing Corporation (IDEMA). External long term credits to the Colombian private sector to finance capital goods imports increased sharply also in 1979, in response to a relaxation of controls over this borrowing. Short term import financing and speculative capital inflows to take advantage of favorable interest rate differentials added to the country's capital receipts. As a result of these developments, net international reserves of the banking system increased by an estimated US$1,265 million in 1979, and total net reserves reached US$3,115 million at the end of the year, the equivalent of about eight months' imports of goods and services at 1979 levels. 2/ 16. Foreign exchange earnings from merchandise exports increased by 24% in 1979, slightly above the 22% per annum average gain of the previous four years. Receipts from coffee exports 3/ rose by 13%, despite a 7% decline in the average FOB price per bag, and accounted for 56% of total merchandise exports compared with 62% in 1978. The increased volume of coffee exports was made possible by a 9% increase in production, a result mainly of re- placing old trees with the higher productivity cuturra variety, and by a reduction of coffee inventories to more normal levels. 17. The growth of non-coffee exports in 1979 was impressive even in comparison with the large increases registered in the late 1960s and early 1970s. Major manufactured goods exports increased by more than 50% in US dollar terms over their 1978 level, and the earnings from non-coffee agricul- tural exports rose by 22%. On a product by product basis, the exports of metallic products, glass, timber and wood products, paper cartons and books, cement, and mechanical and electrical equipment all increased by over 50% in current values. Clothing and textile, and chemical and pharmaceutical exports increased by over 40% in value, and exports of flowers, sugar and rice rose sharply in response to favorable international prices and greater quantities available for export. Flower exports have in recent years managed to pene- trate the U.S. and European markets, becoming one of the success stories in Colombia's export performance. The flowers are grown in areas adjacent to 1/ Exports other than coffee, petroleum derivatives and non-monetary gold. 2/ Net official reserves held by the Banco de la Republica increased by US$1,624 million in 1979, to US$4,106 million, or 10 months' imports of goods and services. 3/ Including an estimated 400,000 bags of contraband. - 10 - Bogata, taking advantage of the year-round favorable climate, and shipped by air to world markets. Good weather also contributed to surplus production of sugar and rice in 1979, permitting exporters to take advantange of the higher international prices. On the other hand, excessively dry weather in the lowlands along the coast reduced the exportable surpluses of cotton and tobacco, thus lowering the export receipts from these items. Foreign sales of cattle and beef plummeted when Venezuela, the country's major importer of these items, limited such imports from Colombia. Among mineral exports, earnings from emerald sales more than doubled in 1979, to over US$100 million. With regard to the direction of trade, exports to the Andean Group countries rose sharply, particularly to Venezuela and, to a lesser extent, Ecuador. These gains, together with the increase in exports to the LAFTA countries and to the United States, accounted for a large part of the export growth. Sales to the EEC countries were affected by a fall in Colombia's competitive position with those countries, as devaluation of the peso was insufficient to offset the relatively high domestic inflation. 18. A number of factors were responsible for the exceptional growth in non-coffee exports in 1979, some of which are mentioned above (e.g., higher international prices, exportable surpluses, etc.). An additional factor was the increase in incentives provided to exporters. Tax rebates on exports, 1/ which had been raised in 1978 to offset part of the real appreciation of the peso that had taken place in prior years 2/, were maintained at the higher rates throughout 1979, and the discount on the immediate conversion of export proceeds was eliminated (temporarily) in April 1979 for most non-coffee exports. At the same time, subsidized medium- and long-term production credit for exports was substantially increased, as was the availability of working capital financing to exporting firms. Finally, the slower growth in domestic demand most likely caused exporters to seek new markets abroad. It should be noted also, however, that a sizeable, but unknown, proportion of the apparent growth in non-coffee exports may have been caused by over- invoicing of export transactions for the purposes of receiving larger tax rebates and of laundering proceeds from illegal export activities. 19. Merchandise import payments rose by only 14% in current US dollars in 1979, despite a more than doubling of the country's import bill for crude oil and peteoleum derivatives which raised their share of total merchandise imports to 16.7% from 8.7% in 1978. Import payments excluding petroleum increased by only 4% in nominal terms over their 1978 level, with payments for consumer good imports actually declining by nearly 30%. Payments for raw materials and intermediate goods imports increased by 10% and those for capital goods rose by about 8%. The low growth of non-petroleum import 1/ Certificados de Abono Tributario (CATs). 2/ After slight improvement in 1978, the real trade weighted effective e exchange rate for Colombia's non-coffee exports probably deteriorated in 1979. As a consequence of the acceleration in inflation and slow rate of exchange devaluation. - 11 - payments occurred despite further import liberalization measures by the Government. Protective tariffs were reduced on average, albeit slightly, during 1978 and 1979, and the proportion of imports not requiring lengthy government review of licensing requests was expanded considerably. The requirement that firms present import and foreign exchange budgets to qualify for licenses was eliminated also. Moreover, the slow rate of peso devaluation lessened the relative cost of imports. On the other hand, the increase in advance import deposit requirements adopted early in 1979 in an effort to force firms to accelerate import payments, apparently had little effect. 20. The slow growth in import payments for 1979 reflects two major developments. First, imports of consumer goods declined sharply in volume terms largely reflecting lower imports of basic foodstuffs. The high domestic production of foods in 1978 replenished stocks and reduced the need for imports. Second, import payments were delayed as much as possible, particularly in the second half of the year, to take advantage of the excep- tionally high interest rates prevailing in Colombia. The fact that import registrations increased much more rapidly than import payments supports this argument. 21. Importers made increasing use of external borrowing to finance their imports in 1979. For instance, ECOPETROL made extensive use of short-term foreign credits to pay for petroleum imports. Relatively low interest rates abroad, which were often as much as 10-15 percent under domestic rates after allowing for devaluation, encouraged this borrowing. Importers also made maximum use of payment terms as a means of taking advantage of the high domestic interest rates. Both the increased use of foreign credits and the delay in paying for imports contributed significantly to the international reserve build-up during the year. The Stabilization Program 22. With the economy under strong inflationary pressure throughout 1979, exacerbated by a mid-year frost in Brazil, the Colombian authorities were compelled to maintain intact the stabilization program introduced in early 1977. The 100% marginal reserve requirement on sight deposits of commercial banks was extended throughout the year, and the ban on counting development bonds as part of reserves, (which was added in 1978) was continued. This latter measure raised the marginal reserve ratio since the banks had to substitute cash reserves for the bonds as they matured. The major additional action taken in 1979 was to raise the reserve requirement on time deposits of commercial banks and development finance corporations to 25%, from 20% for the former and 10% for the latter. As a result of these steps, financial system credit to the private sector increased by only 25% in 1979, and overall monetary growth (Ml) was held to 24% despite a 30% increase in the monetary base. 23. An increasing proportion of financial system credit to the private sector over the past few years was accounted for by subsidized selective credit operations utilizing funds provided by the Banco de la Republica. The - 12 - share of these operations 1/ in total commercial bank lending portfolios rose to 28% in 1979 from 24% in 1977, with the portfolios based on these operations rising by 27% p.a. during this period, compared with only 12% p.a. growth in the portfolio associated with the "own funds" lending of these banks. Thus, while credit policy was restrictive in general, funds were made available to priority sectors (agriculture, small and medium scale industry, power, etc.) of the economy to avoid reductions in production and incomes in those econo- mically and socially sensitive sectors. The acceleration in selective credit became increasingly expansionary during the 1977-79 period, however, as the re- sources captured from the private capital market by the Banco de la Republica failed to keep pace with the growth of such credit. Hence, these operations were supported by primary emission. To eliminate this, the authorities adopted the policy in late 1979 of not expanding selective credit operations in excess of the resources garnered from the capital market for such purposes. Concur- rently, open market operations were introduced and new Central Bank bond issues were authorized for the purpose of obtaining funds to support these operations. These bonds were to pay "market" interest rates so as to be attractive to private investors. Their issuance marks a significant departure from past practice in which Central Bank bonds carried interest rates lower than what the market would dictate and financial institutions were forced to hold them. These new bonds found ready acceptance in the market and by year end they had captured the equivalent of 5.4% of the monetary base. They were instrumental in raising interest rates in the official market, thereby providing greater competition for the extra bank market. 24. Monetary policy was effective in limiting the growth of financial system credit during the past few years and undoubtedly contributed to stabi- lizing the economy. By 1979, however, little margin was left for further tightening of credit, and loopholes had begun to appear in the Government's stabilization program. The high reserve requirement on ordinary credit operations and the low profitability of lending via the selective credit resources of the Banco de la Republica, caused the commercial banks to transfer an increasing proportion of their funds to the extra bank financial market. This market, which is fed also by monies flowing from illegal trading activ- ities, has been providing a source of credit, albeit at very high cost, to borrowers that have been frozen out of the formal market. This dual financial market arrangement has had two significant effects on the economy, in addition to raising the cost of credit to some borrowers and subsidizing others. First, it has substantially weakened monetary policy by excluding from its coverage a large percentage of financial assets and liabilities. In fact, a tightening of credit in the formal market might be counterproductive under the circum- stances because it may result in an even larger shift of funds into the informal market. This may have been occurring in Colombia in the latter part of 1979. Second, the extra bank market, being free of controls, has performed the allocative function normally handled by an open financial system, though at interest rates several notches above equilibrium. The resources channelled through this market are probably allocated effectively. However, this dual 1/ Excluding PROEXPO, which has its own resources from earmarked taxes, but including the Electricity Development Fund (FDE). - 13 - market, with constraints and subsidies on one hand and efficient allocation but unnecessarily high interest costs on the other, is not an adequate substi- tute for a free and unified capital market. The Colombian authorities are fully aware of this and have adopted the policy of moving gradually toward this goal. Significant progress has already been made in this regard as is discussed later in this report. Fiscal Policy 25. Colombia's fiscal policy in 1979 was shaped by the need to avoid additional inflationary pressure on the economy. At the same time, there were pressing needs for investments in infrastructure, energy and the social sectors, and the federal bureaucracy was expanding to accomodate the increased government role in the economy. In view of this situation, the authori- ties sought to limit public expenditures to those projects of highest priority and to enlarge the proportion of public investment covered by domestic savings. Capital transfers from the National Government to the Decentralized Agencies, which carry out the bulk of the public sector investment program, were severely curbed, forcing many of these agencies to reduce their investment programs. At the same time, charges for the products and services provided by the public sector were increased, following the trend established in the previous two years. The price of regular gasoline, for example, was increased by 30% in real terms and many of the country's utility companies raised rates by 2.5% to 3.0% monthly, which was considerably in excess of inflation. Efforts were made to curb subsidies by raising public transportation fares and by increasing the prices of subsidized consumer goods fabricated from costly imported items, e.g., wheat based products, powdered milk, etc. Improvements in tax compliance and administration were sought through the elimination of burdensome provisions in the tax laws (e.g., those permitting the taxation of inflation-related profits) and of complicated tax forms and payments structures. As a general policy, the investment programs of public sector entities were confined to the amount of own savings and non-inflationary financing acquired directly by the entity itself. 26. As a result of 12% real growth in current revenues and a 4.0% real decline in capital transfers, the finances of the National Government in 1979 registered an overall surplus for the fourth consecutive year (See Table 5.3, Statistical Appendix). This surplus, which amounted to 0.5% of GDP, was achieved despite an increase of over 20% in real terms in current expenditures and a doubling of tax rebates granted to exporters. Current expenditures of the National Government rose by nearly 46% in 1979, reflecting both inflation- ary factors and an expansion in the scope of Government operations. (See Table 5.3, Statistical Appendix.) The increases were spread widely across expenditure category, with purchases of goods and services, current transfers to departments and municipalities (partly in response to administrative decentralization objectives), and interest payments on internal and external debt all rising in excess of 50%. Wage and salary increases averaging 30% to 35% granted to Government employees early in the year helped push the wage bill up, and much higher interest rates both at home and abroad, together with a large increase in debt outstanding resulting from expanded borrowing to finance future development projects, contributed to the rise in interest payments. Direct investment expenditure by the National Government, which regularly constitutes only about 4% of total public sector fixed investment, - 14 - rose by 44.0% for the second consecutive year. This increase is not thought to reflect a change in policy in favor of a more active direct investment role for the National Government. However, capital transfers, which account for the vast majority of capital expenditures by the National Government, increased by only 20.8% in 1979, with those directed to the decentralized agencies rising by only 17.2%. 27. The growth (36.4%) in current revenues (Table 3) in 1979 was attribu- table to sizeable increases in gasoline and sales tax collections (37.0% and 34.4%, respectively) and to exceptionally large gains from earnings on foreign exchange holdings and from Banco de la Republica transactions in foreign exchange. These latter two items accounted for 40% of the increase in National Government current revenues in 1979, and in their absence these revenues would have increased by only 22.6% for the year. The major weaknesses on the revenue side were in receipts from the coffee tax, which were affected by the relatively slow growth in coffee export receipts, and in non-tax revenues which declined in absolute terms 1/. Both custom revenues and income tax collections failed to increase significantly in real terms in 1979; the former because of relatively slow growth in import payments and some reductions in tariff levels; the latter because of continued high evasion rates and some tax relief granted to encourage investment. The overall buoyancy of current revenues dropped from 1.31 in 1978 to 1.20 in 1979, while that of the major taxes 2/ taken together declined from 1.34 to 0.92 in the same period. (See Table 5.8, Statistical Appendix.) This fall in responsiveness of the major taxes to GDP growth is a reversion to trends prevailing prior to 1978 and constitutes an issue requiring close attention. 28. The Central Government 3/ has come to play a much greater role in the Colombian economy during the past two years (see Table 4). Reversing the trend established in the previous two years (1976-77) when both Central Government revenues and expenditures declined as a percent of GDP. While current revenues on average were higher in relation to GDP during the 1977-79 period than in the 1974-76 period, both current and direct capital expendi- tures rose but little. The ratios to GDP of all expenditures and current revenues were higher in 1979 than in any recent year however, and the cur- rent account and overall surpluses of the Central Government were significant- ly higher on average in the 1977-79 period than in the 1974-76 period. One may conclude, therefore, that the Government's policy of holding down fiscal expenditure, while at the same time raising savings levels has been success- ful as regards Central Government operations. Of particular significance in 1/ The decline in non-tax revenues was probably in part caused by the ex- tended strike in the Ministry of Finance which adversely affected the administration of these revenues. 2/ Income and net wealth tax, customs taxes, sales taxes, gasoline taxes, and stamp taxes. 3/ Includes the National Government, National Highway Fund and the two social security institutions, Instituto de Seguros Sociales (ISS) and Caja Nacional de Prevision Social (CAJANAL). - 15 - Table 3 - COLOMBIA: NATIONAL GOVERNMENT Growth Rates of Major Revenue Sources, 1974-79 (Percentages) Annual Avg. Average Average Growth Rate 1977 1978 1979 1974-76 1977-79 1974-79 Current Revenues 29.9 32.4 36.4 33.9 32.9 33.4 Income and Net Wealth Tax 13.9 27.9 25.9 33.6 22.4 27.9 Sales Tax 34.3 39.1 34.4 56.9 35.9 46.0 Customs Revenues 32.6 39.0 24.2 25.7 31.8 28.7 Gasoline Tax 40.0 30.2 37.0 30.2 35.7 32.9 Special Exchange Account 60.0 23.9 118.3 40.1 63.0 51.1 (Coffee Tax) (55.1) (18.5) ( 8.6) - (25.9) - (Other) (76.7) (40.0) (397.7) - (130.9) - Nominal GDP Growth Rate 34.5 24.7 30.4 30.0 29.8 29.9 Source: Table 5.4, Statistical Appendix. - 16 - this respect is the sharp gains in revenue of all branches of the Central Government. The National Highway Fund, for instance, registered revenue increases averaging 47% per annum during 1977-79, largely as a result of higher taxes on gasoline consumption, and the social security institutions had revenue gains averaging 36% per annum over the same period. 29. The finances of the important decentralized agencies presented a rather disappointing mosaic in 1979. A substantial deterioration is evident, for instance, in the finances of ECOPETROL, the National Railways Company and some major entities in the power sector. Largely as a result of increased petroleum imports and notwithstanding a 61% nominal increase in current reve- nues owing to higher retail gasoline prices, ECOPETROL experienced its second consecutive year of current account deficit in 1979. (See Table 5.5-1, Statistical Appendix.) With its investments increasing by 36%, ECOPETROL's overall financial deficit rose to nearly 1% of GDP, practically all of which was financed through external borrowing. The financial difficulties expe- rienced by some of the major power companies were of such magnitude as to cause delays in their investment programs, which threatens further deterior- ation in the nation's energy balance. These difficulties, which were confined in 1979 to companies serving less affluent markets, were the result of accel- erating costs, insufficient access to domestic financing and delays in payment of electricity bills by some municipalities and governmental agencies. With shortages of electricity projected even in the absence of these investment cutbacks, the prospects for energy induced constraints on growth have been further enhanced. 30. The financial condition of the National Railways Company (CNR) worsened in 1979, continuing the trend of the past several years. Low oper- ating efficiency, leading to declining traffic, and an inadequate tariff structure were the main causes of the Col$500 million deficit, the highest in CNR's recent history. Over the past five years, CNR's operating deficit has averaged Col$400 million p.a. and it is estimated that over the next five years, i.e., until rehabilitation is completed, the Government may have to pump Col$3 to Col$4 million into the railroads to keep CNR afloat. On the brighter side, the Instituto de Mercadeo Agropecuario (IDEMA), 1/ which had experienced large deficits in 1976 and 1977, registered an overall surplus estimated at Col$4 billion in 1979, its second consecutive year of surplus. (See Table 5.5-5, Statistical Appendix.) Increased operating efficiency resulting from an internal reorganization and reduced subsidies on wheat and other imported foodstuffs accounted for the turnabout in IDEYA's finances. 31. Colombia's consolidated public finances for 1979 2/ are not likely to have improved much over 1978 when current account savings reached 6.2% of 1/ IDEMA is responsible for the marketing of selected agricultural products. Its responsibilities include the importation and domestic sale (some- times at subsidized prices) of basic foodstuffs. Wheat has been its major import in recent years. 2/ Data on the finances of most of the decentalized agencies, the departments and municipalities were not available when this report was being prepared. - 17 - Table 4 - COLOMBIA: CONSOLIDATED CENTRAL GOVERNMENT FINANCES (In millions of Colombian pesos and percent of GDP) Average Average 1977* 1978* 1979* 1974-76 1977-79 Current Revenues $76,770 $101,513 $140,211 $45,840 $106,165 (8.6) (11.3) (12.0) (10.8) (11.4) Current Expenditure 34,440 45,407 63,597 21,569 47,815 (4.8) ( 5.1) t 5.4) (5.0) (5.2) Current Account Surplus/Deficit 42,330 56,106 76,614 24,271 58,350 (5.9) ( 6.3) ( 6.6) (5.7) (6.3) Gross Fixed Invest- ment (Direct) 6,374 9,622 13,630 4,757 9,875 (0.9) ( 1.1) ( 1.2) (1.1) (1.1) Overall Surplus/ Deficit 35,956 46,484 62,984 19,514 48,475 (5.0) ( 5.2) ( 5.4) (4.6) (5.2) * Percent of GDP in parentheses. Source: Bank staff estimates. - 18 - GDP. The gains made by the Central Government in 1979 were probably offset by deterioration in the consolidated decentralized agency accounts. On the other hand, it is also unlikely that public sector savings declined signifi- cantly, and with the restraint exercised on investment expenditures, the sectors' need for financing is not likely to have expanded significantly. Table 5 COLOMBIA CONSOLIDATED PUBLIC FINANCES 1974-1978 (percent of GDP) 1974 1975 1976 1977 1978* Current revenues 19.9 20.9 22.3 21.5 21.6 Current Expenditures 15.4 13.7 16.5 16.0 15.4 Current account surplus 4.5 7.2 5.8 5.5 6.2 Capital Revenue 0.8 0.8 0.5 0.3 0.4 Gross investment 7.9 8.7 7.7 6.5 7.6 of which (fixed investment) (7.1) (6.9) (6.5) (5.8) (6.9) Overall surplus (deficit) (2.6) (0.7) (1.4) (0.7) 1.0) * Estimated Source: Informe Financieros, 1974-1978; Bank staff estimates C. Developments during 1980 32. 1980 was a year of transition for the Colombian economy. The infla- tionary expectations and pressures from the external sector began to give way, permitting adjustments in the stabilization program and the switch to more development oriented policies. The vacuum in aggregate demand created by slower growth in exports seems to have been filled by a resurgence of local private and public investment. The authorities introduced policies designed to stimulate private investment and to gear up for higher public investment levels. Making this transition without exacerbating inflationary pressures or letting the economy fall into a recession is the major challenge facing the authorities during 1981. The tradeoffs between the different government policies--growth, employment, trade, monetary and fiscal--will have to be given careful consideration as the transition takes place. 33. Another transition that began in 1980 is the switch from the develop- ment strategy of the 1970s to that deemed appropriate for the new decade, as laid out in the Plan de Integracion Nacional. The reordering of priorities and programs required to achieve the PIN targets was begun in 1980. Moreover, mobilizing increased domestic resources to finance the PIN's rapid execution remains a sine qua non for the country's future growth and development. - 19 - 34. Limited growth in exports is expected to temper Colombia's economic progress in 1980. Industrial activity, hemmed-in by low international competi- tiveness, and slow growth in domestic demand, is likely to have grown by no more than 3% in real terms, and agricultural output, was affected by drought, high incidence of disease and rising fertilizer costs. Slower growth in domestic incomes and demand as coffee prices fall can be expected to have reduced the expansion in personal services and cause a fall in the growth of commercial activity. Construction, which suffered from oversupply of office space and high price apartments and rising construction costs, was not expected to recover in 1980. On a more positive note, the public sector's contribution to domestic product probably expanded in excess of 7% for the year, and mining activity (excluding petroleum), although a relatively small part of the economy, probably advanced strongly in response to favorable international prices for gold. An increase of about 3-4% in real GDP probably occurred in 1980, making also possible a 1 - 2% rise in per capita incomes. Urban unemployment, which in 1979 reversed the downward trend of the previous two years, rose somewhat in 1980. The reduced rates of population growth and internal migration experienced over the past few years, together with the relative gain in rural wages, should serve to limit the rise in urban joblessness, however. In addition to the above developments, the concession contracts with petroleum producers were adjusted to provide incentives for increased production. The prices of petroleum products were increased substantially; regular gasoline prices were raised by 50%, from US$0.60 to US$0.90 a gallon. 35. In response to lagging growth and changing economic conditions, the Colombian authorities adjusted the stabilization program in early 1980. They began a gradual reduction of the high required reserve ratio which had been in effect since early 1977 and which had become increasingly onerous to both investors and commercial banks. The 100% marginal reserve requirement, which had been largely evaded in recent months through portfolio sales and specialized fiduciary arrangements, was eliminated effective February 1. At the same time monthly adjustments were introduced to raise the average reserve requirement to 50% from 45% by July 1, 1980 in order to prevent bank credit from expanding too rapidly. 1/ Interest rates on certificates of deposit issued by commercial banks, financial corporations and finance companies were freed from controls (ceilings) as were the interest rates on loans made from the proceeds captured through these certificates. This measure had a threefold purpose: first, to increase savings; second, to restore the competitiveness of these certificates vis-a-vis the indexed saving and loan certificates (UPACs) and the dollar denominated certificates of exchange; and third, to provide savers with another competitive alternative to placing their funds in the extrabank market. Considered in conjunction with the introduction late in 1979 of "market- determined" rates of interest on new Central Bank issues of certificates of participation and agro-industrial bonds, these measures constitute a signifi- cant step towards the Government's stated goal of eventual elimination of capital market controls. It is expected that the increase in saving and stability in the institutionalized capital market brought about by these 1/ This ratio was lowered to 45% in October. - 20 - measures will lead to less inflationary pressure and eventually to lower interest rates. The allocation of resources and economic efficiency should be improved also and the effectiveness of monetary policy should be enhanced. 36. Since these monetary policy changes were expected to operate with a lag, their impact was expected only over the course of the year. Meanwhile, primarily as a result of a decline in Central Bank credit to the public sector, growth of base money and the money supply began to slow, despite further strong increases in international reserves. Short-term interest rates rose rapidly, reaching real levels of 23.5%. Shortly after mid-year, world coffee prices weakened considerably and import payments began to accelerate in response to more liberal licensing arrangements and to a reduction in the interest rate differential favoring Colombia. With international reserve accumulation substantially reduced, credit expansion and money supply growth slowed measureably. By mid-August, the growth of MI had fallen to about 16% on an annual basis, and inflation, which had surged earlier in the year, had begun to decelerate. Moreover, by the end of November, MI had been contained to 17% for the first 11 months of the year. The annual increase in the CPI had declined to 26.8% by the end of September from a peak of 29.1% in June. Gradual deceleration of inflation was probable for the remaining months of 1980, with the annual rate of price increase for the calendar year projected at around 26%. 37. Receipts from coffee exports in the first half of 1980 increased by about 30% over the same period of 1979 on the basis of both price and volume increases. Coffee production was up slightly and inventories were drawn down, permitting export volumes to increase by about 8% over January- June 1979. The average price received for coffee exports in the first half of 1980 was nearly 20% above that of the like period of the previous year (when world prices had fallen precipitiously), and even above the average for all of 1979. Minor exports, which had risen sharply in 1979, lost most of their momentum in early 1980, even though export incentives were maintained and devaluation accelerated 1/. An economic slowdown of the more easily exploitable Andean Group markets, particularly Venezuela, may account for this development. Receipts from exports of services rose by 32% in nominal US dollars during the first half of 1980, largely the fruit of higher interest rates abroad and Colombia's increased foreign exchange holdings. Otherwise, the growth of service receipts declined from that of the like 1979 period. 38. Import payments were greatly facilitated by policy changes in early 1980. In addition to the maintenance of high advance import deposit require- ments and maximum payment terms, the use of global exchange licenses was expanded and authorization to hold foreign exchange balances was widened. Another important factor in accelerating import payments, was the more rapid devaluation of the exchange rate, which raised the cost of delaying payment. Import payments, both for goods and services, have responded strongly to these policy actions. During the first semester of 1980, import payments rose by 1/ Through the first nine months of 1980, devaluation of the Colombian peso vis-a-vis the US dollar had increased to an annual rate of 16%, a real devaluation of 3%. - 21 - 40% (31% excluding payments for petroleum) compared with increases of 10% and 24% for the same periods of 1979 and 1978, respectively. This has helped to moderate inflationary pressures arising from the external sector and has some- what reduced the overhang of short-term credit arising from previous import financing. Long-term capital inflows, although substantially less than the increase in 1979 also rose significantly above the average of the previous few years. Inflows to the public sector accounted for nearly all of this increase. Net direct foreign investment continued to rise in early 1980, despite a sharp rise in registered investment abroad by Colombians 1/. 39. Notwithstanding the acceleration in import payments, international reserves continued to accumulate during the first semester of 1980. Official reserves, which had risen by US$500 million by June, continued to increase in subsequent months, before leveling off at a gain of about US$700 million for the January I-July 31, 1980 period. Although world coffee prices fell by about 25% from mid-July to mid-September and some further decline took place, it is possible that Colombia will gain additional reserves in 1980. 40. Colombia's overall public sector savings in 1980 is not likely to be maintained at the high level of the previous few years. Current expendi- tures of the Central Government are expected to increase sharply as a result of a 30% average wage hike for Government employees, a considerable rise in current transfers to the decentralized agencies, departments and municipalities to cover their growing budgetary needs, and a sizeable increase in the public transportation subsidy. At the same time, overall tax buoyancy is likely to decline further. The coffee tax will undoubtedly suffer the effects of recent softness in world prices and lower interest rates in the major international capital markets will most likely preclude any significant rise in earnings on foreign exchange holdings. Despite some administrative improvements, revenues from the sales and income taxes are unlikely to expand much, if at all, in excess of nominal GDP gains, primarily because of the slowing of domestic income growth and the tax relief measures (indexation, etc.) which became effective in January 1980. Customs revenues, on the other hand, should rise in line with the acceleration in import payments and non-tax revenues should recover. In addition, retail gasoline prices were raised twice in 1980, (May and October) for a real increase of 30%. While ECOPETROL's additional revenue from these increases is expected to exceed Col$12,500 million, the increase in the cost of petroleum imports in 1981 is estimated at Col$28,000 million. Further increases in gasoline prices are expected in 1981. Although public sector saving is likely to decline somewhat from the high ratio to GDP achieved in the 1976-79 period, it is still expected to cover over 50% of public investment this year. External sources are being looked for to finance an increasing proportion of the public sector's 1980 credit requirements, in accordance with the Government's policy of limiting public borrowing from the domestic market. 1/ A large part of the capital inflows in 1979, including practically all of the Chemical Bank loan, was used either to refinance prior debts or kept as reserves for subsequent project financing. Thus, these funds did not result in concurrent import payments. - 22 - 41. In conclusion, the transition from stabilization to more growth oriented economic policies appears well underway; however, the public in- vestment programs required to effectuate the transition to the PIN strategy seem to have gotten off to a slow start. An acceleration of these programs will be required if the PIN targets are to be met. - 23 - CHAPTER II DEVELOPMENT ISSUES AND STRATEGY A. Introduction 42. Achiejement during this decade of the present Government's objec- tives of increased productivity and maximum economic growth, improved dis- tribution of income and greater welfare for all Colombians will require a concerted effort to remove from the economy the constraints posed by short- ages of energy, inadequate economic and social infrastructure and insufficient demand. Infrastructure needs are most pressing in the transportation and energy sectors and derive from the low investment levels of the past decade when emphasis was being placed on social sector development. Policies and programs to encourage exports and stimulate domestic demand are needed. The competitiveness of Colombian products in external markets depends on increases in efficiency and reductions in unit costs which improvements to infrastructure would bring about. Greater equality in income distribution and gains in welfare require a strong economy, with rising employment levels, and a set of policies and programs oriented towards providing greater opportunities and expanded public services to low income segments of the population. 43. In recognition of the need to supplement domestic demand and reduce the economy's dependence on coffee, the Plan de Integracion Nacional (PIN) calls for continuation of export incentives. Raising productive efficiency alone is not likely to be sufficient to assure adequate export growth. For the reasons cited above, selling in foreign markets is becoming increasingly difficult and will require redoubled efforts by Colombian exporters to seek and capture these markets. The incentives to be provided under the PIN strategy include exchange rate adjustments sufficient to protect the competitiveness of Colombian goods in external markets; tax incentives (rebates) related to the value of the good to be exported, and credit availability, interest and tariff subsidies to support the investment and other costs of producing and moving exports to markets. The basic strategy is first to restore the international competitiveness lost over the last five years of high domestic inflation and thereafter to utilize exchange rate adjustments only to the degree that maintenance of competitiveness is not achievable through gains in productive efficiency. Under this policy, incentives are to be provided on a selective basis, while the value of Colombia's currency is to be maintained in balance with those of its major trading partners. The PIN also contains policies for temporary tariff reductions on capital goods. It does not include overall import liberalization policies. 44. Economic decentralization, regional autonomy and the linking of dispersed growth centers are strategic objectives of the PIN. The goals to be achieved in this respect are less concentration of economic activity and population in the three major urban centers, and the creation of a "national" market with concomitant benefits from increased trade among regions of the country. Because of its geography, Colombia's development has occurred around a number of relatively isolated growth centers, of which Bogota, Medellin, - 24 - and Cali are the most important. The growth of these three centers was fostered by transportation and communication networks which connected them with one-another and with the major port cities. Similar networks were not extended to other emerging growth centers, however, and while they have attracted capital, labor and entrepreneurship from surrounding areas, their growth has been constrained by the limited size of the surrounding market. Furthermore, once the major transport and communications networks were in place, investments in additional facilities declined and, because of chronic lack of funds for such purposes, rehabilitation and maintenance on the existing networks were not sustained at adequate levels. Consequently, both highway and railroad services deteriorated rapidly so that present transport and communication costs are high and discourage interregional trade. A lowering of these costs through the investments programmed in the PIN, together with increased incentives for investment in areas with high growth potential, could be expected to provide a substantial boost to interregional trade and to overall GDP growth. The decentralization of taxing authority, and regional (departmental and municipal) autonomy over investment programs as specified in the PIN, would seem to be an effective complement to the deconcentration of economic activity. 45. The PIN also places emphasis on the promotion of both small scale and commercial agriculture as a means of diversifying and increasing exports, assuring adequate domestic food supplies, holding down inflation and contri- buting to the welfare and income distribution goals of the Government. Production credit and government-supported, on-farm investment, are major components of the Plan's strategy in agriculture. Continuation of the Integ- rated Rural Development (DRI) project, with early initiation of its second phase, receives high priority as well. Industrial policy is designed to provide clear and stable rules-of-the-game and adequate infrastructure so that private entrepreneurs can invest and expand output in an environment of certainty. Tariff policy is to be used to prevent internal prices from getting too far out of line with international comparators, but without prejudice to the provision of adequate protection to domestic industry. The Administration's approach towards helping the poor takes on a new orientation in the PIN. Selected low income groups, such as workers in the informal sector, and children from poor families are to receive special attention and better focus and integration of social programs is called for. 46. The development strategy outlined in the PIN seems appropriate given perspective world developments and the present stage of evolution of the Colombian economy. The growing energy deficit, with the related potential for serious balance of payments constraint on growth, together with the existence of abundant domestic primary energy resources, argues convincingly for the high priority given to energy development. Likewise, the prospects for slower growth of world trade, together with the present limited domestic market, suggest the propriety of efforts to expand the domestic market and promote exports. However, generating a significantly larger domestic market through deconcentration of economic (primarily industrial) activity, supported, or led, by infrastructure expansion and regional autonomy, promises to be a long and costly endeavor at best. The advantages of agglomeration are particularly strong in Colombia, and the cost of providing the minimum required infrastruc- ture and the other accoutrements (skilled workers, financial services, etc.) - 25 - necessary for encouraging private investors to locate in outlying areas will be high. Also, the drain of public investment resources to regional infra- structure projects with long gestation periods might reduce the short term growth prospects of the economy, and the potential for misallocation of resources would appear great. On the other hand, several dynamic regional growth centers exist in Colombia and the long-term benefits of uniting these centers may be substantial. It probably goes without saying that the success of this element of the PIN strategy requires careful and detailed long-term planning. While this planning is being advanced, investments in recondition- ing and maintaining the existing economic and social infrastructure, along with selective expansion, would appear to merit high priority. 47. The objectives of improving the focus and cost effectiveness of social sector programs would seem to warrant broad support. Despite the substantial expenditure on these programs in the past, the accomplishments have been relatively modest, as is indicated in the PIN. The most pressing social problems have been identified as concerning the health and welfare of the country's youth, particularly those rendered for one reason or another unable to fend for themselves. By better integration and limiting the scope of social programs (nutrition, education, health and health-related services) in the manner suggested in the PIN, significant advances in resolving these problems should be possible. 48. The other elements of the Government's strategy appear to be sound as well. The emphasis on increasing economic efficiency and improving finan- cial intermediation through proper tariff and capital market policies seems appropriate, as do the policy prescriptions for rationlizing agricultural and industrial sector development. On the whole, the PIN provides a good analysis of sector problems and sets forth the general measures the Government plans to take to deal with those problems. Much more work is needed, however, to refine and integrate these sector analyses and to formulate more precisely the specific policies and investment programs required to successfully carry out the PIN strategy. 49. There are two important aspects of bringing off the development strategy that are expected to receive prime attention by the Colombian author- ities in coming months. The first involves improving intersectoral coordina- tion in planning and execution of sector strategies. This seems particularly critical with respect to integrating planning and project execution in the energy and transportation sectors. Major investments are planned in these sectors and they are clearly interdependent. It is also critical for regional development and industrial strategies, as well as for the multidisciplinary programs such as Integrated Rural Development (DRI) and the National Nutrition Plan (PAN). With the basic analysis and programming having been completed, the next stage of planning would seem logically to be the integration of the various sectoral plans and strategies. Work on this next stage has already been started in Colombia with regard to some sectors, e.g., the energy- transport sector integration. 50. The second aspect of the Government's strategy which needs careful attention in coming months has to do with the financial and resource mobiliza- tion features of the Plan. Given the ambitious investment program implied by the Plan, a major effort will be required to mobilize the financial (and - 26 - other) resources necessary for its execution. This, in turn, is likely to require further tax and capital market reforms, or expanded training programs to provide the needed labor skills. The implications for other sectors and for overall growth and employment of massive resource shifts (e.g., to the energy sector) may require evaluation; the results of which may suggest changes in sector priorities, etc. The timing of investment programs should be firmed up and their implications for economic stability (inflation) assessed. Finally, an analysis of the proposed use of external credits to finance these investments could be expected to pay large returns with respect to avoiding possible future debt servicing problems. While these represent only a part of the additional issues to be dealt with as the PIN is refined in coming months, they do illustrate the nature and magnitude of the work remaining to be done if the strategy is to be carried out successfully. Fur- ther work in this regard would be expected to identify the specific policies and program measures required to make the strategy viable within the given timeframe. MAJOR SECTOR ISSUES B. ENERGY 51. Total energy consumption has grown by about 3.5% per year on average since 1975. Energy demand (see Table 6) has emanated mainly from the industrial and transportation sectors, but with a not insignificant portion attributable to commerce and household consumption. In 1979, about half of Colombia's primary energy requirement was supplied by oil, more than two-fifths of which was imported. Although oil and gas make up more than two-thirds of primary energy produced, they represent only 5% of the country's total known primary energy reserves, with the major part of reserves comprised of hydro potential and coal. Colombia's hydro potential is enormous and could provide for a large part of the country's energy needs for at least the next 20 years. Coal deposits are found all over Colombia. While measured and indicated reserves are estimated at 1.3 billion and 0.8 billion tons, respectively, potential reserves have been estimated at 10 billion tons. The prospects for finding additional oil reserves appear favorable; nevertheless, Colombia's priorities in energy, at least at this time, seem clear: to make optimal use of its existing oil and gas resources, while rapidly increasing the use of its hydro and coal resources. If additional oil is found, it would, of course, make an important contribution to solving the nation's energy and balance of payments problems. However, the problematics of discovering oil in commercial quantities, together with the rapidity with which the balance of payments is expected to deteriorate, elevates energy diversification to maximum priority. 52. Resolution of the energy problem depends on the country's success in designing and undertaking a program to promote efficient energy avail- ability, allocation and use. Such a program would be expected to include: energy pricing and other policies that would rationalize energy consumption and encourage the substitution of less costly domestic energy sources for oil, a least-cost plan of investments in energy and related sectors and measures to ensure the program's rapid execution. The success of this program would be determined by the rate of discovery and development of new oil and gas fields, as well as by the timely development of existing ones; the possibility - 27 - Table 6: COLOMBIA - PRIMARY ENERGY RESERVES, MI?1Y AND CONUUMPTIOli&/ (In Kilotons of Petroleum Equivalent and in Percent) Total Primary Resev ys, Supply Consumption, Energy 1979 Percent 1979 Percent Consuming 1977 Percent Source KTPE % KTPE 7. Sector KTPE % Oil 46,000 1 7,803 52 Industry 4,756 37 Gas 132,666 4 3,001 20 Transportation 3,600 28 Coal 1,348,486 40 3,152 21 Residential and Coumercial 771 6 Hydro 1,886,900 55 1,050 7 Electrical Power 2/ 2,700 21 / Other 1,028 8 Total 3,414,052 100 15,006 100 12,855 100 1/ Does not include energy produced from firewood and bagasse. 2/ Electrical power is considered a final consumer of primary energy. Source: Departamento Nacional de Planeacion. - 28 - of producing synthetic fuels economically; and the international competitive- ness of the country's coal resources. Partially because of the complexity of the issues, the sector has been characterized over the last several years, by insufficient progress in: (a) the use of pricing policies and other incentives to channel demand, influence resource allocation and mobilize financing for energy-related investments; (b) the substitution of domestic energy sources, particularly among industrial fuels; and (c) the development of infrastructure to transport hydrocarbons efficiently. 53. Although planning and policy making has improved substantially in some energy sector institutions in recent years, overall planning and coor- dination of policies and investment decisions is still weak. Insufficient coordination between the transport and energy sectors could delay the execution of key projects and result in non-optimal investment decisions. Some recent decisions related to the substitution of gas by coal and the utilization of coal-fired electric plants appear to have been taken without adequate consider- ation of the relevant options regarding plant location and size. The planning, development and use of non-conventional sources of energy appear not to have been given sufficient priority despite the favorable possibilities of develop- ing other sources of energy. An integrated strategy (and related policies) for energy development has not yet been formulated. A study initiated in 1980 by the National Planning Department is expected to provide the basis for improving overall energy planning and policy making. However, a more focused and active governmental role will most likely be required during the next three to five years to attain sufficient progress in the energy sector. Electrical Power 54. The use of electric power has grown rapidly for the past several years, reaching more than 20% of energy consumption in 1977. This growth was supported by a substantial increase in installed capacity and by gradual consolidation of isolated facilities into regional systems to better balance supply and demand nationwide. Hydroelectricity is Colombia's most economic conventional source of energy, and currently provides about 70% of total electricity generated in the country. It is a renewable source, and the country's hydropower possibilities are enormous. If adequately developed, they could provide for a large part of the nation energy needs for at least the next twenty years. Despite substantial past investment effort, however, hydropower's share in total energy supply is still the lowest of all primary energy sources. 55. At the present time expansion of the hydropower sector is cons- trained by insufficient domestic financial resources, the financial weakness of many small power companies (electrificadoras) and an organizational and institutional framework that has not kept pace with sector needs. Despite significant improvement in recent years, sector planning, coordination and regulation required further strengthening. - 29 - 56. Except for EEEB, EPM, and CVC 1/ which have histories of adequate cash generation, the power sector has had to rely heavily on borrowings and budget- ary contributions to finance its investments. EEEB and EPM operate large scale/low cost systems covering the most affluent markets, consequently they have usually been able to finance their investments with an appropriate balance of internal cash generation and borrowing, while still charging relatively low electricity rates. Other companies, e.g., ICEL and CORELCA, 2/ with small, high cost systems serving less affluent markets, have had to rely heavily on national budget contributions. Thus, while past levels of external capital inflow have been adequate to finance the foreign exchange component of investment, domestic resource mobilization, affected by low electricity rates in some companies, inflation and restraints on domestic credit expansion, has not been sufficient. 57. During 1977-79 the Government covered the unfinanced investment gap in the power sector through capital transfers. The amount of resources required for this increased rapidly during the period, however, because of the acceleration in investment and other costs and the erosion in real tariff rates associated with higher than expected inflation. By 1980, EEEB had joined the list of power companies with serious financial difficulties. Recent updates of cost estimates for the peak investment period 1980-85 indicate even larger domestic capital requirements than previously anticipated. Consequently, continued rapid upward adjustments in tariffs will probably be required if the power companies are to establish an adequate rate of return on their assets and generate a reasonable proportion of the necessary domestic financing. The alternative of reducing investment programs would entail extremely high economic cost and directly contravene the Government's least- cost energy development program. On the other hand, reliance on national budget contributions to cover the projected financial deficits in the power sector would place a very heavy burden on the national budget and, possibly cause postponement, or elimination, of priority projects in other sectors. In 1980, the Government reinforced the Electricity Development Fund (FDE) through an injection of monies acquired via the issuance of Central Bank certificates. The purpose of this Fund is to provide a source of financing for the debt service payments of the power companies. While beneficial, the Fund may not generate the amount of resources required during the 1980-85 period. A possible longer-term source of local cost financing would be the issuance of medium- and long-term bonds, which would have to be sufficiently attractive in real yields to be marketable locally in large amounts. Prudence would suggest a careful look at the debt structures and debt servicing capacity of the power companies before deciding on the division between borrowing and rate increases in financing the proposed investment program. 1/ Empresa de Energia Electrica de Bogota (EEEB); Empresas Publicas de Medellin (EPM); Corporacion Autonoma Regional en el Valle del Rio Cauca (CVC). 2/ Instituto Colombiano de Energia Electrica (ICEL); and Corporacion Electrica de la Costa Atlantica (CORELCA). - 30 - 58. The existing policy on construction of new generating facilities established that minimum cost solutions in the provision of electricity are to be sought through development of a master plan for generation, transmission and distribution expansion. Interconexion Electrica S.A. (ISA), established in 1967, was charged with planning and coordinating generation and transmis- sion expansion and with interconnecting the systems of the regional power companies, its shareholders, with the view to effecting least cost national power dispatch. ISA is to construct and own plants of national interest as a means of fulfilling its agreed upon objectives. By 1988, ISA is expected to have direct control over nearly 30% of power sector capacity. The final allocation of plants is pending the completion of a sector financing plan covering the 1980-88 period. 59. Because of delays being encountered in the construction of hydro plants and the strong growth in power demand, it is now recognized that substantial thermal capacity will be required over the medium-term. However, the issues of optimum location and size of these plants have not yet been addressed fully. Moreover, the relative merits of constructing large coal- fired plants (at least 500 MW) interconnected with the national grid, in place of a series of smaller isolated plants, do not appear to have been given adequate consideration. In view of the options made available by planned coal development, the authorities are expected to review carefully these alternatives. Petroleum 60. Colombia's oil production has been declining at an average annual rate of about 6% since 1970, as the flow from new wells has failed to compen- sate for the natural decline in extraction from older wells. This has occurred primarily because investments in oil exploration and development by the private sector during the past decade were sharply curtailed as a consequence of insufficient price incentives. In mid 1980, the Government took a major step to provide adequate incentives to private oil producers by introducing price adjustments for both basic (production following the normal declination of oil fields) and incremental (production in addition to the normal declina- tion resulting from secondary recovery techniques) crude. Basic crude prices were increased from US$1.70 to US$3.83 a barrel and linked to an inflation index. In the case of incremental crude, the price will range between 20% and 50% of the average CIF Cartagena import price paid by ECOPETROL, under a formula which relates the price directly to the ratio of incremental to basic crude production in each field. This is expected to result in a two and a half times increase in the average incremental crude price from the previous average price of about US$4.12 per barrel. 61. Although increased sharply over the past two years, retail prices in Colombia for oil and oil derivatives still do not reflect the opportunity cost of imports and have had only a moderate impact in curbing demand growth. The difference between the cost of oil products at CIF prices and the average selling price to consumers was about US$7 per barrel in 1979. Subsidizing energy prices has drained ECOPETROL's finances and limited its exploration and secondary recovery investments, discouraged conservation and delayed the - 31 - Table 7: COLOMBIA - PROJECTED TRADE BALANCE IN ENERGY, 1979-80, 1986, 1987 AND 1990 (US Dollar Millions) Alternative Preliminary Estimated Current Projection V Alternative Projection 2/ Projection 3 1979 1980 1986 1987 1990 1986 1987 1990 1990 Energy Exports 162 279 1,080 1,340 2,314 755 1,200 2,314 2,314 Coal 16 18 353 534 1,217 28 394 1,217 1,217 Fuel Oil 146 261 727 806 1,097 727 806 1,097 1,097 Energy Imports 571 760 2.599 1.679 2,565 2,870 2,771 3,517 6,609 Crude Oil 211 540 2,480 1,479 1,692 2,480 2,197 1,692 4,784 Petroleum Derivatives 360 220 119 200 873 390 574 1,825 1,825 Trade Balance -409 -481 -1,519 -339 -251 -2,115 -1,571 -1,203 -4,295 Energy Imports/Merchandise Exports 14.1 17.5 31.7 18.3 20.3 36.4 30.4 27.8 52.3 Energy Imports/Merchandise Imports 16.8 17.2 28.0 17.7 20.4 30.0 26.2 26.0 39.8 Energy Imports/GDP 2.1 2.4 4.6 2.7 3.0 5.1 4.4 4.2 7.8 1/ Assumes yearly domestic real price increases in petroleum products to consumers, Cerrejon's coal exports starting in 1986, and increasing domestic oil production coming on stream at the beginning of 1987. 2/ Assumes no yearly real domestic price increase in petroleum products to consumers. Cerrejon's coal exports starting in 1987, and increasing domestic oil production coming on stream in mid-1987. I 3/ Assumes no yearly real domestic price increase in petroleum products to consumers, Cerrejon's coal exports starting in 1986 and no increasing oil production. Source: Bank staff estimates and projections. - 32 - substitution of petroleum products by other sources of energy. Projections of supply and demand under alternative scenarios regarding pricing, etc., indicate that even under optimistic assumptions regarding conservation, secondary recovery, etc., Colombia's overall energy (petroleum) trade balance will most likely result in a deficit of about US$1.5 billion by 1986 (see Table 7). In the absence of continuing real petroleum price increases to domestic consumers, this deficit could reach in excess of US$2.0 billion by that same year. In the event that future exploration efforts do not result in commercially viable discoveries and yearly real petroleum price increases are not adopted, by 1990 the energy trade deficit could reach over US$4.0 billion (27% of expected receipts that year from exports of goods and non-factor services), a level which would seriously diminish Colombia's growth prospects. To avoid this, raising domestic retail prices to international levels and achieving financial viability in ECOPETROL's finances have become prime objectives of the Government, as has the substitution of petroleum derivatives by less costly fuels. These objectives are being approached gradually to avoid excessive disruption to the domestic economy. Other sources of gasoline, including the feasibility of coal liquification and the production of gasohol and methanol might prove to be attractive alternatives to oil over the longer term. At the present time, the extent of possible inter-fuel substitution is unknown, but thought to be sizeable. 62. ECOPETROL's investment program for the present decade requires careful planning by virtue of its large size and the uncertainties regarding domestic oil availabilities and inter-fuel substitution possibilities. Questions such as the appropriate role for ECOPETROL in the exploration for oil, the relative advantages and disadvantages of domestic refining versus importing derivatives, the proper pricing policy, the priorities for invest- ment, and other major energy sector issues are currently being studied by the National Planning Department, aided by domestic and foreign consultants. From this study is expected to evolve a definitive set of policies and program activities, including the analysis of important energy projects. Gas 63. Colombia's natural gas reserves are presently estimated at 4,500 billion cubic feet, of which about three-quarters is located in the Guajira peninsula in the north eastern part of the country. On the basis of prelim- inary geological work, a potential for new discoveries exists in the Guajira and the Middle Magdalena regions. Exploration incentives are diminished, however, by the lack of firm plans to utilize the gas (i.e., markets) and by a policy of agreeing ad hoc with producers on prices to be paid for newly discovered gas, rather than establishing an incentive price in advance of exploration. 64. Proven reserves in the Guajira region would enable the utilization of about 450 million cubic feet per day for 20 years. Several projects have been proposed to make use of this gas. These include: (a) residential and industrial uses in the major metropolitan areas, with a pipeline (Gasoducto del Occidente) to be built to transport the gas to these areas; (b) production - 33 - of ammonia and urea; and (c) production of methanol. The amount of proven gas reserves does not allow for all of these projects to be undertaken. Individual project feasibility remains to be assessed and priorities have yet to be determined. Government projections indicate that by 1990 the consumption of oil products could be reduced by as much as 46% if the gasoducto and methanol plant were constructed. This would involve running a pipeline from the northern coast to Cali and Medelin (Bogota would continue using petroleum derivatives supplied by the proposed Llanos Orientales refinery), where the total demand for gas is expected to reach 90 million cubic feet per day by 1985 and 138 million cubic feet per day by 1990. The pipeline, as currently proposed, would have a capacity of 280 million cubic feet per day, and could cost as much as US$1.0 million per mile (1980 prices). The decision on construction of the gasoducto is complicated by the existence of large coal deposits in the Medellin and Cali areas, which, if developed fully, might compete effectively with the gas. The purposed fertilizer plant would produce 247,000-450,000 tons per annum of ammonia and 335,000-431,000 tons per annum of urea, depending on the location of the plant. An assessment of the tech- nical, as well as economic feasibility would be required in the case of the methanol plant (substitute for gasoline in powering automobiles). Coal 65. Colombia's coal prospects are considered very good. There are several large deposits of high quality coal scattered about the country, the most important of which in terms of size, quality and accessibility is the El Cerrejon deposit located in the Guajira peninsula. Potential resources of up to 10 billion tons have been reported, however, measured and indicated reserves total 1.3 billion and 0.8 billion tons respectively. Thermal coal accounts for 70% of measured and indicated reserves and coking coal the remaining 30%. The major constraint to developing these deposits is the cost of transport, which, because of Colombia's hilly terrain, may offset the advantages of low production costs which may be encountered. 66. Total coal production reached about 5 million tons in 1979. Most of this coal is consumed domestically, with less than 10% exported (mainly to Venezuela). About 700 mines are in production, all privately owned, with three-fifths producing less than 500 tons per month. Only three existing mines produce more than 10,000 tons a month. Only the four largest mines qualify as relatively modern. Intermediate mines have varying of degrees of mechanization, but generally inadequate organization, planning and safety conditions. Small mines usually employ less than 50 workers each and extrac- tion is limited to less than 200 meters below of the surface. Planning, organization and use of machinery are deficient in these mines and safety conditions are very poor. Production is highly inefficient and "high-grading" is the general practice. The resulting high cost of production, combined with inadequate transportation facilities, limits sales to nearby markets. 67. CARBOCOL, the Government coal agency, has been preparing projects for exploiting the country's coal reserves, for both domestic consumption and export. Its major project is El Cerrejon, the northern and central blocks of which are planned for development during the next five years, - 34 - with the southern block left as reserve for future development. CARBOCOL has entered into a joint venture with INTERCOR (an EXXON subsidiary) to develop the northern block. The total project cost is estimated at US$2.9 billion, exclusive of working capital and capitalization of interest during construction. External financing will be required for a large part of the Government's 50% of project investment. Exploitation by open pit mining is expected to begin in early 1986 and initially produce 7.0 million tons per year of low sulphur, low ash and high calorific value coal for export. Thereafter, production is projected to rise gradually to 15 million tons per year by 1989. Long term sale contracts are necessary to justify so large an investment. Both parties to this venture are moving cautiously in the negotiation of long term sales agreement. 68. Development of the El Cerrejon deposits raises several issues concerning transportation and port configurations. Coal from the northern block is to be transported from the mine head by a railroad (to be constructed) to a port (to be constructed) in the Bahia de Portete. CARBOCOL has plans to supply the thermal plants located along the north coast with coal from the Central Block by 1982. While CARBOCOL would be sole owner in this case, mining operations would be let out under contracts. Although the feasibility study of this project has recently been completed, it was not available to Bank staff for analysis. Moreover, the transport requirements still need to be adequately determined. It would seem beneficial to advance planning on the Central El Cerrejon Block in order to assure optimal use of the transportation facilities constructed in the area. 69. With the exception of El Cerrejon North, further analysis is requred before choices amongst the many coal options are made. The prospective cost of producing coal from the various deposits must be determined, as must the relative distribution and marketing costs from deposit to consuming centers (including exports). Additional exploration and testing would better estab- lish the location and magnitude of the country's coal reserves. Only with detailed data on production and distribution costs for the various coal options, as well as for other fuel options, will it be possible to make rational inter-fuel choices and design the optimum coal development policies and programs. The energy study currently being prepared by the National Planning Department is expected to provide the data and analysis on which such choices might be based. Increased private sector involvement will be necessary to develop these resources rapidly. Other Energy Sources 70. Firewood, - is an important source of energy in Colombia. It is used for cooking in most rural and urban areas, and is used extensively to heat homes. Current estimates of the use of firewood are not reliable. Given its importance in many areas of the country, it would seem advisable to prepare an assessment of its role and prospects regarding total energy supply. Reforestation projects are important not only from the point of view of the renewal of firewood resources, but also to protect natural water- sheds and to prevent erosion from clogging hydropower basins and navigable waterways. Geothermal, - resources should be considerable in Colombia, given - 35 - its geological structure. Existing studies indicate, however, that the poten- tial for development of geothermal resources may be limited for the time being, as development cost could be substantially higher than hydro and coal alternatives. There are some exploratory studies being conducted in the El Macizo de Ruiz area with possibilities of 10-20 MW of generating capacity. Additional studies are required to identify further geothermal possibilities. Uranium, - fueled plants constitute a long-term energy alternative and the Government has encouraged uranium exploration by foreign companies. However, nuclear power generation does not appear to be attractive for Colombia for at least the next 20 years, given its supply of low cost alternatives. Gasohol, - production is another long-term possibility in Colombia. Produc- tion costs are still relatively high, however, and new lands would have to be brought into sugar cane cultivation should gasohol production eventually become feasible. With Colombia's vast coal resources, coal liquefaction should be assessed as a potential source of liquefied petroleum gas, oils and chemicals. 71. Even assuming the appropriate energy policies and programs were to be introduced promptly, petroleum would still remain the major primary energy source for Colombia at the end of this decade. As a consequence of substan- tial prospective delays in adopting the appropriate policies and executing energy development programs, however, the country's excessive dependence on petroleum may extend for a considerably longer period. Without doubt the most compelling task facing Colombia during the coming decade is that of developing domestic energy resources, which it has in abundance, and encourag- ing rational energy use. In this connection, achieving international prices at the earliest possible date and within a comprehensive energy pricing policy would appear to be critical. Manufacturing 72. Colombia's manufacturing sector has grown rapidly over the past three decades and now makes an important contribution to growth and employment creation. The share of manufacturing in GDP rose from 14% to 20% between 1950 and 1979, while its share in employment rose from 12% to 18%. Major changes took place in the structure of manufacturing output during this period as well, with consumer goods declining from four-fifths to one- half of the total and intermediate goods increasing sufficiently to account for 40% in 1979. Colombia's comparative advantage has been shifting away from mass-produced cheap labor goods to technologically more sophisticated capital intensive goods. Policies favoring import substitution in the 50s and 60s, followed, but not fully replaced, by export promotion measures in the 70s, were successful in stimulating growth of the sector. Manufac- turing became much more export oriented in the 1970s as a result of the new policy orientation, which recognizned that the possibilities for further import substitution were exhausted and that the growth of domestic demand was insufficient. Growth of the sector declined in the mid-1970s as world recession and a certain loss of competitiveness of Colombian goods in external markets reduced sales abroad, but recovered strongly in 1978 and 1979 as a result of accelerated growth in domestic incomes. Capacity constraints have - 36 - become an increasing factor regarding manufacturing sector growth as a consequence of low investment levels during the past few years. This, along with continued high protection, has led to growing inefficiency in many manufacturing subsectors, serving to reduce competitiveness further and exacerbate inflation. The monetary and exchange rate policies which were used over a prolonged period during the late 1970s as the first defense against inflation were detrimental to industrial investment and export growth. 73. The relaxation of stabilization policy begun in late 1979 and early 1980 was favorable both to industrial investment and export promotion. If inflationary pressures originating in the external sector continue to subside as expected, it should be possible to dismantle further the controls over credit, and the competitiveness of Colombian goods in external markets should increase. Industrial efficiency would continue to be hampered by high protec- tion, however, and a program to reduce further tariffs, quantitative protection and administrative controls would be highly beneficial. It would seem plausible to work out arrangements with industry groups under which financial or other assistance would be given for a temporary adjustment period during which tariff and quantitative controls would be reduced. With such agreements tailored to the specific degree of effective protection enjoyed by the industry subgroup and to its economic prospects, their cost would not be excessive. An alterna- tive would be to revalue the peso, given Colombia's foreign exchange holdings; however, such a measure could increase contraband and affect industrial and export activities seriously. The potential for reductions in average tariff rates is good. In percentage terms, the average effective tariff over all commodity groups was approximately 48% in 1979, with subgroup percentages ranging from 81% to 24%. On a product basis, effective tariffs exceeding 100% are not uncommon. Quantitative restrictions, range from absolute prohibition of licenses for products the domestic pioduction of which is deemed essential, to entirely free issuance of licenses for high priority imports the domestic production of which is considered not to be feasible. Although there has been some relaxation of licensing requirements in recent months (products transferred to less onerous controls, the authorization of global rather than specific licenses, etc.), most import categories are still subject to restraints via the licensing system. In terms of the overall effect on imports, this system is probably equally as burdensome as the high effective tariff levels. The Government's policy as set forth in the PIN of gradually reducing tariff protection and quantitative controls over imports, without prejudice to the provision of adequate protection to domestic industry, is directed towards preventing domestic prices from getting too far out-of-line with international prices. Under the umbrella of excessive protection, many product prices have over the past several years risen substantially above their international counterparts. It would appear advisable to bring these prices into alignment. Administrative controls could also be eliminated and would make importing easier and faster. - 37 - 74. Export promotion policies were important in Colombian industrys' penetration of foreign markets during the early 1970s. Nearly one-half of the increase in exports during the 1967-77 period was accounted for by new products: textiles, garments, machinery, and transport equipment, and print- ing. Export growth was heavily concentrated in the Andean Group countries, with more than two-fifths of industrial exports during this period directed to these countries (particularly Venezuela and Ecuador), compared with three- fifths to all of Latin America. Exports to the Andean Group countries were widely diversified, while those to the industrialized countries were concen- trated in highly labor intensive items such as garments, wood products, and leather goods. Colombia's long term export prospects to the Andean Group countries are not that favorable. Rapid elimination of price and non-price constraints is necessary if markets are to be regained and exports to grow at rates comparable to the early 1970s. Over the longer term, the introduction on a broad scale of modern production technology will be required to keep Colombian exporters in pace with the exigencies of world markets. 75. During the past five years, credit to the manufacturing sector has expanded moderately in real terms. This has been accompanied, however, by a severe reduction in the maturity structure of the credit extended, partic- ularly for that provided by financial corporations which traditionally have been the major source of medium and long term financing for the sector. During the same period, the sector's need for medium and long-term credit has multiplied. An increasing proportion of industrial output is constituted by consumer durables and capital goods which require more credit per unit value of production. Retained earnings, traditionally the major source of investment financing, have been squeezed by the taxing of nominal (inflation-related) rather than real profits, the necessity for companies to pay high dividends to maintain the attractiveness of their shares vis-a-vis other financial invest- ments and by the requirement that depreciation allowances be based on original (non-revalued) assets. While the tax and depreciation issues have now been resolved, share issues are still having difficulty competing with the high returns available on financial assets. With continued high inflation and financial market uncertainty in prospect, the liquidity preference of savers is expected to remain high and the reluctance of financial institutions to term-transfer resources to persist. The establishment in late 1980 of a guarantee fund within the Central Bank to cover large withdrawals of deposits, and of controls over the ratio of short- to long-term lending by financial corporations is expected to result in greater-term transformation by these institutions. However, the availability of domestic medium- and long-term credit is not expected to expand pari passu with demand, and credit from external sources channelled through the financial corporations is likely to remain the major source of such credit. 76. Foreign investment is viewed in the PIN as an important supplement and complement to domestic investment in extending Colombia's industrial development. However, regulations of the Andean Pact Agreement limiting the repatriation of profits and capital and providing incentives based on the degree of national ownership, together with the domestic prohibition on foreign investment in the three major cities, could limit somewhat the role of such investment in Colombia's development. Nevertheless, the diversion - 38 - of investment away from Bogota may result in the creation of new economic activity closer to international markets. Given the advantages of agglomeration in a country like Colombia, it seems unlikely that foreign investment will be attracted to outlying areas in significant amounts in the absence of sufficient infrastructure investment, and the losses in terms of technology transfer and access to external markets, plus the capital and employment benefits foregone, could be expected to be substantial. It might be advisable, therefore, to permit foreign investment in Cali and Medellin pending the provision of infrastructure in the secondary growth centers. Once the basic infrastructure is in place, incentives for industrial decentralization would probably have a better chance of success. Transportation 77. Because of the deteriorated state of infrastructure within the sector, transport costs are high and service is unreliable. This discourages interregional trade and contributes to the concentration of economic activity in a small number of increasingly over-crowded metropolitan areas. Services by both rail and highway are inadequate. Derailments and delays are frequent on the railways largely because of the poor condition of the tract and a high proportion of the rolling stock is out of commission because of lack of main- tenance and spare parts. Many rail services are provided without economic justification, while service needs to be extended into new areas of high natural resource potential. Colombia's highways are also in poor condition, mainly because of a chronic lack of local counterpart funds for maintenance and rehabilitation. Some additions are urgently needed to the highway network and an expanded program of feeder roads connecting isolated rural areas of high agricultural potential would probably provide high investment returns. Selective port investment is needed also, particularly to handle the expected increased flows of coal, petroleum and other natural resources. Most of these investments, including those for rehabilitation and maintenance, are included in the capital development program of the PIN. The total investment required is large and careful transport sector planning, incor- porating projections of economic growth, geographical dispersion of economic activity, product mix, export diversification, etc., is required for optimum development of the country's transport infrastructure. 78. Transport sector planning in Colombia needs to consider both the setting of priorities and the establishment of sector policies. A strong case can be made for substantially increased investment in maintenance and rehabilitation, and the PIN accords high priority to such investments. The priorities among new construction projects are more difficult to determine since they require a careful analysis of probable future spatial development of the country and of the likely nature, size and direction of product flows based on that development. In particular, uncertainties regarding develop- ments in the energy sector, including the perspectives for relative energy prices and for discovery and utilization of additional domestic energy re- sources, complicate the settling of priorities. Insufficient data on present transport activities, costs, etc., increases the difficulty of making choices - 39 - among alternative construction projects. The PIN recognizes these difficul- ties and sets forth what seems to be a well-balanced program of investments, supported by a series of studies to establish the feasibility of further new construction in the sector. In addition to an extensive program of mainte- nance and rehabilitation of the various modes, the PIN foresees through 1982 the construction of 550 kilometers of new highways, 2,000 kilometers of rural roads and the Saboya/Carare rail bypass on the route from Santa Marta to Bogota. Ongoing investments in the Bogota, Cartagena, Barranguilla and Rionegro (Medellin) airports are to be completed, providing improved service on both national and international flights, and selected port expansions are foreseen to improve service and provide specialized facilties, e.g., contain- erization. 77. Transport policy needs include the setting of overall sector guide- lines, the pricing of transport services, the energy implications of transport development, the establishment and enforcement of load and weight controls, guidelines for financing the operating and investment cost of the sector (particularly the issue of National Government support), and the fixing of institutional responsibility for the sector at the various governmental levels. The establishment of policies to rationalize future transport sector growth and characteristics (e.g., vehicle fleet composition) with projected energy availabilities and prices is an especially difficult task. An impor- tant initial step towards the establishment of a comprehensive set of sector policies has been taken in the analysis underlying the PIN. General sector policies are set forth in that analysis, and as development trends sort themselves out, detailed policy prescriptions may be expected. It is important to recognize the high degree of uncertainty regarding future growth trends, energy developments, etc., and to maintain a flexible approach to the estab- lishment of specific subsector policies. Agriculture 80. Agriculture is a key sector of the economy from several points of view. It is important in terms of its participation in GDP (29%) and employ- ment (30%), and its contribution to exports (fully two-thirds of merchandise exports were of agricultural sector origin in 1978 and 1979). It is crucial to the provision of adequate food supplies and to the Government's welfare strategy which emphasizes nutrition and health. In addition, the provision of adequate food supplies on the domestic market is critical to the main- tenance of internal price stability. Colombia is self-sufficient in practic- ally all basic foodstuffs; the major exception being wheat. The production of foodstuffs, in general, has kept up with demand over the past decade. Climatic conditions are volatile in the highlands, however, with periods of drought interposed with periods of excessive rainfall. Consequently, agricul- tural productivity is subject to wide swings as occurred for instance, with the 1977 and 1978 harvests in which a period of drought was followed by a year of particularly favorable growing weather. Abstracting from cyclical swings, the record of long-term productivity growth in agriculture is lackluster at best, except for certain commercial export crops (rice, coffee, bananas, sugar, and palm oil) which have benefitted from intensive research programs. In addition, the efficiency of public institutions providing support to the sector has deteriorated in recent years. - 40 - 81. Raising agricultural productivity will require improved on-farm technology and remunerative and stable demand for farm products. These would provide both the means and incentives for higher productivity. Under the PIN, research and extension services, which have been focussed heavily on commercial export crops in the past, are to be re-evaluated and expanded under direction of a National Council for Agricultural Research and Technology Transfer and supported by the Fund for Agricultural Research and Renewable National Resources. Farmer access to other inputs, such as fertilizer, pesticides, etc., at reasonable cost is to be assured also, in part through the maintenance of low tariffs on imports of these items and in part through the provision of adequate, moderate cost credit. Public investments in irrigation facilities and improvements to farm land are to be accelerated also. Stable demand and remunerative prices are to be secured through measures to raise the efficiency of distribution and marketing of farm produce, including the establishment of collection and marketing centers, storage facilities, etc., and the construc- tion of farm-to-market roads. These measures are expected to increase compe- tition among middlemen, lower prices to the consumer, and raise demand and farm gate prices. Agroindustries are to be promoted to further raise demand. For this purpose, "produce centers" are to be established to promote a steady supply of carefully graded produce for agroindustry, and a special fund to finance agroindustrial feasibility studies is proposed. The success of these programs will depend on improvements in the efficiency of sector institutions, and it is expected that the additional attention will be given to this problem in coming months. 82. Raising the productivity of minifundia and assuring their owners of adequate incomes through farming is a difficult problem to resolve. The vast majority of these farms have landholdings too small to provide their owners with reasonable incomes and many farm families have to seek outside employment or receive transfers from family members, who have migrated to urban areas, to subsist. Recent evidence of a tightening labor market in rural areas may presage higher real wages and incomes for farm families. Their main source of income is from farming, however, and the major difficulties for these farms have been low productivity and lack of markets. Their landholdings are too small to permit much mechanization or to provide the basis for large capital indebtedness. The proposed programs to raise demand and farm prices should help. In addition, the Government intends to continue with the integrated rural development, rural electrification, nutrition and health, education, water supply and other programs which have been designed to increase the welfare of the rural population. The Integrated Rural Development Program (DRI), which is designed to provide economic and social services to small farm units in half the country, is being carefully monitored and evaluated to assess its benefits and costs. Early indications point to a significant rise in productivity as a result of this program. The National Nutrition Program is presently undergoing a careful evaluation also. Subject to the evaluation results, the PIN proposes to continue and expand these programs. 83. Commercial farming in Colombia provides the bulk of the country's agricultural exports and an important part of the basic food items for domestic consumption. Consequently, their output is critical for both the balance of payments and domestic needs. By and large, these farms are highly productive - 41 - and require little Government support. The availability of adequate credit and research and extension services, which were important factors in the rapid growth of commercial farming in the past, is probably the key to continued expansion of this subsector. The Social Sectors 84. As noted earlier in this report, Colombia made substantial gains in raising welfare levels through programs in the social sectors during the 1970s, when heavy emphasis was placed on social sector programs. Nutrition and general health levels improved significantly during this period, school enrollments increased substantially at all educational levels and social security coverage was widened to a much larger segment of the population. Basic services such as water and sewerage and electricity are now enjoyed by more than 50% of the total population, and 90% of the urban population. Over the past two decades the ratio of population to physician and hospital beds has declined by 24% and 9%, respectively, and life expectancy has risen from 53 years to an estimated 62 years. Despite these gains, however, the infant mortality rate is still in excess of 80 per thousand, which is excep- tionally high for a country with Colombia's per capita income level, and an estimated 20%-30% of the population (5 million to 8 million persons) enjoys only a minimum subsistance standard of living. The high infant mortality is particularly distressing since the means of dealing with this problem are well known and are successfully used elsewhere. 85. The PIN sets forth a "new social policy" which singles out the youth of the country and workers in the informal sector as particularly dis- advantaged groups on which additional efforts are to be focussed. Three groups of youth are identified, preschoolers (up to 7 years), school age (7-14 years) and unemployed youth in the 15-18 year bracket. The problems of preschoolers are identified as nutrition and health deficiencies, and "social adaptation difficulties", which are becoming increasingly prevalent in Colombia because of the increasing number of working mothers. Problems facing school age youth include excessive school dropout rates, exploitation of child labor and delinquency. The 15 to 18 age group is currently experien- cing an unemployment rate of around 30%, which puts substantial downward pressure on wages for unskilled workers. For the usual reasons (family, financial, lack of vacancies), a large majority of these youth have not had the opportunity to attend secondary school. 86. To deal with problems of youth at these various levels, the PIN proposes to rely on programs of health and nutrition; education and profes- sional development. However, the State is to take greater responsibility for progress in these areas, especially with respect to programs directed towards preschoolers, with the view to gaining better focus and integration of public sector programs, and involving greater efforts from individuals, families and communities. The National Nutrition (PAN) and Integrated Rural Development (DRI) programs, together with the programs for Community Participation and Integration of Services (IPC) are expected to be important contributors to improving the welfare of Colombian youth in rural areas. A new National Policy on Child Care is proposed to deal specifically with the problems of - 42 - preschool children. These efforts are to be supplemented and complemented by greater effort to provide public services such as water and sewerage, electricity, basic education, etc., to low income urban and rural areas of the country. 87. Policies directed toward the informal sector of the economy, which has grown at least as rapidly as the formal sector in recent years, focus on promoting and supporting economic activities in the sector and on raising worker productivity. Mechanisms of financial intermediation (including credit guarantee funds), which take into account the pecularities of the informal sector, are to be developed. It is expected that these mechanisms will give enterprises in the sector greater access to existing credit lines of the Banco de la Republica, reduce their average cost of credit by attracting "soft" funds to the sector and permit them increased access to technical assistance from credit institutions. In addition, associations of small enter- prises in the informal sector are to be promoted to raise their bargaining strength in procurement, etc., and the technical services of SENA (National Vocational Training Institute) are to be directed increasingly towards this sector. 88. The new directions given to social policy in the PIN strategy seem appropriate. The groups singled out for special attention comprise a high proportion of the economically disadvantaged of the population. The increased emphasis on concentration of effort, better integration of services and com- munity participation should accelerate the gains from social sector programs and raise the efficiency of public entities in providing the required services. On the other hand, these new directions are likely to require an expansion of bureaucracy, and, therefore, of cost, and may very well run into some resistance, particularly from individuals and enterprises in the informal sector that have heretofore been relatively free of government regulation or control. Moreover, there are grwing indications of absorbtive capacity constraints in some of the social sectors, e.g., water and sewerage, education, health, etc., as evidenced by the sLowing of project execution, cost overruns, etc. Efforts to raise absorptive capacity in these sectors will need to be redoubled if the additional demands imposed on sector institutions by the new programs are to be met. - 43 - CHAPTER III INVESTMENT AND ITS FINANCING A. Public Sector Investment 89. A substantial increase and redirection of public sector 1/ invest- ment will be required over the next seveeral years to carry out the development strategy outlined in the PIN. Large investment increases will be needed to develop new energy resources and to provide the economic and social infra- structure required to support economic decentralization and growth, and to effect improvements in welfare. As outlined in the PIN, public sector fixed investment during the 1980-82 period would amount to a total of about US$10,731.2 million, equivalent to 9.7% of estimated GDP, and would average (annually) more than four times the average for 1976-78. This would imply growth in public investment of about 36% p.a. 2/ over the 1979-82 period if the targets were to be achieved; equivalent to a rise of about 16.0% p.a. in real terms. Most of this investment would occur in the energy (37.9%), transport (12.7%) and tele- communications (10.6%) sectors. Investments in electricity and petroleum alone would account for one-third of total public sector capital formation during this period, compared with about 22% in the 1976-78 period. Coal projects would contribute nearly 5% of public investment. The shares of most other sectors would decline, although investments in these sectors are still expected to increase in real terms. The strong growth in invest- ment in the energy and transportation sectors would have the effect of reducing the shares going to the other sectors. The smaller financial size and greater complexity of projects in the social sectors renders more rapid expansion difficult. 90. The increase in public sector fixed investment proposed by the PIN for 1979-82 appears somewhat ambitious. Delays in project execution have occurred already in several major sectors, and further delays, particularly in the energy sector, appear likely. The financial difficulties facing ECOPETROL and several of the power companies are expected to hinder project execution. The same is true for the National Railroad Company. El Cerrejon, 1/ The public sector is defined broadly here to include the Central Govern- ment (National Government, National Highway Fund and Social Security System), Decentralized Agencies and Enterprises at all levels of government, and the Departments and Municipalities. It is not clear from the PIN as to whether or not all projected investment by the Municipalities and Departments are included in these estimates, thus these data may understate the total investment required during the period. 2/ Data are not yet available for 1979, so this growth rate is based on the estimates for 1979 contained in the PIN. Table 8: COAUmIIAs POJIWCTD SUCrOEAL DISTRIDUTION OF PUBLIC GROSS FIXED IWlSlmNr 1980-85 (MIllion. of Colombian Pesos) 1978 1979 P r o i e c t e d 1976-78 1980-85 1979-85 Prelimi- Esti- 1980 191 19 pin3 l9 1985 (. of Total) Growth nary mate Rate Agriculture 7,143 7,755 9,025 12,591 16,533 23,791 31,549 36,832 10.9 7.6 29.7 Industry, Mining, Petrol- 10,672 12,642 17,269 24,051 38,155 65,159 96,448 124,323 21.2 21.3 46.4 eum, of which (Petroleum) (6,673) (8,350) (11,116) (13,143) (17,766) (21,581) (28,055) (37,874) ((1.9) (7.4) 23.7 (Coal) - (86) (1,779) (5,440) (13,264) (35,565) (49,228) (61,535) - (9.8) Nutrition and Bealth 3,475 4,448 5,894 8,221 11,356 16,186 20,881 26,518 6.0 5.2 34.7 Water Supply and Sewerage 3,218 3,958 5,066 6,763 8,986 11,932 16,412 21,653 5.4 4.1 32.7 Power 12,506 21,527 28,228 36,180 47,909 68,918 102,831 139,850 9.9 24.7 36.6 Telecommunications 1,673 3,719 4,568 6,280 8,266 11,860 18,711 25,259 2.7 4.4 37.6 Transport 7,143 12,668 16,129 21,556 31,659 43,084 53,855 69,319 11.4 13.7 32.8 Education 3,475 4,231 5,500 7,040 9,011 11,355 14,193 18,741 5.6 3.8 28.2 Urban Development 6,886 7,022 9,129 11,988 16,234 21,980 29,975 37,469 10.8 7.4 32.2 Other 9,909 8,319 10,231 13,560 16,834 22,107 31,098 39,873 16.1 7.8 29.9 TOTAL 66,100 86,289 111,039 148,230 204,943 296,372 415,953 539,837 100.0 100.0 35.5 Source: Bank Staff estimates. These estimates are based on the sectoral investment programs outlined in the PIN, with adjustmaents to account for known and prospective delays in project execution. - 45 - the large coal project in northeastern Colombia, has already been delayed several months, and because of the complexity of that project, including arranging for the financing required, further delays can probably be expected. Absorptive capacity problems (lack of skilled professionals, organizational and managerial difficulties, etc.) and a lack of counterpart funding has disrupted project execution in some sectors recently, including the water and sewerage, nutrition and health, agriculture and urban development sectors. Moderate delays are likely to persist in these sectors. 91. Considering these absorptive capacity problems and making allowances for probable delays in project execution, a conservative estimate of public sector investment growth would seem prudent. Consequently, public sector fixed investment is projected in this Report to grow by about 7% in real terms over the 1980-82 period, equivalent to about 33% in nominal terms. This estimate allows for a period of relatively slow growth, 1980 and 1981, while measures are introduced to improve absorptive capacity, after which public investment is expected to expand more rapidly. Over the longer period 1980-85, such investment is expected to rise by 36% p.a. on average in nominal terms; 12% in real terms. The power, industry-mining-petroleum, and transpor- tation sectors are expected to account for the bulk (60%) of this investment, with 25%, 21% and 14%, respectively. Among the other sectors, high priority is expected to be given to projects in nutrition, health, small scale agricul- ture and industry, water and sewerage and education. Overall, public fixed investment is projected to average 9.2% of GDP over the 1980-85 period, even with the probable delays in carrying out projects, and is expected to total Col$1,716 billion (equivalent to US$22,260 million). 92. The focus of investments in the energy sector over the next five years will be on hydropower development, on exploration, development, trans- portation and possibly refining of petroleum resources and on development of the country's coal resources. Several large hydroelectric projects will be initiated or competed during this period, with installed hydroelectric capcity programmed to increase by about 80%. Additional large investments are planned in transmission facilities. These investments will permit a 10% p.a. increase in electricity supply to meet the growing needs of the productive sectors of the economy and to supply the needs of a larger proportion of the rural popula- tion. Several large thermal plants are to be constructed, also, primarily to serve as backup for hydropower (particularly during periods of low rainfall). ECOPETROL's investment program is currently being reviewed by the authorities to determine appropriate priorities. Since under the association contracts ECOPETROL must share 50/50 in the development costs of fields discovered by private foreign companies, there exists considerable uncertainty concerning the amount of investment the agency might eventually have to undertake. Explo- ratory activity by the private companies has increased substantially in recent months, however even should oil be discovered quickly, field development invest- ments are not likely to increase until the mid-1980s because of the long pre- investment testing, etc., period required before commerciality can be declared. ECOPETROL's investment for the 1980-85 period is projected to total US$1,800 million, or about US$300 million p.a.. However, should major oil discoveries occur within the next year, this investment could increase sharply in the later years of this period. The magnitude of investment in the coal sector - 46 - over the next few years is also highly uncertain. El Cerrejon North has been declared commercial and the relevant investment amounts are included in the projections above. There are other potential investments, however, including El Cerrejon Central, which are expected to be initiated during the 1980-85 period. With the inclusion of an allowance for investments in additional coal deposits and projecting some further delay in executing El Cerrejon North, the total projected investment in coal during the 1980-85 period totals US$2,050 million, or an average of US$340 million p.a. It is important to note that for both the petroleum and coal sectors the heaviest investment is expected to occur in the 1983-85 period. A great deal of uncertainty exists in the case of investments to utilize the country's natural gas. Until the feasibility studies for the various options have been completed, the investment program to utilize the gas will necessarily remain conjectural. 93. The lack of specificity with respect to investments in most of the energy subsectors highlights the need for an in-depth analysis of the country's future energy balance. The issue in Colombia is not one of the adequacy of energy resources to serve the varied demands for energy. Choosing among alternatives is complicated by the fact that exploration is still underway and the full extent of the country's energy reserves are unknown. For instance, there are good prospects for additional oil discoveries in Colombia, and should major finds occur, choices made on the basis of existing alterna- tives might prove not to be optimum. Moreover, the full extent of commer- cially viable coal desposits is unknown. Some deposits originally thought to have been quite large have turned out probably not commercially viable after further exploration, and other deposits are known to exist, but their size is still a mystery. Despite the uncertainties, choices must be made and soon if severe energy constraints to growth are to be avoided. Unfortunately, choices are presently being made regarding sector investments, etc., without a firm basis existing to support those choices. Consequently, substantial resource misallocation and ineffeciency may result. Only those non-postponable investments with good probability of high economic returns (petroleum explora- tion, El Cerrejon coal) should probably go ahead prior to completion of the DNP energy development study. 94. Investments in transport and telecommunications are projected at Col$310 billion in current terms, about US$4,050 million, during the 1980-85 period. This would constitute about 18% of total public fixed investment during this period. The projected yearly average US$675 million represents a substantial increase over the US$177 million p.a. for the 1976-78 period. Rehabilitating and improving the railway and highway systems will command a large part of these investment funds. Selective construction of new highway and railroad (Saboya/Carare) arteries is contemplated in this investment as well, as is expansion and improvement at some of the major ports. Construc- tion of the Saboya/Carare bypass on the rail link between Bogota and Santa Marta is designed to avoid a particularly treacherous stretch of track which is presently responsible for a high proportion of the derailments and other accidents on that line. There is a question, however, as to whether or not this bypass would be cost-effective in the absence of large coal shipments from the Checua-Lenguazaque area. Improvements to the Rio Magdalena/Canal del Dique waterway and to some river ports are included in these estimates, as are ongoing airport construction and renovation projects. - 47 - 95. To an important degree, investment priorities in the transportation sector depend upon prior decisions in the energy sector. The Saboya-Carare bypass is a case in point, and there are many others (e.g., investments in port improvement and expansion depend upon proposed export shipments of coal and imports of petroleum; highway rehabilitation and new construction hinges somewhat on the nature of the truck fleet, i.e., size and weight, which in turn depends on traffic flow and energy considerations, etc.). Consequently, the PIN proposes that a flexible approach will be taken to the establishment of priorities in the sector until firm plans are drawn up regarding exploita- tion of the country's energy resources. 96. Investments in communications are projected to increase sharply over the next several years. Sector objectives are: to expand substantially the coverage of telephone service, particularly in low income rural and urban areas; to complete the national microwave system and improve long distance service; to extend ratio and television coverage to the entire country; and to improve postal services. An estimated US$165 million p.a. is expected to be invested during the 1980-86 period to achieve these goals. This would represent approximately 4.5% of total public fixed investment during this period. 97. The primary objectives of investments in the agricultural sector are to expand supplies of basic foodstuffs, in order to improve nutritional standards and hold down inflation, to diversify exports so as to lessen the country's dependence on coffee exports, and to improve the welfare of small farmers and landless rural workers. These goals are to be achieved through the provision of adequate credit and extension services to both family and commercial farmers and through integrating rural development programs directed towards small farmers and target areas of rural poverty. Investments via DRI, which provides production credits along with a comprehensive program of social services, are expected to accelerate over the next few years now that many of the institutional constraints associated with initiating such a complex program have been overcome. Other public investments in rural areas (feeder roads, rural electrification and communication, village water and sewage projects, nutrition, etc.) along with the expansion of income and employment opportunities in outlying areas expected to flow from the Government's decentralization efforts, will also contribute to improving rural welfare. Investments in colonization, irrigation, land improvement and increased agricultural research and extension, are expected to raise agricultural productivity, particularly that of small farmers. Production and investment credits to small farmers and commercial producers are to be expanded rapidly over the next few years also. 98. Public investments in mining are expected to increase sharply, as the Government begins to take a more active role in exploiting the country's abundant mineral resources. These investments will take the form of support- ing infrastructure and directly productive investments. Investments in coal and petroleum, plus participation in the Cerro Matoso nickel project, are examples of the Government's expanding role in the sector. Investments to explore for and mine phosphate rock, uranium, copper, and bauxite are also planned for the next few years. The proposed investment amounts are expected to be quite small, however. - 48 - 99. Investment in the social sectors is projected to rise by 32% p.a. in nominal terms (9% in real terms) during the 1980-85 period, accounting for about 21% of total public sector fixed investment. These same sectors accounted for about 28% of public investment on average during 1976-78 period. The decline in their share reflects the surge in investment in the energy and transport sectors, rather than any lack of interest in these sectors. Current expenditures by the public sector on teacher salaries, medical personnel, etc., are expected to increase strongly over the next few years also, in line with the Government's efforts to extend health care, nutrition programs and educational services to rural areas. Urban development programs are increasingly being targeted to low income urban areas and particularly to smaller cities in outlying areas. Investments in water supply and sewerage are expected to maintain their share in total public investment, with continued emphasis on extending such services to small cities and rural villages. 100. The public investment program outlined above focuses directly on the major development constraints facing the country and backs fully the Government's development strategy for dealing with these constraints. It provides a balance between infrastructure investment to support productive investments by the private sector and social investment to improve the welfare of the poorest half of the population. It is considered to be a working plan, subject to modification in subsequent years to allow for unexpected developments on either the national or international economic scene. It is an ambitious, but achievable program, which will require the mobilization of substantial domestic and foreign savings, expecially by the decentralization agencies which will be responsible for carrying out probably 85% of the program. The mobilization of these resources without exacerbating inflation will be one of the major challenges facing the autho- rities over the next few years. 101. The total resource requirements of the public sector are projected to rise by about 33% p.a. over the 1980-85 period, and average 10.8% of GDP. Investment in fixed assets will account for most (85%) of the increased requirements. Because of the favorable terms available to Colombia and the relatively low public sector indebtedness, debt amortization payments are projected to rise by slightly less (25%) than nominal GDP. B. Financing Public Investment 102. If the Government's development strategy is to be executed in its entirety, without financial difficulties or inflationary pressures, substantially greater domestic resources will need to be mobilized. The tax system will require strengthening and full cost pricing of the goods and services provided by the decentralization agencies will have to be achieved. Restraint will have to be exercised on current expenditures by all public sector entities and major efforts to increase operating efficiency and lower costs will be required of public sector enterprises, particularly those which have experienced increasing operating deficits over the past few years. Even with maximum expected gains in these areas, however, considerable external and internal borrowing will be required. Private savings will have to expand in order to accomodate the rise in public sector domestic borrowing without unduly crimping private sector access to credit. Despite the large - 49 - increase in requirements, it should be possible with the careful management to mobilize the required resources without recourse to inflationary Central Bank financing. An alternative would be to execute a smaller investment program and encourage increased private sector investment through proper incentives. 103. The finances of the National Governnment are expected to strengthen during the early 1980s, albeit only moderately. Improvement is expected in the buoyancy of the income and net wealth tax 1/ as a consequence of measures taken recently to enhance administration and reduce evasion, and strong in- creases in revenues from the sales and customs taxes are likely to continue. On the other hand, growth in receipts from the special exchange account will suffer from declining coffee tax revenues and lower earnings on international reserves. While revenues from the coffee tax rose sharply during the first half of 1980 as a result of high prices and increased sales, world coffee prices have since weakened considerably and are expected to continue declining gradually over the next couple of years. Moreover, with Brazil's production expected to reach pre-frost levels and market shares to be governed by international agreement, 2/ Colombia's coffee export volume is projected to stabilize at around 11-12 million 60-kilo bags by the mid-1980s. Consequently, revenues from the coffee tax are not expected to increase significantly. Moreover, international reserves are expected to fall as a result of the large import demands of higher investment levels and slow growth in export receipts. Thus, earnings on reserves will probably decline. If inflation moderates as expected and the rate of devaluation is maintained at about 15% p.a., it should be possible to reduce tax subsidies on exports (CATS) without serious adverse effects on Colombia's sales abroad, but with some saving in revenues. In 1979, these subsidies amounted to about 2.5% of total current revenues of the National Government, and they are forecast to exceed 3% of current revenues over the next couple of years. Consideration may be given to gradual reduction of these subsidies. 104. A number of new tax provisions became effective beginning in 1980. Tax reductions and exemptions were increased and all nominal values in both the capital gains and income and net wealth taxes were indexed to avoid the increased tax burden associated with inflation. A separate tax rate schedule was established for capital gains, replacing the treatment of such gains as regular income for tax purposes, and full tax free reinvestment of these gains in approved projects (80%) and IFI bonds (20%) was allowed. The objectives underlying these measures were a lower tax burden and greater tax compliance, and reinvestment of capital gains. Since capital gains are not a major source 1/ Although receipts from these taxes have fallen from 4% of GDP in the early 1970s, to an average of 3.3% of GDP for the past three years, they still account for over one-third of total tax revenue. 2/ A new international coffee agreement was reached recently which estab- lishes an initial quota of 9.7 million bags for Colombia. Adding exports to countries not covered in the agreement and allowing for modest growth, would raise projections of Colombia's coffee exports to around 12 million bags for 1985. - 50 - tSb1I 9t COLSIA. PUSL1C SlClOR 11VZS72 PROGR5Ar ANID lSS Fln2ANCI10 1978-85 (JUħlous of Colombian Pesos) Prelimiaħry Estimate ?roaoe 1978 1979 1980 1981 1982 _ 1983 1984 ____ - 1mrto sauWrmnts 79,870 112.047 134,378 177,880 242,337 345,930 485.339 628.420 A.. raff Fized lavests 66.100 86.289 111.039 148.230 204.943 296.372 *15.953 539,837 1. C4tral GoVazUt 9.622 13.630 16.762 22.351 31.916 41.426 54.241 70.373 (N&t4-U.e1 Gow.rWt) (2,765) (3.966) (4,363) (5,366) (6,440) (7.836) (9,66) ( ) (National Lighwey TFd) (6,619) (9,388) (12,074) (16,598) (25,011) (33,015) (43,909) (57,534) (Social Security) (738) (276) (325) (387) (465) (555) (668) (760) 2. Devenħzei Agmci. 51.575 67.342 87.545 117,029 161.305 239.247 341.55S 444.145 3. Dep oans 3.980 4.557 5.787 7j639 10.160 13.716 7.6J54 22.244 4. Mwcipalits 623 760 945 1.211 .L562 1.983 2. 00 31075 ,. TlYc1a1 1Yem r 4.978 7.582 8-340 9591 11.317 13.334 15.892 19.799 C. aort4stion 8.792 38,176 14.999 20.059 26.077 36.204 53.494 68.784 Tim ncStO 79.870 112.047 134.378 177,880 242.337 345.930 485.339 628.420 L Pulic Setor Savlngs 56.581 J5.542 90.529 119.884 157.546 206,592 270.868 350.989 1. Cwtral GOvemr t 55.e38 17.347 92.858 120.292 156.059 199.968 252.054 329.834 (National Gover t) 53,002 c7,956 82.632 106,182 136,974 175,327 220.912 2S0,558 (NationAl ig.Wvay Pad) 5.322 ),407 12,040 15,652 20,348 25,841 32,302 40.377 (Social Security) -2.486 -2,016 -1,814 -1,542 -1,263 -1,200 -I.160 -1,101 2. £-tal1zmd AgWies 12,450 14.864 18.729 25.973 3A.164 46,668 64S502 90.056 3. DeParqnct -1.360 -4.519 -5.992 -7.699 -9.B85 -12.694 -14.868 -19.517 4. Ipa i -10.344 -12.150 15.06 -18.682 -22.792 -27.350 -30.820 -39.384 B. CapitAl Revenues 3,759 4,924 6,303 7,941 9,768 11,722 14,066 16,700 C. Loan DiObursements 19,530 31,581 37,546 50,055 75,023 127,616 200,405 260,731 Lxternml 12,517 44,107 32,667 40,335 59,373 97,518 135,550 174,624 Internal 7,013 -12,526 4,679 9,720 15,650 30,098 "4,8ss 5 6,107 Sa tħatry of Finan, Bek st*ff to - 51 - of tax revenue for Colombia, the overall impact on the National Government finances of the more favorable treatment for these gains is not expected to be significant. The net impact on the National Government finances of the income and wealth tax relief depends upon the extent to which taxpayers reduce evasion as a consequence of the lower tax burden. It seems reasonable that faced with a lower tax burden taxpayers may be more willing to declare and pay taxes, and thus tax receipts might increase. 105. The Government has also begun to withhold taxes on certain non-wage incomes, e.g., interest earned on savings and time deposits, rental income, etc. On some sources of income, e.g., rents, withholding will be very difficult to administer; on others, e.g., interest paid through institutions like banks and finance companies, it should be relatively simple and inexpensive. It is still unclear as to how much revenue might be obtained through this withholding, or what its impact might be on the amount and distribution of saving among the various savings instruments. Standing alone, the introduction of withholding on savings accounts would reduce their competitiveness vis-a-vis certificates of exchange, for example, which provide a tax-free return. 106. As significant as these measures are, it seems probable that addi- tional tax measures will be required if public sector savings is to reach the necessary level. There are several possibilities. The base of the sales tax could be broadened by extending its coverage to the retail level, or a general value added tax at all levels could be introduced. Excise taxes could be extended to a broader range of goods, particularly to luxury consumer goods, and tariffs on luxury and semi-luxury imported items could be raised. These taxes would have the dual effect of reducing foreign exchange expenditure on these items and increasing revenues. The corporate income tax could be made progressive through a change in the rate schedule, thereby providing relief to struggling small enterprises while maintaining, or possibly increas- ing, revenues from the tax. Since the overall tax burden is relatively low in Colombia (around 9% of GDP for the past several years; 7.5% excluding the special exchange account), there would appear to be ample room for expanding tax collections. 107. None of these measures is likely to be successful in substantially raising tax revenues unless complementary actions are taken to improve tax administration. The authorities have already adopted measures to simplify tax declarations and to amend the complicated, long drawn out process of tax payment, which involves periodic partial payments extended over a period of several months. Better enforcement of tax legislation is called for, and tax appeal procedures need to be foreshortened, while maintaining appropriate appeal guarantees. Penalties for late and nonpayment of taxes need to be raised to positive real levels in order to avoid providing subsidized loans to tax delinquents. Training programs for tax administrators would probably help increase tax collection efficiency. 108. One promising avenue that the Government is pursuing in its effort to improve tax compliance is that of decentralization and local retention of tax collections. This is to be accompanied by decentralization of responsi- bility and authority for regional development programs, and fits well with the PIN's emphasis on regional autonomy. The departments and municipalities, - 52 - being closer to the sources of revenue, would appear better able to collect taxes, and the taxpayer, seeing directly the benefits from his taxes, would most likely be more willing to pay. While such decentralization can be introduced only gradually as the recipient entities are able to assimilate the additonal duties, over the longer term it could result in a significant increase in revenues and raise the efficiency of public sector spending. 109. Current expenditures of the National Government are projected to grow by about 30% p.a. between 1979 and 1985. This represents a slight reduction from the average 32% p.a. growth during the 1976 -78 period of high inflation. Current transfers to the decentralized agencies are expected to rise rapidly as these entities take on a greater role in carrying out the Government's development programs. These transfers are expected to grow by nearly 37% p.a. during this period. Payments for personal services are projected to increase only slightly in real terms under the assumption that real wage gains are limited to growth in output per worker. Since most of the public sector investment program will be carried out by the decentralized agencies and the departments and municipalities, no significant expansion of National Government employment is expected. For the same reason, only moderate real increases are projected for interest payments and for purchases of goods and services by the National Government. The current surplus of the National Government is projected to average about 2% of GDP (5.4% before transfers) during the 1980-85 period, compared with 3% on average in 1976-78 when the coffee boom and rapid international reserve accumulation (together with inflation-induced restrictions on current expenditures) produced large surpluses. Capital transfers from the National Government to the decentral- ized agencies are projected to grow by 34%, somewhat less than these agencies' projected investment expenditures, under the assumption of greater self- financing. Direct investment by the National Government and transfers to the departments and municipalities are not expected to increase significantly in real terms. 110. The Decentralized Agencies will require substantially greater resources over the next several years if they are to meet the expanded investment targets attributed to them in the PIN. A large part of these resources is likely to come from the National Government as transfers, however, these agencies are expected to generate an increasing proportion of their resource needs through increased charges for the goods and services they supply. The present administration has already raised substantially the charges levied on most publicly supplied goods and services. Increases in electricity rates, in charges for water and sewerage services and in bus fares stand out in this regard, as does the strong escalation of retail gasoline prices in recent months. Despite these advances, the prices of many goods and services supplied by public agencies remain considerably below levels required to maintain a reasonable return on revalued assets. In some cases, the required increases are already programmed and being carried out; in others the essentiality of such increases appears not yet recognized. A general policy assuring adequate pricing by all branches of the public sector has been established by the authorities. - 53 - 111. As a result of expected price increases and despite strong increases projected for current expenditures, the saving of the Decentralized Agencies as a group is expected to average 1.5% of GDP over the next few years, up slightly from the 1.4% of GDP registered in 1978 and up substantially from the 0.7% of GDP achieved in the 1976-77 period. Their own savings, therefore, should cover nearly 30% of their gross fixed investment in this period, compared with coverage of about 19% in 1976-78. 112. Colombia's record in maintaining control over current expenditures has been very good. In the 1976-78 period of high inflation and 6% p.a. (average) real GDP growth, current expenditures of the public sector, excluding the sharply accelerating purchases of petroleum and foodstuffs, rose by less than 5% in real terms. Data are not available on the entire public sector for 1979 as yet, however on the basis of preliminary estimates, real current expenditures of the National Government appear to have risen somewhat in excess of real GDP growth. Future increases in current expenditures will be difficult to control. Large additions to payrolls and other current expenditures will be required by the expanded public sector investment program proposed for the next several years, and public employees will expect further recoupment of real wage losses. However, the Government is expected to continue exerting tight control over current expenditures. In addition, the authorities have undertaken, with assistance from both domestic and foreign consultants, an in-depth study of existing budgetary policies and procedures with the objective of increasing the efficiency of public sector expenditures. It is expected that application of the recommendations of this study will have a substantial positive impact on public sector saving over the next several years. Consequently, the increase in current expenditures are not envisaged to become excessive nor lead to inflationary financing of public sector deficits. 113. Overall public sector savings is projected to average 6% of GDP during the 1980-85 period in the event that all of the above measures are adopted, somewhat about the level achieved in the 1976-78 period. At least an equal proportion of total public sector resource requirements may be financed by public sector savings with respect to the prior period. C. Private Sector Investment and Its Financing 114. Private investment will have to expand rapidly in Colombia over the next few years to supply the goods and services required by the growing economy and to provide employment opportunities for the expanding labor force. In the absence of strong growth in private investment, installed capacity could become a major constraint on growth during this decade. Additional domestic resources will have to be mobilized and allocative efficiency increased to support the necessary growth in private investment. Distortions that have built up in the financial system over the past several years, primarily as a result of measures taken to counteract inflationary pressures, have impaired financial intermedia- tion and raised the cost of non-subsidized credit. With inflationary pressures likely to recede gradually over the next couple of years, it should be possible to eliminate these distortions. Specific policy areas that need attention include interest rates and interest rate subsidies, forced investment require- ments, and the term structure of lending. Significant progress has already been made in reducing the distortions existing in some of these areas. - 54 - 115. With the rate of international reserve accumulation expected to slow in coming months and with Central Bank credit expansion now under control, the Colombian authorities have begun to unfetter the country's capital markets. Some interest rates have been freed from controls, e.g., those on certificates of deposit of commercial banks and financial corporations and on the lending therefrom, and in effect are now determined by supply and demand in the market- place. Based on expectations of lower inflation, consideration may now be given to eliminating controls over all savings and lending operations of financial institutions. Flexible, market-determined interest rates would encourage savings, reduce the size of the extra-bank market by channeling savings to the supervised market, and lead to a more efficient allocation of resources. Small and medium size enterprises would have greater access to credit at more reasonable terms. With interest rates allowed to find their equilibrium levels as determined by market forces, the abrupt shifts of resources from one saving instrument to another as relative returns change would be eliminated, thereby introducing a much needed element of stability into the financial market. In addition, flexible, market determined interest rates, together with the elimination of forced investment requirements, greater use of open market operations, and the reduction in reserve require- ments, would significantly strengthen monetary policy. 116. Financial institutions in Colombia are subject to forced investment requirements which tie up a considerable proportion of their funds in low return investments. The purpose of these forced investments is to channel resources to the Development Funds administered by the Banco de la Republica. These Funds, in turn, provide subsidized credit to priority sectors of the economy. As a result of these requirements, however, the financial institu- tions are forced to pay lower returns on deposits, thereby discouraging saving, and to charge higher fees, commissions, etc., to borrowers than the cost of the institutions' services would dictate. This injects a considerable element of distortion into the financial market. The present Government has introduced a policy of financing these Development Funds through the issuance of bonds carrying market determined interest rates. By mixing these resources with others acquired on softer terms (primarily from external borrowing), subsidies, albeit much reduced, may be provided to the chosen sectors. Any additional subsidy over and above that provided by this mixing of resources, would most likely have to be provided directly by the Banco de la Republica. The policy of financing the public sector deficit with savings captured via bond issues is a major step towards improving capital market operations in Colombia. How- ever, the subsidies produce distortions in the use of resources and should be discontinued. 117. It is proposed that the actions to rationalize the financing of these Development Funds be accompanied by a thorough review of their justifi- cation. For the most part the resources channeled to these funds appear to have been directed to small and medium size enterprises and in general the subsidies involved do not seem to have been excessive. However, subsidies have sometimes been provided to commercial enterprises, particularly in the agricultural sector, for which no justification appears to exist, and there is evidence of diversion of resources to purposes other than those intended. In recent years, the subsidies have become quite large and generated an excessive demand for credit from these Funds. Since there was a limit to what could be covered by investments forced on financial institutions, the authorities had to resort to Central Bank emission to finance these Funds. - 55 - 118. Private investors' access to long term credit has declined in real terms over the past several years, making it increasingly difficult to finance new investments. This was caused by increased liquidity preference on the part of savers and by the inability of financial intermediaries to extend the terms of lending. Inflation and uncertainty regarding relative returns on savings instruments have encouraged savers to keep their savings as liquid as possible. At the same time, financial institutions have been reluctant to lend long term on the basis of short term deposits (i.e., term-transform) for fear that abrupt shifts of resources to other financial institutions would leave them short of resources to cover daily operations. As a consequence, firms have had to rely on rollovers of short term credits to finance their investments. The measures introduced in October 1980 to encourage term-transformation by financial institutions will help, however, a permanent reduction in inflationary expectations and greater interest rate flexibility will probably be required before the long term capital market regains its former effectiveness. 119. Low and uncertain returns on equity shares and reduced retained earnings have retarded growth of equity investments in recent years. The taxation of nominal rather than real profits has left little after tax return for distribution as dividends or for reinvestment. In attempting to maintain payout rates to sustain the attractiveness of their shares, companies have further reduced the retained earnings available for direct investment. Capital gains have also been subject to high levels of real taxation because of inade- quate adjustment of nominal values for inflation, further discouraging invest- ment in equity shares. To a large extent, these problems have beent overcome by the tax provisions which became effective this year. These measures should provide adequate incentives for equity investment and result in improvements in the capital market. The establishment of a National Securities Commission in 1979 should also facilitate investment in equity shares by providing regulations governing the issuance of, and trading in, such shares. - 56 - CHAPTER IV GROWTH ANn BALANCE OF PAYMENTS PROSPECTS A. Growth Prospects 120. The Colombian economy is projected to grow by 5.5% p.a. in real terms over the 1980-85 period (see Table 10). The achievement of this growth will depend upon the success the authorities have in containing inflation and in avoiding foreign exchange constraints in the later years. The latter in turn will depend upon the country's success in expanding and diversifying exports and, in particular, its progress in reducing the projected energy trade deficit. Strong economic growth is needed to maintain high employment and support rising levels of well being for all Colombians. 121. In order to achieve the projected GDP growth rates, total investment will have to expand to an average 23.5% of GDP, up from 18% in the early 1970s and about 21% in recent years. Gross fixed investment, which grew by about 7% in real terms during the 1976-78 period, is expected to grow by about 9% in real terms over the next several years, a pace substantially in excess of real GDP growth. Public sector investment is expected to increase as a proportion of total investment in view of the heavy public investments in energy and infrastructure. Because of relatively slow growth expected in directly productive activities, the incremental capital output ratio (ICOR) will most likely rise somewhat, after having declined steadily over the past several years. Gross national saving would have to average about 21% of GDP during the 1980-85 period in order to avoid too high an increase in foreign indebtedness. This is about the same level of savings achieved in recent years, but significantly higher than that registered in the early 1970s. It assumes that measures are taken to encourage private saving and to increase public sector revenues. An increasing proportion of national saving is expected to be channelled to the public sector. 122. The leading growth sectors of the economy over the medium term are expected to be manufacturing, transportation and communication, and power. Construction activity should pick up strongly as a result of the heavy investments projected in infrastructure and in private construction. Mining activity, despite significant increases in the production of gold and precious gems, is expected to experience limited growth over the next few years because of continued declines in petroleum extraction. By the late 1980s, however, mining is expected to become a leading growth sector of the economy as a consequence of expanded coal and nickel production, and possibly a rise in petroleum output if current exploration activity is successful. Natural gas production is expected to increase sharply in the latter part of this decade as major projects come on line. Growth of the services and trade sectors of the economy, including financing and banking, will likely match the average growth rate of GDP during the 1980-85 period, while the public sector is expected to significantly increase its share of GDP. 123. On the basis of expanded credit and increased investment, particu- larly in commercial farming, agricultural sector growth is expected to average 4% p.a. during the projection period, slightly less than the rate of GDP - 57 - Table 1°- COLOMBIA: NATIONAL ACCOUNTS 1979 AND PROJECTIONS 1979-1985 (Millions of 1970 Colombian Pesos) lI Estimated Projected 1979 198 2 1983 1984 1985 Gross Domestic Product 219,885 230,961 242,916 256,001 270,264 285,941 303,167 Term.s of Trade Adjustment -3,857 -5,018 -7,297 -8,183 -8,963 -9,465 -9,845 Gross Domestic Income 216,028 225,943 235,619 247,819 261,301 276,476 293,322 Imports 23,320 26,864 27,854 28,224 28,651 30,091 32,120 Exports -30,324 -31,051 -31,105 -31,360 -32,316 -34,787 -37,129 Exports (Import Capacity) -26,467 -26,033 -23,808 -23,177 -23,353 -25,322 -27,284 Resource Gap -3,147 831 4,046 5,046 5,298 4,769 4,836 Consuimption 169,009 177,787 185,791 193,610 202,300 212,090 223,779 Investment 43,872 48,987 53,874 59,255 64,299 69,155 74,379 Resource Availabilities 212,881 226,774 239,665 252,865 266,599 281,245 298,158 Gross Domestic Savings 47,019 48,156 49,828 54,209 59,001 64,386 69,543 Factor Service Income -775 -506 -530 -777 -1,158 -1,539 -1,875 Net Current Transfers 24 33 20 23 26 25 23 Gross National Savings 46,268 47,683 49,318 53,455 57,870 62,872 67,691 1/ The external accounts in this table are converted to pesos at the 1970 exchange rate. Source: Banco de la Republica and Bank staff estimates. - 58 - growth. This expansion should, however, assure adequate domestic food supplies, and provide a growing exportable surplus in some crops. Coffee production is not expected to maintain the high growth rates of the past few years, primarily because of lower international prices and increased crop diversification programs directed towards the major coffee growing areas. The gradual replacement of old trees with the higher productivity cuturra variety will continue, but most of the production gains are expected to be offset by declining productivity of existing trees and the transfer of coffee land to other uses. B. Balance of Payments Prospects 124. The rate of growth of the industrialized economies, developments in world coffee markets and the country's success in exploiting additional energy resources will be the major factors influencing Colombia's balance of payments during this decade. Low growth of the world economy resulting from energy related constraints is expected to reduce demand for Colombia's exports, especially exports of manufactured goods. Coffee export prices, which have fallen sharply in recent months, are expected to level off by year-end and remain constant through 1983, after which they are forecast to rise modestly in real terms. With relative market shares controlled under the International Coffee Agreement and world demand not expected to grow much in excess of its natural trend, Colombia's coffee export volume is likely to increase only slowly. 1/ In accordance with the new International Coffee Agreement, exports may be restricted to support the international price. On the other hand, little can be done in the short run to alleviate the external energy deficit because of the long gestation period for devel- oping new energy resources, therefore petroleum imports are destined to increase steadily. Investments in secondary recovery probably have the more immediate payout and energy conservation provides quick returns. Both of these undoubtedly merit the increa.sed attenti6rn they have teen receiving from the Colombian authorities. The current high level of international reserves provides a cushion to support imports for a few years, nevertheless, serious balance of payments constraints on growth are likely by the mid to late 1980s if additional domestic energy resources are not available by that time. 125. Successful balance of payments management in this decade will require the achievement of several objectives in addition to development of the country's energy resources. These include: (1) adoption of import liberalization poliies designed to increase economic efficiency so as to improve Colombian industry's ability to compete in external markets. These policies should emphasize selective reductions in import tariffs, combined with gradual dismantling of import restrictions and administrative controls; (2) continuation of "crawling peg" devaluations to eliminate the gap between domestic and international inflation; (3) policies to increase direct foreign investment, particularly in export activities. Such investment is usually 1/ Colombia's share of the world market rose from 11% to about 16% between 1976 and 1979. table 11 aII s 16A9 S ALA1* 07 PAlTWS; 1978 (ACM%L), 1979 (9G71111alT). 190-95. I1t" (E101OU) (T. Itillio_. et U Dollars) Act.vl lt.11..sary i'oloted 1976 1979 1990 191 192 f 13 1994 1965 1990 lxports of Goo. o Nd -ftactor S.roltoS 4,059 4,910 5,345 5.502 5,912 6,410 7,"67 6,649 14,999 I-port. of Good. nd Iba-tfctor 0.,itc.s 3,722 4,191 5.359 6,255 6,997 7,64 89,61 9,88C 15,002 lO-otrO 6Blo.. 37 719 .16 -753 -1j05 -1 234 -1,151 -1 235 _3 N.t F7.t.r S-ri... -2.7 -127 -91 -105 -166 -264 -375 -497 -969 ft.fit. ^ d letr - c (-295) (-160) (-147) (-165) (-231) (-333) (-432) (.571J (.1,099) Wor..-. oitn Auo. (46) (53) (56) (60) (60) (71) (77) (84) (130) C.n-t Tra.ofr 7 4 a 4 5 6 6 6 9 C.o,,t A o...pt ulwoc. 97 $96 -99 ff34 -1 2* -1 492 -1,S20 -1716 .963 Not Di ...t F.r.ig. last.emt 56 124 125 25 150 250 250 350 450 N.t 7ubli N.di ..*nd Laag-T..e Di.hr. _2 602 741 5s0 911 "6 9O 1,018 772 Cross Disb.r.ots (319) (1.010) (1,058) (62) (1,379) (1,476) (1,540) (1,668) (2,552) Aosett.oloo (-227) C.633) (.317) (-332) (67) (4629) (-69) (.650) (-1, 780) oth- r Nt N4d.v. od Lm$-Te Diabwrasmoo t -20 0oo 67 .21 as 96 110 L 87 Gross DU.b6roo.ts (62) (166) (6) (23) (136) (w49) (157) (222) (311) .ortis.tioas (-62) (416) (-73) (.46) (.51) (.52) (.47) (.74) (.224) SDI All..o.ctiot 24 -- 0th1. Copitol 39 -182 - -- Cooltol AkCeat Uol o.. 519 69 79 S v 1.164 1.192 1220 516 1309 Ov-rall 71ooco .616 -1.265 -?70 200 100 300 300 200 -346 Ch..g. i. Ioorvo (-iNcr.) .616 -1,265 -700 20D0 100 300 300 200 5346 II_or- d,o It... Tot.1 Not loser... of 504119 S74taM (lad of period) 3,11 3,68 3,613 3,515 3,213 2,913 2.713 4,127 R .. Inro To. of l4..th. of leOtg ot Goods A.6*l Servic.. 9.1 7.9 6.6 3.3 6.6 3.7 3.0 o.0 tb6lk Db6 br -.i.4 otie (par.s0) 9.6 9.7 30.6 12.7 1.9.2 14.7 JU2 17.6 E.torool P7b611 D3bt Ot.too:t6 e*d Dtsbw.rd 3,U42 6,33 *,5 5,796 6642 7,32 ,.520 12.875 S-orc Doco d. 1 a*publi.., S_xk f600t 1,ti-t. _ Projections. - 60 - accompanied by the introduction of modern production technologies; (4) interest rate adjustments on domestic financial instruments as necessary to assure yields in line with those available internationally; and (5) restraint on external commercial borrowing by the public sector to finance expenditures and local costs of development projects. The Government has already begun to take the actions required to achieve these objectives. 126. The import needs associated with restructuring and growth of the Colombian economy are expected to cause a turnaround in the balance of payments from the US$600 million current surplus (2.2% of GDP) registered in 1979, to projected current account deficits of US$99 million in 1980 (0.3% of GDP) and US$854 million (2.0% of GDP) in 1981. Over the entire 1980-85 period, the current account deficits are expected to average US$1,150 million, equivalent to 2.8% of GDP. Based on expected availability and use of external financing, net international reserves of the banking system will have fallen to three months imports of goods and services (an adequate level for Colombia) by the end of this period. Imports of goods and services are projected to rise to 19% of GDP for the 1980-85 period, from 17% in 1979. Beginning in 1987 the current account balance is expected to improve as a result of increased export proceeds (coal) and a leveling-off of import growth. 127. Merchandise imports are projected to grow on average by about 16% per year in current US dollars (8% in real terms) during the 1980-85 period. Increases in capital goods imports of 17% p.a. in current US dollars will be required for the accelerated investment effort. Raw material and intermediate good imports are expected to grow in line with real GDP. Although some import liberalization is expected, consumer goods imports will probably continue to be restrained to prevent too rapid a decline in the level of foreign exchange reserves. Imports of crude petroleum and petroleum derivatives are expected to grow rapidly during the next several years as a result of rising domestic demand and continuing declines in produ.ction. By 1981, these imports are projected to reach about US$1,100 million and by 1985 about US$2,100 million, 21% and 32% of merchandise exports respectively, compared with only US$194 million, or 9% of merchandise imports in 1977. By 1987 oil flowing from new discoveries plus that produced by secondary recovery should substitute for a large part of the otherwise large oil import bill. 128. Merchandise exports are projected to grow by only about 10% p.a. in current US dollars during the 1980-85 period. Receipts from coffee exports, which still constitute more than 50% of total merchandise export receipts despite export diversification efforts during the past decade, are expected to decline slightly in nominal terms over the next couple of years and then to increase moderately, reaching US$3.2 billion by 1985 from US$2.3 billion in 1979. The slow growth in coffee export receipts, given their weight in the total, is a major factor in the projected slow growth of merchandise exports over the 1980-85 period. 129. Non-coffee merchandise exports are projected to grow by about 14% per year in current US dollars and by 4.4% in real terms during the 1980-85 period. This projection assumes that existing incentives provided for export promotion such as the CAT, PROEXPO credit and the Plan Vallejo will be continued, albeit possibly at reduced levels, and that the exchange rate will - 61 - be adjusted to maintain the competitiveness of Colombia products in external markets. More rapid growth of non-coffee exports over the longer term will require progress on import liberalization, increased investment in export- oriented activities and development of the country's mineral resources, particularly coal. 130. Prospects for expanding receipts from Colombia's major non-coffee agricultural exports appear promising. The price and world demand outlooks are favorable for most products. However, prospects for volume increases are only fair. Major non-coffee agricultural exports are projected to increase by about 13% per annum in current dollars, during the 1980-85 period, of which about 3% would be the result of volume increases. For the rest of the decade, the projections follow a slightly lower trend. A number of requirements would need to be met to expand the export volume potential of the major agricultural products above the projected level. Cotton exports in particular will require favorable weather and increases in acreage planted. Major investments in irrigation will be necessary to expand output substantially. Rice yields have been rising rapidly over the past decade as a result of the introduction of improved seed varieties, and if sufficient irrigation investments are made, an additional 50,000 hectares could be brought into cultivation producing high yielding varieties. With favorable weather conditions, sugar export volumes from existing acreage could increase rapidly. Favorable prices are expected to provide ample incentives for output expansion. Further volume increases would require bringing new lands into cultivation. Flower and tobacco export prospects are good but will depend on the country's ability to continue penetrating world markets, i.e., on competitiveness. Prospects for bananas are relatively less attractive from the point of view of projected world prices. Competition is expected from rapidly increasing production in Central America. For Colombia to improve its competitiveness in bananas in the major world markets, output increases must arise from increased productivity and not from increased acreage cultivated. There appears to be scope for a rise in yields. In some areas this could be achieved through drainage investments and increased fertilizer usage. Colombia averages 1,800 boxes of banana per hectare in its good banana growing areas as opposed to 2,500 boxes per hectare in Central America and Panama. Prospects for increas- ing beef and cattle exports are only fair in the absence of the Venezuela market opening up again. Unless substantial progress is achieved in eradi- cating hoof and mouth disease, export markets will continue to be limited. Shrimp and shellfish resources have been depleted and despite favorable world demand and prices, export volume increases are not expected. Programs to seed the oceans with these resources, combined with a fishing prohibition for part of the year to allow their replenishment, will probably be required for increases in output over the medium and long term. 131. Major manufactured exports have been projected to achieve lower growth rates than in recent years, reaching an average annual growth rate of about 10% in nominal terms and 4% in real terms during the 1980-85 period. These growth rates are projected under the assumption of low growth in the economies of Colombia's major trading partners, and particularly that the growth of exports to the Andean Group countries, especially Venezuela, will not expand as rapidly as during the past five years. Colombian exports of metallic products, mechanical and electrical equipment and timber and wood products appear to have good possibilities. - 62 - 132. Development of the country's hydrocarbon and mineral resources for export and import substitution is projected to affect substantially the trade balance in the mid to late 1980s. Of particular importance are the Cerro Matoso nickel and the El Cerrejon coal projects and the projects for secondary recovery in the petroleum sector. Exploration investments, pipeline investments and refinery expansions are also important for alleviating future oil deficits and for expanding fuel oil exports. These investments are likely to raise export receipts significantly late in this decade and help offset the effects of relatively slow expansion of the country's major manufactured and agricul- tural exports. Nickel exports are expected to start with about 21 million lbs. in 1982 and rise rapidly to about 50 million lbs. in 1986, remaining at that level until 1990. Coking coal exports have been projected at 360,000 tons per year, about the same as present levels, under the assumption that no major projects will be undertaken during the period. Thermal coal exports from the El Cerrejon mine are expected to start with 7.0 million tons in 1986 and increase to 15 million tons per year by 1989. Exports from El Cerrejon have the potential to be doubled to 30 million tons per year by the mid-1990s and perhaps even earlier if export contracts and additional infrastructure investments are completed. On the other hand, if this project were to be delayed in coming on stream beyond 1986 and at the same time the expected discoveries of petroleum fail to materialize, Colombia's balance of payments prospects would be seriously eroded. Residual fuel oil exports are projected to rise by two thirds, from about 12 million barrels in 1980 to about 20 mil- lion barrels in 1990. This will require the construction of additional refining capacity. Export earnings from coal and fuel oil are projected to reach 20% of the value of both current merchandise exports and imports by 1990, thus highlighting the importance of executing the above projects on time. C. External Capital Requirements 133. Gross external capital requirements are projected to total about US$11.2 billion over the 1980-85 period for an average annual requirement of approximately US$1,870 million. Of this amount, 32% or US$600 million per year on average will be required for amortization of foreign debt, and the balance to cover the current account deficits plus an estimated US$700 million of international reserve build up in 1980. Although international reserve drawdowns are expected to provide a total of US$1,250 million over this period, Colombia is expected to increase its foreign borrowing substantially above past levels. 134. Net foreign investment is expected to increase rapidly during the next several years, primarily in the mining and petroleum sectors, averaging in excess of US$200 million per year during 1980-85. These inflows should provide about 12% of gross external financing during the projection period. About 40% or US$661 million p.a., of gross external financing is expected to come from multilateral and bilateral agencies, and the remaining 48% is expected to come from foreign banks and supplier credits, amounting to an average inflow of US$800 million. External borrowing by the private sector (included in the inflows from foreign banks and suppliers credits) is expected to account for about 8% of total external borrowing during the projection period, averaging about US$115 million per annum while public and publicly guaranteed borrowing is expected to account for the remaining 92%. - 43 - T8tt 12 C0AMlA: PIOIKC1O CAPItAL 8RK0QJ0U7 AMr F?1SAVCiC. 197.-1990 (1. lilli-. of aS 8.11...) x- i FR M1 IO 192 19e3 1t84 1lS5 1984 1987 1988 1989 1990 E.p.ot. of Cood. -d 9o,.faof S .v.. L 4.059 4,910 3,345 5.502 5,912 6,410 7.467 8.649 9,845 10,949 12,213 13,114 14,999 I.Poo1 of Gd. cad u.,-ft.tcr .toi... 3,722 4,191 5.3S9 *.25I t.997 7.644 8.41 9.184 11.145 11,384 12,507 13.680 15,002 S--o--c- 8.1-00 337 719 -14 .753 -1,085 .1,234 .1,1S1 .1,235 .1,300 .435 -294 34 -3 In.t-t o. Pub01. O bt .1 -113 r 183 .242 -300 -313 -413 5 486 427 -5N -125 -053 -917 -950 other F-o1- S.-L.. co _ _d NWTl fa. 1217 60 157 199 178 15s 115 44 -7 .26 11 3 -t0 C- .o.. 97- 22 alft 283 n .1 -I*" ol.hf2 o1_20 1Zli 7U .1l c. 1188 -1-144 A.coll.titfoa (tclaI) -302 -4 .3SO -378 -5t1 4t80 .727 -924 -1.148 .1.209 .1,433 -1,761 -2.004 F.c.c.. Arw Jcc.lAtl -o26 .1.2e5 -700 200 100 300 300 200 200 -62l .181 27 .346 Cco~1 1a.uboo.acoa Uj Loll t ML L.=L LA" LU E iz lMi Liu 3L019 2,728 27I14 L= 71no.cin. )17a.*1 821 1,073 1 199 1 032 1664 7J.72 1.847 2.440 732 3.019 2.72S 2,614 3 313 ?occIgn lnwac.00, 3 124 123 123 150 230 250 350 350 400 400 450 450 I.o.nc 334 1,185 1.064 907 1,514 1,422 1.,97 2,090 2.,03 2.419 2,328 2,U14 2,863 To PubIi SA.c.o (304) (979) (11.058 (883) (1.378) (1,474) (1.340) (1.868) (2.217) (2.324) (2,101) (1,980) (2,552) To POi-at. S.01c (30) (I18) (4) (203 (138) (1") (157) (2223 (2"8 (295) (227) (184) (311) CaPOld ..1 431 .21b -- -- - -- - D.b1 S.-L..c 80Ct1 (P.FW) 8.0 9.4 9.7 10.f 12.7 13.2 14.7 13.2 16.0 16.1 16.9 17.5 17.4 S,0 lncl ddab pvb1c a.d p.blcly-. r_ce. d doba. Icccc.,: 8.0cc do Ia 8.pbllc. 7.0 .1.0 8a81.aten aad pToj.ctte.8 . GA - 7&b61 131 IWaMTA - *WfaTIW AnD D tSiUr MCM 0o IinUm AND LO Tluh CUDItS, 197810 (tr 8t2t1enL US 311 oll4te3 Prel 1.1.2.1, ~~~~~~~~~~~~Pr.j.ttd The,Ii t979 1980 1981 1982 1983 1984 198d 19Lo 1987 198d 19S9 1990 191-900 Co.eiten.n 1.513 J25 9 1 7I 1 764 1942 2La 281 27 279 2.417 283 3.010 217543 .1til.tr.1 amnd Bilateral 880 694 865 7b6 845 951 948 948 938 963 998 1,080 9,102 S.pplino- and Finan-tal Credit. 413 536 293 834. 919 991 1.333 1,669 1.741 1.454 1,IS7 1,930 12 441 Ulisbur-nnnt 1.16 1 907 1.514 1.622 .97 2.090 2J.50 2.619 2.32a 2,164 2,863 20 307 E.i.Li.2 Lo.n. 1.165 361 317 25 169 80 *1 24 10 _9 __ 89 9IltilAtaraL .nd Bilateral 275 316 286 233 138 80 41 24 10 032 S.ppliar. .nd FtL.nncil Cr dtlS 890 25 31 25 11 - - - _ . - e7 N.. Lon- _ 703 S90 1.256 1.453 IJ.17 29 2.79 2.609 2.328 2.164 2,861 19 41) M.Itil.t.r.1 *nd bilateral - 149 290 447 559 635 752 842 898 903 908 967 7,221 SupplLera .nd Ftnan.cI CIrdits .- 554 300 09 894 962 1,297 1,637 1,711 1,425 1,236 1,896 12,1b7 5Our.cat 8anca d. La Rkp.9lfn, Snek Staff Utlaest... - 65 - 135. Of total gross external borrowing (disbursements) by Colombia during 1980-85, about US$1,114 million, or 13% would come from loans committed prior to 1980, while for the remaining US$7,668 million, additional commitments will have to be sought. Of new commitments, about US$4.9 billion (50%) is expected to come from multilateral and bilateral sources, the remainder from suppliers and financial institutions. D. Debt Management and Creditworthiness 136. Colombia's public external debt repayable in foreign currency amounted to US$5.4 billion at the end of 1979, of which US$3.4 billion was disbursed and outstanding. Public debt disbursed and outstanding is projected to rise to about 17% of GDP by 1985 and fall slightly to about 16% by 1990, from about 13% at the end of 1979. Private debt outstanding and disbursed amounted to an estimated US$460 million at the end of 1979. 137. The public debt service ratio is projected to increase to about 15.2% in 1985, from 9.6% in 1979, as a result of the rapid growth foreseen in the public debt and the projected modest export growth. Projections past 1985 show the public debt service ratio peaking in 1990 at 17.6% as the country pays off the heavy borrowing incurred over the previous decade. The debt service ratio of total public and private debt would be about 19.6% in 1990 as compared to an estimated 11.5% in 1979. The ratio of total debt service to GDP should remain low, rising from about 2% in 1979, to a projected 3% in 1985 and 4% in 1990. 138. Although the projected debt and debt service ratios would be rela- tively high compared to past levels, they would decrease substantially in the early 1990s when increased exports from new energy and mining projects come on line. By then, a large part of the required investment in infrastructure should be completed and new commitments for public sector investment projects should decrease substantially. The success of the high investment strategy planned by the Government would therefore depend heavily on the timely devel- opment of domestic energy sources and on progress in implementing the export oriented mining projects contained in the public sector investment program. Given the continuation of sound economic and financial management, Colombia is expected to maintain its creditworthiness through and beyond the 1980-90 period.