Colombia Rally Fizzles as Fiscal Worries Leave Bonds in Limbo

(Bloomberg) -- The relief rally in Colombian bonds that took place in the fourth quarter has given way to one of the worst performances across developing-nation sovereign bonds this year.

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The reversal comes after Finance Minister Ricardo Bonilla unveiled a budget target that disappointed analysts last month. Barclays Plc classified the target as “unambitious,” while UBS called the move a “blow” to fiscal credibility.

Colombia’s deficit is expected to widen to 5.3% of gross domestic product this year from 4.2% in 2023, moving closer to the limits of its fiscal rule as economic growth slows. That’s led some investors to take profits after flocking to the bonds last year when leftist President Gustavo Petro’s attempts to overhaul the market-friendly economy were stymied by congress.

The bonds “are at a tipping point,” said Alejandro Arreaza, an Andean economist at Barclays in New York, who recently cut the notes to hold from overweight. “There is still hope that they could end up 2024 with a deficit smaller than the 5.3% of GDP they presented in February. If they send credible signals pointing in that direction, it would be well received by market. On the contrary, market pressures could re-emerge.”

Colombian bonds due 2034 have dropped 4 cents on the dollar to 101.7 cents this year, after hitting all-time high on the last trading day of 2023, according to data compiled by Bloomberg. The notes soared as much as 14.2 cents in the fourth quarter of last year.

The country’s dollar bonds are the worst performing among Latin American peers year-to-date, with only South Africa, Senegal and Benin dropping further among emerging markets over the same period.

Switching Attention

S&P Global Ratings cut Colombia’s rating outlook to negative last month, citing a prolonged period of weak growth. The report helped shift investor attention to the rising deficit and away from Petro’s failed attempts to push through sweeping reforms of the pension, labor and health systems.

“The fundamentals trajectory still looks weak, with potential fiscal risk,” said Jared Lou, portfolio manager for emerging market debt at William Blair in New York. “It’s hard to get excited about the credit, especially if you think there’s more value in other countries in the asset class.”

Colombia’s situation contrasts with Ecuador and Argentina, where radical new presidents are trying to push through market-friendly reforms after years of mismanagement led to a series of defaults.

Those two countries “are intent on making some big directional shifts regarding policy and thus possibly set to gain from a relative value perspective in the coming months,” said Simon Quijano-Evans, chief economist at Gemcorp Capital Management Ltd.

Going forward, money managers will be closely monitoring the mid-term fiscal plan that’s expected to be presented by the Finance Ministry in June, which is seen as an opportunity to clear up some of the investor uncertainties.

There is “room for outperformance in fiscal accounts this year” which could limit credit deterioration risks, said Armando Armenta, an emerging market strategist at AllianceBernstein.

But while there’s premium relative to other BB-rated peers and Fitch Ratings said it’s comfortable with the stable outlook for the nation’s credit score, some expect spreads to remain rangebound and sensitive to fiscal releases.

There’s technical support due to the nation’s high-yield status, but the relief rally of a weaker reform agenda appears to be over, said Siobhan Morden, managing director for Latin America fixed income at Santander in New York. Colombian bonds are “in limbo at the moment.”

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