OREANDA-NEWS. Fitch Ratings has affirmed Colombia's long-term foreign and local currency Issuer Default Ratings (IDRs) at 'BBB' and 'BBB+', respectively, with a Stable Outlook. The issue ratings on Colombia's senior unsecured foreign and local currency bonds are also affirmed at 'BBB' and 'BBB+', respectively. The country ceiling is affirmed at 'BBB+' and the short-term foreign currency IDR at 'F2'.

KEY RATING DRIVERS

Colombia's flexible and credible policy framework, improved external buffers and favorable macroeconomic performance in relation to 'BBB' peers balance high commodity dependence, increased external vulnerability, limited fiscal flexibility and structural constraints in terms of low GDP per capita and weak governance indicators.

Colombia's track record under its inflation-targeting regime, flexible exchange rate, and healthy banking system underpin its capacity to absorb external shocks and maintain macroeconomic and financial stability. The flexibility of the Colombian peso to absorb the oil shock and increased international financial volatility has been significant, reflecting Colombia's favorable starting position in terms of financial system robustness, limited FX mismatches in the economy and low inflation. The Colombian peso has depreciated by close to 40% since the oil price decline began in H214 and 20% since the end of June 2015.

Nevertheless, strong depreciation of the Colombian peso, the impact of El Nino and a still dynamic domestic demand have pushed inflation above the inflation target at 3% (plus/minus 1 percentage point) and could average 4.9% in 2016. The central bank has responded with 100bps in hikes since September and is likely continue to tighten monetary policy in order to bring headline inflation and expectations under control and support the reduction of external imbalances.

Growth prospects have weakened, as Fitch expects the Colombian economy to expand by 2.8% in 2015, which could slow to 2.6% in 2016, as a tighter monetary and fiscal stance and lower regional public expenditure will weigh on the positive impact of the beginning of the execution of the 4G projects and the full-year impact of the expansion of the Cartagena refinery. The economy could accelerate in 2017 based on infrastructure execution and the easing of the present trade shock.

Colombia's external vulnerability is high as the current account deficit could reach 6.1% of GDP in 2015, thus exposing the country to changes in investor confidence and external debt build-up, as net FDI inflows will likely reduce. The current account deficit is expected to average 4.8% in 2016-2017 due to slower growth, the weaker peso, the full-year positive contribution of the increased capacity of the Cartagena refinery, and recovery in non-commodity exports.

International reserves stood at USD46.8 billion at the end of November 2015 (almost seven months of CXP) and the central bank has not sold USD in the FX market to stem the peso depreciation. Nevertheless, the authorities have indicated they will intervene in the event of high volatility through an option-based mechanism. Colombia renewed access to the International Monetary Fund's Flexible Credit Line (FCL) for USD5.45 billion to further buttress shock absorption capacity and policy credibility.

In spite of expenditure adjustments, central government deficits are likely to increase from 2.4% of GDP in 2014 to 3% and 3.6% in 2015 and 2016, respectively, reflecting a loss equivalent to close to 3pp of GDP in oil revenues between 2013 and 2016. Although the 2016 nominal fiscal deficit could be higher under the fiscal rule in the event of lower growth or weaker oil prices, authorities have stated they will make the necessary adjustments to contain further fiscal deterioration, thus committing to the 3.6% of GDP deficit target.

Government debt, 44.7% of GDP in 2015, has increased and could remain above the 'BBB' median over the forecast period. Nevertheless, deft liability management has improved currency, refinancing and interest rate risks. General government debt maturities will average 2.4% of GDP in 2015-2016, below 5% average for the 'BBB' median.

Fiscal policy flexibility is constrained by a narrow revenue base, a rigid expenditure profile and limited fiscal savings. Hence, a policy response is necessary to provide a credible path for deficit reduction and debt stabilization in the medium term. The government has stated it plans to introduce a revenue-positive tax reform in first-half 2016 in order to improve the efficiency and broaden the base of the current tax system.

Colombia could reach a peace agreement in 2016 through the conclusion of negotiations with the FARC and a plebiscite process. The implementation of a peace agreement could provide a confidence boost in the short term and medium- to long-term benefits (i.e. with investment in energy and agriculture) that could increase growth prospects. In the near term and, given the wider fiscal deficit, such an agreement would highlight the importance for the government to rebuild its revenue base to accommodate required investment without jeopardizing fiscal consolidation.

RATING SENSITIVITIES
The main factors that could, individually or collectively, lead to a rating action are:

Negative:
--Insufficient policy response that leads to faster fiscal deterioration and a rising debt trajectory;
--Continued deterioration of external credit metrics.

Positive:
--Significant strengthening of Colombia's external and fiscal balance sheets;
--A higher growth trajectory that supports debt reduction and reduces Colombia's income gap with higher-rated sovereigns;
--Improvement in governance indicators reducing the gap with 'BBB' peers.

KEY ASSUMPTIONS
--Fitch assumes that oil prices average USD55 in 2015, similar to 2016, and USD65 in 2017.

--Fitch assumes that authorities will undertake fiscal policy measures to confront the oil shock and lower growth.
-- Fitch assumes that the internal conflict in Colombia does not jeopardize investment and growth.