Morningstar DBRS Changes Trend on Republic of Colombia to Negative, Confirms Credit Ratings at BBB (low)

DBRS Inc. (Morningstar DBRS) changed the trend on the Republic of Colombia's Long-Term Foreign and Local Currency - Issuer Ratings to Negative from Stable and confirmed the ratings at BBB (low). At the same time, Morningstar DBRS changed the trend on the Republic of Colombia's Short-Term Foreign and Local Currency - Issuer Ratings to Negative from Stable and confirmed the ratings at R-2 (middle).

KEY CREDIT RATING CONSIDERATIONS
The trend change to Negative from Stable reflects the deterioration in Colombia's fiscal accounts and the economy's weaker medium-term growth prospects. The central government deficit increased from 4.2% of GDP in 2023 to 6.7% in 2024, significantly higher than government expectations of 5.6%. The government aims to narrow the deficit to 5.1% in 2025 but risks to the budget outlook are quickly mounting. Without a sizable fiscal adjustment, public debt dynamics will continue to deteriorate. In addition, lower levels of investment have weakened the medium-term growth outlook. The investment rate over the last three years (2023-2025) has been nearly 5 percentage points lower than the decade prior to the pandemic (2010-2019).

The Colombian economy is gradually recovering after growing at a sub-trend pace in 2023 and 2024. The IMF projects output to expand by 2.4% in 2025 and 2.6% in 2026. Domestic demand is expected to drive the recovery, with investment rebounding from low levels and private consumption strengthening on the back of strong wage growth and higher remittances. However, the imposition of U.S. tariffs presents downside risks to the outlook. The direct effects of U.S. tariffs on the Colombian economy will likely be modest. Crude oil and coal, two of Colombia's largest exports to the U.S., are not subject to new duties. However, the indirect effects - weaker global demand, lower commodity prices, and tighter global financing conditions - will likely weigh on activity.

The BBB (low) credit ratings are supported by Colombia's record of sound macroeconomic policymaking. A credible inflation-targeting regime has delivered price stability for more than two decades. Exchange rate flexibility and sound financial regulation also bolster the economy's resilience to shocks. The credit ratings are constrained by Colombia's governance challenges and increasing fiscal pressures.

CREDIT RATING DRIVERS
The credit ratings could be downgraded if the outlook for public finances fails to materially improve on the back of a structural fiscal adjustment.

The trend could revert to Stable if the government implements a credible fiscal consolidation plan this year that puts public finances on a sustainable path. The credit ratings could be upgraded if the public debt-to-GDP ratio is put on a clear downward trajectory and medium-term growth prospects strengthen on the back of supply-side improvements in the economy.

CREDIT RATING RATIONALE

The Fiscal Outlook is Deteriorating and Putting Pressure on Colombia's Credit Profile

The central government deficit increased to 6.7% of GDP in 2024 from 4.2% in 2023. The deficit was the highest in over 30 years outside the pandemic (2020-21). The deterioration was primarily driven by lower-than-budgeted tax revenue and higher interest costs. The fiscal picture for 2025 does not look better, in Morningstar DBRS' view. The central government is targeting a deficit of 5.1% of GDP, but risks to the outlook are clearly mounting. Revenues will likely fall well short of budget expectations, prospects for revenue-raising measures in the near term are limited, and the Petro administration appears unlikely to prioritize the large-scale spending cuts needed to achieve the deficit target, especially with elections approaching in the first half of 2026. Risks to the fiscal outlook account for the one-category adjustment to the Fiscal Management and Policy building block.

Large fiscal deficits are contributing to higher levels of public debt. Gross general government debt increased from 55% of GDP in 2023 to 61% in 2024. Elevated borrowing rates highlight the need for a credible fiscal consolidation plan. Real yields (i.e. inflation-adjusted) on five- and ten-year government bond yields are running 250-350bps higher than before the pandemic. The IMF projects the debt ratio will stabilize this year on the back of a fiscal consolidation. Given the risks to the fiscal outlook, however, the challenge of structurally tightening fiscal policy and stabilizing the debt-to-GDP ratio may fall to the next administration.

Lower Investment Points to a Weaker - Albeit More Balanced - Growth Outlook

Estimates of potential growth have been revised down in line with lower levels of investment. The IMF estimates medium-term growth at 2.8%; two years ago, projected growth potential was 3.3%, and five years ago, it was 3.7%. Lower public investment, greater economic policy uncertainty, and higher taxes on corporate income may have contributed to several years of lower investment levels. The investment rate is estimated to average 17.4% of GDP from 2023-2025, down from 22.4% in the decade prior to the pandemic (2010-2019). The IMF forecasts that investment will increase over the next five years (average 20.2% from 2026-2030) but remain below pre-pandemic levels.

On the positive side, external accounts are better positioned relative to a few years ago. Despite less favorable terms of trade, the current account deficit narrowed from 6.0% of GDP in 2022 to 1.8% in 2024, almost entirely on the back of import compression. Going forward, the current account deficit is expected to widen as imports increase in a manner consistent with a recovery in domestic demand. Net FDI inflows fully covered the external deficit in 2024, in addition to helping offset net portfolio outflows. Colombia's credible monetary policy framework and flexible exchange rate are helping the economy adjust to evolving global conditions in an orderly manner. Colombia also holds $64 billion in reserves, which provides some protection against downside tail risks.

Election Politics are Getting Underway; Rule of Law Remains a Key Credit Challenge

President Petro came to power in 2022 promising to reduce poverty through greater social spending. Since his congressional alliance collapsed in early 2023, the President has often lacked the legislative support needed to advance his reform agenda. This includes a proposed labor reform, which would raise dismissal costs and reduce working hours. The President is asking Congress to put the reform to a public referendum. While it is unclear whether the Senate will allow it, the President aims to use to the referendum request as a way to energize his base ahead of next year's elections. Congressional elections are scheduled for March 2026. The first round of the presidential election is scheduled for May 2026. President Petro is ineligible for reelection. Beyond that, it is still too early to assess the electoral landscape.

Morningstar DBRS views the rule of law as a key credit challenge. There has been positive news for the country in terms of governance over the last two decades: Colombia has delivered macroeconomic stability through a series of shocks, poverty rates have materially declined, and Colombians' participation in the democratic process has strengthened, according to Worldwide Governance Indicators. The country's record of sound macroeconomic policy management accounts for the one category adjustment in the Political Environment building block. However, Colombia compares unfavorably to most similarly rated countries in terms of the rule of law. Even as the 2016 peace accord with the FARC advances, illegal armed groups continue to fight to control territory and the drug trade. The process of extending the state's presence to remote areas of the country, reintegrating thousands of former combatants into society, and addressing criminal activity tied to narcotics trafficking remain important long-term challenges.

Inflation is Gradually Declining Toward the Target

Price pressures have been subsiding since inflation peaked at 13.3% two years ago. In April 2025, annual headline inflation came in at 5.2%. While inflation has stagnated around 5% (y/y) for the last 6 months, we expect the gradual disinflationary trend to resume in the second half of 2025. With slowing inflation, the central bank lowered the policy rate from 13.25% in November 2023 to 9.25% in April 2025. Monetary policy settings, however, remain tight. The ex-ante real policy rate is above 5.0%, which is clearly in restrictive territory, and it will likely remain restrictive through the end of the year even as the policy rate gradually declines. The credibility of the inflation-targeting regime has helped anchor expectations. According to the central bank's Economic Expectations Survey (April 2025), annual inflation (median) is expected to decline to 4.5% by December 2025 and 3.5% by December 2026, which is within the central bank's 2-4% target range.

The financial system managed the slowdown in the domestic economy relatively well. Consumer credit growth levelled off in 2023 and 2024 amid lower loan demand and higher provisioning requirements on certain loans. The share of non-performing consumer loans declined from the peak of 8.4% in November 2023 to 6.7% in February 2025, and banks have set aside additional provisioning. Overall, we see financial stability risks as contained. Banks are highly capitalized, liquid, and primarily funded by local deposits. In addition, currency mismatches across banks, corporates, and households are limited.

ENVIRONMENTAL, SOCIAL, AND GOVERNANCE CONSIDERATIONS

Environmental (E) Factors
The following Environmental factor had a significant effect on the credit analysis: Resource and Energy Management. The economy is vulnerable to oil price shocks, with petroleum products constituting roughly 30% of Colombia's exports, 10-25% of foreign direct investment inflows, and 5-15% of general government fiscal revenues. This factor is taken into account in the Balance of Payments and Fiscal Management and Policy building blocks.

Social (S) Factors
The following Social factor had a significant effect on the credit analysis: Human Capital & Human Rights. Similar to other emerging market economies and many of its regional peers, Colombia's GDP per capita is relatively low at US$7.9k (US$21.5k on a PPP basis). This largely reflects the low level of labor productivity. In addition, organized criminal gangs continue to commit human rights abuses, especially against journalists, community leaders, and human rights activists. This factor is taken into account in the Economic Structure and Performance building block and the Political Environment building block.

Governance (G) Factors
The following Governance factors had a significant effect on the credit analysis: (1) Bribery, Corruption and Political Risk, (2) Institutional Strength, Governance, and Transparency, and (3) Peace and Security. According to Worldwide Governance Indicators, Colombia ranks in the 44th percentile for Control of Corruption and in the 35th percentile for Rule of Law. Colombia ranks in the 55th percentile for Voice & Accountability. While Colombia has made progress in reducing violence, the country still ranks very low on Political Stability and the Absence of Violence/Terrorism (18th percentile). These factors are taken into account in the Political Environment building block.

A description of how Morningstar DBRS considers ESG factors within the Morningstar DBRS analytical framework can be found in the Morningstar DBRS Criteria: Approach to Environmental, Social, and Governance Factors in Credit Ratings at (August 13, 2024) https://dbrs.morningstar.com/research/437781.

For more information on the Rating Committee decision, please see the Scorecard Indicators and Building Block Assessments. https://www.dbrsmorningstar.com/research/454206.

Notes:
All figures are in U.S. dollars unless otherwise noted. Public finance statistics reported on a general government basis unless specified.

The principal methodology is the Global Methodology for Rating Sovereign Governments (15 July 2024) https://dbrs.morningstar.com/research/436000. In addition, Morningstar DBRS uses the Morningstar DBRS Criteria: Approach to Environmental, Social, and Governance Factors in Credit Ratings https://dbrs.morningstar.com/research/437781 in its consideration of ESG factors.

The credit rating methodologies used in the analysis of this transaction can be found at: https://dbrs.morningstar.com/about/methodologies.

The conditions that lead to the assignment of a Negative or Positive trend are generally resolved within a 12-month period. Morningstar DBRS' outlooks and credit ratings are monitored.

The primary sources of information used for this credit rating include the Ministerio de Hacienda y Crédito Público, Banco de la República, Superintendencia Financiera de Colombia, DANE, International Monetary Fund, World Bank, NRGI, Brookings, Bank for International Settlements, World Federation of Exchanges, and Macrobond. Morningstar DBRS considers the information available to it for the purposes of providing this credit rating was of satisfactory quality.

The credit rating was not initiated at the request of the rated entity.

The rated entity or its related entities did participate in the credit rating process for this credit rating action.

Morningstar DBRS did not have access to the accounts, management, and other relevant internal documents of the rated entity or its related entities in connection with this credit rating action.

This is a solicited credit rating.

For more information on Morningstar DBRS' policy regarding the solicitation status of credit ratings, please refer to the Credit Ratings Global Policy, which can be found in the Morningstar DBRS Understanding Ratings section of the website: https://dbrs.morningstar.com/understanding-ratings

For more information on this credit or on this industry, visit https://dbrs.morningstar.com.

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