Colombia to Tax Dividends, Raise Sales Tax to Defend BBB

  • Drop in crude prices left a hole in public finances this year
  • Government seen proposing tax cut on foreign bondholders

Colombia’s government sent Congress its tax reform bill that seeks to plug a hole in the nation’s finances caused by falling oil revenues, and shore up the country’s BBB credit rating.

The bill sent to Congress includes a proposed a tax on dividends to individuals, an increase in the sales tax of three percentage points to 19 percent -- excluding basic household goods -- and the preservation of the 0.4 percent bank transactions tax. The bill doesn’t include a change in the tax on foreign investors’ bond profits, but the government will propose a cut to the 14 percent levy as it debates the bill Congress, according to a person with knowledge of the matter.

President Juan Manuel Santos’s administration is trying to pass the tax reform amid political upheaval caused by voters’ shock rejection in a plebiscite of a peace accord with Marxist guerrillas. The tax bill debate will be a test of whether the government still has enough clout to pass unpopular tax increases to avoid a credit rating downgrade.

The peso dropped 0.3 percent to 2,926.62 per dollar at 9:02 a.m. in Bogota trading. The yield on the benchmark 2024 bonds declined 2 basis points to 6.9 percent.

Investors had been expecting a reduction in the bond withholding tax, which has contributed to strong inflows into local government debt this year, Citigroup strategists led by Dirk Willer wrote in a report. “Uncertainty will probably lead to bear steepening in the curve and put short-term pressure on COP,” according to the report.

The fiscal deficit will widen to 3.9 percent of gross domestic product this year, from 3 percent in 2015, according to Finance Ministry forecasts. Colombia is rated at the second-lowest investment grade by Moody’s Investors Service, S&P Global Ratings and Fitch Ratings. At a news conference Wednesday, Finance Minister Mauricio Cardenas said that Colombia could aspire to a BBB+ rating in coming years.

Moody’s said in a report this month that the current “polarized political scene” will probably undermine the government’s ability to pass other measures, and that the tax reform is necessary to “preserve Colombia’s credit strengths.”

The government’s decision not to address foreigners’ bond profits in the tax bill may come as a surprise to some observers. Colombia in January 2013 had lowered taxes on foreigners’ earnings from local bonds, known as TES, from 33 percent, which helped spur demand and reduce borrowing costs.

For a QuickTake on Colombia’s peace process, click here

On Oct. 2, Colombians rejected an agreement between the government and the Revolutionary Armed Forces of Colombia, or FARC, by 50.2 percent to 49.8 percent. The peace agreement would have granted the largest guerrilla army in the Americas seats in Congress, reduced sentences for crimes and a program to redistribute land to small farmers who were forced to flee the violence, in return for handing in their weapons. Many voters objected to a group that kidnapped and murdered Colombians receiving lenient treatment.

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