Colombia - Current economic position and prospects (Vol. 1 of 2) : Main report

RETURPN TO RTjp(3jqT[g grglIK RESTRICTED WtITHIN CIRCULATING COPY Report No. WH- 172a ONE viffENTO E RETURNED To REPORTS DIESK IN GENERAL FILES This report was prepared for use within the Bank and its affiliated organizations. They do not accept responsibility for its accuracy or completeness. The report may not be published nor may it be quoted as representing their views. INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT INTERNATIONAL DEVELOPMENT AS.OCIATION CURRENT ECONOMIC POSITION ANI) PROSPECTS OF COLOMBIA (in two volumes) VOLUME I THE MAIN REPORT May 23, 1967 Western Hemisphere Department  CURRE.NCY EQUIVALENTS 1 US $ 13.58 Pesos 1 Peso (Ps.) US$0. 074 1 million Pesos US$73,637  TABLE OF CONTENTS Page No. PREFATORY NOTE ....................................... BASIC DATA .................................... STUYli4RY AND CONCLUSIONS * .... I.... 0... O- * ...... I. THE BALANCE OF PAYi9EWTS CONSTRAINT ON COLOA1BIA'S ECONOhIC DEVELOPYE5NT ............ 1 A. Introduction. ................1 B. Economic Development and the Balance of Payments, 1955-66 ...... 2 II. THE OUTLOOK FOR 1967-70 ........................ 8 A. Introduction . . ............ D . ....**** .**. 8 B. Sectoral Policies ...... .. ... . 9 C. Public Investmert and Its Financing ....... 13 D. Coffee Policy ............ 17 E. Prices and Uages Policy . ... .18 F. Monetary Policy ........... ..eee 18 G. Exchange Policy and the Balance of Payments Prospects ..... ........ ... 19 H. Creditwlorthines- E ....ao.................., , , ..*. 25 STATISTICAL ANNEXES General Note I. National Accounts II. Balance of Payments III. Public Finance IV. Money, Credit and Prices  - 2 APPENDIXES A. THE NEi EXCHANGE REGIiE B. POLICY PERFORMANCE 1961-66 SEPARATE VOLUMES PULIC FINANCE (Vol.. II)  PREFATORY NOTE This report was prepared by an economic mission which visited Colombia in January - March 1967, composed of the following Bank staff members: Messrs. Rayaond Frost, Jose D. Teigeiro and Anthony Churchill.  BASIC DATA Area: 439,825 square miles Population (mid 1967) 18.7 million Rate of Growth (1950-1966) 3.2 per cent Population density: 42.3 Other Significant Factors: Population of principal cities growing at rates of 4 to 10 per cent Gross Domestic Product 1966 Rate of Growth in Real Termas 1950-1966 4.6 1950-1956 5.1 1956-1961 4.1 1961-1966 4.4 Per capita 1966, uS$ 230-270 Origin of Gross Domestic Produ.ct Annual Average (est. at 1958 prices) Rate of inerease 1950 1966 1950-66 Agriculture 37:T 29. 3.0 Manufacturing 14.8 19.3 6.3 Commerce 15.7 15.7 4.6 Transport 5.0 5.9 5.6 Electricity, gas, water 0.5 1.0 9.5 Other 26.2 28.5 -- Total 100.0 100.0 4.6 Percentage of GDP at Market Plrices Est. 1966 Gross Fixed Investment 18.5 Gross Domestic Savings 14.9 Balance of Payments Dbfic:it on Current Account 3.6 Interest and Profits of P:rivate Foreign Investment 0.8 Public Sector Tax Revenue 11.4 Public Sector Savings 4.3 Resource Gap as % of Investmint 19.7 Money and Credit Conversion: Ps. 1.00 US$ 0.074 US $1.00 =Ps. 13.59 Relationship to large monetary or customs ares: Mlembers of LAFTA  - ii - 1962 1963 1964 1965 1966 - (Million Pesos Total Money Supply 6,194 6,925 8,369 9,682 10,622 -/ Time and Savings Deposits 999 1,178 1,316 1,562 1,699 1/ Commercial Bank Credit to Private Sector 5,569 5,984 7,110 8,151 9,857 Cost of Living Index for 2 Workers2/ 181.6 231.1 272.1 291.3 339.9 1/ Eleven month.s 2/ July 1954 - June 1955=100 Plblic Sector - Operations (Million Pesos) 1962 1963 1964 1965 1966 Current Revenues of the Central Government 2,114 3,069 3,847 3,948 6,028 Current Expenditures of the Central Governrment 2,914 2,509 2,878 3,010 4,070 Surplus on Current Account of the Central Government, 200 560 969 938 1,959 Other Public Sector's Sur- plus on Current Account 721 1,051 1,025 1974 1,202 Public Sector Investment Expenditure 2,466 2,813 2,858 3,048 4,155 Capital Account Income, Net 1,545 1,202 864 1,136 994 External Public Debt: (YMllion US $) Total Debt Outstanding, as of June 30, 1966 1,039 Total Annual Debt Service, Est. 1967 113.4 Debt Service Ratio, Est. 15967 17.4  (Million US $) Balance of Payments 1962 1963 1964 1965 1966 Merchandise Exports F.O.B.I/ 394.2 393.0 540.9 484.3 471.3 Merchandise Imports F.G.B. -536.9 -497.5 -575.4 -423.5 -569.5 Other, Net - 25.4 - 27.3 -115.8 -81. 1 -105.4 Deficit on Current : Account (-) -168.1 -131.8 -150.3 - 20.3 -203.6 Net Capital Flows 98.0 179.0 273.6 - 8.9 174.7 Errors and Omissions 27.0 - 78.3 -138.4 82.3) Change in Central Bank Reserves (-increase) 43.1 31.1 15.1 - 53.1 28.9 _/ Excludes Petroleum exports. Commodity Concentration of (Percentages) Exports 1958 1966 Coffee 73. 63.0 Petroleum 15.4 15.0 Bananas 3.1 3.7 Cattle on the hoof 2.9 3.0 Sugar -- 1.5 Tobacco 0.4 1.0 Other 4.6 12.8 Total 100.0 100.0 IMF Position (as of Dec. 31, 1966) (Itillion US$) Quota 125.0 Drawings outstanding 89.0 Gross International Reserves, December 31, 1966 US$ 144.0 million Equivalent to 2.5 months of estimated 1967 merchandise imports.  SU1iARY AND CONCLUSIONS 1. Colombiats economic problem is to reconcile her aspirations for economic development with tthe existence of a structural disequilibrium in the balance of payments arising from the dependence of exports upon coffee. Since the end of the coffee boom in 1954-56, successive Colombian governments have tried to adjust domestic policy to the changing circum- stances in the external sector, establish policies that would provide incentives for the growth of sources of exchange earnings other than coffee, and keep import demand within the limits of the supply of foreign exchange. However, attempts to accelerate domestic development have been slowed by limitations in the supply of foreign exchange, and then brought to a halt by frequent exchange crises. The result has been that Colombia's GDP grew by little more thani 4 percent per year in the 1961-66 period, considerably lower than planned. The Government is looking toward a future growth in the neighborhood of 6 percent. 2. One of the principal causes of the balance of payments problem has been a tendency to maintain exchange rates that were overvalued in realation to the need to provide incentives for minor exports, for petro- leum investment, and to restrain the demand for imports. Since i957/58, Colombia has pursued a truly flexible exchange rate policy only for brief periods. 3. The recent deterioration of the coffee market, operating against a background of insuffucient reserves, has again made the question of balance of payments management critical. Colombia entered once more an exchange crisis at the end of 1966 and currently is in the process of overcoming its effects. Fortunately, the new Governnment that took office in August 1966, has realized that for Colombia to become viable in the world economy a complete reorientation of balance of payments policy capable of producing a radical change in the principal underlying trends was urgently required. This reorientation has been undertaken by means of a completely new set of balance of payments policies, contained in the Government's Decree-Law 444 of March 22, 1967. This Decree-Law creates two principal exchange markets; one of them, the certificate market, has a fluctuating exchange rate to be determined by market forces, with only limited intervention by the authorities. Properly managed, the newly established exchange system gives ground for expecting that new export lines will be developed and that the balance of payments will be viable. 4. The balance of payments is the last outstanding issue on which considerable improvement has yet to be achieved. Colombia initiated a decade of planned economic development with a ten-year plan introduced in 1961. In the first five years ending in 1965, the execution of this development program was impeded, not only by balance of payments problems, but also by deficiencies in planning and project preparation; the adminis-  - ii - trative machinery for project execution; deficient agricultural, fiscal, coffee and wages policies; and an excessive demand for domestic credit. As a result of this, the external assistance that was available to support the development program was left uncommitted, or if committed, was utilized with undue delays. 5. However, since the end of 1965, and more particularly since the assumption of office by the new Government, internal obstacles to an expanded development program are being rapidly removed. Efforts of pro- ject preparation during the past five years have left this Government with an inheritance of projects ready for execution. The Government is rapidly removing the administrative obstacles to their execution by imnproving the management of public agencies, and making necessary changes in sectoral policy and organization. The Government has also moved to provide adequate revenues to finance the public investment program in 1966, and on a much larger scale in 1967. Agricultural policy has greatly improved and coffee policy is such that the coffee sector should be able to contribute to the overafl availability of domestic credit. In the field of monetary policy, the Governuent has moved since 1964 to correct deficiencies of policy. Since 1966 the management of the monetary program is being greatly helped by sounid fiscal, coffee and wage policies. 6. Since 1962 the major foreign lenders to Colombia have agreed that Colombia needs time to develop export earnings from sources other than coffee and have indicated their readiness to support Colombia's pro- gram in the interval while this export diversification effort is proceeding. With such external support, the immediate lack of exchange earnings resulting from Colombia's depe:adence upon coffee need not interrupt the development effort. The newly adopted exchange and balance of payments policies are designed to give adequate incentives for minor export develop- ment and petroleum investment, ensure a steady inflow of foreign exchange earnings from coffee sales, and maintain the cost of imports at a level consistent wjith Colombia's capacity to import. Although the gross liquid and quasi-liquid reserves have increased in the last few months, there is no margin for poor performance in this field since they cover only about one inonth and a half of estimated merchandise imports. 7. Balance of payments results for the first four months of 1967 indicate that the deficit on cuarrent account may not exceed US$ 190 million. This is less than the mission's projection shown on page 23 because of the low level of merchandise imports registered during this period. However, since this reduction has been accompanied by a correspondingly lower level of' suppliers credits, the original estimates for other items of the balance of payments remain unchanged. The mission's balance of payments projections beyond 1967 suggest that Colombiats deficit on current account may increase to about US$ 290 million in 1968, and fall to about US$ 245 million by 1970. To cover these deficits and provide for a modest but necessary increase in exchange reserves would require disbursements of new official capital of between US$ 230 and $300 million, considerably above recent levels. This  - iii - can be achieved provided that the impediments that in the past prevented a faster utilization of the assistance available are effectively removed. However, should the effor-t tco develop minor exports proceed at a slower pace than projected, the medium-term projection of Colombia's balance of payments outlined in the report would not be realized and the Government's objectives for growth would hlave to be reviewed in the light of the resulting reduction in Colombia's creditworthiness for new external borrowing. Creditworthiness 8. Colombia presently has over US$1 billion of external debt, of which US$370 million represernts commitments by IBRD/IDA. The service ratio on existing debt is estimated at 17 percent in 1967. If, as is now expected, the new balance of payments policies are successful in stimulating the development of exports and taking account of the new borrowing planned for the 1967-70 period, this ratio would remain at about 17 percent by 1970. 9. The Government has submitted to the Bank for distribution to the Consultative Group a project list requiring about US$320 million of new external commitments from the Bank and other members of the Consultative Group during the period from July 1967 to June 1968. Including debt un- disbursed, this level of commLitments would represent a substantial increase in official external indebtedness during that year. It would be followed by a lower rate of commitment of new loans from July 1968 through December 1970. 10. The projects inclucled in the list will become the heart of the development program that the Government is preparing. The Governrnent has given evidence of its readiness to take the administrative and fiscal measures required for the effective execution of externally financed pro- jects, and for the realization of their economic benefits. Economic policy in general has been greatly improved. And, finally, a favorable context of balance of payments policy has been established within which the development program can proceed in 1967 and after. On the basis of the policy measures that have already been taken and in the expectation that the new exchange system will be managed so as to achieve the objective of making the external sector's prospects consistent with the development effort, Colombia merits full support in its plans to obtain US$300 to 350 million of external loan commitments through mid-1968. During this period both external lenders and the Government will wish to observe closely the degree of success in the critical effort to enlarge and diversify Colombia's sources of exchange earnings on which Colombia's longer-term growth prospects rest.  I. THE BALANCE OF PAYMENTS CONSTRAINT ON COLOMBIA'S ECONGMIC GROWTH A. Introduction Population :Ll. Colombia has a population of 18.7 million as of mid-1967. Between 1940 and 1950, population grew at a rate of approximately two percent per year, but since tftis period, due largely to the decline in rnortality rates (23 percent between 1945 and 1960), the rate has accelerated to its current 3.2 percent. This acceleration in the growth rate has been accompanied by a shift in the age composition of the population and emigration from rural to urban areas. The 1964 population census shows that 44 percent of the population is under the age of 15 - as compared to, for example 30 percent in Argentina, for the same age group. The rural to urban area shifts have been equally dramatic, shifting from a 38 percent urban population in 1950 to 51 percent in 1966, and an estimated 55 percent by 1970. Both these structural shifts in population, combined with the acceleration in the growth rate, place trenendous pressures upon limited resources; the shift to urban areas requires a large investment in urban infrastructure, and the age composition of the population means that the economy has to support and educate a large percentage of the population outside the labor force. The current animal inciease of about 190,000 in the job- seeking labor force, in addition to the existing open and disguised unemployment, also represents insistent pressure for new employment opportunities. Natural Resources 12. In the tropics, climate is determined by altitude, and Colombia offers land for agricultural exploitation at altitudes ranging from sea level to 9,000 feet. This means that virtually any kind of crop can be grown. There are large under-utilized resources of land suitable for livestock raising. Less than one quarter of the land area is being exploited for agriculture or cattle, leaving plenty of room for agricultural expansion in the long run, though access in the short run is hampered by deficient or non-existing transportation facilities. Large forests have been hardly touched for commercial lumber operations; and ocean fishing has also been little exploited. The principal known nineral resource is petroleum, which presently supplies domestic consumption and around 16 percent of total exports. The exploitation c,f substantial deposits, recently discovered, is expected to result in a substantial expansion of petroleum production over the next few years. There exist resources of coal and iron located close together, presently supporting a steel mill of 170,000 tons capacity, and capable of support- ing an output of over 400,000 tons for 40 years to come. Other mineral resources include gold, mined at the rate of about US$13 million annually; and small amounts of platinum and emeralds. A mineral survey, currently underway, has shown the existence of considerable deposits of laterites, of apparently good nickel content, and phosphates.  -2- Political Developments 13. The period from the end of the Second World War until the early 1960ts was characterized by periodic outbreaks of civil violence, formed by the intense rivalries between the two major political parties, the Liberals and the Conservatives. This led to the breakdown of the consti- tutional government, whichl gale way to a military dictatorship in 1953-57. It was followed in 1958 by a return to constitutional government in the form of a coalition systemt between the two parties, which was designed to last sixteen years. The system provides for the election of alternating Liberal and Conservative Presidents with both parties agreeing to the election of the Presidential candidate, and support at election time. The principle of alternation betwEen Liberals and Conservatives is preserved throughout government, from the Cabinet down, and in the administrative bureaucracy of all public agencies. The system of permanent coalition has demonstrated the ability cf Colombians of differing political affilia- tions to work together. IThe f'irst and second National Front administra- tions completed their terms in 1962 and 1966, respectively. The third National Front administration has been in office since August 1966. This Government has already demonstrated its resolute intention of making a major transformation of the basic environment for economic and social development: it has prepared a sound public investment program for 1967 and the domestic financial resources for its execution have been made available. In addition, agricultural, coffee and monetary policies have been greatly improved and, finally, the nevw exchange and balance of payments policies give ground for expecting that Colombia will become viable in the world economy. B. Economic Development and the Balance of Payments, 1955-1966 14. Colombia's economic problem has been and still is to reconcile her aspiration for economic growth with the existence of a structural dis- equilibrium in the balance of payments. Although in recent years non-coffee exports have increased, export earnings still depend to a substantial degree upon coffee and, with the international price of coffee declining, they cannot finance, by a large margin, the imports required to sustain a satisfactory rate of growth. External assistance can help to finance growth while Colombia is seeking a solution to the persistent problem of balance of payments disequilibrium, and can buy the time needed to bring about this solution. However, external assistance cannot substitute for the solution. 15. Until the collapse of coffee prices in 1955-1957, Colombia's growth was stimulated and financed by the post-war coffee boom. Since 1957 Colombian governments have been confronted by two tasks, these being, first to manage and improve an essentially weak balance of payments, and second, to prepare and execute a development program suitable for external financing which could thus serve as a vehicle for the utilization of external assis- tance. The manner in which Colombia has tackled these problems is discussed below.  - 3 - a) The management of the balance of payments 16. The balance of paymtents was weak in the sense of immediate liquidity; owing to the mismnzEagement by the military government of 1954- 57, the net exchange positior, taking account of commercial arrears, was negative to the extent of at least US$200 million in 1957. This position was improved in the period 1557-59, partly by obtaining long-term re- financing for the arrears, ar.d partly by repaying them out of current exchange earnings. This effort at repayment implied a severe austerity policy, which was forthcoming: in 1957-59. However, it was not steadily maintained thereafter. As will be explained in the next section of this chapter, monetarry, fiscal and. exchange rate policies were not always adequate to manage the balance of payments in 1961-65. For the past four years, gross free and quasi ).iquid exchange reserves have been equivalent to one and a half months of mierchandise imports. (See Annex II, Table 20). 17. As population i.s giowing in Colombia at 3.2 percent, an overall growth rate of less than 5 percent is considered unsatisfactory; in fact, the new Government considers that a target of at least 6 percent would be required to meet the aspirations of the population. The problem since 1957 has therefore been to increase foreign exchange income from sources other than coffee to make it possitble to pay for the rising import bill which these overall growth targets imply. This implied first, the need to keep the economy competitive, so that a variety of new products could be developed for export. Although minor exports have increased substantially during the last few years, their level has not been sufficient to provide adequate foreign exchange, particularly taking into account the fall in earnings from coffee. 18. As a reaction to the position of international illiquidity that emerged in 1957, a comprehenEive system of import restrictions - mainly absolute prohibitions - was re-established. This was an emergency measure designed to prevent the further worsening of the exchange reserve position. However, these emergency restrictions became altered over the years to serve protectionist as wiell as balance of payments objectives. The imports most subject to restricti-on were those in respect of which domestic pro- ducers requested protecti.on. The system initially introduced to protect the balance of payments in the short run, thus had the effect of preventing the achievement of balance of payments equilibrium in the medium-term, because it encouraged the development of high-cost production. Most new developments in both industry and agriculture during this period have I/ tended to be uncompetitive. Fortunately, protection had been slight in the years prior to 1957, so t,hat the country's principal industries at least started on a competitive basis, and are still competitive today, for example, the largest steel mrill - notwithstanding the problems encountered in carrying out the current expansion program - and textile factories.  19. The obvious remedy to this protectionist bias in Colombials import restrictions would have been to liberalize imports, but there has been strong reluctance in Colombia to maintaining the flexible exchange rate policy that a reasonable degree of import liberalization would require. This reluctance has been based on a quite understandable fear of the consequences for domestic price stability of frequent exchange rate adjustments. It is because of this fear that exchange rate adjust- ments in the past decade have always been delayed long past the time they wiere due. But this meant that, the adjustments, when they came, had to ce large; and, being large, they tended to create the very domestic price and wage reaction which the Colomtians hoped to avoid. Past Colombian govern- ments have not wished to experiment with the smaller and more timely adjustments which might have avoided this pattern. 20. For a period of eleven months ending August 1966, a policy of exchange rate flexibility was introduced through import exchange rates, gradually shifting imports from the less to the more depreciated rate. Customs tariff increases of 21 percent also contributed to a further dis- guised movement in the effective import exchange rate. At the same time, a liberalization of no less than 80 percent of imports was achieved, though it was largely intermediate products required by Colombian producers that were liberalized rather than imports of items competing with domestic production. However, due to the sharp drop in coffee earnings during the last quarter of 1966, an exchange crisis took place and the Government introduced a comprehensive system of exchange controls. In March 1967 a new exchange system was established, leaving the determination of the main exchange rate to market forces, with only limited intervention by the authorities. 21. The reluctance to adjust the exchange rate created a problem of incentives for minor exports.!! The traditional Colombian method of dealing with this was to subsidize these minor exports by permitting them to enjoy the more depreciated rate of exchange ruling in the free exchange market. However, the cost of this subsidy fell on the Central Bank. Thus, whenever policy in promoting minor exports was successful, as it was early in 1965, the subsidy threatenei domestic monetary policy. For this reason the subsidy was severely limited in 1963 and most of 1964, and again in May 1965. Summing up, minor exports are equivalent to only about 2 percent of GDP, and since Colombia has ample possibilities for finding alternative sources of foreign exchange earnings, such as meat, sugar, cotton, fishmeal, lumber, minerals and manufactured products, given adequate policy incentives, it should be feasible to improve this level of performance. 1/ M4inor exports include all exports other than coffee and petroleum.  - 5 - 22. Another aspect of Colombia's problem of diversifying her sources of exchange earnings is petroleum policy. The new investments of foreign petroleum companies are a significant potential source of additional exchange earnings, and are largely influenced by the Govern- ment's policy. However, Colombia is a high cost petroleum country and, as such, incentives should be adequate to attract investment by the inter- national petroleum companies. In recent years tax and exchange policies have not provided sufficient stimuli in this field. Nevertheless, important tax issues, which were uncertain in 1963-65, have been satisfactorily solved and the newi exchange regulations represent a movement in the right direction._ b) The preparation and execution of the development progra-2/ 23. The preparation and execution of a development program which could attract external assistance required the preparation of projects suitable for external financing, the improvement of administration in the public sector, the establishment of an appropriate context of economic policy, and the provision of matching domestic savings to cover the por- tion of project costs not financed by external lenders. Colombia did not start to make a coordinated effort along these lines until the preparation in 1961 of its 10-year general development plan and a more detailed 4-year investment plan, aimed at the achievement of a GDP growth rate of 5.6 percent. 24. However, progress vias uncertain in 1962-65, the period covered by the 4-year public investment program. With regard to project prepa- ration, many projects whi.ch were programmed to start in this period did not reach a sufficiently advanced state of preparation to begin until the end of the period, or until a year or two afterwards. Certain public enterprises proved unable to manage efficiently the new and larger programs. Coordination of the development effort by the National Planning Department was deficient.. However, the Government did exercise discipline over external borrowing. Working in coordination with the Bank as leader of the Consultative Group, external borrowing was largely confined to purposes of high priority and restricted to loans on favorable terms, with the result that Colombia emerged from an, imperfect beginning of a larger development effort with a structure of external debt that is favorable. 25. The principal obstacle to the execution of the development pro- gram in 1961-65 was the difficulty of maintaining an appropriate context of economic policy. Apart from deficiencies in exchange rate policy and in the management of the balance of payments, fiscal revenues were inadequate to provide the local resources required by the public investment program, 1/ See Appendix A, paragraphs 20-22. 2/ For a detailed account of policy performance during the period 1961-66 see Appendix B to this report.  - 6 - coffee policy had clear inflationary effects, and, because of these there was not a reasonable degree of financial stability. 26. However, since the end. of 1965 internal obstacles to an ex- panded development program are tieing rapidly removed. As discussed in Chapter II, the Government is rapidlv removing the administrative obstacles to project execution by improvirg the management of public agencies and making the necessary changes in sectoral policy, planning and coordination; in addition, general economic pclicy is now providing an adequate framework for carrying out the development, program. The financing claims on the Governmentts budget of the development program undertaken in 1961 were far beyond the financial resources provided by the existing tax system. Thus, a tax reform was undertaken in 1961 that introduced many desirable refine- ments into the tax system. However, it failed to take into account the impact of such refinements upon Government revenues, with the result that these declined by 20 percent in 1962. Although new tax measures were intro- duced, they were not sufficient to finance the public investment program. Public investment was partly financed by borrowing from the Central Bank in anmounts that contributed to an excessive expansion of total credit. 27. Official coffee policy has been oriented toward the achievement of' two objectives: 1) to maintain the real income of the coffee growers, mostly small farmers, and 2) to prevent the Coffee Federation from recurring to borrowing. However, as the international price of coffee declined and the Colombian cost of living increased, sharply reducing the real income of coffee growers, a step-by-step c~epreciation of the coffee rate was adopted by the Government. Mioreover, since adjustments of the price paid to pro- dtucers usually lagged behind the: falling international price, the Coffee Federation was caught in a financial squeeze between the domestic buying price and the world price. It was not therefore possible to keep the Coffee Federation from having to borrow to cover its current expenses. The result of' this inconsistency in the objectives of past coffee policy forced the Coffee Federation to borrow front the Central Banlc, and from foreign banks. 28. The excessive claims f'or domestic credit originating in the fiscal and coffee sectors made it impossible to maintain a monetary policy consistent with the requirements of sound management of the balance of payments. Furthermore, management of credit to the private sector did not always proceed in an orderly marner. Given the Government's tendency to maintain an overvalued rate and the strong motive thus introduced to specu- late against devaluation, the private sector had an obvious incentive to employ bank credit for the finartcing of imports. In spite of measures taken to enforce legal reserve requirements and rediscount regulations, this demand greatly affected the reserve and rediscount position of the commercial banks and had a double impact on the balance of payments: domestic demand and prices were not stabilized and, secondly, it added to the balance of payments pressures.  -7- Conclusion 29. After t:ie difficulties of past years, Colombia is now demon- strating a capaciuy to prepare projects suitable for external financing, and to establish the administrative and financial conditions for pro- ceeding with those projects. Within this framework, external lending can help finance imports at the levels required for the large development program to which the present Government is committed until the efforts to develop non-coffee exports bear fruit. The present Government's in- tention and ability to proceed with a large development program has brought to a head the problem of structural weakness in the balance of payments. The new Government has recognized the urgency and nagnitude of this problem and on March 22. 1967 issued its Decree-Law 44t2 /containing a completely new set of balance of payments policies. As is explained in Chapter II of this report, these policies should be conducive to reconcil- ing Colombia's balance of payments prospects w<ith her development objectives. 1/ See Appendix A for a complete description of the new exchange regulations.  - 8 - II. TIE OUTLOOK FOR 1967-70 A. Introduction 30. In August 1966 a newi Administration took office, backed by wide- spread popular support and a riajority in the nationts legislature. Since taking office, the new Governmlent has been engaged in a comprehensive effort to remove decision-making obstacles inherent in legislative pro- cedures, wyhich so badly hampered development efforts in recent years. The first, and very significant, result of this effort has taken the form of a constitutional change tha.t substitutes a simple majority for the two- thirds vote formerly required for all economic and social legislation. The Legislature has also recently authorized the Government to establish, by decree wihich has the force of law, a new exchange system. These develop. ments give good ground for the high expectations which are now held, both in Colombia and abroad, for more effective policy implementation from now on. 31. The Government has declared that the objective of its economic program Till be to raise public investment to levels which will ensure a sustained annual growth rate of GDP of 6 percent, in real terms, and will reduce unemployment in the cities as well as disguised unemployment in the countryside. The Government hLas also stated that it intends to achieve these objectives within art overall framework of economic policies that will bring to an end the past excessive inflationary and balance of pay- ment pressures. 32. The Government has given evidence of its desire to mount and execute a large development program. It has revived the National Planning Department. This Department has been reconstituted as a high level agency of the Republic's Presidency wlith responsibility for coordinating the sectoral planning activities cf the various agencies and ministries. This coordination will be related to the preparation of the central govern- ment's annual investment budget. The National Planning Department has also been entrusted with the follov up of the development program execution, in order to make possible timely readjustments whenever these may become necessary. Improved coordination and control should constitute a major step forward towards making the public investment planning operation more meaningful than in the past. 33. As a result of studies undertaken in past years, there is a large number of sound projects ready to be initiated. The new Government has moved with vigor to remove the managerial and organizational deficiencies in the executing agencies, the, deficiencies of sector policy, and the in-  - 9 - aclequacy of funds which have kepit these projects from going forward in the past. In addition, sectora]. planning offices are being activated or created within the various agencies and ministries, such as agriculture, eclucation, etc. Finally, thie Gcovernment's fiscal program will provide the resources necessary for the execution of its program (see section on Public Investment and its Financing below). The critical question remaining is whether performance in carrying out the newily adopted ex- change and balance of payments riolicies will help the Government to re- concile its developmaent objectives with the current balance of payments si:tuation. 3lh. Since 1962 foreigrn lerLders have accepted that Colombia needs time to develop export earnings from sources other than coffee and have indicated their readiness tco support Colombia's program in the interval while this export diversification effort is proceeding. Therefore, the immediate lack of exchange earnings resulting from Colombia's dependence upon coffee need not interrupt the development effort, provided that the management of the newly adopted exchange and balance of payments policies gives adequate incentives for minor exports and for petroleum investment; ensures a steady inflow of foreign exchange earnings from coffee sales; arid maintains the cost of imports at a level consistent with Colombia's capacity to import. These tasks are difficult, but it is of critical importance for Colombia to undertake them successfully if she is to maintain her creditworthiness for the foreign lending on which her de- velopment program so greatly relies. 35. The new Government has already prepared a public investment program for 1967, and intends to have a 1968-70 program completed by the end of the year. Based on externsive conversations with responsible officials, the mission has set Jorth below its understanding of what the Government's goals and policies are, and what major difficulties are fore- seeable. The purpose of this chapter is to describe the type and order of magnitude of the policy nmeasures that have already been taken or the Government will probably ta.e ard is now considering, in order to make possible the achievement of its objectives. B. Sectoral Policies 36. Agriculture has not received sufficient attention in the past. The new Government realizes this and is now preparing to implement an action program - principally credit and marketing - to raise the output and productivity of eight staple foodstuffs - meat, milk, corn, wheat, potatoes, rice, bananas and cassava - which are the items of highest weight iTI consumer expenditures. 37. Additional credit to farmers is being channeled through the newly established Agricultural Furld (Pondo Financiero Agrario), the Banco Ganadero, Caja Agraria and INCOFA (the Institute charged with agricultural  - 10 - development and land reform). The Government has already allocated for 1967 Ps. 800 million to this program - Ps. 600 million for livestock and Ps. 200 million for the other crops - which it considers sufficient to achieve its objectives in 1967. However, the marketing aspects of the program which could turn out to be of even greater importance have yet to be initiated. They include support prices, which are being defined, and additional improvements in the storage facilities and in transportation made available to the National Supply Institute (Instituto Nacional de Abastecimientos - INA). 38. The impact of this program could be to flatten the price fluctu- ations for these foodstuffs as output expands and DIA increases its participation in the marketing of these products. INAts Participation in Basic Foodstuffs Markets (Percentages of the Domestic Production Bought by INA) Actual Program for 1964 1965 1966 196 Rice 2.5 2.4 2.3 8.0 Corn 4.5 5.0 1.2 10.0 V}heat 15.0 9.4 2.0 20.0 Potatoes - 0.6 0.2 1.0 Source: IlA In addition, INA has already been authorized to import wheat and other com- modities in order to avoid price increases caused by deficiencies of domestic supply. 39. Agricultural policy is also oriented towards export development and import substitution. Several short-term measures have already been taken in support of producers of items such as cattle, bananas, and other products. These measures include financing and incentives by the newly established Export Development Fund, and tax and custom duty exemptions. 40. The new Government has also moved to support INCORA with a bill to give the Institute broader powers for land expropriation and more budget support, by appropriating no Less than Ps. 300 million per year and authorizing the Institute to issue Ps. 2.6 billion worth of bonds for land expropriation and acquisition; this is a most important development.  - 11 - 41. In looking beyond 1967, the basis for a longer-term overall agricultural plan is currently being prepared. This plan will contem- plate the need to increase both productivity and output of crop and live- stock products, for domestic as well as export markets. It will also contemplate the need for establishing the needed processing and storage facilities and providing improved marketing facilities. In addition, a program for secondary roads is being prepared which will improve trans- portation and facilitate the movement of farm products to their outlets. 42. The new Government's industrial development policy is still being prepared. In their statements about the direction of future policy, Government officials have shown awareness of the fact that the over-valuation of exchange rates and the excessive protectionism given to Colombia's manufacturing industry have generated excessive demand for imports of raw materials and intermediate products. The Government is undertaking a comprehensive survey of industrial problems and policy that will include aspects such as a reasonable degree of import liberali- zation, custom duties, taxation, labor legislation, financing, etc. Under tlhe coordination of the Industrial Development Institute (IFI), the Government is organizing bipartite - private and public - sectoral committees that will submit recommendations that will be taken into account in the formulation of the Governmentts industrial development policy. Bipartite cormittees are already studying some of the principal sectors of Colombia's industry: metalworking, iron and steel, chemical and pharma- ceutical, petro-chemical, paper and electrical. These committees will give emphasis in their analysis to the need for raising productive efficiency, coordinating related manufacturing activities, developing new production facilities in areas where present productive capacity is in- sufficient to meet domestic demand - if economically feasible - creating new job opportunities, promoting exports and substituting imports, and for reciprocity with manufactured products of other IAFTA countries. 43. There is one aspect of present policies which, if not modified, could affect unfavorably the pirospects for industrial development. This is the legal prohibition of revaluation of assets pari-passu with price inflation and exchange rate devaluation. This policy has the effect that depreciation allowiances computed upon the original peso value of investments do not correspond to the real cost of equipment replacement and therefore represents a strong disincentive for investments on new and expansion of existing productive facilities. Also, as depreciation per- mitted for tax purposes is artificially undervalued, the amount of profits subject to income tax is overstated. Furthermore, this policy has the side effect of distorting the real rate of return and the whole financial position of Colombian enterprises (assets are computed in the balance sheets at their original value, whereas liabilities, including some of external origin, have to be valued at actual exchange rates).  - 12 - 44. The transportation program of the Government will be oriented toward the comjpletion, modernization and extension of the existing in- frastructural networks. In order to improve the basis for the future detrelopment of this sector, the new Government has increased eightfold the gasoline tax, which will have the effect of permitting a more rational distribution of traffic among different modes of transportation by making road users pay for a jmajor proportion of the cost of highway maintenance. Furthermore, the proceeds from this tax are earmarked for highway construction and maintenaance and will be passed on to the newly established Highway Fund (Fondo Vial). 45. Tlhe highwiay program will connect rhrough paved roads the cotmtryts principal regions. This will be achieved when the ma-n trunk roads - the north-south highway and the transversal east-west highways - are completed, which will take place some time during 1969. In addition, the highway program includes the construction of a highway along the northern coast and a paved road up to the Ecuadorian border; both are part of the Panamerican highway system. 46. The railways program is composed of four major subprograms: 1) rehabilitation of track; 2) dieselization of locomotives; 3) replace- ment and increase in the number of freight cars; and 4) the expansion and modernization of existing workshops. With this program the Government intends to improve service and the economic viability of the system. Appreciable success has already been achieved in this respect and the railways provide the most economnic means of long-distance movement of goods. However, in trying to make rapid progress towards the achievement of this goal, attention should also be given to the elimination of lines which have proved to be unecononic, since the areas they serve can be taken care of by other means of transportation. 47.. Colombia's air transportation program contemplates the adapta- tion of the airports with the heaviest traffic movement to jet traffic and improvement with air navigational aids. Some important aspects of the program are yet under consideration - for example, the right mix of investment in airport extension versus acquisition of short takeoff- landing equipment for Colombia. 48. The seaport program contemplates the continuation of the work uncler-ay to rehabilitate the Buenaventura, Tumaco, Santa I4arta, Barranquilla and Cartagena ports. This program includes dock construction and the improvement of the existing facilities for handling of cargo. 49. Agreement has already been reached among the principal power producers, under the Government's coordination, for the establishment of an enterprise that will be the institutional basis for a national power system, and a program to interoDnnect the principal producer-consumer centers - Bogota, Cali, Planizales and Medellin - has already been prepared; construction of the transmission lines will start in the next year and it  - 13 - is expected that it will 'be completed during 1970. This interconnection program will provide the basis for great operational economies and a more rational planning of investmeint in the power sector. 50. The new Government ]aas identified the expansion and improvement of its education program as one of the top priority objectives of its development policy. It is ac,^ordingly planning to give to the depart- ments and municipalities resources to increase their financial contribu- tion to the education program3 through a new earmarked land tax of 2 per mille, and is preparing a series of reform measures aimed at raising both the qualit,y and coverage of tiae present educational system. The main objectives of the Government are: to extend full primary education to all school age population groups in both rural and urban areas; to reform the basic structure, school cycle and curricula of secondary education; and to control the proliferation of new universities that are being founded or planned without proper attention to financial resources, priorities and existing facilities. The Government and the university authorities are considering re-structurizatioa of university education with a view to rationalization of resources. To achieve these objectives the Government is drawing up an integrated educational program consistent with the country's economic and social objectives covering the 1968-71 period. 51. To sum up,the general sectoral objectives and policies described above, which all appear to be well oriented, attest to the Government's recognition of the principal problems affecting adversely the development of individual sectors and its intention to tackle them forthwith. C. Public Investment and Its Financing 52. The new Government's public investment program for 1967, which includes the direct investment of the central government plus the invest- ment expenditures of public sector agencies that receive budgetary trans- fers from the central government or use counterpart funds generated by the AID program loan, covers over 80 percent of total public investment. It represents a 24 percent increase in real terms over 1966 investment expenditures. 1967 Investment Program (million of pesos) Current Prices 1966 Prices 1965 2,183 2,547 1966 3,092 3,092 1967 4,205 3,823 Source: Table 5, Annex I  - 14 - This sharp increase reflects the backlog of projects resulting from the project preparation efforts of the past few years. 53. The Government is taking measures to improve the execution of projects by removing many of the bottlenecks that have impeded a more efficient progress in the past. The Highway Fund created in December 1966 should result in a speed-up in highway contracting procedures. To reduce the past spreading of road funds over too many projects, the Government has reduced by half the number of projects in its highway program, enabling it to concentrate on projects with the highest priority. To confront the problem of limited construction capacity in other sectors, the Government plans to limit new starts in the public investment program to essentials. 54. Tax revenues are currently sufficient to finance the 1967 public investment program without new borrowing at the central bank. In order to raise the necessary budgetary revenues, the Government has already put into effect two new measures, a tax on gasoline and diesel oil, and a system of retention for the income tax. The estimated yield of these two measures will be Ps. 760 million in 1967. However, projections beyond 1967 inldicate that some further measures may be needed and the Government is planning to introduce such measures. These would be mostly of an administrative nature, such as the bill currently in the Congress to extend the powers of the tax authorities in counteracting evasion, to improve the income elasticity of the tax system. Financing of Public Investment Tb)illion of current pesos) Actual P r o j e c t i o n s 7565 1966 1967 1965 1969 1970 Public Sector Savings 1.9 3.2 3.9 4.4 4.9 5.9 Central Government 0.9 2.0 727 E 2 3.0 375 Other 1.0 1.2 1.5 1.6 1.9 2.1 Net External Borrowing 0.7 0.7 0.7 1.3 2.5 2.2 Counterpart Funds 0.1 -.tI/ 0-.6/ 0.3A/ l 0.2/ Internal Credit 0.3 0.73 __ _ IT _0_ Resources Available for Investment 4.1 4.2 5.3 6.6 8.1 8.7 Public Investment j i / ft:./ 9 Surplus or Deficit (-) - - 0.2 0.3 0 -0.3 Export Subsidy - - - ___ _ __ 7 Unfilled Requirements (-) +0 2 -0.1 -0.1 -1.1 1/ The actual annual generation of counterpart funds will be from Ps. 0.1 to 0.2 billion higher than prcjected here. The projection assumes that additional counterpart funds will be allocated to the financing of private sector investment. 2/ This figure includes estimates for the public investment of agencies that do not receive budget support, which are not shown in the table on page 13. Source: Statistical Annex III  - 15 - 55. The above table presents a fairly favorable view of the finan- cial situation of the public sector up until 1970. The Government is aware that this does not leave (ny room for complacency, particularly since the investment program for :L968-70 and the related financing plan have still not been fully define(d. rrhe projected level of the current account surplus of the central government assumes that the Government wJill effec- tively introduce and administer the new system of retentions with its implied higher level of taxationi. It also assumes thaf maximum effort is used to enforce the collection of all existing taxes 56. The Government is awa:re of the extent to which the achievement of its fiscal policy objectives depend on effective implementation of the monetary and exchiange policies. Recent changes in the tax system (see Anmex on Public Finances) have been in the direction of more indirect taxes, particularly on foreign trade and domestic sales, which are extremely dependent on the value and volume of imports. Failure to adiminister the new exchange sysltem with adequate flexibility or to contain future increases in domestic pr-Lces will result in an ercsion of the real yield of these taxes. Of similar importance is the Government's policy with respect to the coffee tax. The Government intends to reduce this tax. from its present level of 26 percent of the value of coffee exports down to 21.5 percent by the end of 1968.2/ Care must be taken to avoid further changes that are not compensated for by alternative sources of revenue. 57. The Government's policy with regard to current expenditures is to hold them at the lowest possible level. The projections reflect this policy and assume that after 1967 there will be an additional 5 per- cent increase over and above that allowed for increases in income and prices which wjill be necessary to operate the facilities created by the large public investment program.. This assumption about current expendi- tuires, which the mission considers modest,is the reason why no substantial increase in public savings as a percentage of GDP takes place over this period. 1/ For a detailed explanation of the assumptions and qualifications suipporting these projections, see Volume II - Public Finance. 2,/ After this report had been completed, Decree 688 reduced further the coffee tax but established an acdditional 1.5 percent import surcharge that will more than compensate for the loss in revenue. (See Note to Appendix A.)  - 16 - Percentage of GDP Current Revenue Public Savings 1966 8.16 4.28 1967 8.32 4.49 1968 8.53 4.50 1969 8.63 h.38 1970 9.22 4.72 58. The estimated levels of public investment reflect what the mission considers may be necessary to sustain the Government's target of a 6 percent growth rate of GDP. Since the Government is still preparing its detailed public investment program for the 1968-70 period, these estimates are based on general macroeconomic relationships which at best can only indicate approxinate orders of magnitude. The relationship between economic growth and thie level of investment, at least for a short run period such as is discussed here, is very uncertain. Furthermore, this uncertainty can be extended to the division between public and private investment. There is no economic reason why this relationship cannot be altered in the future, but given the dominant position of the public sector in economic infrastructure, i-> appears unlikely that the direction will be one of less public investment. 59. The estimates of ex;ernal project assistance available are based on the Government's project list for 1967 and 1968, and on the stock of projects available for 1969 and beyond; but delays that may be encountered in project preparation, financing and construction may substantially alter the pattern over time. External project assistance has been projected to finance only the imported component in all projects except in education, supervised agricultural credilJ and water supply, where external lenders are expected to finance from l40 to 60 percent cf the project costs with the imported component ranging, from 20 to 33 percent of costs. The projected pattern of external project assistance shows that it will provide an increasing proportion of totaL project financing up to 1969, after which it will start to decrease as the effort to develop exports gains miomentum. Percentage Shares of Domestic and External Financing of Pub:lic Sector Projects EDternal Domestic To be Financed 1966 17.5 82.5 - 1967 20.8 79.2 _ 1968 30.4 69.5 0.1 1969 37.3 62.6 0.1 1970 26.8 61.0 12.2  - 17 - 60. The fiscal projections show a surplus in 1968 and 1969, before the export subsidy, but when this subsidy (15 percent of the value of minor exports payable one year from the time of sale) is included, the surplus becomes a deficit. Thle reason for the growth in the size of the export subsidy is the assumed success of the export promotion program. T'he fiscal implication of this subsidy could become a serious cause for concern and some reconsideration of this policy might be called for before 1970. As is discussed below (see section on Exchange Policy in this chapter), with an exchange system that should adequately reflect the domestic-external price relationship, the size of the subsidy required could diminish as soon as other measures for export promotion become effective, D. Coffee Policy 61. If present trends continue to operate, a growing disequilibrium betwseen production of coffee and the projected absorptive capacity of the market is envisaged. The Government has expressed its awareness of this fact, but under the current situation of the coffee market, it does not feel that the establishment o: a strong system of domestic controls of production could be successfu:L without being followed by similar action in other producing countries. Therefore, the Government has declared that it will firmly sponsor and support an agreement with other producing countries to establish maximumn production targets consistent with actual wvorld consumption of coffee. Should such an agreement be reached, it would become a major step forward, not only to reduce the financial claims originating in the operations of stockpiling, but also as an additional instrument to help improve - or at least stabilize - the international market prices. 62. The new Government has also stated that it will give special priority in its financial policy to strengthening the financial position ofI the Coffee Federation, withl a view to keeping it from seeking financing from the Banco de la Republica for purposes other than the Federation's seasonal needs for buying processing and selling coffee. In pursuing this policy, the new Government has a flexible attitude towards domestic prices. This includes, first, the reduction from Ps. 762.50 per load of 125 Kg. in August 1966 to Ps. 715.00 in January 1967, in two different moves to adjust domestic prices for purchases by the Federation to the falling international market prices. Secondly, it also includes pricing coffee for internal consumption at levels which will avoid losses to the Federation. In add ition, the Government will maintain at adequate levels the retention taxw ,in relation to production, export and domestic con- sumption. By means of these policy instruments, the Government will try 1/ See Appendix B, Coffeea Po.Licy, for a detailed explanation of the retention tax.  - 18 - tc) ensure that the Federation's financial position is strong enough to enable it to amortize during 19S7 a part of its domestic and external indebtedness. Since as a side affect of the new exchange system the peso income of the Federation, and in general of the coffee sector, will increase, it should be possible for the Government to keep the Federation in a sufficiently strong financial position beyond 1967 so as to enable it to continue repaying its present domestic and external indebtedness, which currently stand at about Ps. 1 billion and US$90 million, respectively. E. Prices and Wages Policy 63. In order to help prevant speculation arising from the exchange difficulties experienced late in 1966 and early in 1967, the Government froze domestic prices for a majority of products at their November 1966 level, and re-established a comprehensive system of domestic price controls. However, the Government considers that price stability should soon be achieved by means of a prudent monetary policy, adequate incentives to production and a flexible import policy to curb the impact caused by seasonal deficiencies of supply or by imperfections of the domestic market. The Government recognizes the importance of providing appropriate stimuli for productive investments if its growth objectives are to be achieved. The cost of living increase during the first four months of 1967, which was 2.4 percent over December 1966, has been the lowest for a comparable period during the past five years. 6h4. With regard to public utility tariffs, the Government intends to pursue a flexible policy that will make the operation of public utili- ties profitable and allow for the generation of sufficient savings for the investments planned. 65. The Government also intends to pursue a policy of prudent guid- ance in the field of wages, seeing to it that wage increases, both in the public and private sectors, be related to actual productivity increases. However, since the present level of salaries paid to civil servants is making it difficult for the Government to attract qualified personnel, the salaries of the high and medium level staff of certain government agencies, such as the Planning Department, are being raised. F. Monetary Policy 66. The new Government is following a monetary policy that will be consistent with improving the financial stability of the economy and the ba:Lance of payments situation. It is aware that this requires a tight management of the monetary program. However, the Government's fiscal, coffee, price and wages policies will support these overall monetary policy objectives.  - 19 - 67. The management of credit to the private sector (other than coffee) has improved considerably over the first quarter of 1967 and, as a result, the monetary authorities are exercising adequate control over the commercial and specialized banks. This is reflected in the success- ful enforcement of the legal reserve requirements: the bankst legal reserve position has become positive. If monetary policy is to support improved management of the balance of payments and keep the expansion of domestic credit within the permissible limits, it is of the utmost impor- -tance that a tight administration of the primary instruments of monetary policy - legal reserve requirements and rediscounts - be continued in the future. 68. The Government has declared its awareness of the importance of 'Limiting monetary expansion to 15 percent during 1967 and to levels con- sistent with its stabilization and balance of payments objectives in subsequent years. The total expansion of the means of payment has only been 3.8 percent during the first four months of 1967. As indicated above, both the Government and the coffee sector are likely to contribute to the overall availability of domestic credit by reducing their indebtedness with the Banco de la Republica. A bond of constant purchasing power has been created by Decree-Law 866 to tap the savings of the Colombian Social Security Institute. Instruments of a similar nature designed to increase the amount of private financial savings are being considered for application in other sectors, such as housing. These actions consti-tute steps in the right direction, and will significantly contribute to an adequate manage- rnent of the monetary program. External assistance to the private sector either through financial intermediaries such as the Private Investment Fund, the Industrial Development Institute, the Caja Agraria or the Banco Ganadero, or in a direct form, will provide additional resources to help fulfill the credit requirements of the private sector. G. Exchange Policy and the Balance of Payments Prospects 1/ The New Exchange Regime: A Preliminary Evaluation-= 69. On r4arch 22, 1967, the Government issued its Decree-Law 444 containing the new "International Exchange and Foreign Trade Regime." It establishes two exchange markets, an exchange certificate market and a capital market, access to which is controlled; the principal exchange rate, the certificate market rate, is a fluctuating one; it changes the exchange differential for coffee exports into a tax of 26 percent initially, declining to 21.5 percent by the end of 1968,-/it established a Governmental Board for setting domestic prices of coffee for purchase by I/ For a complete description of the New Exchange Regime, see Appendix A to this report. 2/ See footnote to page 15.  - 20 - the Coffee Federation; it gives exporters a tax bonus of 15 percent of the value of exports other than coffee, petroleum and raw hides; it provides for the establishment of an Export Development Fund; it indicates the form in which the petroleum sector's exchange transactions will be handled in the future; it creates a new "Pro-Colombia"' dollar bond that may be purchased by Colombian holders of foreign currency, if they don't wish to convert their foreign currency :holdings into Colombian pesos.!/ 73. On the same date of issuance of the Regime, using the powers given to it by the new legislation, the PMonetary Board issued its Resolution 13, allocating receits and payments betwseen the certificate and capital markets, defining certain exchange rates and the nature and life period of the new exchange certificates and regulating the commercial banks' foreign exchange operations. The table overleaf shows the exchange system emerging from t'ne new regulations. 71. The creation of the certificate market not only is the most iLportant innovation of the new ecchange system, but also permits the expectation that the basic problems that have previously arisen in exchange management will not reappear. Properly managed, the newsly established exchange system givas ground for expecting that new export lines will be developed and that the balance of payments will be viable. 72. The new capital market regulations are, in general, more res- trictive on remittances of dividends and capital patriation than the regulations for private foreign capital under the free market system prevailing until November 1966, although they re Fresent an improvement over the temporary regulations 'then established._/ However, since the mechanisms for control of transactions in this market have just been established, a final judgment on their operation is premature. 1/ In addition, the Regime widens the powers of the Monetary Board, which will be in charge of defining the principal exchange policies within the new legislation. The Board of Foreign Trade emerges as the policy-making body in the field of foreign trade, and the policies set forth by it and the Monetary Board will be carried out by the Superintendency of Foreign Trade, the Superintendency of Banks, and a newly organized Exchange Office, attached to the Banco de la Repablica. 2/ Some big disincentives have been eliminated, such as the five-year period during which remittances were not permitted, and others have been reduced, the 8 percent limit on remittances has been raised to 10 percent for existing and new foreign investment. The National Planning Council has been empowered to raise this liuit for either all foreign investments or only by sectors or individual specific projects. Yet, in the light of the experience in other countries, it could be argued that once the new invest- ments have been authorized 'by the Government, no restrictions should be imposed on remittances.  - 21 - 73. The Government considlers that all possible measures to promote exports other than coffee are necessary. The most important of these at the moment is the 15 percent export tax bonus. However, if the export promotion effort is successful, the fiscal effect of this tax bonus will be very large (see table on page 14) especially from 1970 on. The mission believes that a subsidy such as the tax bonus should be considered by the Government as a temporary measure. If the Government sustains this sub- sidy at its present level beyond 1969, it would imply the need for tax revenues in addition to those contained in the fiscal projections. 74. Changes in the treatment of petroleum transactions have been few. The designation of the capital market rate for exploration made by service companies is a step in the right direction. On the other hand, the new legislation leaves unsolved the proolem of a penalty rate for some oil transactions, which seems tso be inconsistent with the Government's stated objective of promoting the development of Colombia's petroleum resources. 75. In addition, the Regine has made substanti-ve changes in the normal day-to-day relationship between the Government and the oil companies: it has increased the supervisory functions of the Rlnistry of Mines and Oil, particularly in respect to domestic sales of crude oil, service con- tracts in dollars and petroleum export pricing. There is no knowledge yet as to how these supervisory functions are going to be exercised. How- ever, the Ministry's actions dtiring the next twelve months will certainly influence the oil companies' irLvestment plans and programs for the coming years. 76. Colombia's new excharige arrangements represent an important step toward a viable exchange system with a realistic exchange rate, eventually sustainable without restrictions on international payments. However, at the time of writing this report, the new exchange system was only several wieeks old, and some of its features had not yet been fully defined. vhether the system will, in fact, induce the expected response and help make viable Colombia's balance of payments will largely depend on how it is administered during the coming months. The Balance of Payments Prospects 77. Balance of payment results for the first four months of 1967 indicate that the deficit on current account may not exceed US$190 million. This is less than the mission's projection shown on page 23 because of the low level of merchandise imports registered during this period. However, since this reduction has been accompanied by a correspondingly lower level of suppliers credits, the original estimates for other items of the balance of payments remain unchanged. The mission's balance of payments pro- jections beyond 1967 suggest that Colombia's deficit on current account may increase to about US$290 million in 1968 and fall to about US$245 million by 1970. This change would mainly result from a relatively rapid growth  - 22 - Exchaneg Rates (as of May 13, 1967) TColombian pesos per U. S. dollar) Buying Selling 7.67 (Fixed rate) Exchange sales by petroleum companies for exploitation, and for exp]oration other than by separate contractors. 9.00 (Fixed rate) Purchases of crude oil from foreign-owned petroleum companies. Certificate Market Ulb.12 Coffee exports.-/ 2xPorts of re- Imports except those to free ports. troleum products - and cattle hides. Expenses of students approved by the Program loans, project loans and ICETEX. Official services. External loans accruing to the Private In- public debt. Private debt regis- vestment Fund. Other exports tered in the former intermediate market. except those from free ports. 31 Capital Market 16.25 (Fixed rate) 16.30 (Fixed rate) Other exports. Gold purchasee Other imports. Import freight. Invisibles. Other foreign loaWns. Other invisibles. Other foreign Exchange sales by petroleum debt. Profit remittances and companies for exploration under capital repatriation. contract. Capital. I/ Coffee exports are subject to a tax of 24.5 percent of this foreign currency value. 2/ Receipts from exports of crude petroleum need not be sur- rendered. 3/ These exports receive a 15 percent tax credit certificate.  BALANCE OF PAYI4ENTS 1964 - 1966 and PROJECTIONS 1967 - 19701/ (Iviillion of U.S. Dollars) P r o jec t.ions I. Current Account 1 964 1 965?! 1966 1967 1968 196g 1970 1. Exports FOB 540.9 484.3 471.3 480.o 539.6 602.0