(Bloomberg) -- Colombia is entering a vicious cycle of tepid economic growth and low tax revenue, with President Gustavo Petro’s government considering wider budget deficits and investors navigating the deteriorating fiscal outlook.

Last year was the Andean nation’s worst for growth outside of the pandemic since 1999 and first-quarter figures last week showed gross domestic product expanding 1.1% from the previous three months. That’s barely half the rate expected and deepens concerns that the ailing economy will hit the government’s bottom line.

Finance Minister Ricardo Bonilla is trying to manage the brewing crisis by seeking to delay a court-ordered repayment, lobbying lawmakers and criticizing his own tax agency boss over lower revenues. Petro, meanwhile, has blamed the central bank’s high interest rates for curbing demand and crimping growth. 

The administration told markets it expected a budget deficit equivalent to 5.3% of GDP this year, but Bonilla has raised the possibility of asking Congress to change a rule that seeks to prevent excessive government borrowing. And next month, the government will publish new macroeconomic estimates as part of a revised fiscal plan.

“Investors do not like surprises and a mid-term financial update that comes with worse numbers than expected could push bond prices lower, as an initial reaction,” William Snead, a strategist at Banco Bilbao Vizcaya Argentaria, said in an interview.

The nation’s bonds have been some of the worst performers in South America this year, handing investors 3.2% losses while emerging market sovereign notes gained 2.1% during the same period, according to a Bloomberg index. Although returns have picked up in the past month, more red flags on the fiscal side could put additional pressure on prices.

Some investors believe the current fiscal risks are already priced in, given the spreads of Colombian bonds are wider than similarly-rated peers. “If there are no changes in the fiscal rule that imply a continued deterioration, leading to more downgrades, it will still continue to be a cheap BB-rated” country, said Armando Armenta, an emerging market strategist at AllianceBernstein. 

Credit agencies are watching closely, with Fitch Ratings warning last week that it sees increasing risk the government will miss its existing fiscal target. Fitch and S&P Global have already downgraded Colombia to junk, while Moody’s Ratings still has it listed at Baa2 — the second-lowest investment grade rating — with a stable outlook.

“If we see that there are changes in the fiscal rule that could lead to a deterioration in debt metrics in the coming years, that could put pressure on the credit profile,” Renzo Merino, a Moody’s analyst, said in an interview.

Bonilla forecasts Colombia’s economy will expand 1.5% in 2024, which would mark a second year of low growth. His office declined multiple requests for comment last week. But on May 2, the finance minister said: “One thing is to have a fiscal rule with a country that grows at 3%, 4% or 10%. Another thing is a fiscal rule in a country that grew last year by only 0.6%.”

Colombia is grappling with the highest interest rates among its inflation-targeting peers. The International Monetary Fund said earlier this year its sharp contraction in investment likely reflects not only tight monetary policy but also mis-calibration of fiscal policy and uncertainty around the Petro government’s ambitious reforms.

The ratings agencies’ main concern is if debt starts to rise to the point where it becomes unsustainable. Thanks in part to the Colombian peso’s recent strength, rallying more than 18% in the last 12 months, the nation’s debt to GDP ratio fell to 52.8% last year from a peak of 60.7% in the worst part of the pandemic. But the government expects it to climb back to 57% this year.

Colombia’s accounts are under pressure because tax revenue is falling short of expectations. A union of tax workers disclosed that revenue through April was $3.1 billion — or 0.8% of GDP — lower than the government’s forecast, prompting the finance chief to publicly demand an explanation from the agency’s director. 

Bonilla — one of Petro’s closest allies, who was appointed in April 2023 after the president sacked highly regarded economist José Antonio Ocampo — is trying to find any additional revenue he can. 

Last week, he tried to convince the Constitutional Court to delay enforcement of a ruling that obliges the government to return $1.8 billion in tax royalties to oil and mining companies. A decision on that request will come in about two weeks, but after the hearing the judicial board appeared skeptical that the nation’s fiscal sustainability was at risk, as the minister had argued. 

‘Lost Credibility’

When Fitch stripped Colombia of its investment-grade rating in 2021, it incorporated the deterioration of fiscal and debt metrics the government is now facing. 

“We thought Colombia had already lost credibility in fiscal policy, so it’s not a surprise,” Fitch analyst Richard Francis said in an interview. “We don’t say anymore that the macro policy credibility is a strength for Colombia.”

The agency rates Colombia at BB+ with a stable outlook, with another revision due around July. Francis said it’s on the lookout for signs economic growth can rebound to 3% and for a credible strategy to at least stabilize debt levels. 

S&P gives Colombia the same rating as Fitch, but in January it lowered the country’s outlook to negative, citing the risk of a prolonged period of weak economic expansion. Manuel Orozco, a Mexico-based analyst at the agency, said the negative outlook could result in a credit downgrade if languid private investment and sluggish growth continue. 

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