Plaza_de_Bolívar_(Bogotá,_Colombia)_1-1.jpgUncategorized 

Colombia’s Financial Paradox

By Cristobal Vasquez

The average monthly salary in Colombia is only $800, and yet the cost of living is among the highest in Latin America. Just behind São Paulo and Santiago, the average rent is nearly $400 in Bogota. So how can Colombians afford to keep up?

The precise nature of the country’s steady economic growth could explain what exactly is going here. An increase in exports and investments has led to a breakthrough in employment, meaning an increase in GDP per capita. However, the Gini index, which measures the redistribution of personal income in a country, points out that Colombia is the second most unequal country in Latin America, after Honduras. In other words, the consistently celebrated economic growth of Colombia is concentrated in the hands of a wealthy few, and the money that enters the country is not evenly distributed. And despite this concentration, there is a curiously high level of consumerism across the Colombian societal strata.

The key to explaining such high levels of consumerism could be to identify where the largest amounts of capital are kept in the country and where they are invested. In most cases, the money ends up in banks—entities that have experienced a significant increase in activity over the past few years, reflecting the country’s current economic growth. Nonetheless, the banking industry is about one thing: lending money. So the more money banks receive, the more they have to reinsert back into the market to avoid leaving the liquid assets inactive. The more it circulates, the higher their profits.

The high circulation of money within financial markets has a causal effect on the increase in credit the banks are offering. This increase of credit supply, more than mere economic growth, can explain the high levels of consumption in Colombia.

In fact, according to a special report on financial stability from the Banco de la República, Colombia’s Federal Reserve, 34.1 percent of the financial institution’s portfolio was comprised of household credit in December 2013. The figure represented “historically high levels” of credit given to households in Colombia. 

“The indebtedness of the households scales up to $52 billion, of which 69.4 percent corresponds to consumption credits and 30.6 percent to mortgage credits. As a percentage of the GDP, the household debt increased of 18.5 percent in December 2013 with respect to the same month of the previous year,” stated the report. Even more worrying,  50.6 percent of Colombians’ monthly income is used to pay consumer and mortgage debts.

The competition to allocate that money into the credit market pushes financial institutions to adopt aggressive allocation strategies and to loosen credit requisites. Despite the client’s credit history and the methods used to verify the repayment capacity of the debtor, the strength of the market and the need for profit end up being prioritized over the strict requirements that the banks have to follow in order to lend money.

The issue is not consumption itself, which actually stimulates the economy and generates jobs, among other benefits. The problem comes down to the fact that credit is being used only for consumption purposes and that the need for lending money outweighs the risk of lending it.

We can talk about redistribution through the credit system, for the sake of believing that the economy of the country is impacting everyone. But this redistribution is not sustainable and will heat up the economy as it triggers a snowball of debt that can’t only be paid with more debt, and one that will keep snowballing until the economy explodes.

Something similar happened in the U.S. in the mid 2000s when banks, with the approval of rating agencies, kept granting mortgage credits and omitted all the legal requirements. The bubble exploded as people couldn’t keep paying their interest, and the crisis went global. Fortunately, the U.S. government decided to take on the debt to avoid a greater catastrophe. In the case of Colombia, it is doubtful the government would have the capacity to adopt a private debt of such magnitude and turn it public at a price that Colombians would be willing to pay.

Another well-known model for what might happen next in Colombia is the case of Greece. A decade ago, well-off European Union members decided to lend their excess supply of money to invest in Greece, despite the risk it implied. During that time, there was an economic boom in the country. Suddenly, people had cars, houses, and were consuming without constraint until the bubble burst and people couldn’t afford to pay their interests. The government didn’t have the capacity to solve the problem and thus implemented austerity measures to respond to all the credit obligations, provoking major protests.

Yet deploying these types of solutions in Colombia would have altogether different consequences that would go far beyond mere protests, as occurred in the national agricultural strike of 2013. During this confrontation, policemen adopted violent measures against protesters, accused of being part of guerrillas groups. The violence ended with a death toll of 12 people, 484 wounded, and four missing along with numerous human right violations.

Financial institutions should be more cautious when they offer credit if the economic conditions are too weak to face the responsibility of mounting debt. Colombians shouldn’t fall for the same trap if it’s proven that an excess of credit in the market caused this recent financial crisis.

Instead, let’s take for granted that the market incentives come before government laws, and that the banks will always need to return the money they receive back to the market. Colombians should then assume the responsibility for their consumption pattern and try to understand the reasons that push them to consume so much and so unnecessarily. Identifying the reasons behind the desire for needless consumption and trying to inhibit it could be more effective and profitable than trying to fundamentally change the entire system. 

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Cristobal Vasquez is the former economic and finance reporter at World Policy Journal. He tweets at @tobalvasquez.

[Photos courtesy of Wikimedia Commons]

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