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Colombia's history of a near failed state wracked by violence, ultra-violent narco-traffickers and left-wing terrorism has left an indelible mark on popular culture. It seems many investors still perceive Colombia in this light as a high risk frontier market that only represents investment opportunities for the exceptionally risk tolerant or the foolish. However, the Colombia I know is far removed from how it is perceived in developed countries and portrayed by the media. Perhaps the most apt description of Colombia is to borrow a quote from Sir Winston Churchill, who in the Second World War described Russia as; "a riddle wrapped in a mystery inside an enigma", but this description could easily be applied to modern Colombia.

Colombia is a country of immeasurable beauty, with soaring mountain peaks, glistening sandy beaches, luxuriant tropical jungles, boundless biodiversity and most importantly for investors a liberal business environment and booming economy. The country, its government and people have eagerly sought to shed Colombia's violent past becoming the latest Latin American country ardently seeking integration into the global economy. All of which has seen Colombia seek to shed its historical legacy and reach its full economic potential. It is this overwhelming desire to make-up for the economic stagnation and lost opportunity created by over 40 years of civil conflict and lawlessness that has seen the country embrace the global economy and focus on building an economic environment conducive to foreign investment and business.

Just as we are seeing Brazil's extraordinary economic growth stall, Colombia's is still gathering momentum, although this can be attributed to the country coming from a lower and more recent developmental baseline. It was only by the mid-2000s as former President Uribe's hard-line security crackdown began to pay off that foreign business and investors alike could start to realistically consider Colombia as an investment location. But this security crackdown was not with its casualties, many of which were social and legal values and principles, which many in more developed countries take as a given right. They included the even handed application of the rule of law, defined property rights, a secure standard of living and the right to benefit and prosper from your own labor.

The current Colombian government of President Juan Manuel Santos has pushed on with a policy mandate of continuing to improve internal security as well as creating a liberal and business friendly market, combined with addressing some of the more pressing social justice issues. All of which has contributed to an increasingly cohesive social and economic environment that has finally allowed Colombia to be poised to reach its true economic potential.

Colombia's GDP Growth Continues

As a result of the government's policies and a stable security situation the business environment in Colombia is burgeoning with growth and positivity. This has seen Colombia's economy grow relentlessly over the last decade experiencing an average annual GDP growth rate of 4.5% during this period. In comparison, Brazil, a favorite of emerging market investors and Latin America's economic powerhouse, averaged average annual GDP growth rate for the same period was lower at 3.8%. Colombia's ongoing strong economic growth is clearly illustrated by its 2011 GDP growth rate of 5.9%, which was one of the highest for the year in Latin America. Furthermore, this strong growth has continued with the country seeing its economy expand during the first quarter 2012 by 5.1%, exceeding expected growth of around the 4.5%.

This rate of economic growth is even more astounding when it is considered that by the end of 2011 the Chinese economy has been slowing and the European financial crisis deepening driving down the global demand for Colombia's export products. It is in fact a remarkable achievement, which not only bodes well for further strong economic growth but implies there are other catalysts which are less dependent upon commodities exports driving economic growth.

The main catalysts driving Colombia's remarkable economic growth are ongoing global demand for the country's main commodities oil, natural gas and coal in conjunction with robust domestic demand, a flourishing educated and entrepreneurial middle-class, strong fiscal management and liberal economic policies focused on deregulation. These are all working together to create an atmosphere that is conducive towards increasing foreign investment in Colombia, which has become a key driver of economic growth.

Foreign Direct Investment Flourishes in Colombia's Liberal Economy

Foreign direct investment ('FDI') in Colombia has been surging ahead for some time, as a direct result of the commodities boom that emerged once the security environment was stabilized. This created the opportunity for many oil companies to commence exploration and production in a country where hydrocarbon exploration was severely limited by the ongoing and broad based low intensity armed conflict. This conflict in conjunction with poor infrastructure and the rugged terrain had limited exploration for hydrocarbons to less than 30% of the country. As a result investment in the industry is increasing with exploration is continuing to ramp-up, not only from the government controlled oil company Ecopetrol (NYSE:EC), but also with foreign energy and resource companies increasing investment in the country. Chevron (NYSE:CVX) has invested considerable funds in developing natural gas production in Colombia including commencing a multi-wall offshore drilling program because of the extension of a natural gas export agreement with Venezuela. The country is also seeing extensive investment in the energy industry from small to medium cap companies such as Pacific Rubiales (OTCPK:PEGFF), Gran Tierra Energy (NYSEMKT:GTE), and Petrominerales (OTCPK:PMGLF).

As this foreign investment grows it has provided further impetus for strong economic growth and seen the government further is policy of economic deregulation in stark contrast to other Latin American countries such as Argentina and Brazil. Both Brazil and Argentina's governments are progressively ratcheting up economic intervention and protectionism as a means of controlling and stimulating economic growth. This is clear when comparing the number of protectionist measures implemented by these countries in comparison to Colombia. Argentina leads Latin America having implemented 165 protective measures, while Brazil is ranked second with 87 measures implemented, whereas in comparison Colombia has only seven protective measures in place.

Foreign investment in Colombia by the end of 2011 had almost doubled from its 2010 level to $13.2 billion. Furthermore, during the first four months of 2012 this explosion in foreign investment has continued with foreign investment inflows of $5.9 billion, which is a 28% increase on the same period in 2011. It is predicted that foreign investment in Colombia for 2012 will increase by 21% from its 2011 total to $16 billion. The majority of this foreign investment is channeled into the oil and gas sector followed by mining, financial services and manufacturing. This rapidly expanding foreign investment is an important catalyst in Colombia's rapidly expanding economy and it is also fueling the appreciation of the Colombian peso against the U.S dollar and growing domestic demand.

A Positive Business Environment Drives Domestic Demand

A further sign of Colombia's growing economic strength is the expanding urbanization of the country's population and an expanding educated middle-class, which is increasing demand for consumer credit, products and services. This demand is indicated by the growth of private sector credit, which for the first 2012 grew by 2.2% from the fourth quarter 2012, expanding by 1% in March 2012 alone. Furthermore, retail sales in March 2012 grew by a healthy 6% in comparison to the same period in 2011.

The strength of this growing domestic demand is demonstrated by Colombian industrial production increasing by 1.7% in the first quarter 2012 in comparison to the same period in 2011. This growth in industrial production was led by the consumer product industries of confectionery, meats, transport and beverages, which were followed by the steel and iron, and the non-metallic minerals industry.

Another positive indicator of the strength of Colombia's economy and the current positive economic climate is the falling unemployment rate, which has fallen by 31% over the last decade to 10.4% in March 2012. This also represents a 1.5% fall in unemployment from February 2012 and is also a 0.5% drop on the unemployment rate in March 2011.

The strength of Colombia's economy and the rising strength of its business sector is indicated by the performance of Colombia's main stock index, the Indice General de la Bolsa de Valores de Colombia (IGBC). Since the beginning of 2012 the index has increased in value by 14% since the end of 2011. In comparison for the same period the Brazilian stock index the BOVESP (^BVSP) has fallen by 5% and the Dow Jones Industrial Average (^DJI) has risen by 3%.

As a result of this vigorous economic growth the Colombian peso has rallied strongly against the U.S dollar and is up 8% in value so far in 2012. It is likely that the Colombian peso will continue to rise in value through 2012 because of Colombia's ongoing strong economic growth and domestic consumption. This will force the Colombian central bank to keep interest rates high in order to keep a lid on inflation and cool domestic demand. Currently the Colombian central bank has set the national rate at 5.25%, and there is pressure to raise the national rate with fears the economy is becoming overheated. If the central bank elects to increase interest rates, it will make Colombia even more appealing to foreign investors.

This attractiveness to foreign investors can only increase as the Brazilian government continues to push interest rates down in the hope of kick starting domestic economic growth. Since hitting a high of 12.5% in July 2011, the official Brazilian interest rate is now at 9%. As a result the torrent of 'hot money' that surged into Brazil is now exiting at almost the same rate, as the Brazilian economy slows and it is likely that some of this 'hot money' will make its way to Colombia. However, the inflow of 'hot money' is not a positive for Colombia and the government needs to act to ensure that it doesn't flood the economy as it did in Brazil.

Colombian Exports Grow Despite the Global Slowdown

Colombia has had a trade surplus since 2008, primarily because of expanding oil, natural gas, coal and commodities exports to its main trading partners. For the first quarter 2012 total exports grew by 22% when compared to the same period in the previous year, leaving Colombia with a first quarter trade surplus of $1 billion. As at the end of the first quarter, Colombia's key trading partners are the U.S accounting for 38% of all Colombian exports followed by China at 6.6%, Spain at 5.8%, the Netherlands at 4.5%, Chile at 3.8% and Venezuela at 3.5%.

On first impressions this would indicate that Colombia should have seen exports decline as demand for oil and commodities falls due to the Chinese economic slowdown and the deepening of the European financial crisis. However, during the first quarter not only did Colombia's total exports rise but exports to China grew by a massive 227.9%, mainly because of higher sales of fuels and products from extractive industries. Colombia's increasing first quarter exports combined with a strengthening relationship with China bodes well for further growth in exports through 2012. This should also be enhanced by the Colombian government seeking a closer trade relationship with China and recent moves towards a free trade agreement with China.

A further catalyst that enhances the opportunity for further economic growth in 2012 is the commencement of the Trade Promotion Agreement (TPA) coming into effect on 15th May 2012. This complements the existing free trade agreements ('FTA') that Colombia has in place with Mercosur (Brazil, Uruguay, Argentina and Paraguay) and Canada.

According to the Colombian government the country should benefit significantly from the agreement stating that its believes it will add 10% to exports and one percentage point of economic growth in 2012, which should see the creation of around 300,000 new jobs.

There are a number of Risks that can Derail Colombia's Economy

Colombia's economic growth is highly dependent upon global demand for its commodities particularly from two of the economies that are experiencing significant economic slowdowns, the U.S and the European Union. This risk is further increased as China which is also experiencing an economic slowdown becomes an increasingly important trade partner. If there is a further slowdown of the U.S economy it will have a significant and adverse impact on demand for Colombian exports. While the declining demand for oil will have another although this should be somewhat muted as supply-side constraints take-up the slack.

While the overall security situation in Colombia has improved immeasurably over the last decade it is still problematic as witnessed by the bombing in Bogota last Tuesday and an escalation last year in FARC attacks on oil infrastructure including pipelines. While these incidents shouldn't act as a major drag on economic growth, particularly as the security situation in major cities has been stabilized, investors need to be conscious that any significant escalation in the activities of armed groups can be difficult to predict and on a large enough scale can seriously affect the economy particularly the oil and tourism industries and have a very negative effect on foreign direct investment.

Colombia's 2012 Economic Outlook

I believe the overall outlook for Colombia throughout 2012 is extremely favorable as domestic demand will increasingly drive economic growth and pick up some of the slack left by a lower global demand for Colombia's key exports. In addition, for as long as the security situation remains stable and I have no doubt that it will, the country will continue to attract significant amounts of foreign investment. This is because of the higher interest rates, the country's strong economic growth and a favorable investment and business environment. I believe that for 2012 Colombia should see an economic growth rate of between 5% and 5.5% and all of the indicators, as discussed, support this outlook. Furthermore, it is almost double Brazil's forecast rate of 3%, double the 2.5% estimated for the U.S and higher than Argentina's forecast 4.6%, without the political risk.

Overall, I believe that Colombia, despite the media stereotypes of it being a violent and unstable country presents as a far more attractive investment option than South America's other major economies of Brazil and Argentina. In the case of Brazil, it is because there is rising political and investment risk being driven by the leftist economic agenda and reactive economic policies of the Rousseff government. In addition, at this time Brazil is experiencing a significant economic slowdown that will impact substantially on investment returns. In comparison Argentina has typically run on an unpredictable boom and bust economic cycle, which is currently fused with an erratic and self-serving government that has increased investment risk beyond an acceptable level.

How Investors Can invest in Colombia's Growth Story

I have been quite bullish on Colombia for some time and the overall economic outlook is quite favorable for Colombia and good news for investors seeking access to this booming Latin American economy. This strong economic growth bodes well for Colombia's two dual listed companies, Ecopetrol and Bancolombia (NYSE:CIB), which I have been bullish on for some time. Investors can also choose from two Exchange Traded Funds that are specifically focused on Colombia are the Global X FTSE Colombia 20 ETF (GXG) and the Market Vectors Colombia ETF (COLX).

Of the two ETFs my preference is the GXG which tracks the FTSE Colombia 20T Index, a market capitalization weighted index of the 20 most liquid stocks listed on the Colombian stock exchange and it has increased by 17% for the year to date. Its largest shareholding is Ecopetrol one of the best performing oil stocks for the year to date. The ETF has an overall exposure to Colombia's oil industry of 25%, which is made up of 15.77% allocated to Ecopetrol and 9.18% to Pacific Rubiales. Obviously this high exposure to oil will certainly act as a counterweight to any increase in value should the price of oil fall further.

However, the Colombian financials exposure totaling 29% should drive value due to increasing domestic demand and growing consumer credit. Furthermore, its retail exposure to Colombia's largest supermarket chain Exito totaling 5.32% will also benefit from this. COLX provides exposure to publicly traded companies that are domiciled and primarily listed in Colombia or derive at least 50% of their revenues from Colombia. For the year to date it has increased in value by 14% and should see similar performance to GXG because it has similar exposure to the Colombian oil, financial, retail and utilities sectors.

Colombia's economy is certainly poised to deliver another year of strong economic growth and it should deliver returns for investors even if the demand for oil and other commodities continues to fall. This economic growth will be supported by growing domestic demand while being driven by two catalysts, the commencement of the TPA with the U.S and stronger trade relations with China. The country also presents as a viable investment opportunity for those investors seeking Latin American exposure but are unwilling to risk a recession in Brazil or the rising political risk in Argentina.

Disclosure: I am long EC, CIB.

Source: Colombia: Poised To Reach Its Economic Potential