Colombia Defence and Security Report Q1 2009

The early November 2008 resignation of General Mario Montoya, head of the Colombian armed forces, does not appear to signify the end of President lvaro Uribe's campaign to clean up the army's image.

With talk of further changes to senior military personnel in the pipeline, we believe Uribe is now keen to show his concern over human rights abuses, particularly given that US President Barack Obama has been a major critic of Colombia's human rights record under Uribe's tenure.

Colombia's short- and long-term political risk ratings remain at 70.6 and 60.8 at the end of 2008. The changing fortunes of the Fuerzas Armadas Revolucionarias de Colombia (FARC) have been largely behind the improvement in Columbia's security position. The insurgent group, which has dominated Colombian politics in recent years, has suffered a number of significant defeats in recent months that have left the group severely hobbled.

In late October, the Colombian army rescued ex-congressman Oscar Lizcano from FARC captivity. In September, the army killed eight members of FARC, including Aicardo 'El Paisa' Agudelo. However, FARC undertook a bombing in Cali at the beginning of September and an attack in Putomayo Department in late November. At the end of October, FARC released a public letter which indicated that it was still open to a hostages-for-prisoners swap, despite having lost French-Colombian politician Ingrid Betancourt, their highest profile hostage.

Another interesting development, which further undermines FARC's capabilities, has been the recent turnaround in previously fraught relations with neighbouring Venezuela. Venezuelan President Hugo Chvez, previously considered the unique supporter of the group's political aims, has changed his stance, pressuring the organisation to use non-violent means and release hostages. This is in line with the Colombian government's stance and thus frees the way for its anti-crime solutions (which are highly militarised).

Meanwhile, relations with bordering Ecuador appear to have some way to go. Ecuadorian President Rafael Correa reiterated this quarter that there would be no resumption of diplomatic relations with Colombia while President lvaro Uribe remains in power. Ecuador broke off diplomatic relations with Colombia in Q308 in the wake of an attack on FARC's base on Ecuadorian territory. Earlier in the year, in response to Colombian accusations that Ecuador has supported FARC, Ecuadorean Foreign Minister Maria Isabel Salvador called on the Organisation of American States (OAS) to investigate matters further.

Our view is that FARC is being significantly weakened by political pressures from neighbouring governments, a drop in previously enjoyed public favour, and financial difficulties. While we believe that desperation could force the remaining FARC elements to resort to increasingly violent activity, we think the overall security threat, and consequently Colombia's political risk profile, could improve significantly in the medium term.

With inflation close to 8% year-on-year (y-o-y), well above BanRep's inflation target range of 3.5-4.5%, BMI now believes that the central bank will hold overnight lending rates at 10.00% until there is clear evidence of a slowdown in CPI, and the Colombian peso shows some sign of stabilising against the US dollar. That said, with global oil prices well down from July's record highs, and dismal economic growth data for September suggesting that Colombia's economy is already feeling the effects of the global economic downturn, we believe BanRep will choose to start cutting rates in early 2009.

BMI has downgraded our 2008 real GDP forecast to 4.2% from 5.0%, mainly due to a slowdown in private consumption, the principal driver behind the country's recent expansionary cycle, highlighted by poor economic data in June. However, we see real GDP growth picking up in the latter stages of 2009 (with our 2009 year-end target at 4.5%), as we expect a decline in the overnight lending rate to improve domestic liquidity conditions.