Colombia to End Controversial $9 Billion Swiss Franc Swap by May

(Bloomberg) — Colombia expects to unwind its controversial swap in Swiss francs at a profit ahead of the presidential election in May, marking the end of a key pillar of its unconventional debt strategy.

The operation, a $9.3 billion total return swap with a group of international banks, was set to be paid off by the end of July. Still, the government is taking advantage of favorable market windows to accelerate the process, according to the architect of the operation, national public credit director Javier Cuéllar.

Colombia redeemed 20% earlier this week and preparing to pay off an additional 15% in coming days, he said.

“My goal is to get it canceled before the election,” Cuéllar said Friday, in an interview in Bloomberg’s Bogotá office. “I already have the dollars. I’m simply waiting for the best window of opportunity.”

The redemption means that Colombia gets back billions of dollars in collateral it pledged for the operation, which is comprised of a basket of sovereign dollar bonds, peso-denominated notes, and US Treasuries.

Although the transaction hasn’t fully closed, Cuéllar estimates that the local currency debt portions will generate profits of about $400 million, with total savings, including fiscal, amounting to about $3.7 billion.

The total return swap was the cornerstone of Cuéllar’s debt strategy, which surprised investors for its radical departure from Colombia’s previous approach. As well as the currency swap, the plan has also included buybacks of both local and global bonds, a $6 billion private placement of peso notes with a foreign investor and the first eurobond issuance in almost a decade.

Some critics argued that the operations have high currency and rollover risks that might create future problems.

Cuéllar defended his strategy, saying it has generated savings and prevented a massive increase in the country’s debt, despite the widening fiscal gap. He said he has no intention of doing more bond swaps, either in local or foreign currency, for the remaining five months of Gustavo Petro’s administration. This is because local rates are currently too high due to inflation pressures and the global environment is not favorable due to the war in Iran, he said.

“I believe the market is underestimating the impact of this war,” he said. “If this is not corrected soon, there could be a very strong impact on the global economy.”

What he does plan to do is a buyback of local currency bonds in the coming weeks for about 10 trillion pesos, or $2.6 billion, he said. He also ruled out more private placements of peso debt like the one the government did last year with Pacific Investment Management Co.

As the government recovers the collateral from the swap and unwinds the associated derivative commitments, added to the announced buyback Cuéllar said this would lower Colombia’s gross debt by about $28 billion on the balance sheet, by canceling liabilities linked to the collateral and the derivatives.

IBR-Linked Bonds

The local yield curve has inverted, with bonds maturing in 2030 trading at 14.2%, while notes due in 2050 trade about one percentage point lower than that. The government has been aggressively auctioning bonds at the short end of the curve and, for Cuéllar, it is preferable for Colombia to issue shorter-term debt and take on refinancing risk rather than lock in high borrowing costs through long-term issuance.

“At this moment, it is much more convenient to position ourselves on the short end, even with an inverted curve, while yields remain around 13.5%,” Cuéllar said. “When we need to refinance in three years for another three-year period, yields are likely to be much lower than they are now.”

Borrowing costs are being driven higher by expectations of further interest rate hikes by the central bank. However, Cuéllar said that markets are overreacting to those expectations.

The finance ministry is considering issuing local bonds linked to the interbank overnight rate (IBR), which is directly tied to the central bank’s policy rate.

“We should expose ourselves to floating rates so that, when the market moderates its expectations in one, two or three years toward lower levels, public debt can benefit from lower costs and we won’t be locked into 30-year fixed rates,” he said, adding that the government expects to incorporate the instrument into its regular auction program.

The government’s cash position is among the top concerns for investors and analysts. A mix of nearly $4 billion in TES issuance with government entities in February, along with public bond sales and coming corporate tax payments in April, has helped build a solid cash buffer. As a result, the country will not need additional cash for the remainder of the administration, he said.

“I have sufficient cash to see out the rest of the government, both in dollars and in pesos,” he said.

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