Colombia’s Dual Power Environment: Carlos Vigil Cruz, Sarah Kearns, Wendy Loveland, Armondo Tautiva How is business conducted ?

Colombia’s Dual Power Environment:

Carlos Vigil Cruz, Sarah Kearns, Wendy Loveland, Armondo Tautiva

How is business conducted ?

Agenda

Colombia - a backgrounder The other power: guerrilla legacy and

paramilitary power The US/Colombian political story Business in Colombia

Cocaine, heroin & supply and demand Non-drug related attempts at growth Case studies: Consumer products & Oil

Colombia at-a-glance

Area: 439,700 sq milesCapital city: BogotaPopulation: 36.2 millionMestizo (58%) European (20%)Mulatto (14%) African (4%)Afro-Indian (3%) Indian (1%)Government: DemocracyPresident: Andres Pastrana ArangoGDP: US$ 172 billionGDP per capita: US$ 4,850Major industries:-Agriculture: coffee, bananas, sugar cane-Minerals: Oil, iron, coal, gold, emeralds-Manufacturing: food, textiles, chemicals- Drugs: coca and cannabis

Colombia at-a-glance

• Colombia is the most troubled country in the West Hemisphere

• “colombianization”= failing state• Reasons based on economical resources: oil,

cocaine, land• Drug criminals, guerrillas, and paramilitary groups

are feeding a spiral of violence• Colombia supplies 80% of the world’s cocaine and

the majority of heroin

Violence

• Violence displaced 750,000 from 1995 to 1998, 300,000 in 1999 alone

• Violence between Government forces, Paramilitaries, and Guerrillas resulted in 3,000 deaths for 1999

• Shift in values; illegal activity is more acceptable - a way of life

Recession

• Deepest recession in 70 years• 20% unemployment rate• Recession seen as caused by reduced exports,

low oil prices, and diminished investment flow

• Dependence on foreign capital (U.S.) to fund war with insurgents

• Only way to make money is to participate in drug trade

The Other Power

• The rise of various insurgent groups has been facilitated with profits from the illicit drug trade

• These groups rival the government in resources and power

• The economy has been drained by the efforts to fight these groups

FARC – EP

• Born in 1964

• Rural based, pro-Soviet guerrilla

• Size of Force approx. 15,000

Activities

•Armed attacks

•Kidnappings for profit

•Ties to narco traffickers

•Bombing oil pipelines

•Killing Colombian and foreign citizens, and U’wa indigenous

Demands

•Agrarian Reform

•Increased social spending

•Reform the armed forces

•Natural Resources sovereignty

ELN

• Formed in 1965

• Pro – Cuban, anti U.S. Group

• Size of Force approx. 5,000

Activities

•Pipelines bombing

•Inflicted massive oil spills

•Extortion and bombing U.S. and other foreign businesses

•Kidnapping for profit

•Force opium and coca cultivators pay for protection

Demands

•Demilitarize municipalities

•Natural Resources sovereignty

•Social and Political Reform

EPL

• Rural based guerrilla

• Size of Force approx. 500

Paramilitary Groups

United Self Defense Groups of Colombia (AUC)

• Illegal armed groups of extreme right• Fight against guerrilla groups or civilian population

perceived as guerrillas “social base”• Formed by military in the early 80’s• Originally based on farmers, settlers and “campesinos”• Declared illegal in 1989 due to their excesses• Supported by landowners, businessmen, drug dealers and

occasionally by military personnel

Paramilitary GroupsActivities• Responsible for about 70% politically motivated killings• Responsible for the forced displacement in Colombia

- 1 every 4 Colombians has been forced to leave his/her home town- Today all this land left is out of production- This situation led to a high economic and social cost

Demands• Political and Democratic Reform• Agrarian and Urban Reform• Petroleum and Energy Policy• Environmentally Sustainable Development• Narcotraffic

Effect on Colombia

• Colombian president Pastrana forced to negotiate with FARC guerrilla leader Marulanda

• Colombian Government spends over $1billion on fight

• Military involvement withparamilitary groups; police disempowered

• Destroyed judicial system

US Involvement

• U.S. heavily involved in every aspect of Colombia’s antinarcotics operations.

• U.S. contributes $300 million annually in aid (mostly toward antinarcotics efforts).

WHY?• U.S. exports to Colombia = $5.2 billion• U.S. imports from Colombia = $4.7 billion• U.S. also the largest foreign investor (38% of foreign

direct investment)• Colombian drugs affect US social system/budget

The Drug Economy: Schools of Thought

Stem Supply poison the coca fields blow up drug labs punish offenders patrol borders use US resources to

eradicate the source of drugs

Decrease Demand institute more drug

treatment programs increase follow-up

treatment time for detox patients

use US resources to reduce demand for drugs

Ineffective US Policy?

US Policy = stem supply Dramatic increase in funding

(from $13B to $19.2B in past four years) violence disrupts country, not just

drug community drug labor and production is

extremely mobile increasing US involvement stokes

anti-US sentiment volatility = capital flight drug production has tripled in the past

decade

Past policy= reduce demand 1971: Nixon allocated 2/3

funding into treatment and prevention national crime rates dropped drug-related arrests fell # federal inmates decreased highest number of addicts sought

help

Supply & Demand in a Drug Economy

P

Q

S

D

What’s the incentive to change the status quo?

Other Options for Growth Debt issuing

Colombia issued $500M for 20 yr. global bond, 550bp over US Treasuries There is some faith in Colombian risk despite BB+ ratings

– 12.08% yield for Colombia vs. 11.7%, 12.9% in Argentina and Brazil respectively

Private sector loans Coffee sector developed consortium, received $83M, 5-yr. syndicated loan;

securitized future export receivables on its coffee crops Oil companies also securing loans on future receivables

Moving toward free market policies assumes privatizing will be more efficient, and will attract outside investors

Examples of Dual Power• Guerrillas met with Clinton• Guerrillas do European Tour

– 6 FARC rebels met with Italian business and political leaders in February, 2000

– Delegation visited Spain, Switzerland, etc.– Wearing “crisp business suits and ties”

• Founder of AOL (Kimsley) met with Guerrillas– Held 3 hours of talks with Guerrilla leader Marulada– Told Guerrilla leaders of enormous potential investment in Colombia– Discussed ways to accelerate the peace talks– President Pastrana also played host to Mr. Kimsley at an investment seminar

in Colombia in January (Pastrana proposed he meet with the FARC)

Examples of Dual Power• President of NYSE met with FARC leadership

– Mr. Grasso visited FARC held region in June 1999 to meet Paul Reyes, senior rebel commander

– Reyes rallied against the foreign “intervention” represented by the $1.6 package currently being considered…it is a “declaration of war”

– American aid = “barbarian intervention”

• President Pastrana on the Guerrilla's meeting with Clinton in 1998: “I promoted it (the meeting). I said to the FARC, “You tell me you want to eradicate drugs. If so, tell the U.S. directly.” And they said, “We need money to invest in alternative development”.

• In 1998 Pastrana launched peace talks with the Guerrillas

Doing Business in Colombia: The Reality

• Guerrillas: danger, violence, kidnapping• Legal importing is discouraged

– Legal importation takes twice as long as illegal– Consumer goods are subject to a 20% CIF and 16% VAT

• Equates to a 50 - 60% Margin over basic FOB price of a legally imported good and encourages contraband

– Bureaucracy• Unreal amounts of paperwork• Example of shipment two years ago: stuck for 4 months b/c of a phrase on the import license.

Shoes could not go back to the Free Zone in Panama, nor into the country. In the end, customer won suit, but it was too late.

• Estimate: Over US $5 billion in imports enters country illegally every year

• Expectation from customs that you won’t follow the rules– If you follow the written rules, customs officials won’t receive their “salary” from “tips”

Doing Business in Colombia: The Reality

• SDNT’s: Specially Designated Narcotics Traffickers– Brings new meaning to finding a good partner!– The Government has a list of companies & individuals on the list with whom

business cannot be legally conducted• This list is readily available in Washington, D.C.

• Importing of old or used clothing, closeouts, irregulars, off-season merch is prohibited by law (but, distributor’s can find a way…)

• Transparency: Colombia is not a signatory to WTO and thus complains about non-transparency in the bidding on major gov’t contracts is an issue

• Counterfeits are plentiful: – New Star– Counterfeits can be seen in country before the real product arrives!

Using Distributors to Reduce Risk• Real risk of violence & kidnapping - avoid it by not being there

– Not only kidnapping, plenty of street crime as well

• Idiosyncrasies of doing business in Colombia -- can foreign business people really figure it out? Not usually….need local partner

• Foreign exchange risk is minimized: royalties are paid based on factory prices in US dollars

– In Colombia, the exchange bands were just widened, meaning the C. Bank is not going to intervene in the same way, the currency can fluctuate more

– This is a cash business which is inherently risky: Consumers buy in pesos, no installment payment. Credit cards are available, but high rates, 20%, make them impractical for many

Using Distributors to Reduce Risk

• Tax Issues: Distributor’s can get around the rules– If you paid all required taxes, you’d be bankrupt in six months– Import duties: you can’t compete if you do business legally

• Distributors can manage counterfeit issues on a local level more quickly.

– Can give them limited power of attorney

• Personal relationships• They can work the system in a way US companies can’t

– Selling to wholesaler: you invoice the vendor at $10, when you really charge $20 (to avoid tax), so vendor pays $10 by check, but has to find the other $10 in cash in the black market so that it can’t be traced

– Where is the black market, who do you call? • Operates like a bank: call and get exchange rate

Consumer Goods: Converse Case

• Licensee purchases factory direct, pays FOB• Royalties are paid to Converse• Same partner for 25 years• Distributor sells both direct to retail chain, and to sub-distributor• Footwear market is half formal and half informal• Informal markets have better pricing, 20% cheaper, but riskier

– 20% gets you a mall with security & parking– Not uncommon for wealthy people to send chauffeurs in to make

purchases– Like a flea market, but more organized

Risks Associated with Distributors

• Lack of Control over Brand Image– Not all distributors can handle informal and formal markets…some have

contacts in one but not the other

• Difficult to get payments in tough times– Easy to get credit, but if things get tight…banks hold back on credit

• For consumers and for the Distributor

• Contracts don’t mean much: contractual obligations to invest $ can be ignored

• If distributors engage in illegal activity: can tarnish reputation of company • Communication and reporting is sporadic and unreliable• Totally unsupervised environment

– Ex: Converse shoes in Macy’s and K-Mart in the same city

Guerrillas and the Oil Business Colombia is facing the possibility of being a net importer of oil for

the first time since 1985 July 1999, then-president of Ecopetrol, Carlos Rodado went on an

international road show to promote improved contractual terms to foreign oil companies. Trying to test if lower royalties, reduced state share, better contractual terms could

outweigh the security risks The tour concluded with scheduled start of Peace talks w/FARC (which were

postponed, again)

BP Amoco scaled back investment plans because of security issues Other foreign oil companies are reluctant to enter Colombia due to

risk Costs of private security are extremely high

Guerrillas and the Oil Business

ELN denounced Ecopetrol’s new terms as sell out to multi-nationals Will increase their sabotage campaign (in March 99, 18 tractor trailers transporting

drilling equip. owned by Ecopetrol were burned up) Attacks on the pipeline are commonplace The pipelines have been declared a military objective by ELN and FARC

Guerrilla tactics at different stages of oil project development Facilitate operational support…claiming they are helping since the project

offers economic & social benefit to the region Then, at the exploration & drilling stages, they begin to pressure the oil

companies– Request medical supplies, social projects, etc.– Extortion: demanding financial contributions to their armed struggle– Low level terrorist attacks, as the operation grows, so do the demands– Infiltrate the foreign owned company: form unions, etc.

Why do companies stay?

• Profitability• Prospects for future growth

Scary Thoughts...

Without the Guerrillas… Many US jobs would be gone….DEA, etc. A CT based company making Black Hawk helicopters could miss out on a lucrative contract Less roads and schools might exist in Colombia (in very rural areas) Some farmers incomes would drop significantly

The Guerrillas have their own R&R resorts in Panama The Guerrillas are not producing drugs…only taxing and protecting FARC members often are better paid and equipped than the military FARC issued press release: list of journalists targeting for assassination The president himself was kidnapped by a drug cartel in 1988 Pastrana: elected by largest majority in Colombian history, and must negotiate “outside

the law” Cocaine cultivation up 140% in 1 year: Can we learn something about production?