Chile on course for a higher credit rating

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By:
Jeremy Weltman
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A reform-minded government and resilient economy have instilled confidence in Chile’s prospects among analysts, despite the risks.

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High five: Chile’s reaching new heights, even in the isolated centre of its copper-mining industry


Chile’s risk score has improved this year, rising to 77.37 points out of a maximum 100, to its highest level in three years.

That puts the country within half a point of Hong Kong – positioned 14th in Euromoney’s global risk rankings – with the Latin American country poised for a move into the top tier of Euromoney’s risk survey for the first time.

Chile would then join an elite group of lowest-risk sovereign borrowers, becoming the first LatAm country to do so, and would justify a double-A credit rating.


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The country has been long considered a low-risk investment, despite vulnerability to copper prices.

“Chile enjoys strong democratic governance and stable government, its policies and regulatory frameworks are ranked at the top of the global rankings for middle-income and advanced economies, and it is commonly cited as the best example of structural economic reforms in Latin America,” says ECR expert Constantin Gurdgiev, a professor at the Middlebury Institute of International Studies (MIIS).

Using a wide range of risk factors, including capital access – another factor improving this year – the longer-term trend remains firmly positive, with Chile gaining more than eight points in the risk survey since 2007.

Economic growth slowed from 2014 to 2017, averaging 1.7% in real terms, compared with 5.3% from 2010 to 2013, but the country avoided recession, unlike Argentina, Brazil, Ecuador and Venezuela in the region.

This year’s third-quarter growth slowed from the pace evinced during the first half of the year, mirroring advanced industrialized economies, but was still 2.8%; above the 2017 third-quarter outturn under the previous government, supported by booming domestic demand.

Forecasts published by the IMF suggest GDP growth will slow down on a year-average basis from 4% in 2018 to 3.4% in 2019 due to a deteriorating global economy and tightening financial conditions, but remain broadly in line with medium-term growth potential.

OECD forecasts released this week concur, stating: “Growth is projected to remain strong over the next two years. With an uncertain external environment, solid domestic demand will underpin growth, aided by a stable inflation environment, public infrastructure projects and a tax reform.”

Copper production

Strike action in the copper-mining sector prompted analysts to downgrade the labour market/industrial relations factor this year.

However, copper production is now expected to pick up pace as the risk of labour strikes recedes after successful contract renegotiations, and as investments in upgraded facilities bear fruit, offsetting some of the problems associated with declining copper-ore grades.

Production by copper mining group Antofagasta declined in the first nine months of 2018, but is expected to rise quite sharply from the fourth quarter onwards, while other companies – for instance, Anglo American and Codelco – have increased output this year.

As Gurdgiev at MIIS explains: “Chile’s earlier risks, most notably relating to the country exposure to the global industrial raw-materials demand shocks, have been abating in more recent months, with the domestic economy, and exports of food, forestry and internationally traded services picking up the slack in the supply capacity.”

More detailed forecasts on Chile provided by the IMF for 2019 show a central government deficit of 2% of GDP, public sector gross debt – including all central government, central bank and public enterprise liabilities – rising to 45% of GDP, and central government debt totalling 26% of GDP.

The fiscal consolidation programme is projected to stabilize the debt ratio by the early 2020s, the current-account deficit will remain below 3% of GDP, and foreign currency reserves likely to cover around five months of imports – all supporting the macroeconomic risk outlook.

Underpinning a high score for bank stability, with Chile exceeding many higher-ranking countries in the survey, the IMF states: “The banking system is generally well-capitalized, non-performing loans remain low and a new banking law that aims to close the gap with Basel III minimum solvency requirements has been recently adopted.”

According to Lorenzo Naranjo, assistant professor of professional practice at the University of Miami, and a contributor to the survey, the world economy in general is becoming more uncertain and that has implications for Chile’s economy.

Last week, however, the IMF praised Chile, notably for the reformist approach of the new government led by Sebastián Piñera, who was elected in December to serve as president for a second time after completing four years in 2014, cementing victory for his centre-right Chile Vamos coalition.

“The government has brought more optimism to private investors, who feel more confident on the rule of law and decrease in corruption,” says Naranjo.

Corruption

Political risk indicators have improved, including corruption, government stability, and the regulatory and policymaking environment, despite the fact the government does not have a majority in congress and will need to work collegiately to pass reforms to the pensions system, labour laws and tax code, while addressing social policies and combatting corruption.

Any success on the latter will help to underpin the risk rating, given that “Chile is still coping with a widespread lack of trust in its main institutions”, says ECR contributor Alfonso Dingemans, an assistant professor at the University of Santiago, noting recent corruption scandals involving the army and uniformed police force Carabineros de Chile.

The government is also enduring heightened tensions among indigenous communities after the death of a Mapuche activist during a police operation, but these are concentrated in southern regions and should eventually diminish if appropriate action is taken.

There are other risks Dingemans cites concerning the quality of education and workforce training, and an inability to lower the unemployment rate below 7%.

However, he notes that although Chile will remain a commodity exporter, this will shift from copper to lithium for use in rechargeable batteries, and adds tellingly that “economists and policymakers are optimistic regarding the economy’s ability to absorb successfully international shocks”.

Gurdgiev is similarly positive, noting: “The country’s long-term outlook remains strong and is supported by the forward-looking policy reforms of the current government.”

That much is underlined by Chile’s “good track record”, says Dingemans, and is one reason why the country is still riding high in Euromoney’s risk survey.