DBRS Confirms Chile’s Ratings on Strong Macroeconomic Management

DBRS has today confirmed the Republic of Chile’s long-term foreign currency rating at A (high) and long-term local currency rating at AA (low). The trend on both ratings is Stable.

“The Stable trends reflect DBRS’s belief that the severe damage caused by the February earthquake and tsunami will not present a long-term disruption to Chile’s economic growth,” says Michael Heydt, DBRS Senior Financial Analyst. “It is also clear that after years of exemplary fiscal management, Chile has the capacity to carry out reconstruction without putting a strain on public finances or its credit ratings.”

Despite immediate production losses following the earthquake, the economy is rapidly recovering, growing 6.5% in the second quarter of 2010. The Central Bank of Chile estimates that the earthquake destroyed 3% of the economy’s capital stock, suggesting a moderate decline in productive capacity. However, the largest copper mines, primarily located in the north of the country, suffered limited structural damage, and the government’s reconstruction plan, combined with private investment, should help rebuild the capital stock and support growth in the affected regions.

The government estimates that reconstruction will cost $8.4 billion (5.1% of 2009 GDP) over the next four years. Although Chile could fund the entire reconstruction program with offshore fiscal savings, the government has designed a more balanced financing plan, which includes tax changes, budget reallocations, the sale of public assets and borrowing. The financing plan aims to limit the repatriation of offshore funds that could lead to peso appreciation, which would erode competitiveness, and save sovereign wealth fund resources for future counter-cyclical needs.

Chile’s ratings are underpinned by a sound macroeconomic policy framework, low debt burden and stable political institutions. A rules-based fiscal and monetary policy, a flexible exchange rate and a well-regulated financial system have helped the Chilean economy withstand the economic consequences of the global recession and the February earthquake. In 2009, central government debt totaled a very low 6.1% of GDP. With $14.5 billion saved offshore and $25.2 billion in international reserves, Chile is a net public creditor. Furthermore, there has been strong political consensus in favor of the macroeconomic policy framework across several administrations, and this is one of Chile’s biggest strengths.

Chile has sustained strong economic growth and improving standards of living for the last two decades. From 1990 to 2009, the economy grew at an average annual rate of 5.1%, real GDP per capita doubled and the poverty rate declined from 38.6% to 15.1%. On January 11, 2010, Chile became the first South American member of the Organization for Economic Cooperation and Development (OECD).

While OECD membership reflects progress in economic and social development, it also highlights the country’s long-term challenges. First, Chile is a small open economy with 60% of exports concentrated in the mining sector. Although Chile’s macroeconomic policies are designed to dampen the effect of copper price fluctuations on the real economy, economic growth and fiscal revenues are exposed to the commodity price cycle. Second, GDP per capita is only 43% of the OECD average, and educational outcomes do not compare favorably with other OECD countries or emerging economies in East Asia. Improvements in the quality of education and microeconomic reform could help sustain higher rates of growth and accelerate the convergence in labor productivity.

DBRS will continue to monitor how the government addresses the country’s social development needs during reconstruction. Improvement in Chile’s credit profile partly depends on reforms that facilitate productivity-driven growth. This, in addition to ongoing attention to structural concerns, including efforts to broaden the export base and reduce income inequality, could put upward pressure on the ratings in the coming years.

Notes:
The applicable methodology is Rating Sovereign Governments, which can be found on our website under Methodologies.