DBRS Confirms Chile at A (high), Changes Trend to Positive on Economic Strength

DBRS, Inc. (DBRS) has today confirmed its ratings on the Republic of Chile’s long-term foreign debt at A (high) and long-term local currency debt at AA (low), and changed the trend on both ratings to Positive from Stable. The ratings are underpinned by Chile’s sound macroeconomic policy framework, strong public balance sheet and stable political institutions. The Positive trends reflect Chile’s sustained strong economic performance and demonstrated capacity to weather adverse shocks.

Expansionary fiscal and monetary policies, in addition to a healthy financial system, mitigated the effects of the global financial crisis and contributed to a rapid recovery. After contracting 1.7% in 2009, the economy expanded 5.2% in 2010 and the Ministry of Finance expects growth of 6.5% in 2011. The sharp rebound in domestic demand was accompanied by strong job creation and gains in real wages. Domestic financing conditions have also been supportive of the recovery, with credit expanding 7.7% in 2010 and accelerating through the first nine months of 2011. Consensus forecasts point to GDP growth of 4.2% in 2012.

However, in the event that the external environment deteriorates sharply, Chile is prepared to provide strong policy support. With $17.9 billion (7.7% of GDP) saved offshore in sovereign wealth funds and $14.0 billion (6.0% of GDP) held by the Public Treasury, fiscal savings are above pre-crisis levels. Central government debt amounts to only 10.1% of GDP, one of the lowest debt burdens in either advanced or emerging economies. As a result, the public sector – including the Central Bank – has a net creditor position equivalent to 9.6% of GDP. Furthermore, the fiscal accounts are back in surplus, reaching 2.8% of GDP in the first nine months of the year.

With a sound banking system and ample foreign currency liquidity, Chile is also well-positioned to manage a potential return to unfavorable financing conditions. Chilean banks are liquid and well-capitalized with high quality capital. Furthermore, their net foreign exchange exposure is moderate and reliance on foreign funding, including parent banks, is relatively limited. In November 2011, the Central Bank held $38.8 billion (16.6% of GDP) in reserves, up $12.8 billion from a year prior. This, in addition to fiscal savings, provides Chile with sufficient liquidity to cover all external debt maturing in the next 12 months.

Sound macroeconomic policies, openness to trade and investment, and a well-developed financial system have contributed to Chile’s strong economic performance and improved living standards. From 1990 to 2010, the economy grew at an average rate of 5.1%, real income per capita more than doubled and poverty declined from 39% to approximately 15%. Moreover, Chile’s high national savings rate, which averaged 23.1% of GDP from 1990 to 2010, finances high levels of domestic investment and limits the economy’s reliance on net external borrowing.

Despite these positive developments, labor productivity is low compared to advanced economies, and GDP per capita is 45% of the OECD average. Income distribution is among the most unequal in the world and education outcomes in Chile, although strong by regional standards, rank similarly to Turkey and Russia and below most economies in Central and Eastern Europe.

In addition, Chile is a highly open economy with a narrow commodity-dominated export base. Nearly two-thirds of exports are concentrated in the mining sector, partly the result of a substantial rise of copper prices in recent years. 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. China, a key driver of global copper demand and international prices, has quickly become Chile’s largest trading partner, accounting for 24.4% of Chile’s exports in 2010. A marked slowdown in China’s growth would likely have a significant effect on copper prices and, therefore, on economic activity in Chile.

Consensus across the political spectrum on the policy framework is one of Chile’s greatest strengths. Sustained commitment to sound macroeconomic management, in addition to further improvements in economic performance, is likely to lead to an upgrade of the ratings.

Note:
All figures are in U.S dollars unless otherwise noted.

The principal applicable methodology is Rating Sovereign Governments, which can be found on the DBRS website under Methodologies.

The sources of information used for this rating include the Central Bank of Chile, Ministry of Finance, INE, IMF, OECD, and Haver Analytics. DBRS considers the information available to it for the purposes of providing this rating was of satisfactory quality.

Lead Analyst: Michael Heydt
Rating Committee Chair: Alan G. Reid
Initial Rating Date: 30 May 2006
Most Recent Rating Update: 30 August 2010

For additional information on this rating, please refer to the linking document under Related Research.