DBRS Confirms the Republic of Chile at AA (low), Stable Trend

DBRS, Inc. (DBRS) has confirmed the Republic of Chile’s long-term foreign currency issuer rating at AA (low) and the long-term local currency issuer rating at AA. In addition, the short-term foreign currency issuer rating was confirmed at R-1 (middle) and the short-term local currency issuer rating was confirmed at R-1 (high). The trend on all issuer ratings remains Stable.

Chile’s ratings are underpinned by (i) a sustained commitment to sound macroeconomic policymaking, (ii) an exceptionally strong public sector balance sheet, and (iii) a demonstrated capacity to weather adverse shocks. These factors, along with a stable political environment, have contributed to Chile’s lengthening track record of strong economic growth, macroeconomic stability, and improving social indicators.

The Stable trend reflects DBRS’s assessment that Chile has ample fiscal and monetary flexibility to support the economy in the event of an adverse shock. In addition, sound macroeconomic management is expected to continue under the incoming administration of President-elect Michele Bachelet.

Further diversification of the Chilean economy into high value-added sectors, thereby enhancing economic resilience, could result in upward pressure on the ratings over the medium term. On the other hand, the ratings could face downward pressure if a shock derails the country’s political commitment to sound macroeconomic management.

The Chilean economy is well positioned to manage deterioration in global financing conditions. The country benefits from a flexible exchange rate, adequate reserve levels, and a healthy financial system. High inflows of foreign direct investment also provide the economy with a stable source of external financing.

The government also has the capacity to provide strong policy support if the economic outlook weakens. Central government debt in September 2013 amounted to 12.5% of GDP, one of the lowest debt burdens in either advanced or emerging economies. Chile’s fiscal policy is guided by the structural balance rule that ties public spending to cyclically-adjusted revenues and directs the government to save any surplus. Favorable external conditions and high commodity prices over the last decade allowed Chile to strengthen its surplus reserve funds. With $22.9 billion (8.1% of GDP) saved offshore in sovereign wealth funds as of November 2013 and $7.3 billion (2.6% of GDP) held by the Public Treasury, fiscal savings are above pre-crisis levels. As such, the public sector – including the central bank – has a net creditor position equivalent to 7.8% of GDP.

With low inflation and anchored inflation expectations, the Central Bank of Chile also has the capacity to provide support to the economy if necessary. The central bank already cut the policy rate 75 basis points in the last two quarters to combat slowing economic activity. Monetary policy flexibility is one factor that distinguishes Chile from other developing countries that have raised rates to stabilize their exchange rates and dampen inflationary pressures.

As a result of Chile’s macroeconomic policies, its openness to trade and investment, and its well-developed financial system, the country has sustained strong economic performance and improved living standards. From 1990 to 2012, the economy grew at an average rate of 5.2%, real income per capita more than doubled, and the poverty rate was cut from 39% to 14%. The central bank expects 2013 GDP growth to have slowed to 4.2% as a result of slower growth in domestic consumption, weaker demand for exports, and decreased capital investments. The economy nonetheless benefits from tight labor market conditions, rising real wages, and favorable terms of trade, despite modestly lower copper prices. The central bank forecasts a similar growth rate in 2014.

Notwithstanding these positive developments, Chile has a productivity gap with developed countries for several reasons. First, income distribution is highly unequal, as the wealthiest 10% receives nearly 40% of the national income. Second, education outcomes, based on OECD reading, science, and math assessments, are weak when compared to developing economies in East Asia or Eastern Europe. Third, Chile suffers from energy challenges. Chile depends on imported fossil fuels to meet 75% of its energy demands, and public opposition to domestic coal and hydro projects is strong. Increasing the availability of domestic power sources could reduce energy costs and improve the competitiveness of domestic firms.

Chile’s narrow commodity-dominated export base poses the largest external challenge. Approximately 60% of exports are concentrated in the mining sector. This is partly the result of a substantial rise of copper prices in recent years. Although Chile’s macroeconomic policies are designed to dampen the effects of copper price fluctuations on the real economy, economic output 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 a quarter of Chilean exports in 2013. A slowdown in China would likely have a significant effect on copper prices and, therefore, on economic activity in Chile.

Notes:
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 principal applicable rating policies are Commercial Paper and Short-Term Debt, and Short-Term and Long-Term Rating Relationships, which can be found on our website under Rating Scales.

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.

This rating is endorsed by DBRS Ratings Limited for use in the European Union.

For further information on DBRS’ historic default rates published by the European Securities and Markets Administration (“ESMA”) in a central repository see http://cerep.esma.europa.eu/cerep-web/statistics/defaults.xhtml.

Generally, the conditions that lead to the assignment of a Negative or Positive Trend are resolved within a twelve month period while reviews are generally resolved within 90 days. DBRS’s trends and ratings are under constant surveillance.

Lead Analyst: Jason Graffam
Rating Committee Chair: Roger Lister
Initial Rating Date: 30 May 2006
Most Recent Rating Update: 8 February 2013

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