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

DBRS, Inc. has confirmed the Republic of Chile’s long-term foreign currency issuer rating at AA (low) and its 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 ratings remains Stable.

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

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. In contrast, the ratings could face downward pressure if the political commitment to sound macroeconomic management weakens.

The economy benefits from sound macroeconomic fundamentals, despite below trend growth. Consensus forecasts expect growth of 1.7% in 2014 and between 2.5% and 3.5% this year, down from average growth of 5.5% between 2011 and 2013. Slowing activity is due to domestic and external factors affecting mining sector investment and private consumption. Nonetheless, the flexible exchange rate, adequate reserve levels, and a healthy financial system cushion any negative impacts. The oil shock of 2014 has lowered energy costs for producers and consumers and has counterbalanced the decline in copper prices. Moreover, the improved trade surplus has boosted the current account.

Given the country’s low debt level and high public sector savings, the government has the capacity to provide strong policy support if the economic outlook weakens. The 2015 budget shows a countercyclical commitment by the government. Guided by its structural balance rule, the deficit is set to widen to 1.9% for 2015. The government is committed to eliminating the structural deficit by 2018. Central government debt in September 2014 amounted to 13.7% of GDP, one of the lowest debt burdens in both advanced and emerging economies. With roughly $27.7 billion saved in sovereign wealth funds, shock-absorbing fiscal buffers are above pre-crisis levels. Including Central Bank net assets, the public sector has a net creditor position equivalent to 8.0% of GDP.

Furthermore, the Central Bank is equipped to provide support to the economy if necessary. Despite some price pressure in 2014, inflation expectations are well anchored. Currency depreciation and declining commodity prices caused price indices to rise last year, but inflationary pressures appear to have subsided with inflation expected to fall within the target band by end-2015. Notwithstanding these credit strengths, the Chilean economy faces several structural challenges that result in a productivity gap with developed countries.

Chile’s commodity-dominated export base is narrow. Approximately 60% of exports are concentrated in the mining sector. 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 and accounts for a quarter of Chilean exports. A more precipitous slowdown in China would likely have a significant effect on copper prices and, therefore, on economic activity in Chile.

The quality of education and labor market rigidities are the main structural challenges that contribute to low productivity growth in the economy and unequal income distribution. Educational outcomes do not compare favorably with emerging economies in Eastern Europe or East Asia. Furthermore, high dismissal costs and a relatively high minimum wage tend to weaken employment prospects and contribute to the persistence of an informal economy. Partly as a result of these factors, productivity growth is well below the OECD average and Chile underperforms on human development indicators relative to peers in the AA category. Despite some progress over the last decade, income distribution in Chile is highly unequal.

Notwithstanding a positive oil shock in 2014, Chile has energy vulnerabilities. Chile depends on imported fossil fuels to meet 75% of its energy demands, and public opposition to domestic coal and hydro projects remains strong. Increasing the availability of domestic power sources could reduce costs and improve the competitiveness of domestic firms.

To meet the increasing public demands for higher quality public services, the Bachelet administration has put forward an ambitious reform agenda. Education, labor, and tax reform aim to reduce inequality and boost long-term growth prospects. Likewise, the government has announced measures to address high energy costs and has set renewable energy targets. Reforms are meant to improve the quality of economic opportunities and reduce structural vulnerabilities. The long term economic implication of the reforms are unclear.

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 Ministry of Finance, Central Bank of Chile, 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: 28 February 2014

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