Fitch recently lowered its long-term foreign currency rating for the Republic of Chile by one notch to A from A+ and adjusted the outlook to stable from negative. The move reflects a ‘prolonged period of economic weakness and lower copper prices, which are contributing to a sustained deterioration in the sovereign balance sheet.’ They note ‘per-capita income convergence’ with its A-rated peers has weakened and while government debt to GDP remains below the A median it has risen from the low levels that underpinned the A+ rating. Fiscal policy remains prudent as spending has been pre-financed with tax increases but weaker copper revenues have eroded some of the fiscal space.
Fitch’s view is the most pessimistic of the rating agencies: Moody’s still rates Chile Aa3 with a stable outlook and S&P took their long-term foreign currency rating down a notch to A+ in July with a stable outlook. S&P noted that ‘prolonged subdued economic growth has hurt Chile’s fiscal revenues, contributed to increases in the government’s debt burden, and eroded the country’s macroeconomic profile.’ That said, Moody’s make a valid point that debt to GDP figures of 25% for 2017 and 27% for 2018 is still considerably lower than most Aa rated sovereigns where the median is 38%.
It is true Chile’s debt levels have risen, it runs a small current account deficit (1.4% of GDP in 2016) and the government is forecasting a 2017 fiscal deficit of 3.2 percent of GDP, up from 2.2 percent last year. However, this needs to be set against the fact that Chile has an asset buffer too (Economic and Social Stabilization Fund, Pension Reserve Fund, Education Fund and other treasury assets) which S&P estimate amounted to USD28.8bn (11.8% of GDP) at the end of 2016. Thus, the net debt profile of Chile adjusted for government assets looks much stronger: S&P estimate it at 11% of GDP in 2017.
Nevertheless, given Chile position has weakened it is perhaps unsurprising that Chile’s counter cyclical fiscal policy (since 2001 they have targeted a balanced budget over a business cycle) is also now coming under focus ahead of the Presidential election later this year: The former President Sebastian Piñera (in office 2010-2014) is the front-runner from the opposition party Chile Vamos (CV) has made it clear that he thinks the fiscal deficit needs to be tackled helping to boost business confidence and investment. While the concept of counter cyclical spending is well accepted projections have been based on overly optimistic growth and copper prices meaning Chile’s debt and deficits have been worse than expected.
Fitch’s move also has had knock-on rating impacts on quasi sovereign credits such as the copper miner Codelco, 100% owned by the Chilean government, which has seen its rating also lowered to A from A+ and the outlook revised to stable from negative. Codelco is rated A+ (stable) by S&P on a long-term foreign currency basis and A3 (negative) by Moody’s. S&P equalise Codelco’s final rating with the sovereign given the track record of explicit support and the expectation that this will continue.
At the time of writing, Codelco issues such as the 6.15% 2036 and 4.5% 2025 are trading up slightly since last Friday. Fitch had put Chile and Codelco on a negative outlook at the end of last year so the market most likely had already factored in any negative downgrade news but perhaps not enough of the robust emerging copper backdrop: for example, Codelco 4.5% 2025 is up over 5 points year to date while the copper price has continued its meteoric rise and is now (at the time of writing) up close to 18% year to date. We still see value in Codelco: on our models and using an A rating Codelco 6.15% 2036 is trading just over 3 notches cheap, with a yield of 4.33%.