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Fitch Downgrades Chile to 'A'; Outlook Revised to Stable
August 11, 2017 / 1:52 PM / 4 months ago

Fitch Downgrades Chile to 'A'; Outlook Revised to Stable

(The following statement was released by the rating agency) NEW YORK, August 11 (Fitch) Fitch Ratings has downgraded Chile's Long-term Foreign-Currency Issuer Default Rating (IDR) to 'A' from 'A+', and Long-term Local-Currency IDR to 'A+' from 'AA-'. The Outlook has been revised to Stable from Negative. The ratings on senior unsecured foreign bonds have also been downgraded to 'A' from 'A+'. The Country Ceiling has been downgraded to 'AA' from 'AA+', and the Short-Term Foreign- and Local-currency IDRs to 'F1' from 'F1+'. KEY RATING DRIVERS The downgrade of Chile's IDRs reflects the prolonged period of economic weakness and lower copper prices, which are contributing to a sustained deterioration in the sovereign balance sheet. In Fitch's view, growth is unlikely to recover to levels consistent with per-capita income convergence with 'A' peers. Government debt to GDP remains well below the 'A' median but has risen considerably from the low levels that underpinned Chile's upgrade to 'A+' in 2011, and is on a path to converge with the 'A' median as a share of revenues. Fiscal policy has prudently pre-financed spending initiatives with tax increases, and has buffered the economy during its weak period by pursuing a gradual adjustment to structural losses in copper revenues, but this is involving some erosion in fiscal space with which to confront future shocks. Chile's 'A' rating and Stable Outlook are supported by strong governance and a credible policy framework, which has preserved macroeconomic stability. Fitch expects a broadly disciplined policy framework to be maintained after 2017 elections, and that recovery in growth and copper prices (albeit to more moderate levels) and gradual consolidation efforts will contain public debt metrics in a range consistent with the 'A' rating. Chile's period of weak economic growth following the mining super-cycle is lasting longer than expected. Fitch projects growth will ease to 1.4% in 2017 from 1.6% in 2016, in contrast with prior forecasts for a moderate recovery. Weaker-than-expected activity in 2017 mostly reflects the impact of a strike at the Escondida copper mine in the first quarter, but mining output elsewhere has stagnated as a result of temporary and structural factors. Growth in non-mining activities has also slowed in 2017 from already lacklustre levels. Consumption has remained relatively resilient, but investment has stayed sluggish due to lower construction activity (following a prior surge in anticipation of tax hikes) and still muted corporate investment plans. Fitch projects growth will recover to 2.4% in 2018 and 2.8% in 2019 on improvement in external conditions and growth. The change in government in 2018 presents an opportunity to improve confidence and growth prospects; however, the potential for the next government to deliver a significant near-term growth boost appears limited in Fitch's view, given tighter fiscal constraints and the long time horizon for improvement of Chile's main growth bottlenecks (e.g. human capital, demographics). Estimates of potential growth have been cut significantly in recent years (the independent fiscal committee cut its estimate from 4.8% in 2013 to 3.0% in 2016) due to lower investment, while demographic and productivity trends have not improved. The weaker growth outlook diminishes prospects for further convergence of Chile's per-capita income with the 'A' median. Fitch expects the central government deficit will rise to 2.9% of GDP in 2017 from 2.7% in 2016 - less than previously expected due to higher copper prices and strong one-off receipts related to phase-out of a corporate tax benefit (FUT). In 2018, public finances will benefit from a final revenue boost from the 2014 tax reform. The government intends to allocate most of these new funds to its key pledge to expand higher education funding, so that significant restraint would be needed in other areas for it to achieve its fiscal consolidation goal (0.25%-of-GDP reduction in the structural deficit). Fitch expects the effective deficit will remain at 2.9% in 2018, as structural consolidation and cyclical improvement offset the absence of further one-off revenues. Fitch projects a gradual reduction in fiscal deficits after 2018, and sees limited upside for the pace of consolidation regardless of who wins the 2017 election. The end of the boost from the tax reform and pre-existing spending commitments will leave the next government with a tight budget envelope. Appetite for further revenue-raising measures appears low, and proposals have even emerged to partially roll back recent corporate tax increases. Consolidation is thus likely to require significant spending restraint, but scope for cuts could be narrowed by high social demands and political pledges to address them, as well as growth concerns. Chile's fiscal rule has guided prudent fiscal policy through cyclical shocks to copper prices and growth, but has become a less strict fiscal anchor in the context of a shock of a structural nature. A new interpretation of the rule - targeting a trajectory for the estimated structural deficit (subject to revision) instead of specific levels - effectively avoids a need for additional spending restraint in the face of revenue losses deemed to be permanent. Fitch projects general government debt will rise to 25% of GDP in 2017 from 21% in 2016, and around 30% of GDP by 2019, driven by fiscal deficits and other below-the-line borrowing needs (legacy pension obligations, capitalization of public companies, and participation in the student loan market). The debt burden should remain well below the 'A' median of 50%, but it has grown at the fastest pace in the 'A' category in recent years and is on a path to converge with the 'A' median as a share of revenues (130%). Favorable global market access and a strong local investor base should accommodate the higher debt burden, while liquid assets (including a stabilization fund with 6% of GDP in assets) confer additional financing flexibility. Macroeconomic imbalances have remained contained following the terms-of-trade shock. Inflation has fallen to low levels (1.7% in July) after being above target in prior years, and expectations have stayed well anchored. The current account deficit remains low and well financed by foreign direct investment inflows. Financial soundness indicators in the banking sector have also remained strong throughout the period of weak growth. General elections are scheduled for November 2017, and a potential presidential run-off vote in December. Fitch expects Chile's robust policy framework will be preserved under the next administration, although the content of reforms to address social demands (security, pensions, education, healthcare) and to improve growth prospects could differ depending upon who wins. A new electoral system increasing proportionality in the congress, along with tensions in the center-left coalition, may pose a new, potentially more challenging backdrop for legislation. SOVEREIGN RATING MODEL (SRM) and QUALITATIVE OVERLAY (QO) Fitch's proprietary SRM assigns Chile a score equivalent to a rating of 'A' on the Long-term FC IDR scale. Fitch's sovereign rating committee did not adjust the output from the SRM to arrive at the final LT FC IDR. Fitch has removed the +1 notch previously assigned to the indicative SRM output for Macro Performance and Policies. A credible policy framework has preserved macroeconomic and external stability, but has been unable to prevent a sustained weakening in economic growth and public debt metrics, implying some reduction of fiscal space to confront shocks. Fitch's SRM is the agency's proprietary multiple regression rating model that employs 18 variables based on three-year centered averages, including one year of forecasts, to produce a score equivalent to a LT FC IDR. Fitch's QO is a forward-looking qualitative framework designed to allow for adjustment to the SRM output to assign the final rating, reflecting factors within our criteria that are not fully quantifiable and/or not fully reflected in the SRM. RATING SENSITIVITIES The following risk factors individually, or collectively, could trigger a negative rating action: --Sustained growth under-performance relative to rating peers, leading to further divergence in per-capita income relative to the 'A'-category median; --Faster-than-expected increases in the government debt burden and/or erosion of fiscal credibility. The following risk factors individually, or collectively, could trigger a positive rating action: --Improvement in growth prospects and economic diversification that narrows the per-capita income gap with peers; --Improvements in the country's fiscal and external balance sheets. KEY ASSUMPTIONS --Fitch's base case assumes that copper prices do not deviate substantially from current levels; --The investment plans of Codelco and other private sector companies are sufficient to maintain broadly steady copper production in the medium term. Contact: Primary Analyst Todd Martinez Director +1-212-908-0897 Fitch Ratings, Inc. 33 Whitehall Street New York, NY 10004 Secondary Analyst Shelly Shetty Senior Director +1-212-908-0324 Committee Chairperson Charles Seville Senior Director +1-212-908-0277 In accordance with Fitch's policies the issuer appealed and provided additional information to Fitch that resulted in a rating action that is different than the original rating committee outcome. Fitch Ratings has downgraded Chile's Long-term Foreign-Currency Issuer Default Rating (IDR) to 'A' from 'A+', and Long-term Local-Currency IDR to 'A+' from 'AA-'. The Outlook has been revised to Stable from Negative. The ratings on senior unsecured foreign bonds have also been downgraded to 'A' from 'A+'. The Country Ceiling has been downgraded to 'AA' from 'AA+', and the Short-Term Foreign- and Local-currency IDRs to 'F1' from 'F1+'. KEY RATING DRIVERS The downgrade of Chile's IDRs reflects the prolonged period of economic weakness and lower copper prices, which are contributing to a sustained deterioration in the sovereign balance sheet. In Fitch's view, growth is unlikely to recover to levels consistent with per-capita income convergence with 'A' peers. Government debt to GDP remains well below the 'A' median but has risen considerably from the low levels that underpinned Chile's upgrade to 'A+' in 2011, and is on a path to converge with the 'A' median as a share of revenues. Fiscal policy has prudently pre-financed spending initiatives with tax increases, and has buffered the economy during its weak period by pursuing a gradual adjustment to structural losses in copper revenues, but this is involving some erosion in fiscal space with which to confront future shocks. Chile's 'A' rating and Stable Outlook are supported by strong governance and a credible policy framework, which has preserved macroeconomic stability. Fitch expects a broadly disciplined policy framework to be maintained after 2017 elections, and that recovery in growth and copper prices (albeit to more moderate levels) and gradual consolidation efforts will contain public debt metrics in a range consistent with the 'A' rating. Chile's period of weak economic growth following the mining super-cycle is lasting longer than expected. Fitch projects growth will ease to 1.4% in 2017 from 1.6% in 2016, in contrast with prior forecasts for a moderate recovery. Weaker-than-expected activity in 2017 mostly reflects the impact of a strike at the Escondida copper mine in the first quarter, but mining output elsewhere has stagnated as a result of temporary and structural factors. Growth in non-mining activities has also slowed in 2017 from already lacklustre levels. Consumption has remained relatively resilient, but investment has stayed sluggish due to lower construction activity (following a prior surge in anticipation of tax hikes) and still muted corporate investment plans. Fitch projects growth will recover to 2.4% in 2018 and 2.8% in 2019 on improvement in external conditions and growth. The change in government in 2018 presents an opportunity to improve confidence and growth prospects; however, the potential for the next government to deliver a significant near-term growth boost appears limited in Fitch's view, given tighter fiscal constraints and the long time horizon for improvement of Chile's main growth bottlenecks (e.g. human capital, demographics). Estimates of potential growth have been cut significantly in recent years (the independent fiscal committee cut its estimate from 4.8% in 2013 to 3.0% in 2016) due to lower investment, while demographic and productivity trends have not improved. The weaker growth outlook diminishes prospects for further convergence of Chile's per-capita income with the 'A' median. Fitch expects the central government deficit will rise to 2.9% of GDP in 2017 from 2.7% in 2016 - less than previously expected due to higher copper prices and strong one-off receipts related to phase-out of a corporate tax benefit (FUT). In 2018, public finances will benefit from a final revenue boost from the 2014 tax reform. The government intends to allocate most of these new funds to its key pledge to expand higher education funding, so that significant restraint would be needed in other areas for it to achieve its fiscal consolidation goal (0.25%-of-GDP reduction in the structural deficit). Fitch expects the effective deficit will remain at 2.9% in 2018, as structural consolidation and cyclical improvement offset the absence of further one-off revenues. Fitch projects a gradual reduction in fiscal deficits after 2018, and sees limited upside for the pace of consolidation regardless of who wins the 2017 election. The end of the boost from the tax reform and pre-existing spending commitments will leave the next government with a tight budget envelope. Appetite for further revenue-raising measures appears low, and proposals have even emerged to partially roll back recent corporate tax increases. Consolidation is thus likely to require significant spending restraint, but scope for cuts could be narrowed by high social demands and political pledges to address them, as well as growth concerns. Chile's fiscal rule has guided prudent fiscal policy through cyclical shocks to copper prices and growth, but has become a less strict fiscal anchor in the context of a shock of a structural nature. A new interpretation of the rule - targeting a trajectory for the estimated structural deficit (subject to revision) instead of specific levels - effectively avoids a need for additional spending restraint in the face of revenue losses deemed to be permanent. Fitch projects general government debt will rise to 25% of GDP in 2017 from 21% in 2016, and around 30% of GDP by 2019, driven by fiscal deficits and other below-the-line borrowing needs (legacy pension obligations, capitalization of public companies, and participation in the student loan market). The debt burden should remain well below the 'A' median of 50%, but it has grown at the fastest pace in the 'A' category in recent years and is on a path to converge with the 'A' median as a share of revenues (130%). Favorable global market access and a strong local investor base should accommodate the higher debt burden, while liquid assets (including a stabilization fund with 6% of GDP in assets) confer additional financing flexibility. Macroeconomic imbalances have remained contained following the terms-of-trade shock. Inflation has fallen to low levels (1.7% in July) after being above target in prior years, and expectations have stayed well anchored. The current account deficit remains low and well financed by foreign direct investment inflows. Financial soundness indicators in the banking sector have also remained strong throughout the period of weak growth. General elections are scheduled for November 2017, and a potential presidential run-off vote in December. Fitch expects Chile's robust policy framework will be preserved under the next administration, although the content of reforms to address social demands (security, pensions, education, healthcare) and to improve growth prospects could differ depending upon who wins. A new electoral system increasing proportionality in the congress, along with tensions in the center-left coalition, may pose a new, potentially more challenging backdrop for legislation. SOVEREIGN RATING MODEL (SRM) and QUALITATIVE OVERLAY (QO) Fitch's proprietary SRM assigns Chile a score equivalent to a rating of 'A' on the Long-term FC IDR scale. Fitch's sovereign rating committee did not adjust the output from the SRM to arrive at the final LT FC IDR. Fitch has removed the +1 notch previously assigned to the indicative SRM output for Macro Performance and Policies. A credible policy framework has preserved macroeconomic and external stability, but has been unable to prevent a sustained weakening in economic growth and public debt metrics, implying some reduction of fiscal space to confront shocks. Fitch's SRM is the agency's proprietary multiple regression rating model that employs 18 variables based on three-year centered averages, including one year of forecasts, to produce a score equivalent to a LT FC IDR. Fitch's QO is a forward-looking qualitative framework designed to allow for adjustment to the SRM output to assign the final rating, reflecting factors within our criteria that are not fully quantifiable and/or not fully reflected in the SRM. RATING SENSITIVITIES The following risk factors individually, or collectively, could trigger a negative rating action: --Sustained growth under-performance relative to rating peers, leading to further divergence in per-capita income relative to the 'A'-category median; --Faster-than-expected increases in the government debt burden and/or erosion of fiscal credibility. The following risk factors individually, or collectively, could trigger a positive rating action: --Improvement in growth prospects and economic diversification that narrows the per-capita income gap with peers; --Improvements in the country's fiscal and external balance sheets. KEY ASSUMPTIONS --Fitch's base case assumes that copper prices do not deviate substantially from current levels; --The investment plans of Codelco and other private sector companies are sufficient to maintain broadly steady copper production in the medium term. Contact: Primary Analyst Todd Martinez Director +1-212-908-0897 Fitch Ratings, Inc. 33 Whitehall Street New York, NY 10004 Secondary Analyst Shelly Shetty Senior Director +1-212-908-0324 Committee Chairperson Charles Seville Senior Director +1-212-908-0277 In accordance with Fitch's policies the issuer appealed and provided additional information to Fitch that resulted in a rating action that is different than the original rating committee outcome. Media Relations: Elizabeth Fogerty, New York, Tel: +1 (212) 908 0526, Email: elizabeth.fogerty@fitchratings.com. Additional information is available on www.fitchratings.com Applicable Criteria Country Ceilings Criteria (pub. 21 Jul 2017) here Sovereign Rating Criteria (pub. 21 Jul 2017) here Additional Disclosures Dodd-Frank Rating Information Disclosure Form here Solicitation Status here#solicitation Endorsement Policy here ALL FITCH CREDIT RATINGS ARE SUBJECT TO CERTAIN LIMITATIONS AND DISCLAIMERS. 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