Chile
Press Release

Moody's downgrades Chile's ratings to A2, changes outlook to stable from negative

Bnamericas Published: Thursday, September 15, 2022

PRESS RELEASE from Moody's
15 September 2022

New York, September 15, 2022 -- Moody's Investors Service ("Moody's") has today downgraded the Government of Chile's long-term local and foreign-currency issuer and senior unsecured ratings to A2 from A1, and the senior unsecured foreign-currency long-term shelf rating to (P)A2 from (P)A1. The outlook has been changed to stable from negative.

The rating downgrade was driven by fiscal and economic trends that have gradually but persistently weakened Chile's credit profile, aligning it with that of A2-rated peers. Although the country entered the coronavirus crisis with lower debt than peers and with fiscal buffers, its debt burden had been rising steadily before the crisis and the pandemic exacerbated the upward trend.

The country's decisive rejection of the proposed new constitution in the September 4 constitutional plebiscite indicates that the political consensus has likely shifted in favor of more modest changes to Chile's sociopolitical and economic arrangements, following social unrest that started in 2019.  Still, the constitutional reform process remains unresolved and will likely lead to a structural increase in social spending at a time when medium-term growth prospects remain modest. The government has emphasized its commitment to fiscal consolidation and has taken measures that have led to a material correction in the fiscal accounts in 2022. However, the political economy behind increased social spending pressures will pose challenges to these efforts in the coming years. Even after taking into consideration the potential for higher government revenue as a result of an upcoming tax reform, Moody's expects the debt burden will continue to rise in the coming years gradually approaching the A-rated peer group median.

The stable outlook reflects Moody's expectation that Chile's credit profile will remain aligned with that of A2-rated sovereigns, supported by strong institutions and policymaking. Moody's expects the authorities will remain committed to and prove effective in maintaining macroeconomic and financial stability throughout the constitutional reform process. Following rejection of the proposed constitution in the plebiscite on September 4, Moody's expects the reform process to continue well into 2023 and potentially beyond, ultimately resulting in a new constitution that will expand social rights, helping to mitigate sociopolitical risks at the cost of higher social spending.  

Chile's local-currency (LC) and foreign-currency (FC) ceilings remain at Aaa. The five-notch gap between the LC ceilings and the issuer rating reflects the government's relatively small role in the economy and financial system, strong track record of predictable and reliable institutions and policymaking, moderate political risk and higher external imbalances with greater reliance on revenues from the mining sector. The lack of a gap between LC and FC ceilings reflects the absence of transfer and convertibility risks, itself anchored in a history of strong economic institutions supporting currency convertibility and open capital accounts.

RATINGS RATIONALE

RATIONALE FOR THE DOWNGRADE TO A2

FIRST DRIVER:  FISCAL TRENDS THAT HAVE GRADUALLY BUT PERSISTENTLY WEAKENED CHILE'S CREDIT PROFILE

Moody's assessment of Chile's fiscal strength reflects the marked deterioration in the country's fiscal metrics over the past decade from a strong starting point and its expectation of a continued, albeit gradual, debt increase over the medium term. The government's strong fiscal starting point relative to A-rated peers provided support to Chile's credit profile, but the accumulation of government debt became a key credit concern even before the pandemic. Persistent fiscal deficits have led to an uninterrupted rise in the general government's debt to GDP ratio to 36% in 2021 from around 11% in 2011.

Looking ahead, while the government has emphasized its commitment to fiscal consolidation, the political economy behind rising demands for increased social spending will pose important challenges to these efforts, despite the potential for higher government revenue as a result of an upcoming tax reform. Moody's anticipates a continued but gradual rise in debt with the ratio to GDP coming above the 40% mark over the medium term and moving closer in line with the A-rated peer group median.

The government's financial buffers have diminished, and the share of foreign-currency-denominated debt has increased. Sovereign financial assets declined to around 5% of GDP as of June 2022 from around 8% in 2020, after having been drawn down during the pandemic.  Smaller financial buffers will limit the government's future capacity to manage shocks and increased government foreign-currency borrowings have pushed the corresponding share to 36% of debt outstanding from about 21% in 2019, resulting in higher exposure to exchange rate shocks.

As fiscal metrics weakened at a faster pace than that of its peers in previous years, fiscal strength is becoming less effective in offsetting the country's longstanding weak credit attributes when compared to similarly rated sovereigns (e.g., limited economic diversification, high dependence on commodities, lower GDP per capita and relatively large economy-wide external debt).

SECOND DRIVER: MEDIUM-TERM GROWTH PROSPECTS REMAIN MODEST AND POLITICAL AND FISCAL POLICY UNCERTAINTY RELATED TO CONSTITUTIONAL REFORM REMAINS

The Chilean economy expanded by 12% in real terms in 2021, making it one of the fastest emerging market economies to recover and surpass its pre-pandemic output levels. However, the strong recovery was driven by unsustainable private consumption, which was spurred by a combination of withdrawals from pension savings accounts and government fiscal stimulus. Moody's expects GDP growth to slow significantly to about 2% in 2022 and be flat (0%) in 2023 as domestic demand declines, driven by tightening fiscal and monetary policy measures. Additionally, high inflation is eroding households' purchasing power and political uncertainty around the constitutional reform process is adversely affecting near-term private investment prospects.

Chile has the largest reserves of copper and lithium in the world and stands to gain from the global transition toward a green economy. Nonetheless, the country faces structural challenges, including low productivity growth in both the mining and non-mining sectors. Average annual GDP growth has been on a declining path over the past three decades. From the late 1990s to the mid-2000s, real GDP growth of 4%-5% was supported by well-anchored inflation expectations and the signing of free trade agreements that opened trade and led to strong productivity gains. During the 2006-13 period, growth benefited from high copper prices and held steady at around 4%. However, according to Chile's central bank, the economy's current medium-term growth potential has declined to around 2.8% and estimated non-mining trend GDP growth has fallen to a range of 2.4%-3.4% for the period 2021-30, reflecting weaker mining and non-mining sector productivity.

Chile's sociopolitical consensus has shifted in favor of higher government social spending following mass protests and social unrest in 2019 that triggered a constitutional reform process, which remains unresolved following rejection of the proposed new constitution in the September 4 plebiscite. Uncertainty will linger until a process for drafting and implementing a new constitution is clearly defined. Moody's expects the Boric administration to work with Congress and reach an agreement on the next steps of the constitutional reform process, which will likely extend well into 2023 and potentially beyond. Investment sentiment is likely to remain subdued until the process is more clearly defined and political consensus emerges.

The likelihood of fundamental changes to Chile's institutional framework has declined given rejection of the draft constitution and broad support for preserving key elements of Chile's economic model.  In Moody's view, the next attempt at constitutional reform is likely to be more narrowly focused and orderly, demonstrating the strength of Chile's institutions and governance framework, a key supporting feature of the sovereign credit profile.

RATIONALE FOR THE STABLE OUTLOOK

The stable outlook balances the fiscal and economic pressures that Chile faces with Moody's expectation that the authorities will be willing and able to adopt policies that preserve macroeconomic and financial stability over the medium term. Chile's credit profile retains important credit features, including strong institutions that over the years have allowed the authorities to maintain fiscal prudence, resulting in governance and overall policy effectiveness scores that are in line with, or above those of, similarly rated peers. Faced with rising social demands, Chile's institutions are expected to effectively navigate socioeconomic and political challenges, including the next attempt at constitutional reform. Moody's expects the constitutional reform process to continue well into 2023 and potentially beyond, ultimately resulting in a new constitution that will expand social rights, helping to mitigate sociopolitical risks.  

The stable outlook also considers contained external risks. Moody's assessment of Chile's susceptibility to event risk, driven by external vulnerability risk, reflects significant growth in private external debt. At around 75% of GDP in 2021, the country's external debt exposure is mitigated by the fact that a significant amount is related to foreign direct investment and intercompany lending. Moody's assessment of the country's susceptibility to event risk is also informed by limited exposure to banking sector risk and its favorable assessment of government liquidity risk, supported by the government's continued access to deep domestic and external funding sources, notwithstanding tighter global financial conditions.

ENVIRONMENTAL, SOCIAL, GOVERNANCE CONSIDERATIONS

Chile's ESG Credit Impact Score is moderately negative (CIS-3), reflecting its moderate exposure to environmental and social risks, driven mostly by high social demands for better quality and more coverage of public services, and strong governance and policy effectiveness that help mitigate the sovereign's susceptibility to these risks.

Moody's assesses Chile's exposure to environmental risks as moderately negative (E-3 issuer profile score), given the country's exposure to physical climate risk because of its low-lying coastal areas, susceptibility to natural disasters and large swathes of land prone to drought and desertification. Chile's adaptation and mitigation efforts related to climate shocks are important mitigating factors to this exposure. Efforts are concentrated in areas such as clean transportation, energy efficiency, renewable energy, land use and climate-resilient management of water resources.

Exposure to social risks is moderately negative (S-3 issuer profile score), reflecting rising social demands. Recent social unrest, which at times has been violent, demonstrates the presence of underlying social discontent and demands for the government to deliver, among other things, higher quality and wider coverage of health and education services, more affordable transportation and housing, and higher pension payouts.

Chile's strong governance framework has demonstrated its proactive ability to manage economic and sociopolitical shocks, thereby serving as a credit benefit (G-1 issuer profile). Chile's sound framework of governance and record of prudent macroeconomic and fiscal policies are key factors underpinning the assessment of its institutions and governance strength, as well as the strength of its executive, legislative and judicial systems.

SUMMARY OF MINUTES FROM RATING COMMITTEE

GDP per capita (PPP basis, US$):  26,713 (2021)  (also known as Per Capita Income)

Real GDP growth (% change):  11.7% (2021)  (also known as GDP Growth)

Inflation Rate (CPI, % change Dec/Dec):  7.2% (2021)

Gen. Gov. Financial Balance/GDP:  -7.7% (2021)  (also known as Fiscal Balance)

Current Account Balance/GDP:  -6.4% (2021)  (also known as External Balance)

External debt/GDP:  75.4% (2021)

Economic resiliency:  a2

Default history:  No default events (on bonds or loans) have been recorded since 1983.

On 12 September 2022, a rating committee was called to discuss the rating of the Chile, Government of. The main points raised during the discussion were: The issuer's economic fundamentals, including its economic strength, have not materially changed. The issuer's institutions and governance strength, have not materially changed. The issuer's fiscal or financial strength, including its debt profile, has materially decreased. The issuer's susceptibility to event risks has not materially changed.

FACTORS THAT COULD LEAD TO AN UPGRADE OR DOWNGRADE OF THE RATINGS

Upward pressure on the rating could emerge if fiscal consolidation proves effective in durably reversing the buildup of government debt registered over the last five years and government financial buffers increase significantly. A sustained increase in Chile's medium-term growth prospects, supported by government policies that increase total factor productivity and promote economic diversification, could also exert upward pressure on the rating.

Negative credit pressures could emerge if the effectiveness and credibility of macroeconomic policymaking were to deviate from its track record of prudent fiscal and monetary policy management. A more rapid deterioration of government debt metrics, caused by wider-than-expected fiscal deficits, or the materialization of contingent liabilities, would also be credit negative.

The principal methodology used in these ratings was Sovereign Ratings Methodology published in November 2019 and available at https://ratings.moodys.com/api/rmc-documents/63168. Alternatively, please see the Rating Methodologies page on https://ratings.moodys.com for a copy of this methodology.

The weighting of all rating factors is described in the methodology used in this credit rating action, if applicable.

REGULATORY DISCLOSURES

For further specification of Moody's key rating assumptions and sensitivity analysis, see the sections Methodology Assumptions and Sensitivity to Assumptions in the disclosure form. Moody's Rating Symbols and Definitions can be found on https://ratings.moodys.com/rating-definitions.

For ratings issued on a program, series, category/class of debt or security this announcement provides certain regulatory disclosures in relation to each rating of a subsequently issued bond or note of the same series, category/class of debt, security or pursuant to a program for which the ratings are derived exclusively from existing ratings in accordance with Moody's rating practices. For ratings issued on a support provider, this announcement provides certain regulatory disclosures in relation to the credit rating action on the support provider and in relation to each particular credit rating action for securities that derive their credit ratings from the support provider's credit rating. For provisional ratings, this announcement provides certain regulatory disclosures in relation to the provisional rating assigned, and in relation to a definitive rating that may be assigned subsequent to the final issuance of the debt, in each case where the transaction structure and terms have not changed prior to the assignment of the definitive rating in a manner that would have affected the rating. For further information please see the issuer/deal page for the respective issuer on https://ratings.moodys.com.

For any affected securities or rated entities receiving direct credit support from the primary entity(ies) of this credit rating action, and whose ratings may change as a result of this credit rating action, the associated regulatory disclosures will be those of the guarantor entity. Exceptions to this approach exist for the following disclosures, if applicable to jurisdiction: Ancillary Services, Disclosure to rated entity, Disclosure from rated entity.

The ratings have been disclosed to the rated entity or its designated agent(s) and issued with no amendment resulting from that disclosure.

These ratings are solicited. Please refer to Moody's Policy for Designating and Assigning Unsolicited Credit Ratings available on its website https://ratings.moodys.com.

Regulatory disclosures contained in this press release apply to the credit rating and, if applicable, the related rating outlook or rating review.

Moody's general principles for assessing environmental, social and governance (ESG) risks in our credit analysis can be found at https://ratings.moodys.com/documents/PBC_1288235.

At least one ESG consideration was material to the credit rating action(s) announced and described above.

The Global Scale Credit Rating on this Credit Rating Announcement was issued by one of Moody's affiliates outside the EU and is endorsed by Moody's Deutschland GmbH, An der Welle 5, Frankfurt am Main 60322, Germany, in accordance with Art.4 paragraph 3 of the Regulation (EC) No 1060/2009 on Credit Rating Agencies. Further information on the EU endorsement status and on the Moody's office that issued the credit rating is available on https://ratings.moodys.com.

The Global Scale Credit Rating on this Credit Rating Announcement was issued by one of Moody's affiliates outside the UK and is endorsed by Moody's Investors Service Limited, One Canada Square, Canary Wharf, London E14 5FA under the law applicable to credit rating agencies in the UK. Further information on the UK endorsement status and on the Moody's office that issued the credit rating is available on https://ratings.moodys.com.

Please see https://ratings.moodys.com for any updates on changes to the lead rating analyst and to the Moody's legal entity that has issued the rating.

Please see the issuer/deal page on https://ratings.moodys.com for additional regulatory disclosures for each credit rating.


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