Fitch Ratings, the international rating agency, today upgraded Chile's long-term foreign currency sovereign rating to 'A' from 'A-', reflecting improvements in growth prospects and ongoing reductions in government debt underpinned by fiscal surpluses. The country ceiling was raised to 'A+' from 'A', and the long-term local currency sovereign rating was affirmed at 'A+'. The short-term foreign currency rating is 'F1'. The Outlook on the ratings is Stable.
'The general government surplus of 1.7% of GDP in 2004 demonstrates that Chile's structural fiscal balance rule is working, allowing the government to pay down debt during periods of faster growth while leaving space for some counter-cyclical easing when the economy slows,' said Roger M. Scher, head of Latin American Sovereign Ratings at Fitch. Chile has benefited from high copper prices over the past year, contributing to 6.1% economic growth in 2004 and expectations that growth could exceed 5% again this year. Copper-related revenues above trend prices supported debt prepayment of $1.1 billion through the Copper Compensation Fund and helped reduce general government debt to 31% of GDP from 34% of GDP at the end of 2003.
While GDP and export growth have clearly benefited from high copper prices, there are signs that the improvement is broad-based and that above-average growth is likely to continue over the medium term. Export growth was 13% last year, but domestic demand also rose 8%, supported in part by recent gains in employment. Furthermore, growth in industrial exports exceeded growth in copper exports, indicating that more labor-intensive Chilean companies remain competitive despite the appreciation of the peso over the past year. In dollar terms, noncopper exports rose 23% in 2004. Looking forward, the benefits of trade and investment agreements with a broad range of countries are expected to help advance ongoing diversification of export products and markets.
Political consensus in support of orthodox economic policies among parties from a wide ideological spectrum minimizes the potential for policy volatility related to the December presidential and legislative elections. Chile was the first country to adopt sweeping market reforms 25 years ago, and these policies have been sustained and deepened through three democratically elected governments. A capital markets reform law that would improve financial sector regulation is before the legislature this year and is likely to be approved, but no other substantive changes in economic policy are expected in the run-up to the election. The OECD has recommended certain changes to labor law to reduce informality and promote greater participation by women and young people, but these are not likely to be considered this year.
Gross external debt equal to 107% of broad exports is in line with peers, but Chile has higher external debt net of international reserves and bank foreign assets at 61% of broad exports, compared with just 8% among similarly rated sovereigns. When outward external equity and direct investments are considered, however, Chile's net international investment position does look somewhat better. Also, less than 20% of gross external debt is short-term, a share that is considerably lower than most 'A' range sovereigns. Looking forward, continued growth in exports and development of local capital markets should support reductions in net external indebtedness, but rapid declines are not expected.
Economic performance is expected to be solid over the medium term, but the Stable Outlook reflects certain limits to further improvements in creditworthiness. Chief among these is the above-average level of net external debt. Substantial indexation of government debt, including central bank debt, to prices and the exchange rate is also a constraint on the local currency rating at current levels, as it precludes monetization. Sustained rapid growth in exports would help address both of these concerns, as it would support the accumulation of external assets and the repayment of dollar-denominated central bank obligations.