Bad news received the Chilean economy on the eve of the National Holidays. After more than four years without movement, Moody’s Investors Service lowered Chile’s long-term issuer and senior unsecured debt ratings to “A2” from “A1” on Thursday where it had been since July 2018.
Along with this, the credit rating agency lowered to (P) A2 from (P) A1 the provisional rating of long-term senior unsecured debt in foreign currency, and changed the outlook to “stable” from “negative”.
The main rationale behind this setting were the “fiscal trends that have gradually but persistently weakened Chile’s credit profile”reads a statement.
The agency recalls that although the country faced the outbreak of covid-19 with a debt lower than that of its peers and with fiscal reserves, “its debt burden had been constantly increasing before the crisis and the pandemic exacerbated the tendency to rise”.
The letter states that “the decisive rejection” of the country to the new Constitution indicates that “the political consensus has probably shifted in favor of more modest changes in Chile’s sociopolitical and economic arrangements, after the social unrest that began in 2019.” But, he emphasizes that “the process of constitutional reform remains unresolved and will likely lead to a structural increase in spending at a time when medium-term growth prospects remain modest.
The team led by William Foster hopes that the national authorities “remain committed and demonstrate their effectiveness in maintaining macroeconomic and financial stability throughout the constitutional reform process.”
They warn that “uncertainty will persist until the process of drafting and implementing a new constitution is clearly defined”, and that “investment sentiment is likely to remain subdued until the process is more clearly defined and political consensus emerges”. In addition, they hope that the new process will continue until “well into 2023 and potentially beyond, finally giving rise to a new Constitution that will expand social rights, helping to mitigate socio-political risks at the cost of greater social spending.”
Regarding the content of the eventual next Magna Carta, they point out that “the likelihood of fundamental changes in Chile’s institutional framework has diminished, given the rejection of the draft Constitution and the broad support for the preservation of key elements of the Chilean economic model.”
Along these lines, they suggest that “the next attempt at constitutional reform is likely to be more focused and orderly, demonstrating the soundness of Chile’s institutions and governance framework, a key feature that supports Chile’s sovereign credit profile. ”.
Fiscal consolidation
Although the rating agency acknowledges that “the government has emphasized its commitment to fiscal consolidation and has taken measures that have led to a material correction of the fiscal accounts in 2022”, it also warns that “the political economy underlying the growing pressures of the social spending will pose challenges to these efforts in the coming years.”
Although Moody’s considers the potential higher tax revenues as a result of the tax reform promoted by the government, it also anticipates that the burden of the debt continues to increase from the current 36%, to exceed 40% in the medium term and “gradually approaching the A-rated peer group median.”
The report also finds that the government’s financial reserves have decreased and the proportion of debt in foreign currency has increased. Sovereign financial assets fell to around 5% of GDP in June 2022 from around 8% in 2020, after being withdrawn during the pandemic, it details.
The rating agency notes that “the stable outlook balances the fiscal and economic pressures facing Chile with Moody’s expectation that the authorities will be willing and able to adopt policies that preserve macroeconomic and financial stability in the medium term.”
They highlight that Chile’s credit profile maintains “significant credit characteristics, including strong institutions that over the years have allowed the authorities to maintain fiscal prudence, which has led to overall governance and policy effectiveness scores.” that are in line with, or above, their similarly rated peers”.
Future actions?
Moody’s indicates that the rating could come under upward pressure if fiscal consolidation “proves to be effective in lastingly reversing the build-up of debt recorded in the last five years and the financial buffers of the government increase significantly”. Added to this would be “a sustained increase in Chile’s medium-term growth prospects, supported by government policies that increase total factor productivity and promote economic diversification.”
On the contrary, the pressures could be negative “if the effectiveness and credibility of macroeconomic policy were to deviate from its record of prudent management of fiscal and monetary policy”, or “a more rapid deterioration of public debt metrics”. , caused by larger than expected fiscal deficits, or the materialization of contingent liabilities”.
Financial Journal-RIPE