Country Risk Analysis: Republic of Chile

1
Country Risk Analysis Republic of Chile

• Based on a country risk report by
• Alina Maria TANASA
• Dalis CHHORN

Last updated on April 2002
2
Outline

• I Country Snapshot
• II Political Social Setting
• III Economic Performances Structural Issues
• IV Fiscal, Monetary Exchange Rate Policies
• V Balance of Payments
• VI Debt Analysis
• VII Rating Rankings
• VIII Strengths Weaknesses
• IX Country Risk Overview

3
Geography

• Chile - where the land ends
• Area - 756,950 sq. km
• Arable land - 7
• Coastline 6,435 km
• Chile - extravaganza of crazy geography
• North - the Atacama Desert
• Center - thickly populated valley with most of
  Chiles arable land (Mediterranean climate)
• South - Punta Arenas
• Natural resources copper, timber, iron,
• ore, nitrates, precious metals, molybdenum

4
People
Chile's capital, Santiago

• Population - 15,328,467 (July 2001)
• Growth rate 1.13 (2001)
• 90 mestizo, 5 Indians, 5 European descendent
• Capital city Santiago (population 5.2 million)
• Large cities Concepción, Viña del Mar
• Rural population 15
• Life expectancy 75.94 years
• Illiteracy rate 4.8 (Latin America 12)

5
Culture Religion

• Culture an intoxicating blend of the many
  influences that have shaped it
• two Nobel Prize winning poets
• a leader in the world of folk music
• Religions Roman Catholic 89, Protestant 11,
  small Jewish and Muslim populations
• Language Spanish and a handful of native
  languages, including Aymara, Mapulche and Rapa Nui

6
History

• 1520 - Ferdinand Magellan landed in Chile
• 16th century - Spanish Settlement despite fierce
  resistance from the Indian tribe of the
  Araucanians
• 1810 - Independence from Spain
• Sept. 18, the Chilean Independence Day
• 1879-83 - War of the Pacific (Peru Bolivia)
• First half of the 20th century - the political
  climate swing between right and left

7
Pinochet Leader of the bloodiest coup in
20th-century Latin America
History

• 1960s - the social reforms were successfully
  instituted by the Christian Democrats
• 1970 - The Allende Regime
• 1973-1989 - Pinochet Government
• 1990s - Civil Rule Restored
• March 2000 - Ricardo Lagos, the first socialist
  president to run the country since Allende
• 2001 Pinochets trial

8
II Political Social Setting

• Constitution - September 1980
• based on the Spanish law
• some influences from the French and Austrian
  laws
• Elections since 1989, fair and open
• Next presidential election 2006
• Administrative divisions
• 12 Regions the capital
• Provinces (Governor)
• Municipalities (Mayor or Alcalde)

9
Government

• Republic with Executive, Legislative and Judicial
  branches
• Main political actors
• The center-left Concertacion from socialists to
  center Christian Democrats
• The center-right opposition coalition of Alianza
  por Chile

10
Political actors

• Concertacion
• Christian Democrat
• Socialist
• Party for Democracy
• Radical Social Democrats
• Alianza por Chile
• Independent Democratic Union
• National Renovation

• Pressure Groups
• The Roman Catholic Church
• University student federations at all major
  universities
• United Labor Central (CUT)
• The Army

11
Executive branch

• President Ricardo Lagos Escobar
• since March 2000 (the president is both the
• chief of state and head of government)
• Economic reforms
• capital market and capital account liberalization
• improved corporate governance
• labor market reforms
• unemployment insurance
• fiscal consolidation
• state modernization and decentralization
• public health educational reforms

12
Legislative Judicial branches

• Bicameral National Congress
• Last elections - December 2001
• Judicial Branch
• The Supreme Court (Corte Suprema)
• A series of appellate and lower courts

13
Legislative Judicial branches

• Outcomes of the December elections
• The weakening of the governing Concertacion
• The shift in votes from the center Democracia
  Cristiana party to the right-wing Union
  Democratica Independiente
• gt With no elections until 2004, the direction of
  political economic policies will most likely
  become more consensus-based

14
Social Issues

• Poverty - reduced to half throughout the 1990s
• strong economic growth well directed social
  programs
• LAs 3rd highest income/capita on a purchasing
  power basis (GNP/capita was 8410 PPP dollars in
  2001, the regional average was 6052 PPP dollars)
• Decreased from 46 in 1987 to 21 in 2001
• Currently 11 of salaried workers receive minimum
  wage
• Income Disparity
• income/capita one of the least equitably
  distributed in LA
• Gini coefficient 56.5 (out of a total of 100,
  with zero representing complete income equality)

15
Social Issues

• Labor codes changes
• September 2001 after 2 years of debate,
  legislation modifying the labor code was approved
  by the Congress
• Main changes introduced by the reform
• Labor unions of different companies will be
  allowed to negotiate collectively if the owners
  agree
• The maximum hours worked during a week were cut
  from 48 to 45 from 2005
• The introduction of part-time work contracts and
  work-training contracts gt encouraging employment
  of youths

16
Social Issues
Unemployment persistence
Government job creation - 150,000

• held down private consumption (grew only by 2
  in 2001)
• declined to 8.9 2001Q4 from 9.7 in the
  previous quarter

17
Social Issues

• Military power
• International disputes
• short section of the southern boundary with
  Argentina is indefinite
• Bolivia has wanted a sovereign corridor to the
  South Pacific Ocean since the Atacama area was
  lost to Chile in 1884
• dispute with Bolivia over Rio Lauca water rights
• territorial claim in Antarctica (Chilean
  Antarctic Territory) partially overlaps Argentine
  and British claims

18
Social Issues

• Military power
• Designates four of the nine appointed senators
  every eight years
• Maintains distinct pension and health insurance
  systems
• The budget for the three armed services is pegged
  to a 1989 level of about 3bn and is adjusted for
  annual inflation (about 4.5 of GDP)
• 10 of the annual earnings of the state copper
  company Codelco (0.4 of GDP) are set aside for
  military acquisitions

19
III Economic Performances

• Unlike most of Latin America, Chile is
  experiencing a deceleration rather than an
  outright halt to growth
• Weaker economic performance reflected
• a deterioration in Chiles terms of trade and in
  global import demand
• uncertainty generated by Argentinas financial
  crisis
• weak domestic demand
• gt These factors are likely to slow growth into
  the first half of 2002 before a moderate upturn
  is foreseen in the second half

20
Structural Issues

• Privatization
• Most of Chiles state assets were privatized in
  the 1970s and 1980s, beginning with banks and
  manufacturing firms in 1974-79, and followed by
  telecoms, electricity, and steel production in
  1984-89 (large role of the debt/equity swaps)
• State ownership of economic assets ( 34.5 of
  GDP at end-2000) includes 100 ownership of
• Banco del Estado, Chiles fourth largest bank
• Codelco, the copper producer
• Enap, the oil and gas monopoly
• Enami, a copper processing concern
• the postal service and some railways

21
Structural Issues

• Privatization
• Future privatizations could take the form of
  concession sales through the states
  public-private partnership program
• Since 1995 the government has awarded contracts
  for 30 projects, primarily highways and
  airports, generating 5.1bn
• The government presented a portfolio of
  concession sales in infrastructure projects and
  prisons that could provide 3.1bn over 2001-2003

22
Structural Issues

• Banking system
• Chile's banking sector is the soundest and most
  solid in all of Latin America (credit strength)
• The Central Bank is autonomous from the
  government
• The only state-owned bank is the Banco del Estado
• Chile has the highest banking penetration in
  Latin America
• Private banks handle nearly all corporate
  business
• The largest Chilean bank is the new Banco Chile
  (Banco de Chile merged with Banco Edwards)
  followed by Banco Santiago and Banco Santander
  Chile

23
Structural Issues

• Banking system
• Provisioning and asset quality are comparable to
  OECD country banking sectors
• Strong prudential regulations and extensive
  disclosure requirements developed after the
  1982-84 banking crisis are enforced by an active
  banking superintendency
• Chile's financial system remained solid despite
  adverse domestic and external conditions, in part
  because of strong supervision

24
Structural Issues

• Tariffs Trade - low level of protectionism
• Over the last two decades - unilateral tariff
  reductions brought rates from approximately 75
  to a flat rate of 9 by 2001, with the
  concomitant elimination of non-tariff barriers
• In 1998, the government approved a schedule to
  reduce tariffs to 6 by 2003 by lowering tariff
  levels by 1 per year
• Opted not to enter NAFTA in 1998

25
Structural Issues

• Tariffs Trade
• Has tariff preferences granted by bilateral trade
  accords with Canada, six Latin American
  countries, and associate status in Mercosur
• Efforts to sign bilateral free trade agreements
  with the EU and the US
• Negotiations with Central America countries and
  Korea
• Negotiations with the US may be completed by
  early 2002

26
Structural Issues

• Capital market reforms
• November 2001 Chile advanced the liberalization
  of its domestic capital market gt Additional
  reforms
• Elimination of the 15 capital gains tax levied
  on heavily traded stock bond transactions
• Elimination of the 4 tax paid by Chilean banks
  when repatriating interest earned on foreign
  credits
• Tax exemptions on income earned from selected
  savings investments
• This will help to
• Promote savings
• Stimulate investment financing
• Encourage competition

27
IV Fiscal Policy
Conservative (sustained macroeconomic stability
significant poverty reduction) Austerity gt
reflected in general government surplus
throughout much of the 1990s
28
Fiscal Policy

• 2000 - Logos administration, in order to
  strengthen the fiscal position in line with his
  promises, pursued a prudent fiscal policy
• gtdefined its objective in terms of structural
  balance of the central government (can be
  adjusted for cyclical developments), with an
  annual surplus of 1 of GDP to be first achieved
  in 2001 and then maintained
• 2001 Tax changes approved by the Congress
• Individual income tax rates were reduced from 45
  to 43
• Corporate rates raised from 15 to 16 (2003
  17.5)
• Restrictions on the use of accelerated
  depreciation
• gt the general Government deficit 1 of GDP

29
Fiscal Policy

• Pension system
• 1981 landmark reform Pension privatization
• gt the state-run pension system transformed into
  a private system (AFPs)
• Deficit between the declining number of
  contributors and those still receiving pensions
  under the old system
• Transition cost 3.2 of GDP since 1981,
  financed by taxes
• January 2002 - the AFPs won the right to manage
  the insurance accounts to offer investors five
  types of funds (instead of two) with varying risk
  profiles

30
Monetary Exchange Rate Policy

• 1. Interest Rates
• Chiles independent Central Bank
• Since August 2001, it targets the daily interbank
  nominal interest rate
• Manages short-term liquidity primarily by using
  repurchase agreements, open market operations
  credit lines
• Reasons
• Reduce volatility in the exchange rate
• Lower short-term nominal interest rates
• More suitable for a flexible exchange rate regime
• Provide greater transparency

31
Monetary Exchange Rate Policy

• 2. Inflation
• Chile inflation-targeting framework (target band
  is 2 - 4)
• 2001 inflation lt 3 despite the depreciation in
  the peso, due to a slower than expected recovery
  in domestic demand

2001- was at the second lowest point since 1938
32
Monetary Exchange Rate Policy

• 3. Exchange rate
• September 1999 - freely floating exchange rate
• 2001 the nominal exchange rate came under
  pressure due to
• Lower copper prices
• Reduced domestic growth
• Continuing uncertainty about Argentina
• August 2001- the Central Bank intervened to
  support the peso
• Sold 700mn of its foreign reserves
• Issued 2bn USD-indexed bonds

33
Monetary Exchange Rate Policy

• In 2001, the peso depreciated about 14 against
  the dollar, largely as a consequence of contagion
  from Argentina and lower cooper prices.

The currency strengthen since November as a
result of the central bank intervention growing
sector differentiation from Argentina.
34
V Balance of Payments

• Current account balance
• Trade balance
• Non-debt creating flows
• FDI
• Portfolio equity investment
• Net errors and omissions
• International reserves

35
Current account balance
36
Trade Balance
Trade is important for Chile but it is not the
only sectorthat Chile relies on.
37
Trading Partners
38
Exports structure
39
Export percentage of GDP

• Chile is a big player in the copper global
  market 42 of world copper production
• Codelco state-owned copper company that holds
  70 of national production
• Canada is the largest single investor in copper

40
Imports structure
?Chile is vulnerable to the oil price changes
41
Trade balance

• Falling prices of copper and agriculture products
  exported matched with the falling price of the
  oil imported
• Depreciation of the peso in 2001 helped to
  increase non-traditional goods exports in 2002 ?
  off-set the deterioration in terms of trade

42
Foreign Direct Investment
43
Foreign Direct Investment

• From 1994 to 2000
• Large inflows in mining, services, energy,
  banking, transport and telecom
• Large outflows to US and other Latin American
  energy and financial service sectors
• ? Outflows 1bn in 2001
• 2001 boost in FDIs ? sales of domestic telecom
  and electric companies
• 2002 most of the state-owned companies are
  already privatized adding with poor mining prices
  gt FDIs will decrease

44
Foreign Direct Investment
45
Foreign Direct Investment
Mining is the largest sector for FDIs
46
Net Errors and Omissions
In millions of USD
Source IIF

• No capital flight ? investors have confidence in
  the Chilean market
• No under or over invoicing

47
International reserves
Foreign reserves fell by 0.5 billion in 2001
because of the central bank interventions in the
foreign exchange market to limit the depreciation
of Peso triggered by the crisis in Argentina.
48
Debt Analysis

• Composition of the debt bydebtors, creditors,
  maturity, currency interest
• Financial position in the IMF
• London Club claims
• Debt swaps
• Bond market
• Liquidity Solvency ratios
• Amortization schedule

49
Composition of debt by debtors

• Chiles external debt is low (37,790 mil
  end-2001) compared to other LAC
• gt less dependent on the debt
• gt less vulnerable to swings in external
  financing
• 1990s - the growth in corporate debt accounted
  for virtually all the expansion in Chiles gross
  external debt
• Currently, 85 of Chiles external debt is owed
  by the private sector, sharply up from 31 in
  1991 and 53 in 1993
• Chiles lower country risk and better
  institutional framework gt large Chilean
  corporates have successfully accessed credit
  abroad

50
Composition of debt by debtors
51
Composition of debt by creditors- medium and
long-term debt -

• Commercial banks represent the most significant
  source of external financing (43 of total MT
  LT external debt at end-2001)
• International bond issuance (up from 2 of
  medium- and long-term debt in 1993 to 34 in
  2001) has gradually displaced borrowing from
  multilateral organizations (fell from 28 in 1993
  to 4 in 2000 )

52
Composition of debt by creditors- medium and
long-term debt -
53
Composition of debt by maturity

• 83 of the total external debt stock is medium
  and long-term in nature

54
Composition of debt by maturity

• Only 32 represents original
• ST liabilities in 2001

Duration of 4.2 years at the end of 2000
55
Composition of debt by currency and by interest
96 of debt denominated in USD
63 of the debt at floating rate
56
Financial position in the IMF - February 28,
2002 -

• No financial arrangement with IMF since 1990 gt
  Chile has current account sustainability
• Althoungh, now Chile has a CA deficit, it is
  expected to decrease in 2003 and to convert to
  surplus in 2004 due to the increases in export
  earnings

57
London Club claims
From BIS, the total claims from London Club at
the end of Sep. 2001 are 42.457 bn including 47
from Spain, 17 from the US and 7 from
Germany. There is a discrepancy between the BIS
data and the Central Bank of Chile regarding the
total external debt.
58
London Club claims
59
Debt swaps

• Chile established the first institutionalised
  debt-equity swap in May 1985
• It had been able to retire 10.1bn through debt
  swaps between 1985-1990

60
Debt swaps
Chile retired almost 70 of its debt
gtSignificant enough to reduce the debt burden
gtPromote foreign direct investment it
converted the countrys debt to equity via
privatisation gtStrengthened the private sector
finance gtHelped Chile to be able to return to
the international capital markets
61
Bond market

• Amount outstanding at Dec. 2001 US 6 billion

62
Bond market

• US 2.9 billion bonds were issued during 2001
• US1.6 billion issued to finance the investment
  in electricity, telephone, forestry and highway
  concession projects
• US 650 million issued by the government with
  the yield of 7.2 (256 bp over the US treasury)
• gtHelp to finance the central banks
  interventions in the foreign exchange market
• gtCompensate the decline in the governments
  revenues due to the decrease in the copper price

63
Bond market

• The Chilean bond spreads have not been affected
  by the rising risk aversion towards the emerging
  markets and the worsening of Argentina crisis
• The spreads on the 500 million bond issued in
  1999 fell to 170bp at the end of January 2002
  from 221bp at the beginning of 2001

Bond spreads
64
Bond market

• Chile intended to sell 550 million international
  10-year bonds this year in order to take
  advantage of the decline in the borrowing rate gt
  refinance the debt
• Coupon 7.125
• Spreads 115 bp over the US treasury (the spreads
  of Mexico and Brazil are 2.41 and 6.99
  respectively)
• The spread fell due to
• Expected economic growth of Chile ( 3.2 growth
  in 2002)
• The economic strengthen in the US, Chiles
  biggest trading partners

65
Liquidity ratiosCurrent Account to GDP ()
A negative CA balance, but a better ratio
compared to other LAC or A category sovereigns
66
Liquidity ratiosCurrent Account to GDP ()
67
Liquidity ratios Budget deficit / GDP ()

• General government budget surplus throughout
  much of the 1990s
• March 2000 1 structural surplus - the
  government targeted a 1 of GDP structural
  surplus for 2001-2005
• 2001 the general government deficit 1 of GDP
  and in 2002 it is likely to reach 2 of GDP gt
  negative impact on the ratings

68
Liquidity ratios Reserves / Imports per month
Brazil 8 months Mexico 3 months
Chiles import cover 10 months
69
Liquidity ratios Debt Service Ratio
Chiles debt service ratio as a percentage of
foreign exchange receipts (exports of goods
services) was 33 in 2001 and it is expected to
rise to 35 in 2002
70
Liquidity ratios Interest Ratio
Chiles interest ratio as a percentage of foreign
exchange receipts (exports of goods, services
income) was 7.9 in 2001 and it is expected to
decrease to 6.1 this year
71
Solvency ratios External debt / GDP ()

• Chiles external debt as a percentage of GDP
  increased steadily since 1997
• In 2001 the ratio was 58
• It tends to be toward the higher range of A
  category sovereigns

72
Solvency ratios External debt / Exports ()
Compared with other LAC, Chiles ratio is better
than Brazils ratio, but Chile should improve it.
73
Solvency ratios External debt / Exports ()
Compared with other A category sovereigns,
Chiles ratio is decreasing, but not as much as
the median rate.
74
Solvency ratios ST debt / Reserves ()
Chiles international reserves are a good cushion
to external shocks, although the ratio is
increasing steadily.
75
Amortization schedule

• Concentrated in 2001-2003 reflecting the sizable
  increase in the non-bank private debt contracted
  in 1996-1999
• Amortization requirements of the public sector,
  by contrast, are moderate and will steadily
  decline

76
Debt Analysis - Conclusion

• Chiles moderate external debt burden is
  characterized by
• Limited central government indebtedness
• Rising private sector debt
• Favorable maturity profile
• Favorable external liquidity compared to other
  Latin American and A- rated sovereigns

77
Ratings (2001)
gt Low country risk
78
Coface Country risk rating 2001
The country rating measures the average corporate
payment default in a given country and indicate
to what extent a companys financial commitments
are affected by the local business, financial and
political outlook. It ranks from low degree of
risk (A1) to high degree of risk (D)
A3 Adverse political or economic circumstances
may lead to a worsening in service payments,
although the probability of a payment default is
still low.

79
Euromoney Country risk (185 countries)
80
EuromoneyGlobal projection rating

• Global projection rating assess the possibility
  of
• economic growth in 185 countries.

81
Corruption Perceptions Index 2001

• Chile 18/91 Ireland
• Germany 20
• France 23
• Japan 21
• U.S 16
• Mexico 51
• Argentina 57
• Brazil 46

The country ranking is related to the
international perceptions of the degree of
corruption as seen by business people, risk
analysts and the general public. It ranges
between 10 (highly transparent and democratic)
and 0 (highly corrupt).
82
Opacity Index 2001

• Singapore
• United States
• Chile
• U.K
• Hong Kong
• Mexico
• Italy
• Hungary
• Uruguay
• Egypt

• Opacity the lack of clear, accurate, formal, and
  widely accepted practices
• CLEAR Corruption, Legal system, Economic
  policies, Accounting guidelines and Regulatory
  frameworks
• By PricewaterhouseCoopers

83
Human Development Index (HDI)
84
Cofaces Index of external payment arrears

• Source COFACE

85
Strengths

• Strong macro-economic fundamentals
• Sound financial system (robust fiscal monetary
  policy)
• Low fiscal and CA deficit
• Moderate external debt
• Low inflation
• Capital market liberalization
• Social consensus in favor of market oriented
  economic policy

86
Strengths

• Net creditor position of the public sector
• Strong external liquidity position
• Enjoys the lowest risk premiums in the region
• The states low level of interference in the
  economy
• Equal treatment provided to local and foreign
  investors
• Rich in natural resources
• Good quality of life and of human resources

87
Weaknesses

• Reduced parliamentary majority of the ruling
  Concertacion alliance after the recent elections
• Military still wields unproportional amount of
  power
• Increasing general government budget deficit
• Increasing private sector debt burden
• Heavy dependence on primary commodity exports
  (copper 40 of total exports low-value-added 62
  of the total exports)
• Small domestic market
• Unemployment persistence
• Marked by excessive social inequality (the upper
  20 of the population holds 60 of the countrys
  wealth)

88
Overall Risk Assessment
Social Political stability
Economic growth prospects
Domestic financial stability
External competitiveness
89
Overall Risk Assessment
Balance of payments sustainability
Debt servicing capacity
Overall MT perspectives
90
Main data sources
www.latin-focus.com www.fr.com www.bloomberg.com w
ww.fitchrating.com www.standardandpoors.com www.mo
odys.com www.coface.com www.transparency.org www.b
radynet.com www.unitar.org www.opacityindex.com ww
w.foreigninvestment.cl

• IMF
• World Bank IDB
• BIS
• UNDP
• The Central Bank of Chile (Banco Central de
  Chile)
• Banco Santander Central Hispano
• Deutsche Bank
• Euromoney
• IIF