For many years, Chile has wanted to move away from its large dependence on copper, which accounts for roughly a third of its current account revenues. In the past months, the price of copper has fallen to its lowest level since mid-2017 (see graph). President Sebastián Piñera’s centre-right coalition aims to diversify the country’s economy, by shifting away from copper and becoming a regional financial centre. To achieve this goal, the coalition introduced a tax reform bill in the Senate. In parallel, the central bank of Chile is trying to gain admission for the Chilean peso to the CLS (originally Continuous Linked Settlement), a US financial institution that settles more than half of the world’s foreign exchange transactions. If the process is successfully completed, which is likely to happen by 2021, the Chilean peso would be the first South American currency to be settled via CLS.
The price of copper has dipped sharply due to the decreased demand of China, the main consumer of the red mineral. Indeed, China’s economic growth is slowing due to the country’s deleveraging policy and the trade war between the USA and China. As Chile’s current account revenues and fiscal revenues rely on copper incomes, the country is being hurt. Though the public finances are relatively healthy, the impact on the current account balance and external debt is particularly worrisome. The current account balance has been in deficit since 2011 and has been on the rise in the past 3 years. Besides, this deficit (of 3.1% of GDP in 2018) is likely to widen in 2019. Nominal external debt and debt service have been swelling in the past years (see graph 2). Therefore, efforts towards the diversification of the economy are necessary.
The wish to transform the country into a regional financial centre is a step in the right direction. Chile’s main competitive advantages to bring about this shift are its very solid institutional framework, deep local financial markets and the stable political situation. However, Piñera’s lack of a majority in Congress can delay the reforms. Furthermore, the effects of the diversification are expected to be felt only in the long term. Therefore, in the coming years, the country is likely to remain very vulnerable to fluctuations in copper prices.
The outlook is stable for the short-term political risk. It is currently in category 2/7 based on the country’s relatively low short-term debt and its healthy level of foreign exchange reserves (covering almost 4.5 months of imports in January 2019). Credendo’s MLT political risk is in category 3/7. The biggest downside risks are the rising global trade tensions between China and the USA. Furthermore, the volatility of financial markets and emerging market exchange rates could put pressure on the already elevated external debt and external debt service of Chile.
Analyst: Jolyn Debuysscher – J.Debuysscher@credendo.com