Chile: Selected Issues

This Selected Issues paper examines a number of potential factors that may have influenced the short-term behavior of the exchange rate between the Chilean peso and the U.S. dollar during the period of floating exchange rate, including the possible impact of developments in Argentina during 2001. The paper investigates whether copper prices can be successfully forecasted over medium-term horizons, emphasizing the properties of copper prices most relevant in the Chilean context, including for fiscal policymaking. The paper also provides a snapshot of the Chilean banking and corporate sectors.


This Selected Issues paper examines a number of potential factors that may have influenced the short-term behavior of the exchange rate between the Chilean peso and the U.S. dollar during the period of floating exchange rate, including the possible impact of developments in Argentina during 2001. The paper investigates whether copper prices can be successfully forecasted over medium-term horizons, emphasizing the properties of copper prices most relevant in the Chilean context, including for fiscal policymaking. The paper also provides a snapshot of the Chilean banking and corporate sectors.

V. A Note on the Corporate Sector’s Potential Vulnerability69

A. Introduction

152. Given the role of the corporate sector as a source, as well as a transmission channel, of financial crisis in a number of countries in recent years, it is important to be aware of potential fragilities in this sector’s financial position, especially at a time of economic instability in neighboring countries and broader external volatility.

153. Given the importance of the corporate sector in the Chilean economy, it is evident that potential vulnerability in this sector would be closely associated with an economy-wide vulnerability.70 In Chile, the corporate sector (broadly defined as comprising all private sector, non-financial incorporated enterprises) is the dominant user of foreign and domestic financing: it owed more than 80 percent of the country’s external debt at the end of 2001 (itself about 60 percent of GDP), accounted for about 60 percent of total bank credit, and held about 50 percent of total foreign assets at end-2000 (mostly in foreign direct investment and trade credits). The corporate sector is linked also to other sectors of the domestic economy through production, investment, and consumption linkages. Thus, it is essential to assess its financial soundness to monitor aggregate vulnerability.

154. This notes seeks to identify potential vulnerabilities of Chile’s corporate sector to a range of shocks, including particularly financing and exchange rate shocks, by looking at the level and the time-profile of selected balance sheet and cash flow indicators that have turned out to be relatively good predictors of financial distress in other countries—see Stone (2002a and 2002b) and Mulder and Perrelli (2001).71 To place this indicator-based analysis in context, the note provides also a brief overview of the corporate sector’s structural characteristics.

155. The evidence analyzed suggests that the financial position of Chile’s corporate sector is sound overall, with no evident signs of vulnerability and limited exposure to foreign exchange risk. The time profile of some of the indicators considered suggests that this position was even stronger in the mid-late 1990s (apart from exchange rate exposure, which appears to have decreased in recent years); this is an indication that the Asian crisis first, and the less buoyant growth performance later, may have taken some toll on the corporate sector’s financial strength. The evidence suggests also that some economic sectors are potentially more vulnerable than others. These are tentative and partial conclusions in the context of a solid legal framework (including also an effective bankruptcy regime) conducive to healthy domestic financial development, and in the presence of significant foreign ownership, especially in those sectors which appear to be relatively more vulnerable.

156. The analysis is subject to a number of limitations, and thus the conclusions should not be regarded as final. The main limitation is the limited availability of data on a comparable basis across countries. The issues under considerations also are diverse and complex, and it is difficult to produce a comprehensive assessment. Therefore, additional analysis would be needed to grasp more firmly the aggregate implications of the large amount of company data currently available on Chile’s corporate sector. The existence of this information is doubtless an additional strength of the environment in which Chile’s corporate sector operates, and no doubt the company-specific information is continuously processed by market analysts, particularly with a view to judging the value of individual companies’ securities. For questions of economy-wide vulnerability, however, a more aggregated analysis is warranted. In so far as more aggregate information and analysis may help the functioning of markets, there is much scope for further work in this area.

157. The note is organized as follows: section B considers structural characteristics such as the ownership structure, legal framework, and main sources of financing; section C examines balance sheet and cash flow indicators of leverage, profitability, and liquidity; and section D explores the issue of foreign exchange risk exposure.

B. An Overview of Chile’s Corporate Sector

158. Chile’s business sector (including state-owned and financial enterprises) comprises about 500 incorporated large-size enterprises and 500,000 formal micro-, small-and medium-size enterprises (SMEs), according to data from the Superintendencia de Valores y Seguros (SVS) and the National Institute of Statistics.

159. As already mentioned, the corporate sector is here defined as comprising all private sector, non-financial incorporated enterprises, which represent the majority of the universe of 500 incorporated companies. Thus, this definition excludes SMEs and state owned enterprises, as well as private incorporated enterprises operating in the financial sector. While this is not necessarily the only possible definition, it is one that better fits Chile’s specific economic and institutional context and the purpose of the analysis.

160. In Chile, the role of state-owned enterprises is limited and well defined. The public sector controls one commercial bank (Banco del Estado) and three large nonfinancial enterprises with combined assets valued about 13 percent of GDP at end 2000 (most of which belonging to CODELCO, the national copper company); the remaining 31 largest non-financial public enterprises had combined assets valued 6 percent of GDP at end-2000. As a whole, the state-owned enterprise sector is profitable, and it is responsible for less than 10 percent of Chile’s external debt. As regards the SMEs, their financial position is not crucial from a vulnerability perspective given their relatively low level of financial integration with the rest of the economy and that they have no access to international capital markets.72

161. The distribution of Chilean firms across economic sector of operation is broadly in line with that of GDP. Firms in the corporate sectors, however, differ markedly in size, ownership, and financial structure. Hence, we now move on to describe some broad characteristics of this “population,” which are not only relevant to assess vulnerability but also support our choice to focus on a much smaller “sample” in the analysis (based on indictors) in the rest of this chapter (Sections C and D).


162. Ownership in the corporate sector appears to be rather concentrated. Although about 300 different shares were listed on the Santiago Stock Exchange at end-2000 (a high number by international benchmarks), the portion of the these firms’ equity floating on the market is relatively small, suggesting that a large share of the economy’s equity is still “privately” owned.73 The economy’s equity is concentrated in about 40 economic groups or conglomerates with very diversified business interests in the economy, including in the financial sector.74

163. Foreign ownership in the corporate sector is significant, especially in the mining, electricity, and telecommunication sectors. Although it is difficult to aggregate information from company-by-company data to obtain a reliable summary indicator of such ownership, an indirect measure suggests that foreign ownership in the corporate sector might be around 30 percent: only two-thirds of the about 40 conglomerates mentioned above are classified as “national groups” in the local financial press based on company-by-company data from the SVS.75

Legal framework

164. Chile’s corporate sector enjoys a sound legal framework, judged on the basis of international standards. According to a recent worldwide comparison—see Rafael La Porta and others (1996), from which this sub-section is largely based—Chile’s legal framework provides for a relatively effective basic rule of law (in terms of well-defined property rights, enforceability of contracts, and avoidance of corruption) and very strong shareholder and creditor protection.

165. More specifically, according to this evidence, Chile’s “rule of law” score is close to the worldwide average despite the fact that its legal system, as in most of Latin America, derives from French legal tradition, which in turn scores lowest among the four systems considered (the others being Scandinavian, German, and Anglo-Saxon, in decreasing order of performance). Chile’s shareholder and creditor protection, however, is among the highest ranked in the world.76 Corporate governance was strengthened further in the context of the capital market reform in 2001.

166. The broad characteristics of the legal framework describe above are reflected also in Chile’s bankruptcy law, which guarantees strongly creditor rights while featuring some debtor protection mechanisms (Box 1). Guaranteeing creditor rights is necessary to foster financial development, while providing some debtor protection helps to minimize the economic dislocation and the social cost associated with firm failures. Other countries’ experience has shown that an effective bankruptcy regime is a key ingredient of successful strategies aimed at minimizing social and economic costs in the event of a crisis.

Chile’s Bankruptcy Law

An effective bankruptcy regime is conducive to financial development and may help minimize ! the costs of a hypothetical crisis. Chile’s bankruptcy law (last revised in 1982 following a major financial crisis and a failed experiment with a regime more favorable to debtors) provides for strong creditor protection with some safeguard mechanisms for debtors. Overall, the law has functioned well thus far, and it appears adequate also from a vulnerability standpoint. Of course, its ability to handle a large number of cases in a situation of systemic financial distress has never been tested.

Several aspects of the law assure strong creditor protection. It is easy to initiate a bankruptcy proceeding (for instance, just one overdue commercial obligation is a sufficient cause to initiate the procedure in certain cases). Once initiated, the process is predictable, and creditors have strong assurances to realize their claims. It may take time to complete, though (up to three years in extreme cases). Finally, the majority quorums necessary to impose decisions on the minority take into account the interest of both large and small creditors.

Four main safeguard mechanisms protect debtors under the existing law, albeit less strongly than creditors. Before a bankruptcy declaration, a restructuring rather than a liquidation may be agreed upon between the debtor and the creditor through extra-judicial agreements (“convenio extra-judicial”) or preventive judicial agreements (“convenio judicial preventive”). After a bankruptcy declaration, it is possible to guarantee the continuing of activity (“continuidad efectiva de giro”) and the liquidation of the firm as a on-going concern (“venta como unidad operativa”). However, all these mechanisms protect the debtor in the “private” interest of maximizing the recovery value of the creditor’s claim rather than in the “public” interest of preserving the economic value of the firm.

The existing law has served Chile’s economic system well over the past two decades by resolving predictably those cases of illiquidity and/or insolvency that arise in ordinary times. Past and recent highly publicized cases, as well as the worldwide comparison of legal frameworks mentioned in the text of this chapter, do not point to the existence of significant problems.

The existing law appears also adequate from a vulnerability perspective, as it limits the ability of a minority of creditors to veto a restructuring or a liquidation. A qualified majority of creditors can force restructuring or liquidation decisions upon the minority under the debtor protection mechanisms above (except under extra-judicial agreements, which perhaps is the reason why these agreements are rarely used in Chile). Nevertheless, the effectiveness of these mechanisms has never been “stress tested” in an actual crisis context.

Further indicating the absence of major problems with the existing bankruptcy law, a recent proposal for change (being discussed between the government and private sector entities) focuses on improving its functioning and application (to minimize the time needed to complete the process and remove the social stigma attached to it) rather than on introducing a radical overhaul of its basic principles.

Sources of financing

167. Chile’s corporate sector has made significant use of foreign capital through syndicated loans and the issuance of bonds and equities, though use of such financing remains concentrated in a relatively small number of companies—the largest and highest rated companies.77 Foreign direct investment (FDI) remains the main source of foreign capital for most firms in the corporate sector; but even the distribution of FDI is relatively skewed toward the largest companies and concentrated in a few sectors (mining, utilities, telecommunication). Therefore, domestic financial markets have an important role to play to support private investments and growth in “good times” and help smooth adjustments to internal and external shocks in “bad times”, as borne out by a large academic literature on finance and growth and finance and macroeconomic volatility—see, for instance, IDB (1996).

168. The pace of development of domestic credit and capital markets accelerated in the 1990s in Chile, assisted by continued liberalization and prudent regulation supervision, following two decades of intermittent growth. This is shown by a second recent study by Francisco Gallego and Norman Loayza (2000), from which most of the evidence quoted in this sub-section is drawn. As a result of good policies and a favorable legal environment, toward the end of the 1990s, domestic credit and capital markets had reached a development stage comparable with that of more advanced economies in terms of their size in relation to GDP. Moreover, according to this evidence, the local equity and bond markets had surpassed the credit market in terms of size at the end of the 1990s, supported by the presence of significant institutional investor base, including pension, mutual, and investment funds and life-insurance companies.78

169. In terms of liquidity and efficiency, however, domestic financial markets in Chile have not yet reached such a similar level of development and remain below world average. Furthermore, a broadly related study by Ricardo Caballero (2002) finds that only the largest companies (or those part of a conglomerate) maintained access to domestic financing during a recent “bad time”, the period 1998-2000 after the Asian, Russian, and Brazilian crisis. This latter study too, however, does not consider data for 2001, when the local corporate bond market boomed, bringing the stock of bonds outstanding to US$6 billion (about 10 percent of GDP) and the number of private sector issuers to more than 60, while the economy was coping with various external shocks. In addition, neither Caballero (2002) nor Gallego and Loayza (2000) consider recent important developments in local derivative markets: the local foreign exchange forward market, for instance, reportedly has now a daily turnover broadly comparable to the spot market, with maturities available up to three years.

170. As a result of these new developments, retained earnings, which had traditionally been the most important source of domestic financing along side bank credit becamealessimportant source of investment financing in the 1990s. Nonetheless, the econometric evidence reported by Gallego and Loayza (2000) shows that only the largest firms (or those part of conglomerates) ceased to face a binding financing constraint in the 1990s; other companies continued to be sensitive to “cash-flow” variables, thus suggesting they continue to be financially-constrained.

171. In summary, by reviewing the sources of financing available to the corporate sectors, albeit briefly and in broad terms, we saw that only a limited number of companies—the largest and highest-rated—might in principle have been able to load their balance sheets with debt financing in such a way to become vulnerable to shocks. On those grounds, but also because of the difficulties of conducting a balance sheet and cash flow indicator analysis with a larger sample, in the next section we shall focus only on companies listed on the stock exchange and included in the IPSA index—the index comprising the 40 most actively traded stocks on the Santiago Exchange.

C. Balance Sheet and Cash Flow Indicators

172. Research on the role of the corporate sector as a potential source as well as transmission channel of financial crises points to the importance of specific balance sheet and cash flow information—most notably on interest cover, leverage, liquidity, profitability, and foreign exchange exposure.79 According to this research, corporate sector-driven crises have tended to unfold in two stages. The first stage was a long build up of balance sheet fragilities rooted in poor governance, excessive credit expansion, accelerated capital inflows, and, in many cases, overheating of the economy. In the second stage, a shock, often external, triggered a sudden crisis, with the severity of the crisis directly associated with the degree of leverage, previous availability of financing, and weakness in corporate governance and in the general legal environment.

173. Interest cover (the ratio of earnings to interest expenses) is a cash flow indicator that measures the risk that a firm may not be able to service its debt on time, potentially signaling proximity to a situation of distress. Leverage indicators measure a firm’s indebtedness relative to its assets or net worth and quantify a firm’s exposure to the risk that shocks to profitability may impair its repayment capacity pushing it into insolvency. Corporate liquidity indicators determine a company’s ability to carry out its operations without endangering credit quality and thus the risk of facing a refinancing shock. Such liquidity indicators include (i) the “current ratio”—current assets (cash and accounts receivables) to current liabilities (debt and other liabilities coming due within a year)—(ii) the “quick or acid ratio”—current assets minus inventories to current liabilities—and (iii) the ratio of short term liabilities to total liabilities.

174. Profitability is naturally a crucial determinant of corporate strength, affecting capital growth, attraction of new equity, operating capacity, ability to withstand adverse shocks, and, ultimately, repayment capacity and survival. A sharp decline in corporate sector profitability (for instance, as a result of economic slowdown) may serve as leading indicator of financial system distress. However, care should be taken to distinguish between normal cyclical fluctuations in profitability from other more persistent tendencies. The most common indicators of profitability are (i) the return on equity (earnings to average equity), (ii) the return on assets (earnings to average assets) and (iii) or the operating margin (earnings to sales) that measures income in relation to costs, and reveals a firm’s strength in maintaining a healthy margin and capital growth.

175. This literature emphasizes the difficulties in formulating vulnerability assessments based on these indicators including because of limitations on data availability, lack of uniform accounting practices across countries, and absence of established benchmarks against which to assess the indicators in individual cases, among other reasons. Despite these difficulties, this section attempts to assess the soundness of the Chile’s core corporate sector against the yardstick of a small subset of standard balance sheet and cash flow indicators, chosen among those discussed above based mainly on data availability. To put indicators for Chile’s corporate sector in some perspective, these are compared to those of about 600 companies drawn from eight other emerging markets and three industrial countries for which data comparable (at least in principle) are available through end-2000 (Table 1-5).80

Table 1

Earnings Before Interest, Taxes, Depreciation, and Amortization (EBITDA) To Interest Expense On Debt 1/

(Indicator of general financial soundness)

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Sources: Worldscope database; and IMF staff calculations.

Number of times.

Table 2

Total Debt to Common Equity 1/

(Indicator of leverage)

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Sources: Worldscope database; and IMF staff calculations.

In percent

Table 3

Short-Term Debt to Total Debt 1/

(Indicator of vulnerability to temporary cut-of from financing-in combination with leverage)

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Sources: World database; and IMF staff calculations.

In percent

Table 4

Current Assets To Current Liabilities

(Current Ratio) 1/

(Indicator of liquidity)

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Sources: Worldscope database; and IMF staff calculations.

Number of times.

Table 5

Earnings Before Interest and Taxes (EBIT) minus Income Taxes and Other Taxes To sales 1/

(Indicator of Profitability)

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Sources: World database; and IMF staff calculations.

Number of times.