Abstract
This note discusses Chile's macroeconomic policy framework, the role of institutions in Chile, policies over time, export specialization and economic growth, trade policy strategy and recent agreements, an overview of recent developments in capital markets, and corporate financing in Chile. The role of the public sector in establishing debt benchmarks, an assessment of the country’s external position, distress among Chile's foreign-owned firms, balance sheets of public sector finances, and an update on the Chilean banking system have been noted in this paper.
VII. Establishing Debt Benchmarks in Chile: The Role of the Public Sector1
1. Public debt management has been receiving increased attention in Chile, including with regard to promoting development of financial markets. While the total stock of public debt owed to the domestic private sector has not been rising significantly—it has been broadly stable at around 30 percent of GDP for some time—it is substantial enough for its management to be of consequence, for both the public and private sectors.
2. To date, the management of public domestic debt has been a task for Chile’s central bank, since nearly all such debt is found on its balance sheet. As of end-2002, the central government still had essentially no debt to the domestic private sector, though the Ministry of Finance has indicated that it is considering a domestic bond issue.2
3. In September 2002, the bank began a program of modernization of its debt management procedures, with these objectives:
Increasing the liquidity, and facilitating the internationalization of, the domestic fixed-income market;
Deepening the process of “nominalization” of Chilean financial markets, encouraging the private sector to continue shifting away from use of inflation-indexed instruments;
Prompting greater capital market efficiency, including development of markets for private debt and hedging instruments.
4. The bank considered that these moves would serve its broader objectives of deepening and modernizing capital markets and enhancing the economy’s integration with Chile’s main trading partners.
The specific actions that the central bank took include:
Following international standards in the design of its debt issues, using “bullet” amortization, and interest paid twice a year;
Increasing the stock of instruments that would serve as references or benchmarks for debt markets, with a view to establishing a yield curve based on liquid markets for low-risk instruments at various maturities.3 Following international standards for liquidity, a minimum size for each issue would be US$300 million.
Increasing both the relative share and average maturity of its (nominal) peso debt issues, beginning with a new 5-year maturity (previously, the longest maturity of peso issues had been only 2 years);
The central bank has reduced inflation-linked debt in favor of dollar-linked and peso debt.
Citation: IMF Staff Country Reports 2003, 312; 10.5089/9781451807592.002.A007
The central bank has reduced inflation-linked debt in favor of dollar-linked and peso debt.
Citation: IMF Staff Country Reports 2003, 312; 10.5089/9781451807592.002.A007
The central bank has reduced inflation-linked debt in favor of dollar-linked and peso debt.
Citation: IMF Staff Country Reports 2003, 312; 10.5089/9781451807592.002.A007
5. These steps build on earlier actions by the central bank that have shifted its liability structure away from inflation-indexed debt in favor of both peso and dollar-indexed debt.4 The greater use of longer-term debt denominated in the domestic currency in particular is widely considered essential in the maturation of emerging economies and in particular reducing their vulnerability to external financial crisis. In that vein, the eventual goal would be to persuade international investors to hold peso-denominated instruments issued by the private sector. Establishing benchmarks, and otherwise promoting the development of the domestic market for such instruments, is seen as a step in that direction.
6. The bank expects that the reform of its debt structure, by generating a rising volume of intermediation, will allow the market to create new hedging markets for specific risks.
7. A further benefit of the new debt issues has been the information about inflation expectations now conveyed by interest rate differentials between inflation-indexed and non-indexed debt. On the new five-year issues, such differentials have stayed close to the bank’s inflation objective (i.e., to the midpoint of the 2–4 percent target bank).
8. The size of the BCCh balance sheet creates the opportunity to create a considerable range of benchmarks—not only at different maturities, but also in domestic debt is not expected to grow very significantly via fiscal deficits, given the government’s commitment to fiscal discipline.5 Still, simply on the basis of existing central bank debt—on the order of US$20 billion, to be compared to the above-mentioned US$300 million standard for minimum issue size—it is clear that the central bank has the opportunity to provide a considerable range of benchmarks. Of course, at the margin benchmarking in any one instrument type reduces the scope for benchmarking in others.
9. Going forward, the bank’s announced policy is to hold constant the share of dollar-indexed instruments in its debt liabilities.6 BCCh debt is now divided (in increasingly equal shares) between inflation-indexed peso debt, dollar-indexed peso debt, and simple peso debt, as shown in the figure. Although the rise in the share of dollar-indexed debt since 1997 may appear as an upward trend, in fact it occurred in three discrete episodes (in 1998,2001, and 2002), in which the bank’s motivation was foreign exchange market intervention rather than benchmarking.
10. In the last few years, the BCCh has reduced the share of inflation-indexed (UF) instruments in its liabilities significantly, by roughly half. This decline has come at the shorter maturities; indeed, all of the BCCh’s debt having maturity greater than five years continues to be in UF form. This pattern reflects the BCCh’s deliberate policy of promoting “nominalization” of private balance sheets in general, at the same time recognizing that a market preference for inflation protection will likely persist in long-maturity market segments (e.g., mortgages and pension savings). Looking forward, the 0–5 year market will be increasingly nominalized while the longer-term issues, from 5 to 20 (and possibly more) years will be in UF.
11. The BCCh’s strategy thus entails the eventual loss of the traditional shorter-term UF benchmarks. Such a change naturally involves some costs, at least during a period of transition. One such area may be the interest rate swap (IRS) market, which is not yet fully developed in Chile. The IRS market is relatively illiquid, as the end of short-dated UF issuance has made the market less complete in the 0–2 year segment, and the UF curve does not provide a continuous reference point to price IRS contracts.7 Looking forward, further progression of the nominalization process will allow the market to price IRS off the curve for nominal peso debt.
Aspects of the Chilean Market for Foreign Exchange (FX) Hedging Instruments
12. The Chilean market for FX hedging instruments primarily uses the spot and the NDF (non-deliverable forward) markets.
13. The market for FX hedging is fairly liquid, with transactions in the spot and NDF market reportedly reaching daily volumes of US$1.4 billion. Most contracts are valued from US$3–5 million, and monthly demand for corporate hedges tends to be about US$4–6 billion. The usual tenor for FX hedge contracts is between 90 days and two years with ample liquidity; corporates typically roll over their hedges for a longer duration. Cross-currency swaps are available for up to five years, with typical fixing at 30 day intervals.
14. In recent years, a significant outside stimulus to the private hedging market has been the BCCh’s net issuance of dollar-indexed debt. The bulk of this injection was in the second half of 2001, when the stock of such debt rose to more than 7 percent of GDP, from about 2 percent of GDP in the previous year; a further increase, to 9 percent of GDP, occurred in 2002. Both increases were part of periods of exceptional intervention to support the Chilean peso. Looking forward, the bank’s announced policy is to hold steady the share of dollar-indexed instruments in its total debt liabilities.
Prepared by Manmohan Singh.
Domestic debt of the public enterprises is limited mainly to a few recent issues, including by the state-owned copper company CODELCO and the Metro. Subnational governments have no financial debt.
For the time being, the bank is concentrating its new issues at original maturities of two and five years, for both nominal peso and dollar-indexed debt. For inflation-indexed debt, the bank is issuing at maturities of 5, 10, and 20 years.
The greater issuance of peso-denominated debt is part of the bank’s “nominalization” strategy, begun in 2001, when the bank switched its operational target from an inflation-indexed interest rate to a simple nominal interest rate (see Country Report No. 02/155; 7/31/02).
The (temporary) deficits permitted under the structural balance rule tend to be moderate in size. Debt issues by the public enterprise sector might play a greater role, though in the past most such debt financing has been from external sources.
Although as always the bank reserves the right to for-ex intervention if it identifies exceptional circumstances.
A further indication of illiquidity in the shorter-term UF market is that UF interest rates are not quite as far below nominal peso rates as indicators of inflation expectations would predict. For example, in June 2002, one and two year yields on inflation-indexed instruments were only about 240 basis points below yields on nominal peso issues with corresponding maturities. Surveys of inflation forecasts, however, suggested somewhat higher expected inflation rates, closer to 3 percent.
