Chile: Selected Issues
Author: International Monetary Fund
Publication Date:
08 Oct 2003
eISBN:
9781451807592
Language:
English
Keywords:
ISCR; CR; Chile; export; debt; market; medium-and-long term debt amortization payment; sensitivity analysis; FDI liability; sustainability framework; GDP deflator; International investment position; Current account; Foreign direct investment
Download PDF (806.9 KB)

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.

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.

IX. An Assessment of Chile’s External Position1

A. Introduction

1. This chapter provides an assessment of Chile’s external position, integrating information on the country’s international investment position and structure of external debt.2 The objective is to analyze the possibility of an external liquidity squeeze on the balance of payments as well as to test for potential solvency problems. The approach followed combines the standard IMF debt sustainability analysis framework and alternative tests using newly published data on Chile’s international investment position. The analysis focuses on (i) external debt dynamics, (ii) sensitivity of gross external financing requirements to specific shocks, and (iii) implications of Chile’s international investment position for external vulnerability.

2. The main results underscore the strength of Chile’s aggregate external position. We summarize below our key findings.

  • Using the standard debt sustainability framework, we see that various hypothetical shocks during 2003–04 would raise the external debt-to-GDP ratio during those years, but would still be consistent with a gradual decline in the debt ratio thereafter. Moreover, although some of the shocks considered would substantially raise the debt ratio for a time, the risks of these standardized shocks seems remote, given the strength of Chile’s current policy framework.

  • Liquidity problems are not expected given the country’s significant international reserve holdings.3 A drawdown in international reserves would be sufficient to cover Chile’s annual gross external financial requirements under all stress tests considered.

  • Chile’s foreign asset position is a source of strength. Liquid external asset holdings by the private sector were more than sufficient to cover the country’s total external financing requirements at end 2001.4 Foreign direct investment in Chile amounted to two-thirds of GDP helping explain that foreign-owned Chilean resident firms held more than half of Chile’s total external debt. Sensitivity analysis using the net international investment position shows the dampening effects of direct investment holdings on the aggregate net liability.

  • The sound policy framework, including credible inflation targeting, foreign exchange free float, and strong fiscal position, should provide enough flexibility to accommodate and support temporary shocks to external financing conditions.

3. The results of aggregate analysis of vulnerability carry some caveats. In principle, the aggregate approach could mask financial vulnerabilities in specific sectors or business groups that could have amplifying effects with systemic implications (a general problem, not particularly specific to Chile). On the other hand, analysis relying on traditional residency-based aggregates could also understate potential sources of strength, especially in the case of Chile. In particular, the presence of foreign-owned Chilean resident firms responsible for half of total external debt could be a source of external support, as demonstrated recently by the case of Enersis (see accompanying chapter). Chile’s supportive investment environment with strong property right guarantees is a key determinant on the willingness of foreign parent companies with long investment strategies to support their Chilean resident subsidiary in periods of financial stress.

4. The chapter is organized as follows. Section B describes the features and characteristics of Chile’s debt and international investment position. The next section presents the medium-term baseline scenario and uses standard sensitivity tests to assess sustainability. Section D considers gross external financing requirements and develops its sensitivity analysis based on standard shocks as well as a more detailed consideration of rollover rates in the short term. Finally, Section E focuses on the implications of the net external position.

B. Characteristics of the External Position

5. Chile’s total external debt has experienced an steady increase in recent years. From 1997 to 2002, external debt grew by 50 percent in U.S.dollar nominal terms, reaching US$40 billion at end 2002 (see Figure 1).5 The slowdown in economic activity and depreciation of the Chilean peso also contributed to the rapid increase in the debt to GDP ratio, which doubled during the five-year period. At end 2002, total external debt represented 61 percent of GDP.

Figure 1.
Figure 1.

Chile: Evolution of External Debt

millions of us$

Citation: IMF Staff Country Reports 2003, 312; 10.5089/9781451807592.002.A009

Source: Central Bank of Chile

6. Concern about the sharp rise in total external debt, however, should also take into account the following factors:

  • Most of this debt is long-term (see Figure 1a). Short-term debt on an original maturity basis, excluding trade credits, represented just 6 percent of total debt in 2002 while the duration of the medium-term debt averaged five years. On a residual maturity basis, short-term debt amounted to 21 percent of total debt in 2002.

  • Most of the debt is owed to foreign banks (see Figure 2b). About half of long-term debt comes from foreign banks while market bond financing represents a quarter of total long-term debt. (In vulnerability analyses, banks are usually considered more likely to be “supportive” during times of stress than bondholders.)

  • Most of the external debt corresponds to the private sector, in particular foreign-owned companies. The private sector external debt represented 82 percent of the total and foreign-owned firms accounted for 63 percent of that amount (or about 50 percent of total external debt).

  • The increase in the external debt was associated with an increase in external asset accumulation by the private sector. Private sector direct investment abroad and portfolio investment rose fourfold from 1997 to 2002, reaching 40 percent of GDP in 2002. Given Chile’s supportive investment environment, some foreign multinational firms have used Chile as an investment hub to manage its investments in the region.

  • On the other hand, the majority of long-term debt used a floating interest rate, making debt servicing more vulnerable to interest rate fluctuations.

7. In contrast to the surge in gross external debt, the net external liability position was almost flat in nominal terms during the 1997–2002 period, at US$27 billion. By 2002, it amounted to 39 percent of GDP with gross liabilities representing 126 percent of GDP. The stock of direct and equity investment in Chile stood at US$56 billion (two-thirds of total liabilities), while direct and equity investment abroad amounted to US$24 billion (see Table 1).

Table 1.

Chile: International Investment Position

(Billions of US$)

article image
Sources: Central Bank of Chile, IMF

8. Compared to other emerging market countries, Chile’s international investment position shows a higher degree of financial integration. By end 2001, Chile’s total foreign liabilities was the highest level among the selected group of emerging countries (reference) At the same time, Chile had the largest holdings of foreign assets relative to GDP and had among the lowest leverage (ratio of liabilities to assets). Chile had also the lowest share of debt in total liabilities holdings while maintaining a strong external liquidity position. When compared to other Latin American countries, Chile has a high reserve-to-GDP ratio, but is roughly similar to the average of some Eastern European countries and below some East Asian economies (see Table 2).

Table 2.

Countries: International Investment Position, 2001

(in percent of GDP)

article image
Sources: IMF

C. External Debt Sustainability Analysis

Baseline Projections

9. The staffs baseline scenario assumes a pick up in economic activity over the medium term to close the output gap by 2008. The output growth rate is expected to pick up to 5.5 percent in 2006 before falling back to the growth rate of potential output by 2008. The current account deficit would see a gradual widening from 1 percent of GDP in 2002 to 2.5 percent in 2008. Most of the current account deficit would be financed by debt; the baseline has only a modest recovery in net FDI flows reaching about three quarters of the previous decade average level. Nominal external interest rates would increase to 7.4 percent by 2006 and the real exchange rate is projected to be broadly constant over the period. The country risk premium is expected to remain low, at 100–120 basis points

10. Under the baseline scenario, total external debt increases from US$40 billion 2002 to US$56 billion in 2008. The moderate growth in external indebtedness reflects a gradual widening of the current account and some recovery of FDI. The debt-to-GDP ratio is expected to follow a downward path dropping to 54 percent by 2008. The drop in the debt-to-GDP ratio is largely driven by the expected pick up in economic activity.

Sensitivity Analysis

11. Table 3 illustrates the sensitivity of the baseline external debt projection to changes in assumptions. We consider shocks in 2003–04 to real output growth, the current account, the GDP deflator in U.S. dollar terms (a proxy for the real exchange rate), and the level of interest rates; the magnitude of each shock is set to be twice the historical standard deviation (calculated over the previous 10 years). Using ten-year historical average values would imply a lower debt-to-GDP path falling to 51 percent at the end of the period

Table 3

Chile: External Debt Sustainability Framework, 1998-2008

(In percent of GDP, unless otherwise indicated)

article image

Derived as [r - g - ρ(1+g) + εα(1+r)]/(1+g+ρ+gρ) times previous period debt stock, with r = nominal effective interest rate on external debt; ρ = change in domestic GDP g = real GDP growth rate, ε = nominal appreciation (increase in dollar value of domestic currency), and a = share of domestic-currency denominated debt in.

The extendable on from price and exchange rate changes is defined as [-ρ(1+g) + εα(1+r)]/(1+g+ρ+gρ) times previous period debt stock, ρ increases with an appreciate and rising inflation (based on GDP deflator).

Defined as current account deficit, plus amortization on medium- and long-term debt, plus short-term debt at end of previous period.

12. In all the cases considered, the debt-to-GDP ratio rises considerably during the shock years (2003–04) before dropping to levels generally higher than the 2002 level. The most significant increase would occur in the extreme and unlikely scenario of a combination of two-standard deviation negative shocks to the nominal interest rate, real GDP growth and current account. Similarly, a 20 percent depreciation of the foreign exchange rate would bring external debt to 74 percent of GDP. However, the downside risk of a sharp exchange rate depreciation seems limited, in light of the decline already experienced by the Chilean peso in recent years.6

Other Sensitivity Tests

13. Using information on the international investment position, we could also consider more specific shocks to income flows from investments abroad. For instance, a two-standard deviation drop of the implicit rate of return of direct and portfolio investments would lead to an increase in the current account deficit of about 0.7 percent of GDP, representing less than half of the current account shock considered above.

14. We also consider the effect of copper price shocks on the current account given that copper represents more than one-third of total exports or 10 percent of GDP. Given the high volatility of copper prices, a two-standard deviation negative shock to copper prices would drive the average price to a hypothetical 52 cents per pound, or two-thirds of the price assumed under the baseline for 2003. Under this extreme scenario, the direct, static impact on the current account would be on the order of 2 percent of GDP.7 The effect would have the same order of magnitude as the shock considered in the standard sensitivity test on the current account. The likelihood of such a large negative shock is reduced in light of the consensus that copper prices are already in the low end of the cycle, below their medium or long-run levels. Also, such a price would be considerably the cost floor of many of the world’s copper mines, and below the real prices at which mines began to shut down during the late 1990s.8

D. Gross External Financing Requirements

15. Total gross external financing requirements have risen in recent years to reach 12.6 percent of GDP in 2002. This need is dominated by the need to amortize medium- and long-term debt coming due each year. Similarly, most of the recent increase is due to an increase in such scheduled amortizations (see Table 5). Interestingly, actual amortization exceeded scheduled amortization in 2001 and 2002, as firms chose to prepay external debt and shift toward domestic financing.

Table 4.

Chile: Gross External Financing Need, 1998-2008

(In US$ billion, unless otherwise indicated)

article image

Defined as non-interest current account deficit, plus interest and amortization on medium- and long-term debt, plus short-term debt at end of previous period.

Gross external financing under the stress-test scenarios is derived by assuming the same ratio of short-term to total debt as in the baseline scenario and the same debt. Interest expenditures are derived by applying the respective interest rate to the previous period debt stock under each alternative scenario.

Table 5.

Chile: Gross External Financing Requirements

(in US$ billion)

article image
Sources: Banco Central de Chile, staff estimates

Excludes trade credits estimated to be US$2.9 billion at end 2002.

16. Under the baseline, total annual gross external financing requirements are expected to decline from a high of 12.6 percent as a share of GDP in 2002 to 10 percent in 2006. The drop is largely driven by the expected surplus in non-interest current account throughout the projection period and the pick up in economic growth. Also, medium-and-long term debt amortization payments are expected not to increase but to hover around the 2002 level as important payments coming due in 2003–04 have been recently rescheduled.9 The baseline assumes that short-term debt remains constant in nominal terms. We assume that about two-thirds of the external debt has floating interest rates, broadly consistent with past experience.

Sensitivity Analysis

17. The sensitivity tests underscore again the responsiveness of external requirements to changes in assumptions (see Table 4 and Figure 4b). In particular, external requirement is most sensitive to a shock in the current account which would bring it to over 17 percent of GDP. All other shocks would keep the external financing needs below 15 percent of GDP. None of the shocks considered would bring the total financing requirements above official international reserves (now almost 25 percent of GDP). Moreover, private sector liquid foreign asset holdings (considering only currency and deposits) amounted in 2002 to 8 percent of GDP, representing more than two thirds of the private sector’s short-term external debt on a residual maturity basis.

E. Net External Position

18. Chile’s foreign asset position is a source of strength. We consider three aspects of Chile’s international investment position (IIP) that would dampen the effects of the shocks considered in the previous sections. First, we underscore the role of Chile’s large FDI liabilities in providing external support in periods of stress. Second, we note the solid liquid asset position including the significant foreign liquid assets by the private sector. Third, we follow a balance sheet approach to show the counterbalancing effect of shocks on the aggregate net asset position of the country.

19. The country’s large FDI liabilities are a source of external support in periods of stress. As shown in Table 2, the relative size of foreign direct investment in Chile stands out when compared other emerging economies. The necessary counterpart of these investments is the large share of direct investment income outflows in the external current account. This component has important implications on how the current account adjusts to shocks affecting domestic activity.

20. Sensitivity analysis on the implicit rate of return on foreign investment shows that a one-standard deviation negative shock would lead to a 2 percent of GDP improvement in the non-interest current account. Given the likely high correlation between changes in the output level and implicit rates of return, a sharp drop in output growth would bring a sharp adjustment in the current account driven by lower investment income outflows, everything else constant.

21. Chile’s liquid assets, of both the public and private sectors, appear to rule out reasonable liquidity risks. At end 2002, total liquid external assets—even on a narrow definition—amounted to US$21 billion (32 percent of GDP), accounted for more than half of total external gross debt and covered about 2.6 times gross external financing requirements. Liquid holdings by the private sector, considering a narrow definition that includes only foreign deposit and currency holdings, amounted to US$5 billion at end 2002.

22. The picture is only more favorable if one considers short-term trade credits owed to Chilean firms. At end-2002 these amounted to 12.5 percent of GDPs. Empirical evidence shows that these type of credits have a low probability of default, thus providing further support to the strength of Chile’s aggregate balance sheet.10

23. The balance sheet effect of a foreign exchange depreciation shock has no negative effect on the net asset position as a share of GDP. If we assume that FDI liabilities are denominated in local currency, then the reduction on FDI liabilities from the exchange rate depreciation would more than compensate for the drop in the U.S. dollar value of GDP. For example, a 20 percent depreciation of the peso would lower the ratio of net liabilities to GDP from 40 percent to 32 percent, and would reduce the ratio of liabilities to assets from 146 percent to 129 percent.

Table 6.

Chile: Balance Sheet Indicators

(in percent)

article image
Sources: IMF

Liquid assets include only international reserves and currency and deposits abroad.

Figure 2.
Figure 2.

Chile: Composition of External Debt

Citation: IMF Staff Country Reports 2003, 312; 10.5089/9781451807592.002.A009

Source:
Figure 3.
Figure 3.

Chile: International Investment Position, 1997-2002

(in US$ billions)

Citation: IMF Staff Country Reports 2003, 312; 10.5089/9781451807592.002.A009

Figure 4.
Figure 4.

Chile: External Debt Sensitivity Analysis

Citation: IMF Staff Country Reports 2003, 312; 10.5089/9781451807592.002.A009

Source: Central Bank of Chile, IMF estimates.

References

  • Chee, K., J. Kiholm Smith, and R. Smith, 1999, “Evidence on the Determinants of Credit Terms Used in Interfirm Trade,” Journal of Finance, 54(3), 1109–1130 (July).

    • Search Google Scholar
    • Export Citation

  • International Monetary Fund, 2002, “Assessing Sustainability,” Staff Memoranda 02/166, (Washington: International Monetary Fund).

  • International Monetary Fund, 2002, “Forecasting Copper Prices in the Chilean Context,” Chile—Selected Issues, IMF Staff Country Report No. 02/163, (Washington: International Monetary Fund).

    • Search Google Scholar
    • Export Citation

  • International Monetary Fund, 2000, “Assessing External Vulnerability: The Case of Chile,” Chile—Selected Issues, IMF Staff Country Report No. 00/94, (Washington: International Monetary Fund).

    • Search Google Scholar
    • Export Citation

  • Nilsen, J. 2002, “Trade Credit and The Bank Lending Channel,” Journal of Money, Credit and Banking, 34(1), 226–28, (February).

1

Prepared by Rodolfo Luzio.

2

Current work at the Central Bank of Chile (BCCh), in preparation of a Financial Stability Report, has focused on developing a more detailed and comprehensive assessment of Chile’s external position.

3

The analysis in this chapter does not refer to the more demanding question of the optimal level of international reserves. Rather, the level of reserves is here compared to the level of financing needs under various scenarios. To consider the optimal level of international reserves, a more comprehensive analysis of the costs and benefits of liquidity holdings would be required, including with greater attention to the probability of adverse shocks.

4

Using a narrow definition of liquid assets, which includes only short-term deposit and currency holdings, but excludes short-term credits, would indicate that private sector liquid holdings would cover more than two thirds of the private sector’s short-term debt on a residual maturity basis.

5

Total external debt excludes trade credit liabilities which are expected to be published in September 2003.

6

From end 1997 to end 2002, the Chilean peso dropped by 31 percent in real effective terms.

7

The negative effect on the trade balance would be somewhat larger, but the effect on the current account would be partially offset by reduced profit outflows by foreign-owned mining companies.

8

See Selected Issues volume from the 2002 Article IV consultation, “Forecasting Copper Prices in the Chilean Context.”

9

Enersis, recently agreed with foreign banks to reschedule its loan commitment worth $2 billion coming due in 2003 and 2004 beyond 2008. (See accompanying note.)

Same Series

Other IMF Content

Other Publishers

Cover IMF Staff Country Reports
Chile: Selected Issues
Author: International Monetary Fund
Volume/Issue:
Volume 2003: Issue 312
Publisher:
International Monetary Fund
ISBN:
9781451807592
ISSN:
1934-7685
Pages:
160
DOI:
https://doi.org/10.5089/9781451807592.002

Chile: Evolution of External Debt

millions of us$

Chile: Composition of External Debt

Chile: International Investment Position, 1997-2002

(in US$ billions)

Chile: External Debt Sensitivity Analysis