Chile: Selected Issues
Author: International Monetary Fund
Publication Date:
01 Sep 2005
eISBN:
9781451951615
Language:
English
Keywords:
ISCR; CR; PPP firm; firm; debt; Chile; bank; external debt; U.S. dollar; debt liability; debt position; debt path; Private debt; International investment position; Currencies; debt securities
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This Selected Issues paper on Chile assesses the long-term outlook of Chile’s private pension system. The paper provides an overview of Chile’s recent experience with public–private partnerships (PPPs), focusing on the design of its institutional framework. The paper discusses that Chile’s experience with PPPs, currently covering 44 projects, has been successful. It also analyzes bank profitability and competition in Chile from an international perspective. It also compares Chile’s external private debt across industrial and emerging market economies and analyzes implications for external vulnerability.

Abstract

This Selected Issues paper on Chile assesses the long-term outlook of Chile’s private pension system. The paper provides an overview of Chile’s recent experience with public–private partnerships (PPPs), focusing on the design of its institutional framework. The paper discusses that Chile’s experience with PPPs, currently covering 44 projects, has been successful. It also analyzes bank profitability and competition in Chile from an international perspective. It also compares Chile’s external private debt across industrial and emerging market economies and analyzes implications for external vulnerability.

IV. Perspectives on Chile’ s Private External Debt1

A. Introduction

1. Although Chile’s sovereign debt is rated investment grade by all major rating agencies, perceptions of financial vulnerability linked to high levels of private external debt have been cited as a constraint for further upgrades.2 At 55 percent of GDP on average in 2002–04, Chile’s external debt ratio exceeds the ratios of most countries with similar debt ratings, with most of Chile’s debt originating from the private sector.3 However, the ratio of total external debt has declined sharply in recent years, from about 60 percent of GDP at end-2002 to 46½ percent at end-2004.

2. Over the medium term, Chile’s external debt is projected to decline slightly under the scenario corresponding to the authorities’ intended policies, suggesting a sustainable debt path. A non-increasing external debt path is considered to be a sufficient condition for a country to remain solvent and, assuming that Chile continues implementing prudent macroeconomic policies as envisaged in the baseline-scenario presented in the Staff Report, its external debt is expected to be sustainable over the medium term.4 Moreover, there are no short-term risks to external liquidity—defined as the risk of failing to service debt if the net amount of maturing debt can not be refinanced—since the Central Bank’s gross external reserves comfortably exceed short-term external debt by residual maturity. Stress tests, however, highlight the sensitivity of the external debt-to-GDP ratio, in particular of the private sector, to large exchange rate shocks.

3. This paper analyzes the size and structure of Chile’s external debt from an international perspective and investigates whether perceptions of financial vulnerability are justified. Section II sets the stage by comparing Chile’s external liability and asset positions with those of other economies. Section III tests whether Chile’s level of economic development, openness, size, institutional quality, and other economic attributes warrant the level and structure of its external liabilities. Section IV examines the maturity, ownership, sectoral, and currency composition of the private external debt with a view to highlighting potential vulnerabilities, and Section V concludes.

4. The analysis suggests that the fairly high level of private external debt does not pose significant short-term risks to financial stability. The level of external indebtedness largely reflects the high degree of financial integration between Chile and the rest of the world. Factors that mitigate risks associated with the high level of external debt are a favorable maturity and ownership structure, a high level of foreign reserves, a small stock of external public sector debt, and the increasing availability of financial instruments to hedge against exchange rate risk. The development of markets for currency derivatives and domestic currency denominated debt will be key to further reduce the vulnerabilities associated with Chile’s external liability structure in the medium term.

B. Chile’s External Asset and Liability Structure from an International Perspective

5. The Chilean economy enjoys a high degree of international financial integration. Chile stands out among other emerging market economies as a country with a comparatively high level of external assets as a share of GDP (Figure 1). These external assets consist mainly of a large stock of central bank reserves, direct investments abroad by Chilean resident corporates, and portfolio investments by private pension funds. The bulk of Chile’s external liabilities consists of debt and a stock of direct investment that is among the highest in the world as a percent of GDP. By contrast, the share of portfolio equity liabilities is relatively small (Figure 2).

Figure 1.
Figure 1.

External Assets and Liabilities

percent of GDP, 2001-2003 average

Citation: IMF Staff Country Reports 2005, 316; 10.5089/9781451951615.002.A004

Source: Author’s calculations based on International Investment Positions, IFS, IMF.
Figure 2.
Figure 2.

Private External Liabilities

percent of GDP, 2001-2003 average

Citation: IMF Staff Country Reports 2005, 316; 10.5089/9781451951615.002.A004

Source: Author’s calculations based on International Investment Positions, IFS, IMF.

6. Chile’s total external debt-to-GDP ratio exceeds that of most countries with similar debt ratings, but is only about half the level in industrialized countries. Compared with other emerging market economies whose foreign-currency debt are similarly rated Baa by Moody’, Chile has larger than average debt and debt-service ratios (Table 1). This has been constraining improvements in Chile’s debt ratings. By contrast, Chile’s external debt-to-GDP ratio is close to half the average external debt-to-GDP ratio in industrialized economies.

Table 1.

External Debt Indicators

Comparison with Countries with Similar Debt Ratings 1/

article image
Source: Moody’s Investor Service; and Fund Staff estimates.

Baa-rated countries include Bahrain, Barbados, Chile, Croatia, El Salvador, India, Kazakhstan, Mauritius, Mexico, Oman, Russia, Saudi Arabia, South Africa, Thailand, Tunisia.

The debt service ratio is defined as the ratio of principal and interest payments to current account receipts.

7. Mirroring strong fiscal policies in the past two decades, public debt accounts for a limited share of Chile’s overall external debt position. At end-2004, the external debt of the nonfinancial public sector stood at slightly below 10 percent of GDP. This level compares favorably with public-sector external debt levels in most emerging market economies.

8. The Chilean private sector, on the other hand, has accumulated a large stock of external debt (Figure 3). Chile is similar to most emerging market economies in that a large share of private external debt is held by the non-financial corporate sector rather than by resident banks. At the same time, private Chilean residents hold higher level of external assets, in percent of GDP, than most other emerging economies. This stands in contrast to industrialized economies, where the banking sector generally holds the bulk of external debt (Figure 4). External private debt positions in most industrialized economies largely reflect the intermediation of foreign funds into external debt assets by banks and multinational corporations, translating into smaller net debt exposures. By contrast, in Chile, as in most emerging market economies, the external assets of the private sector are relatively small and, thus, net indebtedness is relatively large in relation to gross external debt (Figure 5). This explains why the external debt level tends to attract greater scrutiny than it would in a typical industrialized economy.

Figure 3.
Figure 3.

Chile: Total and Private External Debt

Citation: IMF Staff Country Reports 2005, 316; 10.5089/9781451951615.002.A004

Figure 4.
Figure 4.

Private External Debt

percent of GDP, 2001-2003 average

Citation: IMF Staff Country Reports 2005, 316; 10.5089/9781451951615.002.A004

Source: Author’s calculations based on International Investment Positions, IFS, IMF.
Figure 5.
Figure 5.

External Debt of the Nonbank Private Sector

2001-2003, percent of GDP

Citation: IMF Staff Country Reports 2005, 316; 10.5089/9781451951615.002.A004

Source: Author’s calculations based on International Investment Positions, IFS, IMF.

C. An Empirical Investigation of the Determinants of International Investment Positions

9. This section presents a set of cross-country empirical regularities that characterizes international investment positions, with a focus on the private sector. The analysis conditions the external asset and liability positions of a group of countries on their economic and institutional characteristics. The estimation results are used to compute benchmark levels of external liabilities for Chile, as predicted by cross-country regularities, which are then compared with actual levels. This enables an assessment of whether Chile’s external liabilities can be deemed to be excessive when macroeconomic and institutional factors that determine external positions are taken into account.

10. The analysis builds on the findings of the recent literature on the determinants of international investment positions. Unlike international capital flows, which reflect the adjustment of external assets and liabilities to their desired levels in response to changes in the economic environment, the stocks and composition of external assets and liabilities reflect the economic history of a country, including expectations about economic prospects. Thus, identifying the determinants of net external asset and liability positions is more challenging than identifying those of net capital flows. Nonetheless, recent efforts to collect data on International Investment Positions (IIP) in a consistent manner across countries, and increased availability of detailed IIP data from the IMF’s International Financial Statistics, have allowed a number of empirical studies to shed light on the determinants of external capital structures across countries.5 The analysis in this section builds on the findings of this literature by expanding the set of potential explanatory variables and examining overall and private sector positions separately.

11. The analysis uses comprehensive data on IIPs to study external gross and net asset positions. The set of examined IIP components includes the overall and private sector net external asset positions (as a background for the study of the various components of external liabilities), total and private sector gross external debt, and portfolio equity and direct investment liabilities, all measured as ratios to GDP. It also includes debt, portfolio equity, and direct investment liabilities expressed as a share of total private sector liabilities. All the dependent variables are drawn from the International Investment Positions database of International Financial Statistics and are averaged for the period 2001-2003 (the most recent 3-year period covered in the database). Appendix 1 provides further details on the dataset used for the analysis.6

12. The determinants of private and total external liabilities are investigated on the basis of variables previously identified by the literature, as well as additional variables considered to be relevant for the Chilean case. The set of explanatory variables are averages for 1996–2000. They include variables that were determined to be relevant for international investment positions by the prior literature, such as the level of economic development, size, trade openness, and institutional quality. In order to capture the presumably greater need for international risk-sharing in economies characterized by high volatility of real variables, the volatility of the terms of trade and its interaction with trade openness are also included.7 Appendix 1 lists the rationale behind investigating each of these variables as potential determinants of external capital structures. For each dependent variable, a large number of regressions were estimated using different combinations of the regressors. The model that provided the best adjusted R-squared was used to calculate a fitted value for Chile. Table 2 presents the regression results and the fitted values for Chile within one-standard error confidence intervals.

Table 2.

International Investment Positions: Ordinary Least Squares Regressions

article image
Notes: Robust standard errors in brackets. * significant at 10%; ** significant at 5%; *** significant at 1%. External Private Debt corresponds to the sum of Banks and Other Sctors’s Bonds and Notes (in Portfolio Investment Liabilities) and Other Investments in the International Investment Position Statistics in the IMF’s IFS. Other Investments include Bank Loans, Currency, Deposits, and Other Liabilities. The Appendix provides further detail on data sources and variable definitions

13. The results suggest that Chile’s total debt-to-GDP ratio is very close to what would be expected on the basis of the estimated empirical model, but its private external debt is significantly larger than expected. As shown in columns 3 and 4 of Table 2, the total debt-to-GDP ratio is close to the predicted level. Given that private debt is higher, this implies that the public sector’s external debt is lower than what would be predicted by the model. In addition, the levels of portfolio equity and direct investment financing as ratios to GDP are well within the one-standard-error intervals around the fitted values (columns 5 and 6), as are the shares of these equity financing categories in the total external liabilities of the private sector (columns 9 and 10). This suggests that the Chilean private sector is an outlier in its external debt stock, but not necessarily in its composition, thus ruling out the notion of excessive debt reliance by the Chilean private sector at the expense of other forms of financing.

14. In net terms, the external positions of the Chilean economy and the private sector are also in line with the predictions based on the empirical estimates. Specifically, both the net foreign assets of the overall economy and of the private sector are within the confidence intervals predicted by the model. This finding lends support to the hypothesis that Chile is financially integrated with the world economy in a balanced manner—with high levels of both external assets and liabilities (Table 2, columns 1 and 2).

15. Empirical regularities suggest that the comparatively low level of public external debt may have provided room for the high level of private sector external debt. Crosscountry data points to a negative empirical relationship between the net external asset positions of the private and public sectors (Figure 6), which also holds for external debt stocks. This inverse relationship suggests that the external borrowing of the private and public sectors are partly substitutable. Hence, with a relatively small public sector in Chile given the extensive privatization process in the past decades (e.g. key utilities are privately-owned), one would expect larger borrowing needs of the private sector.8 Further, the negative relationship may also reflect the fact that, in many countries, a large amount of external borrowing by the public sector tends to increase the country risk and crowd out borrowing by the private sector.9 In the Chilean context, it might be argued that the small debt of the public sector has produced a positive externality for the private sector, in the form of lower interest rate spreads than those that would have prevailed under a high level of public debt.

Figure 6.
Figure 6.

Net External Assets: Private versus Public Sectors (percent of GDP)

Citation: IMF Staff Country Reports 2005, 316; 10.5089/9781451951615.002.A004

Source: Author’s calculations based on International Investment Positions, IFS, IMF.

16. Two central conclusions emerge from the analysis so far. First, the relatively large size of the Chilean private external debt stock can partly be ascribed to the fact that the external indebtedness of the public sector is unusually low for a country with Chile’s characteristics. And, conditional on Chile’s economic and institutional attributes, the total debt position of Chile is not excessive from a cross-country perspective.

D. The Structure and Composition of Chilean External Private Debt

17. This section reviews the structure of Chile’s private sector external debt and the financial soundness of the corporate sector, in an attempt to highlight potential strengths and weaknesses. In general, a given level of external indebtedness can imply different degrees of financial vulnerability depending on the maturity structure and currency composition of the debt, the overall financial health of the borrowers, and the extent to which they use natural or financial hedges against risks.

Maturity and Interest Rate Structure

18. Most of Chile’s private external debt liabilities have long-term maturities, but slightly less half of the debt is at floating interest rates. In Chile, the share of external debt with short-term maturities is significantly lower than in the average of emerging market economies (Figure 7) and the average maturity of the long-term debt stock is relatively high, at slightly above 4.5 years. About 60 percent of the short-term debt is held by the commerce and financial sectors, which naturally rely more heavily on short-term financing than other sectors of the economy. The small share of short-term debt and the relatively smooth path of projected debt service are positive indicators for rollover risks in Chile. Furthermore, the stock of gross official reserves comfortably exceeds the amount of short-term external debt by residual maturity. However, about 45 percent of the debt is at floating interest rates, implying that the cost of debt service would worsen in the event of an unfavorable external shock.10 A study by the Central Bank of Chile estimates that the cost of debt service increases by US$200 million for every 100 b. p. increase in external borrowing rates.11

Figure 7.
Figure 7.

Share of Short-term Debt in Total Private External Debt (percent)

Citation: IMF Staff Country Reports 2005, 316; 10.5089/9781451951615.002.A004

Source: Author’s calculations based on International Investment Positions, IFS, IMF.

19. A mismatch between the currency denomination of debt and revenues can lead to financial distress if revenues are highly volatile in terms of the currency unit in which the debt is denominated. In recent emerging market crises, extreme cases of distress have often been associated with large foreign-currency denominated debt in the nontradable sector: large depreciations of the currency in real terms tend to magnify the cost of debt service in sectors where earnings are not naturally linked to the exchange rate. Such risks are not, however, confined to very large devaluations. A floating exchange rate and volatile terms of trade tend to make real earnings and the real exchange rate volatile, and thus expose borrowers to risks if debt, but not earnings, are denominated in foreign currencies.

20. In Chile, external debt is almost exclusively denominated in foreign currencies, mostly the U.S. dollar. This structure suggests a potentially significant exposure of real debt service costs to exchange rate fluctuations. Cowan, Hansen, and Herrera (2004) provide evidence that real exchange rate depreciations led to significant declines in the investment rates of Chilean firms that had net exposures to exchange rate risk on their balance sheets. However, these authors also find that Chilean firms tended to match the currency denomination of their debt with those of their assets and income streams, in particular since the shift to a floating exchange rate regime in 1999. Their results suggest that the effective foreign currency exposure is smaller than suggested by foreign-currency debt levels alone.

21. Close to 40 percent of the private sector external debt is naturally hedged against currency fluctuations. The composition of the external debt stock by economic sector in Chile indicates that 38 percent of the private sector external debt is held by firms in the agriculture, mining, and manufacturing sectors (Table 3).12 In these sectors, earnings are either directly or indirectly denominated in foreign currencies, as prices move closely with the exchange rate. Another 25 percent of the private sector debt is held by financial institutions, where regulations have ensured careful management of exposures to currency movements. Data collected for the 2004 Chile Financial Sector Stability Assessment (FSSA) indicate that Chilean banks hedge 90-100 percent of the net foreign currency position on their balance sheets.

Table 3.

Chile: Gross External Debt, by Economic Sector, 2000-2004

(US$ Million)

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Source: Central Bank of Chile(1) Valor nominal.(2) Excluye intereses devengados.

22. Borrowers in economic sectors where no natural hedges exist are increasingly using financial hedges against exchange rate risk. A database constructed by Cowan, Hansen, and Herrera (2004) based on corporate annual financial reports (FECUs)—which accounts for roughly one third of the external debt position of the nonfinancial corporate sector—shows that financial hedges are mostly used by corporations in the nontraded utilities, transport, storage, and communications sectors. The same database also shows that, at end-2002, 18 percent of the total U.S. dollar-denominated debt of the corporations included in the database was covered by net long positions in forward dollar contracts.13 However, the bulk of exchange rate risk hedging was concentrated in a small number of large firms (Table 4). Apart from the naturally-hedged mining sector where most firms do not file annual reports with the Superintendency of Securities and Insurance (SVS), it is likely that financial hedging against currency risk is less pervasive among the typically smaller firms that are not included in the FECUs database. The extent to which the firms that are not covered in the FECUs database are exposed to currency risk on account of their external debt positions is an issue that merits further investigation.

Table 4.

Chile: US Dollar Denominated Debt Exposures in A Sample of Non-Financial Corporations, 2002

(in percent, unless noted otherwise)

article image
Source: Author’s calculations based on a dataset provided by Cowan, Hansen, and Herrera (2004).Note: The total stock of US dollar denominated debt covered in the sample corresponds to about one third of the external debt of the Nonbank private sector in 2002. Data on corporations in the Construction, Personal, Social and Community Services, and Other Unclassified Sectors are not shown, as they account for a very small share of US dollar denominated debt and hedging activity.

23. The presence of domestic agents with both long positions in foreign currency assets and domestic currency liabilities has fostered a fairly liquid onshore market for currency hedges. In the onshore market for forwards, which accounts for most of the hedging activity in Chile, pension funds and exporters provide the bulk of foreign-currency paying positions to corporate end-users. The cost of forwards is estimated to be lower than in other emerging market economies, and comparable to those in Australia and New Zealand (Chan-Lau, 2005). As in most other countries, maturities are skewed towards the short term, with seven-days to one-year maturity contracts accounting for 81 percent of the total in 2004.14

24. To more fully hedge against risks stemming from exchange rate fluctuations, external borrowers in Chile would have to increasingly enter into exchange rate risk-sharing agreements with nonresidents. It is estimated that in Australia and New Zealand—two natural resource based economies with high levels of private sector external indebtedness—the overall extent of hedging against exposures stemming from foreign-currency denominated external debt is higher than in Chile. Moreover, in Chile and in other emerging market economies, the amount of currency-risk sharing between residents and nonresidents (through cross-border trading of derivatives) remains fairly low relative to the amounts observed in industrialized economies. Thus, to more fully hedge against exchange rate volatility, external debt holders in Chile will have to increasingly shift net exposures to currency risk to nonresidents.

25. Increasing the share of debt in domestic currency would help reduce the financial vulnerability of Chilean firms operating in the non-tradable sector. The share of domestic currency-denominated external borrowing is almost nonexistent in most emerging market countries, and also remains low in many small industrialized open economies (Figure 8). Eichengreen, Hausmann, and Panizza (2004) report that the vast majority of international debt securities are issued in five major currencies: the U.S. dollar, the euro, the Japanese yen, the Swiss franc, and the sterling pound.15 A sound track record of inflation appears to be a necessary condition for the ability of countries to issue domestic currency-denominated external debt. However, the ability to issue debt in domestic currency also appears related to the relative size of the country in international debt markets. The larger the stock of outstanding debt securities issued internationally by a country, the deeper and more liquid are the markets for such securities. Nonetheless, several countries, including Australia, Canada, New Zealand, and South Africa—all natural-resource based economies like Chile, have managed to attract foreign investments in domestic currency debt, despite their relatively small size in international debt markets.

Figure 8.
Figure 8.

Share of Foreign Currency Denominated International Debt Securities (2001)

Citation: IMF Staff Country Reports 2005, 316; 10.5089/9781451951615.002.A004

Source: Eichengreen, Hausmann, and Panizza (2004).

26. Some emerging market governments have recently met the challenge of successfully issuing domestic currency debt abroad. In recent months, some Latin American countries—including Colombia—successfully issued international bonds denominated in local currency. In addition, private entities have issued global bonds denominated in or indexed to the local currency in Mexico and Brazil. These developments are encouraging for other emerging market economies that would benefit from reducing their net exposures to exchange rate fluctuations.

Ownership

27. The high share of foreign ownership of external debt is a source of financial strength and stability in Chile. Slightly more than half of the private external debt belongs to foreign-owned companies, and about one fourth is owed to parent companies abroad.16 The mining sector, which has attracted a large amount of foreign direct investment, accounts for a sizable share of external debt. Given Chile’s favorable macroeconomic and institutional environment, a number of multinational firms—for instance in the electricity sector—have strategically invested in Chile as a hub for further investments in the region, financing their investments partly by external debt. Direct investments in other countries in the region have exposed foreign-owned corporations to occasionally volatile external earnings, but during recent incidences of debt-distress among foreign owned corporations—some of which were driven by losses incurred in other countries in the region—foreign parent companies have been fully supportive of their Chilean subsidiaries.17

28. Incentives in the Chilean tax code contributed to the external borrowing of foreign-owned corporations in the 1990s, but these incentives were partly eliminated in 2001. Throughout the 1990s, Chile’s corporate tax code presented incentives for foreign-owned corporations to borrow externally from parent companies, as interest payments on external debt with related companies were subject to a tax of 4 percent, whereas dividend remittances were taxed at 35 or 42 percent.18 In 2001, in an effort to reduce the evasion of domestic taxes, the tax rate on interest payments to related companies was raised to 35 percent for companies whose debt with related companies exceeded their equity by more than 300 percent. Partly as a result, the rate of external debt accumulation by foreign-owned nonfinancial corporations has declined since 2001.

Corporate Sector Financial Soundness

29. Ultimately, the sustainability of Chilean external debt will depend on the financial soundness of the Chilean corporate sector. Despite their high level of external debt, the overall leverage of Chilean corporations is not large in comparison to those of their peers in Australia and Canada, or in comparison to those observed in emerging market economies in Asia or Latin America (Table 5). In the mining sector, which accounts for about one third of private external indebtedness and where debt has financed projects with flows of income based on proven reserves of copper or other metals, leverage appears to be lower than in most comparator countries and regions. Moreover, aggregate and sectoral Black-Scholes-Merton (BSM) default probability estimates calculated using corporate-level data for 2003-04 indicate that Chilean corporations were financially sound (Figure 9).

Table 5.

Leverage Ratios in Publicly Listed Corporates by Sector, 2003 (in percent)

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Source: Brooks and Ueda (2005).
Figure 9.
Figure 9.

Market Cap Weighted BSM Default Probabilities, 2004

in percent

Citation: IMF Staff Country Reports 2005, 316; 10.5089/9781451951615.002.A004

Source: Brooks and Ueda (2005).

E. Conclusions

30. Although Chile’s private sector external debt is relatively high by emerging market standards, the more moderate level of total debt largely reflects Chile’s economic attributes. The empirical analysis suggests that Chile’s relatively high level of per capita income and trade openness, as well the relatively small size of its economy, warrant its level of external indebtedness. However, Chile is unusual in terms of the composition of external debt by institutional sector, with the private sector holding a larger amount of debt than expected from cross-country empirical analysis. The relatively small stock of public debt, which in part reflects the relatively small size of the public sector following the privatization program, appears to have provided additional room for private sector indebtedness abroad.

31. It would be desirable to have a larger share of Chile’s external debt denominated in Chilean pesos or hedged. As recommended by the 2004 FSSA, the establishment of an organized exchange for derivatives trading, allowing for banks, pension funds, and insurance companies to underwrite option contracts would foster the development of the onshore currency derivative markets. If exposures to currency fluctuations are to be hedged to a larger extent, however, Chilean residents with external debt will have to increasingly enter into currency risk-sharing agreements with nonresidents. Raising the awareness of small and medium-sized firms regarding the benefits of hedging against exchange rate risk would also be desirable.

Data Sources and Determinants of International Investment Positions

1. Data Sources and Descriptions

Dependent Variables. The source for countries net foreign assets and debt liabilities is Lane, P. and G. M. Milesi-Ferretti (2005). The source for all other dependent variables is the International Investment Position reported by the IMF’s International Financial Statistics. The dependent variables are expressed as ratios to GDP or to total private sector liabilities (the sum of FDI, portfolio equity, portfolio debt, and other investments categories), where the private sector is defined as “Banks” and “Other Sectors”. The data are averages for 2001-2003. Financial centers (Switzerland, Hong Kong, U.K, Cyprus, Panama, Ireland, The Netherlands, Malta and Bahrain) are excluded from the sample).

Independent Variables. Data on the terms of trade was obtained from the World Development Indicators database of the World bank, and the World Economic Outlook database of the IMF. Data on broad money (M2) was obtained from the IMF’s International Financial Statistics. For all the other variables see the data sources in Faria and Mauro (2004).

2. Determinants of International Investment Positions

A recent line of research has sought to identify the cross-country empirical regularities associated with external assets and liabilities (Lane and Milesi Ferretti, 2000, 2001, Lane 2004, Faria and Mauro, 2004). The empirical investigation of international investment positions (IIP) in this paper has been largely guided by the set of determinants explored in this literature. The determinants investigated in the present analysis of IIPs are listed below, with brief explanations of their relevance for the analysis.

Real GDP per capita. Countries with lower levels of economic development would be expected to obtain external finance in order to build their physical and human capital stocks and smooth consumption on the path of convergence to higher per capita income levels. In practice, however, the presence of repudiation risk and moral hazard limits the access of developing countries to external finance. This enables countries that can offer more collateral to access international capital markets more strongly—making it more likely that countries with higher per capita output to accumulate relatively higher amounts of external liabilities.

Country size measured by GDP. Larger countries tend to have more diversified productive structures, more potential to share risk domestically, and thus deeper domestic financial markets. This is likely to limit the need to accumulate external liabilities.

Trade openness and terms of trade volatility. Countries that are open to international trade are more likely to be committed to honor their external obligations, given the larger costs of trade sanctions in the event of a default on financial obligations. This might imply that more open economies have more favorable credit risks, and access external credit at better terms. Moreover, countries that are more dependent on net export revenues may prefer to hold smaller amounts of liabilities and greater amounts of assets, as a buffer stock against trade-related income volatility. The latter is likely to increase with the volatility of the terms of trade, which is captured by an interaction term between openness and terms of trade volatility. The volatility of the terms of trade itself may result in an accumulation of external liabilities in countries with lower income levels. In a pure accounting sense, countries that have prolonged periods of trade surpluses (deficits) are more likely to have larger (smaller) net foreign asset positions. Given the possibility that imports and exports may have opposite effects on asset and liability positions, its useful to explore whether it matters to incorporate these variables separately as opposed to their sum.

Natural Resources. The ownership of natural resources—measured as the sum of fuel, ore and metal exports as a share of total exports or GDP—is likely to permit an increase in credit to a country as natural resources may serve as collateral (Lane, 2004). Also, the exploitation of natural resources require large scale capital investments, which might attract foreign investors, especially in emerging market economies. Since fuel resources are often owned and operated by public sectors to a greater extent than ore and metal mines, the analysis differentiates between these two types of natural resources in an empirical analysis of the external asset and liability positions of the private and the public sectors.

Institutional Quality. A number of studies have stressed the possibility that countries with weak institutions may attract more FDI as a share of total liabilities—since FDI might be more difficult to expropriate than other investments. Others have suggested that non-FDI investments—in particular banks’ external debt—are more likely to be bailed out during crises, resulting in higher shares of FDI in countries with weak institutions (Wei, 2001). Lane (2004) reports a positive impact of institutional quality on per capita external indebtedness in developing countries in 1995-98, whereas Faria and Mauro (2004) find higher institutional quality to be associated with greater shares of FDI and equity liabilities in developing countries. Here we test the significance of an overall index of institutional quality as well as an index of regulatory quality on the IIP variables.

Depth of local financial markets. The deeper the local financial markets are, the less would be the need for the residents to obtain financing from abroad. The depth of financial markets, however, are likely to be correlated with the sophistication of financial markets, which could attract foreign investments.

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  • Lane, P.R., 2004, ”Empirical Perspectives on Long-Term External Debt”, Topics in Macroeconomics, Vol. 4, Iss. 1, Art. 1.

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  • Lane, P.R. and G.M. Milesi-Ferretti, 2000, “External Capital Structure: Theory and Evidence, CEPR Discussion Paper Series, No. 2583. (London: Centre for Economic Policy Research).

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  • Lane, P.R. and G.M. Milesi-Ferretti, 2005, “The External Wealth of Nations Mark II: Revised and Extended Estimates of Foreign Assets and Liabilities, 1970-2003” (unpublished; Washington, International Monetary Fund).

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1

Prepared by Oya Celasun (RES). The author has benefited from useful discussions with T. Cordella, K. Cowan, C. Echeverr A. Faria, E. Jadresic, O. Jeanne, L. F. Jimenez, S. Lehmann, G. M. Milesi-Ferretti, and A. Rebucci. Special thanks to K. Cowan, E. Hansen, and L. O. Herrera (for sharing their data on Chilean nonfinancial corporations); P. Lane and G. M. Milesi-Ferretti (international investment positions); U. Panizza (currency denomination of internationally-issued debt securities), and M. Leos (Moody’s debt ratings).

2

Fitch upgraded Chile’s sovereign long-term foreign currency rating to A in March 2005, following a similar upgrade by S&P in January 2004. Moody’s has kept its rating (Baa1) unchanged since 1995. It changed its outlook from “stable” to “positive” in February 2005, but cited high levels of external private debt as a source of vulnerability.

3

Unless noted otherwise, the term private external debt in this paper refers to the external debt of all sectors other than the general government and the monetary authorities. This definition is dictated by data availability and the need to use a consistent definition across the sample of countries covered in the analysis.

4

Solvency requires that the net present value of non-interest current account balances be at least as large as the net present value of the country’s external debt. See, Blanchard and Fischer, Chapter 2 (1989).

5

Lane and Milesi-Ferretti (2000, 2001) investigate the determinants of IIP and its subcomponents. Focusing on developing countries, Lane (2004) and Faria and Mauro (2004) study the determinants of external debt and equity liabilities.

6

The country coverage of the sample is dictated chiefly by data availability. Both industrialized and developing countries were included in the analysis, but financial centers, where gross positions are not meaningful, were excluded.

7

It would be expected that economies characterized by high real volatility exhibit a preference for equity rather than debt liabilities, as equity liabilities allow for more risk sharing relative to debt liabilities.

8

It is also conceivable that one domestic institutional sector intermediates funds from abroad to the other domestic sector.

9

Vergara (2004) notes that in Chile, the small size of the total public debt stock has allowed for favorable corporate tax rates and strong private investment rates partly financed by foreign borrowing.

10

Caballero (2002) notes that the cost of international borrowing is strongly negatively correlated with Chile’s terms of trade and business cycle, implying that Chilean corporations’s terms of access to international credit is highly procyclical.

11

See Informe de Estabilidad Financiera, Banco Central de Chile, June 2005.

12

The transport, storage, and communications sector is usually also classified as tradable, although the extent of pass-through from the exchange rate to prices in this sector would be expected to be less than that in the agriculture, manufacturing, and mining sectors.

13

Using annual financial reports (FECUs) filed by nonfinancial corporates with the SVS, the 2004 FSSA estimated that, excluding natural hedges, this proportion was higher, with about 42 percent of the total net foreign currency-denominated liability position hedged at end-2003.

14

In Australia and New Zealand, the maturities of forward contracts appear to be shorter, with 55 and 74 percent of contracts maturing in less than seven days, respectively (Bank of International Settlements, 2004).

15

The dataset compiled by Eichengreen, Hausmann, and Panizza (2004) covers only bonded debt issued crossborder. It thus excludes loans and locally issued bonds.

16

Over the past ten years, the increase in the external private debt of Chile has largely resulted from the external borrowing of foreign-owned corporations. The external debt of domestically owned corporations has been fairly stable.

17

Chapter VI of Kalter, et. al. (2004) discusses the debt difficulties of Enersis and AES Gener in 2001–2002, two foreign owned corporations operating in the electricity sector. The financial difficulties faced by Enersis was due to losses incurred on foreign investments in the region, while the difficulties of AES Gener were the result of the financial problems faced by its parent company in the United States.

18

Such gaps in the tax treatment of interest versus dividend payments to related foreign companies are smaller or nonexistent in most other mineral-exporting economies, which have similarly attracted a large presence of foreign-owned companies. See PricewaterhouseCoopers (2004).

Same Series

Other IMF Content

Other Publishers

Cover IMF Staff Country Reports
Chile: Selected Issues
Author: International Monetary Fund
Volume/Issue:
Volume 2005: Issue 316
Publisher:
International Monetary Fund
ISBN:
9781451951615
ISSN:
1934-7685
Pages:
84
DOI:
https://doi.org/10.5089/9781451951615.002

External Assets and Liabilities

percent of GDP, 2001-2003 average

Private External Liabilities

percent of GDP, 2001-2003 average

Chile: Total and Private External Debt

Private External Debt

percent of GDP, 2001-2003 average

External Debt of the Nonbank Private Sector

2001-2003, percent of GDP

Net External Assets: Private versus Public Sectors (percent of GDP)

Share of Short-term Debt in Total Private External Debt (percent)

Share of Foreign Currency Denominated International Debt Securities (2001)

Market Cap Weighted BSM Default Probabilities, 2004

in percent