Chile:: Selected Issues Paper

International Monetary Fund. Western Hemisphere Dept.

doi:10.5089/9781484383919.002.A001

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Chile:

Selected Issues Paper

Author: International Monetary Fund. Western Hemisphere Dept.

Publication Date:: 09 Nov 2018

eISBN:: 9781484383919

Language:: English

Keywords:: ISCR; CR; debt; GDP; Chile; net debt; household debt; debt increase; trading partner; Chilean economy; debt rule; Exports; Credit ratings; Fiscal rules; Global; North America; debt in Chile; debt composition; hedged FX debt exposure; NFC debt issue; Private debt; Mortgages; Housing prices; Domestic debt

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Private sector debt in Chile has been increasing at a faster pace and has remained higher than regional and emerging market peers since 2010. However, a closer look at the underlying dynamics and drivers offers a number of mitigating factors. While corporate debt increased largely through higher external borrowing, the rise in household debt was mainly domestic through mortgages. Non-bank financing has also been increasing, pointing at the importance of closer supervision. The analysis in this paper suggests that neither of these developments presents any imminent risks to the Chilean economy, because debt is either FDI-related, long-term with fixed rates, hedged, covered by corresponding private sector assets, or associated with firms with large foreign operations. Nonetheless, there are still macro-financial linkages which should be managed closely through better data collection and supervisory practices and, if necessary, macroprudential policies.

Abstract

Private Sector Indebtedness in Chile: High but with Limited Risks¹

A. Introduction

1. In the aftermath of the Global Financial Crisis, corporate debt across emerging market economies surged in light of ample liquidity, search for yield, and large international capital flows. There has also been heterogeneity across emerging markets (EM) in terms of financial vulnerabilities imposed by the increase in debt. Recent studies focusing on non-financial corporate debt have identified a number of factors that determine these vulnerabilities: borrower characteristics, debt maturity, currency denomination, and risk mitigation practices (see BIS, 2015; Tarashev et al, 2016, Advjiev et al, 2017). FDI-related (direct investment debt) corporate debt has also picked up in several EMs and became comparable in size to other types of capital inflows. This trend highlighted new potential vulnerabilities especially in EMs where lending translated into increase in overall leverage (Advjiev et al, 2017). This paper will describe and assess the surge in Chile’s corporate debt and discuss the limited risks in light of these afore-mentioned factors and other debt dynamics and characteristics.

2. With Chile’s high level of financial development, total private sector debt exceeds those of regional peers and several other emerging markets, faring closer to advanced economies; however, underlying dynamics and debt composition have been different. Chile’s total private sector debt (about 190 percent of GDP in 2017) consists of domestic household debt (about 44 percent of GDP), domestic non-financial corporate debt (about 94 percent of GDP) and external non-financial corporate debt (about 45 percent of GDP). In comparison to peer emerging markets (with the exception of China), Chile’s private sector debt stands higher and has increased at a faster pace. However, total private debt has traditionally been above these countries. The main subcomponents are: higher external debt of non-financial corporates (NFCs) and higher domestic debt of households. These subcomponents are leading to an increase in both external and domestic debt.

B. External Debt

3. External private sector debt reached 48 percent of GDP in 2017, due to high levels of borrowing by non-financial corporates. It rose consistently from almost 30 percent of GDP in 2010. Notably, both the level and growth rate of external private debt have been higher than in other EMs. While it has come down from its peak in 2015, it still fares significantly above EM average of 17 percent of GDP and closer to advanced economies’ average of 46 percent, in line with Chile’s high financial development and market access.

4. About half of external non-financial corporate debt was FDI-related, which is generally associated with lower risks. External corporate debt had two main components: FDI-related debt and international corporate bonds.² In 2017, each were around 20 percent of GDP. The surge in FDI-related debt is in part explained by loan transfers from foreign-based parent companies of Chilean corporates. This is in part due to a tax advantage of foreign investment in Chile, via debt rather than equity, so that non-financial corporates have increasingly utilized this type of loans from parent companies to finance investments.³ This implies that part of external corporate debt in Chile is close in nature to equity, and hence it is not necessarily associated with typical risks from indebtedness, such as those due to investor sentiment and counterparty risk.

5. The other half of foreign non-financial corporate debt is of long maturity or hedged, and often backed by other assets. External non-financial corporate debt also rose through corporates’ increasing international bond issuances in recent years reaching over 20 percent of GDP in 2017 (BIS and Central Bank of Chile/Monetary Policy Report 20181H) The outstanding corporate bonds are mostly of long-term maturity, with fixed rates and denominated in U.S. dollars (BIS). The average maturity is 5 years and only around 10 percent of this debt is short-term (BIS). A substantial portion of this debt has been issued by large Chilean corporates with substantial earnings in U.S. dollars such as mining companies and other exporters (Central Bank of Chile Statistics). As such, it does not necessarily present significant or imminent maturity or currency mismatch risks. Fig. 7 shows that the mining sector has been the largest private borrower with 25 percent of total external debt. Only a small portion of this debt (corresponding to 4 percent of GDP) has been issued by corporates with peso-denominated accounting (Central Bank, Monetary Policy Report, 2018. However, most of these companies have implemented FX risk mitigation policies resulting in hedged FX debt exposures. The practice of hedging has been widely adopted by corporates, limiting the impact of exchange rate fluctuations on revenues.⁴ The international investment position of NFCs also demonstrates that around 50 percent of their foreign liabilities are backed up by foreign assets, lowering the risk of their debt obligations (Fig. 8) (Central Bank of Chile Statistics). Additionally, when scaled by GDP, corporate debt might overestimate the relevance of indebtedness, given the importance of revenues and value added obtained abroad.⁵

6. Global market conditions appear to have had limited impact on Chilean corporates access to international markets (see also Box 1 in Staff Report). Gross NFC debt issues have been increasing since 2009 with a decrease only in 2015–16 due to the economic downturn (Fig. 6, 9, 10), without a visible effect on the cost of borrowing. This also illustrates how international investors perceive Chilean corporates’ risk differently from other EMs due to their structure. CDS spreads and bond yields have been below regional peers. Overall, these factors mitigate corporates’ external debt risk as indicated by markets.

(2017 total; US$181 billion) — ^{Figure 7.}

(In millions of U.S. Dollars, end of each period) — ^{Figure 8.}

C. Domestic Debt

7. Domestic debt levels and trends have been comparable to other EMs, although non-bank financing started to play a relatively more prominent role. In 2017, domestic debt constituted the largest portion of private sector debt and increased substantially from 101 percent in 2010 to 140 percent of GDP in 2017. The increase has been partly fueled by higher household debt, which rose by 12 percent of GDP since 2010, while domestic corporate debt increased by 25 percent of GDP. Such trends have been associated with increasing financing from non-bank financial intermediaries including pension funds, insurance companies, and mutual funds. While non-bank financing has been increasing across all EMs over the past decade, the ratio of non-bank to bank financing in EMs is lower at 1:3 compared to 2:3 in Chile. This phenomenon was in part driven by the increasing volatility in global markets over the past decade, which gave an incentive to large Chilean institutional investors such as pension funds to redirect their investments to the domestic market, leading to higher liquidity and lower borrowing costs, and explaining the increase in non-bank financing.

(In percent of market value GDP) — ^{Figure 13.}

8. Besides non-financial corporates, households have been the largest contributors to private sector debt in Chile. There have been two major trends in household debt concerning systemic risk: an increase in mortgage loans and the role of non-bank financing. Household debt constitutes about one-quarter of total private sector debt in Chile, at around 44 percent of GDP in 2017. Its exposure is limited to domestic borrowing only, and increased by about 12 percent of GDP since 2010. Compared to other large EMs, household debt in Chile is at the top of the distribution. A large part of household debt is bank-financed, composed of mortgage loans (24 percent of GDP in 2017), and consumer loans (10 percent of GDP in 2017). The remaining (other) household debt is from non-bank financial intermediaries and includes shadow banking (credit cards by large retail stores), educational loans (backed by the State) and mortgage loans provided by non-traditional lenders, such as insurance companies. Most of the increase is associated with bank-financed mortgages.

9. In Chile, the increase in mortgage loans was also accompanied by an increase in real house prices. Two sets of house prices indicators are currently being used to track these price developments by supervisory authorities. Both indices report a similar upward trend. On the one hand, the OECD real house price index based on Central Bank of Chile data shows a 15 percent increase in real prices since 2010, which is modest by international standards (text chart, left panel).⁶

The correlation coefficient between house prices and mortgage loans over this time period is positive and significant: 0.85. On the other hand, the real house price index of the Chilean Chamber of Commerce, illustrates a much larger increase in prices. However, this index is based on new construction prices (including properties in development) in Santiago.

10. While not constituting any immediate risks, recent developments in household debt highlight the importance of broadening financial sector surveillance and systemic risk. Increasing household borrowing from non-bank financial intermediaries imply that financial surveillance should be deepened also beyond banks, to monitor and contain any risks from this expanding source of finance. Secondly, these trends indicate a need to improve data quality and comparability, as well as to closely monitor housing market and mortgage loans in order to assess any build-up of systemic risk over time. For example, data on asset (house) prices should be systematically collected and assessed, so as to be able to contain possible housing market vulnerabilities—which would have implications for the rest of the economy via macroprudential policies. Chile’s plans to centralize financial sector supervision and efforts to contain shadow banking are expected to mitigate these risks. Since bank-financed mortgage loans are mostly long-term with fixed/inflation indexed interest rates, any negative developments in house prices are not expected to pose an immediate risk to the banking sector. However, the emergence of macro-financial linkages would imply that any macroeconomic shocks affecting borrowers’ income and ability to service debt could lead to distress in banks’ balance sheets. This could be addressed with additional macroprudential policies. For the time being, banks voluntarily utilize a number of prudential measures, such as loan-to-value (80 percent for standard customers and 90 percent for prime ones) and debt-service-to-income ratios (25 percent). With the implementation of the new banking law, these could be better monitored under a unified macroprudential framework and authority, which could also address related issues for broader financial sector.

D. Concluding Remarks

11. Since 2010, private sector debt increased through external corporate and domestic household debt placing Chile above EM average; however, risks appear limited and possible macro-financial linkages call for stronger monitoring. While debt is above regional and EM peers, Chile’s high level of financial development partially explains this trend. Moreover, unlike most EMs, transmission of exchange rate volatility to the financial sector is contained in Chile through strong monetary policy credibility and effectiveness as well as covered foreign exchange positions. The increase in debt does not present imminent risks to the Chilean economy, because debt is either FDI-related, long-term with fixed rates, hedged, covered by corresponding private sector assets, or associated with firms with large foreign operations. Nonetheless, macro-financial linkages are significant, deeming broader financial sector and systemic risk surveillance necessary. Risks to the outlook concerning corporate borrowing include shocks to copper prices and to export demand from trade disputes or partners’ growth slowdown (see Staff Report). Moreover, stronger surveillance of conglomerates would minimize large-exposure and related-party lending risks and limit any spillovers to, or spillbacks from, the financial sector. Concerning household debt, economic distress affecting borrowers’ capacity to repay their debt would be a potential channel of transmission from the real economy to the financial sector. On the upside, the availability of long-term funding for the banking sector (such as from the pension funds) is a source of stability and shock absorber for the banks, which are already well capitalized. Approval of the pension reform might also slowly increase funding for banks over time, since pension funds are a significant source of stable financing for banks (see Staff Report for more details on preliminary plans for the pension reform). This would highlight the importance of continued management of credit risk to avoid any deterioration in banks’ asset quality. The upward trend in real house prices would benefit from closer surveillance and data collection to avoid any build-up of asset price vulnerabilities. An additional issue to be closely surveilled is the growing non-bank financing, which differs from traditional sources and point to the need of further strengthening the regulatory and surveillance environment.

References

Avdjiev, S., Hardy, B., Kalemli-Özcan, S. and Servén, L., 2018, Gross Capital Flows by Banks, Corporates, and Sovereigns, The World Bank (Washington).
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BIS (Bank of International Settlements), 2015, What do New Forms of Finance Mean for EM Central Banks?, BIS Papers, No. 83, November.
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Central Bank of Chile, 2017, Financial Stability Report 2017 (First Semester).
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Central Bank of Chile, 2018, Financial Stability Report 2018 (First Semester).
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Central Bank of Chile, 2018, Monetary Policy Report September 2018.
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Tarashev, N., Avdjiev, S., and Cohen, B., 2016, International Capital Flows and Financial Vulnerabilities in Emerging Market Economies: Analysis and Data Gaps. Note submitted to the G20 International Financial Architecture Working Group, August, Bank for International Settlements, Basel.
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Prepared by Burcu Hacibedel.

In comparison, financial companies, including private and public banks and other financial institutions, issued much smaller amounts of external debt securities, with private banks’ amount outstanding equivalent to 4 percent of GDP and other financial corporations and public banks at 1 percent of GDP each.

A foreign-based parent company pays a 4 percent withholding tax on interest income derived from lending to a Chilean company whereas t tax rate goes up to 35 percent if the parent company invests as equity. However, the decision on how to finance Chilean branch may involve several accounting aspects, rather than tax-exemption only, such repatriation of retained earnings.

The external debt of companies with a mismatch of more than 10 percent of their assets amounts to barely 0.3 percent of GDP (Central Bank of Chile, Monetary Policy Report September 2018). Corporates for which hedging data is not available have external debt equivalent to 3 percent of GDP.

In their Financial Stability Report 2017H1, the Central Bank of Chile suggests a number of alternative measures, such as debt-to-assets, to better gauge the NFC debt.

The real house price is given by the ratio of nominal price to the consumers’ expenditure deflator in each country, both seasonally adjusted, from the OECD national accounts database.

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