Chile : Assessment of the Impact of the Proposed Arrangement Under the Flexible Credit Line on the Fund’S Finances and Liquidity Position

Request for an Arrangement Under the Flexible Credit Line-Press Release; Staff Report; and Staff Supplement

Abstract

Request for an Arrangement Under the Flexible Credit Line-Press Release; Staff Report; and Staff Supplement

Introduction

1. This note assesses the impact of the proposed Flexible Credit Line (FCL) arrangement for Chile on the Fund’s finances and liquidity position, in accordance with the policy on FCL arrangements.1 The proposed arrangement would cover a 24-month period, with an access level amounting to SDR 17,443 million (1,000 percent of quota). The Chilean authorities see the FCL as a complement to existing buffers, providing insurance against elevated external risks—including those that would arise from a prolonged outbreak of the COVID-19 pandemic. They intend to treat the arrangement as precautionary and temporary, exiting as soon as the 24-month period is completed, conditional on favorable developments in external risks.

Background

2. Chile has an exemplary track record of meeting its obligations to the Fund under past arrangements. Chile had several Fund arrangements during the 1950s to 1980s. Since 1980, Chile has had three arrangements with the Fund, an Extended Fund Facility (EFF) arrangement from August 1985 to August 1989 (SDR 825 million, 187 percent of its quota at approval) and two Stand-By Arrangements (SBAs), from January 1983 to January 1985 (SDR 500 million, 154 percent of quota at approval) and from November 1989 to November 1990 (SDR 64 million, 14.5 percent of quota at approval). Chile has no outstanding credit with the Fund (Annex 1).

3. Chile has established very strong policy and institutional frameworks.2 Over the past two decades growth averaged about 4 percent, consistently above the average for the region. Since the introduction of the inflation targeting regime in 1999, inflation has remained around the central bank’s target range (3 +/- 1 percent), supported by a strong monetary policy institutional framework and well-anchored inflation expectations. A strong fiscal framework anchored on a fiscal rule and structural deficit targets, a relatively low level of public debt by international standards (both in gross and net terms), and substantial fiscal buffers (including a sovereign wealth fund and other assets) are expected to provide ample room for Chile to undertake countercyclical fiscal policies in the wake of the current COVID-19 global pandemic. Chile’s financial regulatory and supervisory system is robust. The recently approved general banking law will further bolster the resilience of the banking sector by closing the gap with Basel III minimum solvency requirements, enhancing stabilization tools, and improving corporate governance.

4. Notwithstanding its very strong fundamentals and policy settings, Chile’s open economy is exposed to substantial external risks from the ongoing COVID-19 outbreak. The initial impact of the pandemic materialized through weaker external trade and capital outflows, and since the beginning of March (with the first confirmed cases of COVID-19) it has been compounded by the need to impose social distancing measures. Chile remains exposed through both trade and financial linkages to the massive global economic and financial shocks associated with the pandemic. Taking all this into account staff has revised down growth projections for 2020 and 2021, from 0.9 percent and 2.7 percent (respectively) in the January 2020 WEO to -4.5 percent and 5.3 percent (respectively) in its latest forecast.

5. Total external and public debt levels remain moderate and are expected to remain stable over the medium term under the baseline. Chile’s total external debt has been broadly stable around 58–66 percent of GDP over the past 6 years (Table 1), remaining at around 70th percentile levels compared to other emerging markets. By contrast, much lower external public debt amounted to only about 6.1 percent of GDP at end-2019. Public sector gross debt stood between 17 and 28 percent of GDP in 2015–2019, of which about one fifth was denominated in foreign currency in 2019. Total public debt is projected to reach 36.4 percent of GDP in 2021, reflecting the fiscal impact of the government responses to last year’s social unrest and to the COVID-19 outbreak. Debt sustainability analyses suggest that both external and public debt would remain sustainable with high probability.

Table 1.

Chile: Total External Debt, 2014–2020 1/

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Sources: Chilean authorities and IMF staff estimates.

All data are for end-year.

Baseline scenario.

The Newt Flexible Credit Line Arrangement-Impact on the Funds Finances and Liquidity Position

6. Risks and impact on Fund finances from Chiles FCL arrangement are assessed in the context of a downside scenario. Consistent with the idea that the FCL serves as insurance in the face of the potential realization of downside risks, and that the authorities intend to treat the FCL arrangement as precautionary, any drawings on the FCL would be expected to take place only when macroeconomic conditions notably worsen vis-à-vis the baseline projections. Therefore, and consistent with the practice for other precautionary arrangements, risks and impact on Fund finances and liquidity are assessed in the context of a downside scenario. Table 2 provides a comparison of the main macroeconomic assumptions underlying the baseline and adverse scenarios. The shock is assumed to be temporary, concentrated in 2020 when it reduces the real GDP growth rate by 4 percentage points relative to the baseline. After a temporary drop, real GDP growth picks up in 2021 and 2022 somewhat faster than assumed under the baseline, by 2 and 1 percentage points, respectively. Exports of goods and services decrease by 15.5 percent in the adverse scenario in 2020 and remain lower than in the baseline scenario by a small margin during 2021–2024. Gross international reserves decrease by US$5.7 billion, US$3.8 billion and US$1.9 billion respectively, compared to the baseline scenario, during 2020–2022.

Table 2.

Chile: Comparison of Macroeconomic Assumptions Under Baseline and Adverse Scenarios

(in millions of US dollars)

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Sources: Chilean authorities and IMF staff projections.

7. If Chile were to purchase the full amount available under the proposed FCL arrangement in a downside scenario, its capacity to repay to the Fund would remain adequate (Table 3).

  • In the illustrative downside scenario described above, if Chile were to draw all the resources available under the new FCL arrangement this year, its external debt would rise to about 92.8 percent of GDP in 2020, and public external debt would rise to about 21.3 percent of GDP. These ratios would be just above or below the median of other exceptional access cases approved since 2008 (Figure 1). Chile’s outstanding use of GRA resources would account for 12.2 percent of total external debt and about 53.3 percent of public external debt. Fund credit would initially reach 11.4 percent of GDP and nearly 68.9 percent of Chile’s gross international reserves. Peak Fund exposure relative to GDP or total external debt would be close to the median of recent exceptional access arrangements, although its ratio to gross international reserves would be well above the median (Figure 2). Although projected outstanding Fund credit in percent of quota around the peak is above those expected in other recent FCL arrangements in the event of full drawdown, it would be below that of most exceptional access cases approved since September 2008 (Figure 3).

  • External debt service would be high in 2020, but subsequently decline and remain manageable under staff’s medium-term macroeconomic projections. Chile’s projected debt service to the Fund would only represent 0.2 to 0.3 percent of GDP in 2020–2022, peaking at about 3.8 percent of GDP in 2024, reflecting large repurchases.3 Chile’s peak total external debt service and peak debt service obligations to the Fund as a share of exports of goods and services would be in the top quintile for exceptional access SBAs approved since September 2008 (Figure 2). At 15.4 percent, the latter would also be significantly higher than recent FCL cases for Mexico (5.6 percent) and Colombia (5.7 percent).

  • At the same time, there are several risk mitigating factors. Chile has very strong policy and institutional frameworks, which should serve to shelter the economy from the effects of the global COVID-19 pandemic. Most capacity to repay indicators suggest moderate credit risk to the Fund in terms of Chile’s capacity to repay. Moreover, Chile has a track record of uninterrupted access to international capital markets at favorable terms for several decades. It maintains investment grade status according to the three major rating agencies and is consistently among the highest-rated emerging market countries. Finally, the authorities intend for the FCL to be precautionary and temporary.

  • It is worth noting that, while public external debt service ratios are moderate, private external debt obligations are projected to rise to 21.5 percent of GDP in 2020 before falling to more moderate levels. On the other hand, while non-financial corporations’ external debt is large compared to peers, it is largely FDI-related (which reduces roll-over risks) and hedged against exchange rate risk.

Table 3.

Chile: Capacity to Repay Indicators 1/

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Sources: Chilean authorities, Finance Department, World Economic Outlook, and IMF staff estimates.

Assumes full drawing under the FCL upon approval and materialization of an adverse scenario, even though the authorities intend to treat the arrangement as precautionary.

Based on the rate of charge as of April 23, 2020. Includes surcharges under the system currently in force and service charges.

Staff projections for external debt, GDP, gross international reserves, and exports of goods and services reflect the adverse, and not the baseline, scenario under which the full FCL drawing is assumed.

Figure 1.
Figure 1.

Debt Ratios of Recent Exceptional Access Cases 1/2/

(EA cases since September 2008)

Citation: IMF Staff Country Reports 2020, 183; 10.5089/9781513545998.002.A002

Sources: Finance Department and IMF staff estimates.1/ Estimates as reported in relevant staff reports on the request of SBAs or arrangements under the EFF approved since September 2008.2/ Asterisks indicate PRGT-eligible countries at the time of the program.
Figure 2.
Figure 2.

Peak Fund Exposure and Debt Service Ratios for Recent Exceptional Access Cases 1/2/

(EA cases since September 2008)

Citation: IMF Staff Country Reports 2020, 183; 10.5089/9781513545998.002.A002

Sources: Finance Department and IMF staff estimates.1/ Estimates as reported in relevant staff reports on the request of SBAs or arrangements under the EFF approved since September 2008.2/ Asterisks indicate PRGT-eligible countries at the time of the program. In Panel F, Georgia’s debt service to the Fund includes one from PRGF loan.3/ Excluding arrangements with members belonging to the euro area at the time of the approval of the arrangement: Greece, Ireland, and Portugal.4/ For arrangements of which total external debt (or debt service) ratio is not available, public external debt ratio is shown instead.
Figure 3.
Figure 3.

Projected Fund Credit Outstanding in the GRA Around Peak Borrowing 1/

(In percent of quota)

Citation: IMF Staff Country Reports 2020, 183; 10.5089/9781513545998.002.A002

Sources: Finance Department and IMF staff estimates.1/ t represents the time when outstanding credit to the Fund is at its peak. Time is expressed in months. For illustrative purposes it is assumed that Chile’s FCL is fully drawn down at the time of Board approval.

8. The proposed FCL arrangement with Chile under the FCL (SDR 17.443 billion, or 1,000 percent of quota) would have a significant but manageable impact on the Funds overall liquidity position. The Fund’s Forward Commitment Capacity (FCC) would decline by over 9 percent from its current level of some SDR 190 billion to around SDR 173 billion (Table 4). If Chile were to draw under the FCL arrangement, it would be automatically excluded from the Financial Transaction Plan (FTP) and the FCC, which is currently only based on quota resources, would decline by another SDR 1.4 billion.4

Table 4.

Chile: Impact on GRA Finances

(In SDR millions, uncles otherwise indicated)

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Source: Finance Department.

The FCC is defined as the Fund’s stock of usable resources less undrawn balances under existing arrangements, plus projected repurchases during the coming 12 months, less repayments of borrowing due one year forward, less a prudential balance. The FCC does not include resources from currently unactivated lines of credit, including the New Arrangements to Borrow or bilateral commitments from members to boost IMF resources.

Current FCC minus access under the proposed arrangement.

Based on current Fund credit outstanding plus full drawings under the proposed FCL.

9. If the resources available under the FCL arrangement were fully drawn, the GRA credit exposure to Chile would be the Fund’s second largest and would exceed the Fund’s current level of precautionary balances:5

  • Fund credit to Chile would represent 19.8 percent of total GRA credit outstanding as of May 15, 2020, and 16.6 percent of GRA credit outstanding after taking into account Chile’s FCL arrangement. Chile would be the second largest Fund exposure after Argentina (SDR 31.9 billion) and before Egypt (SDR 10.6 billion). The concentration of Fund credit among the top five users of GRA resources would increase marginally to about 68.5 percent, up from 67.5 percent as of May 15, 2020.

  • Fund exposure to Chile after a full drawing on FCL resources would amount to 104.4 percent of the estimated level of precautionary balances (PBs) at end-FY2020.

10. The proposed FCL would have a moderate impact on the concentration of the Fund’s lending portfolio, both in terms of regions and among Fund facilities (Figure 4):

  • Regional concentration to Latin America would increase slightly. Currently, the Western Hemisphere accounts for about 62 percent of GRA credit and undrawn balances, including for precautionary arrangements. With the proposed FCL for Chile, that share would rise to 66 percent. The Fund experienced comparable regional concentration in the past, including in the aftermath of the global financial crisis, when lending to Europe accounted for the bulk of the Fund’s lending exposure.

  • Among the Fund’s different facilities, the share of FCL commitments would rise moderately. Commitments under FCLs, which represent the bulk of precautionary arrangements, stood at around SDR 52 billion in mid-May, 2020, or 49 percent of total GRA commitments (Figure 4). With the proposed FCL for Chile, the share of commitments from FCL arrangements would increase to 57 percent.

Figure 4.
Figure 4.

IMF Lending Concentration—By Region and by Lending Instrument

Citation: IMF Staff Country Reports 2020, 183; 10.5089/9781513545998.002.A002

Source: IMF Finance Department.

Assessment

11. The proposed FCL arrangement with Chile would have a significant but manageable impact on the Fund’s finances. The arrangement would cover a 24-month period with access in an amount of SDR 17,443 million (1,000 percent of quota). The immediate impact would be a decline of about 9 percent in the Fund’s lending capacity going forward. Nevertheless, the Fund’s overall liquidity position is expected to remain adequate after the approval of the proposed FCL arrangement. At the same time, in view of highly elevated risks to global growth and financial stability at present, a close monitoring of the liquidity position is warranted. In particular, the scale of potential new demand for Fund resources in the aftermath of the global COVID-19 pandemic is subject to large uncertainty and could be unprecedented.

12. If the proposed arrangement were drawn in full, the GRA credit exposure to Chile would be almost 17 percent of the Fund’s outstanding credit and over 100 percent of the Fund’s current precautionary balances, but staff judges the credit risk to be moderate. Assuming full drawing of 1,000 percent of quota under an adverse drawing scenario, most capacity to repay indicators suggest moderate credit risk to the Fund in terms of Chile’s capacity to repay. Moreover, Chile has very strong policy and institutional frameworks, which should serve to shelter the economy from the effects of the global COVID-19 pandemic. Chile also has a track record of uninterrupted access to international capital markets at favorable terms for several decades. Finally, the authorities intend for the FCL to be precautionary and temporary.

13. The authorities consider access to the FCL to be temporary with exit dependent on the evolution of external risks. The requested level of access is meant to provide insurance against a wider range of adverse external shocks, preserve investor confidence, and support the authorities’ macroeconomic strategy. The Chilean authorities intend to treat the arrangement as precautionary and temporary, exiting as soon as the 24-month period is completed, conditional on the evolution of external risks amid the uncertain global economic and financial environment. The authorities have indicated that they intend to reassess the external risk situation and the requested level of access at the time of the mid-term review.

Annex I. History of Arrangements with the IMF

This annex provides a brief overview of Chile’s Fund arrangements from 1983 to present1.

Chile has an exemplary track record of meeting its obligations to the Fund under past purchasing arrangements. Chile had three Fund arrangements in the 1980s and fully repaid its remaining outstanding credit in 1995 (Table I.1).

From 1983 to 1989, Chile had two arrangements under the Stand-By Arrangement (SBA) and one Extended Fund Facility (EFF).

  • In January 10, 1983, the Fund approved an SBA equivalent to SDR 500 million (154 percent of quota) when Chile’s financial problems were aggravated by the world economic slump and the prices of copper, Chile’s principal export product, collapsed. Under that arrangement, Chile made purchases totaling SDR 500 million, and its outstanding credit stood at SDR 795 million (245 percent of quota) at end of 1984. Chile made repurchases after 1986.

  • In August 15, 1985, an EFF equivalent to SDR 825 million was approved to support the Government’s medium-term economic policy and reform program during the period 1985–89. Solid performance under the program supported by this EFF allowed Chile to fully repay all its outstanding obligations to the Fund.

  • In November 8, 1989, a one-year Stand-By Arrangement equivalent to SDR 64 million was approved. Chile made full drawings and the obligations were fully repaid in 1995.

Annex Table I.1. Chile: IMF Financial Arrangements, 1983–2020

(in millions of SDR)

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Source: Finance Department.

As of end-December.

1

See “Flexible Credit Line – Operational Guidance Note”, SM/18/198, which documents the requirement for an assessment prepared by FIN/SPR on the impact of the proposed FCL arrangement on the Fund’s finances and liquidity position, as a supplement to the staff report.

2

Chile – 2018 – Staff Report for the Article IV Consultation (Country Report No. 18/311).

3

The projected figures on debt service used are calculated assuming that full amount available under the arrangement is purchased upon approval of the arrangement, and that all repurchases are made as scheduled.

4

Taking into account resources held as prudential balances, the decline in the FCC would be equal to 80 percent of Chile’s quota. See Financial Transactions Plan for the Period October 2019-July 2020.

5

There is an important distinction between credit risk and credit exposure. Credit risk in this assessment is a combined concept taking into account various factors that could affect the probability that a borrower country will fail to meet its financial obligations to the Fund on time, as reflected partially in Capacity to Repay indicators. Credit exposure by contrast is a concept linked more directly to the size of the Fund’s commitment to a member country.

1

The first IMF program for Chile was approved on April 1st, 1956. This appendix focuses on the most recent arrangements.

Chile: Request for an Arrangement Under the Flexible Credit Line-Press Release; Staff Report; and Staff Supplement
Author: International Monetary Fund. Western Hemisphere Dept.
  • View in gallery

    Debt Ratios of Recent Exceptional Access Cases 1/2/

    (EA cases since September 2008)

  • View in gallery

    Peak Fund Exposure and Debt Service Ratios for Recent Exceptional Access Cases 1/2/

    (EA cases since September 2008)

  • View in gallery

    Projected Fund Credit Outstanding in the GRA Around Peak Borrowing 1/

    (In percent of quota)

  • View in gallery

    IMF Lending Concentration—By Region and by Lending Instrument