Economic review
Even before the first case of Covid was recorded, at the beginning of March 2020, Chile’s economy had been disrupted by an idiosyncratic shock: Chile’s worst political unrest in decades. The violent protests, which began during the last quarter of 2019, provided the context against which discussions about the economy were set.
“Chile’s response to the pandemic was proactive and multi-faceted,” said Andrés Pérez, international finance coordinator at Chile’s Ministry of Finance.
The government moved to defend the country’s physical, economic and financial well-being with a stimulus package that saw the healthcare system’s budget increase, measures implemented to protect workers against loss of income, and the introduction of tax measures to support small and medium-sized enterprises (SMEs). The Ministry of Finance, the central bank, and financial regulators, combined to ensure the flow of credit to companies and consumers. The central bank reduced interest rates and increased its bond purchase programme, while structural changes were initiated to foster greater growth, mainly by enhancing competition.
Those measures have made a positive impact, with Scotiabank projecting a strong recovery for the economy in 2021 of 7.5%.
“We see a strong rebound in consumption and investment, fuelled by a benign interest rate environment, the strong price of copper, and a continued accommodative monetary policy and stimulus in terms of fiscal policy,” said Stephen Guthrie, senior vice president and head of wholesale banking at Scotiabank Chile.
That said, unemployment is running at relatively high levels of more than 10%, so there is still quite a way to go before employment returns to pre-crisis levels. “And demand for commercial credit is very weak, especially in the corporate and higher-end segments of the market,” said Guthrie. Where there is growth, it is in the sector falling under the government’s guarantee programme.
Demand for consumer credit is also weak, which is put down to the amount of liquidity in the market. Consumer liquidity is a function, once again, of government support programmes, as well as the controversial government-sanctioned three rounds of withdrawals from pension funds.
Mortgages are recovering but, overall, demand for loan assets remains relatively subdued.
The experience of the corporate world can be split into two periods: 2020 and 2021. Electricity demand from regulated clients – residential customers and small businesses – declined. This drop in demand was tempered by stable consumption levels from large industrial and mining companies, something that was not only positive for revenues in the energy industry but an indication of better times for the overall economy.
“The authorities did a very good job with the different plans that were implemented,” said Eduardo Milligan, CFO of Engie Energia Chile, the power utility and locally listed unit of Engie Group. “Not all countries in our region were able to mitigate the impact on economic activity due to the crisis in this way.”
Weaker levels of energy consumption in the first half of the year reflected the slowdown in the domestic economy, but sectors reliant on international trade also had to contend with a global economic slump. They experienced huge swings in demand for their products.
Celulosa Arauco y Constitución, Latin America’s largest forestry, pulp and wood products company and the second largest global producer of all pulp, wood pulp, and wood panels, is a good example of the volatility faced by companies reliant on the global economy. It sells 85% of its output on the international market.
“The trend last year was very difficult,” said the company’s CFO, Gianfranco Truffello. “Demand for our wood products collapsed at the start of the pandemic and we had around two months where we were operating at 50% capacity in the wood product division.”
That situation turned around once the world began to emerge from the first wave of Covid.
“Very quickly, starting in July, demand rebounded very aggressively. We are now selling at record levels, full production, record prices,” he said.
The recovery points to some key changes in the construction sector, where a sudden rush to affect home improvements has led to strains in the supply chain for timber. In addition, the success of the vaccination programme and the rise of e-commerce – and its need for packaging, has resulted in record prices for pulp.
“Right now, we are in very good shape in terms of prices and demand,” said Truffello.
The international focus of other parts of Chile’s economy also benefited from the post-first-wave global rally, with industrial mining output rising in response to a surge in demand (and prices) for copper.
Electricity consumption increased as mining output grew and that trend is likely to continue. In May, even with several regions under quarantine, Engie Energia Chile realised a 7% growth in electricity generation compared with 2020, while in 2020 production decreased, but only by 3%.
The financial market
Chile is a very open economy, given its reliance on international trade and revenues, so the path taken by its financial markets is largely determined by global events. The local political situation and implementation of policy issues, such as the pension draw-downs, has created an overlay of domestic volatility, however. It will continue to do so.
The panel is keeping a close eye on the direction of interest rates in the US for an indication of what to expect in Chile. US rates have been trending higher in tandem with a stronger economy and a jump in inflation although long-term yields remain at historically low levels.
Despite recent statistics, inflation is not yet seen as an issue. Carolina Mery, CIO of AFP Habitat, the country’s largest private pension fund, said the uptick in interest rates indicated improved economic activity rather than being a harbinger of rampant price rises. Truffello agreed with Mery, pointing to short-term supply constraints as being partly responsible for current price pressures.
He outlined the scene: the international economic outlook has become more positive, masks are starting to come off in the US, people are returning to restaurants and demand for consumer goods is increasing – good news for the paper industry.
“We look at the rest of the world and it looks like summer is coming. Everything is more positive,” said Truffello.
The picture is not so rosy on the domestic front. “When we look at Chile, then it’s more like winter is coming,” he said. “We are more negative because of the election at the weekend.”
The market spiked immediately after the election results but, notwithstanding the short-term election-related volatility, term interest rates remain low from a historical perspective. Guthrie said that US rates began to move higher in mid-December, with emerging markets – including Chile – following suit after a lag. “Rates in Chile, both inflation-adjusted as well as normal rates, began rising mid-February by 1% to 1.25% across the curve, reached a period of stability around mid-April and then started to come down again.”
Debt capital markets
Guthrie highlighted very healthy local, as well as international, debt capital market activity in 2020, despite Covid.
“Supply in the local market is typically around US$5bn per year,” he said. “That is what we saw last year and this year it is running about US$1.5bn year-to-date. The international market is around US$15bn, and we are seeing reasonable year-to-date levels as well.”
The message is that Chilean issuers, in general, remain very attractive to national investors and its largest issuers remain attractive to a broad range of investors. They can tap the local market, the international market, even the bank market, which is open to corporate credit.
The positive borrowing environment of the last few years has been good news for Milligan, since Engie has committed to investing US$2bn in renewable power plants between 2020 and 2025.
“Fortunately for us, we concluded a liability management exercise in January 2020, just before the crisis started, which gave us enough liquidity to get through the year,” he said. Engie also sold accounts receivables to an SPV, with the SPV issuing a corporate bond in the international markets, and it also found a way to mechanism to monetise the reduction of CO2 emissions (the US$125m financial package from IDB Invest was a world first).
“We have been busy,” said Milligan. “The capital market and the bank market has been there to support us, and we see several possibilities to continue financing our capex programme for the next years.”
At a governmental level, Chile found itself requiring significantly larger-than-expected funding to get it through the Covid shock. But Chile had additional pressure on its financing activities due to the social unrest of 2019.
To compensate for the anticipated reduction in revenues associated with a contraction in economic activity and the tax measures taken to enhance household and corporate liquidity, the government turned to a combination of debt and the use of pension fund assets.
Chile’s financing strategy was determined by a checklist, said Perez: ensuring competitive terms for the sovereign while generating market benchmarks; further diversifying the investor base through the issuance of thematic bonds, such as green, social and sustainable; and issuing dollar-denominated bonds.
There has also been greater emphasis on flexibility and transparency on the debt management strategy, he said, such as adjusting the issuance calendar, for example, to accommodate unexpected changes in financial conditions, at home and abroad.
The government’s financing needs for this year are expected to be somewhere in the order of US$24bn, of which a little under 50% has already been raised. That may change, of course, depending on the evolution of the pandemic.
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