OREANDA-NEWS. Chile's robust, flexible fiscal and macroeconomic policy frameworks are an important buffer against falling copper prices, Fitch Ratings says.

Low public debt and significant resources in its stabilisation funds also underpin shock-absorption capacity. But lower copper prices present downside risks to investment and growth, and highlight structural challenges, including the economy's narrow base.

Chile's commodity dependence is more evident in its external accounts (copper made up 51% of exports in 2014) than its fiscal accounts. The fiscal framework buffers spending from cyclical swings in copper prices by basing budgets on a long-term copper price estimate, USD3.07/pound in the 2015 budget.

Borrowing needs will increase with copper prices below this level, but the impact will be limited by copper's reduced share in fiscal revenues (8% in 2014, down from 29% in 2007). The sovereign is well positioned to meet extra financing needs, with significant cash on hand after December's USD2bn-equivalent global bond issuance, or through additional issuance in the local capital market.

Low projected deficits and public debt (15% of GDP in 2014) relative to 'A' and 'AA' rated peers should keep public finances a key credit strength. But stabilisation of copper prices at lower levels would mean reduction of the long-term copper price estimate in future budgets, requiring greater consolidation efforts to reach a structural balance by 2018. The structural deficit target for 2015 is 1.1% of GDP, up from 0.9% in 2014 to allow for capital spending-based stimulus.

The macroeconomic policy framework also underscores the economy's shock-absorption capacity. A flexible exchange rate allowed the peso to depreciate by around 15% over 2014, improving external accounts by reducing imports and supporting non-mining exports. This, along with a reduction in oil prices, reduced the current account deficit to around 1% of GDP in 2014 from 3.4% in 2013.

Net exports made a large contribution to GDP growth in 2014, counteracting weak domestic demand. Sustained lower copper prices would reduce these positive trends, but could be largely offset by the fall in oil prices.

But lower, more volatile copper prices further weaken prospects for the mining sector, which faces rising local costs (labour, energy and water), ageing deposits, and competition from lower-cost producers. Weaker mining activity could spill into the broader economy via construction, transportation and other services.

Falling copper prices could further weaken business confidence, which is at its lowest level since 2009 and drove a large contraction in investment in 2014. These factors increase downside risks to our forecast of a modest recovery in GDP growth to 2.6% in 2015 from 1.8% in 2014 - sharply below the previous four years' average.

Lower copper prices may provide an opportunity to reduce the economy's dependence on mining, Chile's key structural weakness relative to 'A' and 'AA' sovereigns. The weaker peso has supported non-mining exports, which suffered from a strong currency during the commodity boom.

The government plans to submit legislation to strengthen its legal framework for FDI, which could support investment and productivity gains in non-mining sectors. Equity FDI inflows into Chile rose 34% yoy in 2014 to end-November, reflecting continued investor confidence in Chile's institutional strengths and buying opportunities presented by a weaker peso.
We affirmed Chile's 'A+'/Stable rating in October.