OREANDA-NEWS. November 17, 2015. Fitch Ratings has affirmed Chile's Long-term foreign- and Local-currency Issuer Default Ratings (IDRs) at 'A+' and 'AA-' respectively. Fitch has also affirmed Chile's senior unsecured foreign bonds at 'A+'. The Outlook for the Long-term IDRs is Stable. In addition, the Country Ceiling has been affirmed at 'AA+' and the short-term foreign currency IDR at 'F1'.

KEY RATING DRIVERS

Chile's ratings are supported by a credible macro policy framework centred on a strong sovereign balance sheet, inflation-targeting regime and flexible exchange rate. Strong governance standards support the stability of these policies. These strengths counterbalance Chile's low per-capita GDP and high commodity dependence relative to peers.

Chile's economy is facing a period of sluggish growth as it adjusts to a less favourable external backdrop. Weaker Chinese growth and copper prices have weighed on investment and confidence, and concerns over an ambitious social reform agenda funded by tax hikes have fed into a climate of uncertainty. Fitch projects growth of 2.1% in 2015, little changed from 1.9% in 2014. Some improvement in the external demand and domestic confidence are expected to lift growth only marginally to 2.3% in 2016, with the balance of risks biased to the downside. Tighter fiscal and monetary policies will constrain the pick-up to growth in the near term, but they reflect authorities' commitment to maintaining confidence in the policy framework.

Estimates of Chile's rate of potential growth have been cut to around 3.5% from 5% in 2013 as the mining super-cycle has ebbed, weakening prospects for convergence of Chile's relatively low per-capita income with the 'A' median. The potential benefits of a reform agenda centred on improving education and social equity depend on pending content and implementation and would mostly materialize over the long term. Progress on an energy agenda, if sustained, could support higher investment in this sector and reduce end-user prices in the medium term.

Persistence of inflation above the target band (3% +/-1pp), driven by pass-through from peso depreciation, has narrowed room for accommodative monetary policy. This prompted the central bank to initiate a tightening cycle in order to anchor expectations, which have moved higher at the twelve-month horizon but remain anchored at the 3% target midpoint at the 24-month horizon relevant for monetary policy.

Chile's slowdown has been accompanied by a swift adjustment in external accounts. The current account deficit has narrowed to a near-balanced position in 2015 on lower imports and profit repatriation by foreign companies, induced in part by a weaker peso. A relatively high corporate external debt burden has not resulted in significant signs of financial stress in the context of peso depreciation. Intercompany lending has been a main driver of the increase and is subject to lower rollover risk, and the authorities highlight that borrowers are largely hedged either naturally via FX-linked earnings or financially through the use of derivatives.

Public finances face a period of higher deficits and rising debt as they adapt to weaker growth and copper prices, but their strong starting position affords scope for a gradual adjustment to this new scenario. Fitch projects weak revenues from falling copper prices and sluggish growth will lift the central government deficit to 3.0% of GDP 2015 from 1.6% in 2014. These factors are likely to keep the deficit at these higher levels in 2016, offsetting a structural improvement supported by new revenues from the 2014 tax reform and withdrawal of fiscal stimulus (real spending is budgeted to rise 4.4% in 2016, down from 9.8% in the 2015 stimulus year).

Lowering of the parameters used in the fiscal rule (potential growth, long-term copper price) has confirmed a weaker outlook for structural revenues in the medium term. This has presented the authorities with a trade-off between consolidation and social spending goals, and the policy response has been pragmatic in indicating a more gradual approach to both. Instead of their initial target of a structural fiscal balance by 2018, the authorities will aim for 0.25pp of GDP per year in structural deficit reduction. Fitch projects that this consolidation path, if sustained, could stabilize debt around 27% by 2020, still among the lowest levels in the 'A' category. The Economic and Social Stabilisation Fund, with 6% of GDP in assets, represents an additional fiscal buffer.

Support for the administration and its reform agenda fell sharply in 2015 on sluggish growth, concerns over some reform elements, and revelations of irregularities in corporate and political financial dealings. This prompted a cabinet reshuffle mid-year, as well as some efforts to address technical issues with the 2014 tax reform and business concerns with a pending reform to strengthen labour unions. Revelations of illicit party financing and corporate collusion have dented confidence in the political system and business sector, but have also demonstrated the ability of Chile's institutions to take action. Judicial investigations have moved forth, and policymakers are advancing on agenda to strengthen transparency, corporate governance, and rules surrounding political financing.

RATING SENSITIVITIES

The main factors that, individually or collectively, could lead to negative rating action are:

--Weakening of investment and growth prospects that leads to a widening of the per-capita income gap with peers;
--Erosion of fiscal policy credibility and/or the public sector balance sheet;
--Increased external vulnerability stemming from higher external indebtedness and/or erosion of external buffers.

The main factors that, individually or collectively, could lead to positive rating action are:

--Improvement in medium-term growth prospects and progress on productivity-enhancing structural reforms that bridge the per-capita income gap with peers;
--Significant improvements in the country's fiscal and external balance sheets.

KEY ASSUMPTIONS

--Fitch's base case assumes that China's economy slows in a sustainable and orderly manner, and that copper prices do not decline substantially from current levels;
--The investment plans of Codelco and other private sector companies are sufficient to maintain broadly steady copper production;
--On-going corruption investigations will not materially damage overall governance and institutional stability in Chile.