Chile: Exchange rate volatility and political uncertainty raise country risk

The exchange rate volatility that the country has registered during the last weeks added to the prospects of lower growth and the political uncertainty due to the referendum, and the reforms being promoted by the government changed the trend that Chile’s country risk indicators had been showing since the beginning of the year.

When Gabriel Boric’s government took office, Chile’s country risk, as reflected in the Chile Credit Default Swap (CDS), stood at 80.3 points, while the Embi, a country risk indicator prepared by JP Morgan, stood at 190 points, even in the first months of government it continued to fall until reaching a minimum of 145 points at the beginning of April.

Today both are far from those levels; even the Embi, as of July 18, reached 207 points, returning to pre-change of government levels. And so far in July, the average is precisely 200 points. This level in monthly terms has not been seen since June 2020, when it was 209.

In the case of CDS, the trend break began to be noticed in mid-June when it surpassed the 100-point barrier. It then continued that trajectory until it reached levels of 130 points. On July 23, it closed at 135.6, and so far in July, it has recorded an average of 128 points. It is their highest record since February 2016.

WHAT EXPLAINS THIS RISE?

Experts deliver several arguments that explain this change in trend. Among them are political uncertainty, the slowdown of the economy, and the exchange rate volatility that has been present in Chile.

Sergio Lehmann, the chief economist at Bci, says that the rise in country risk “recognizes an economy that will grow less than expected in the coming years due to a weakened investment. Behind this are the impacts of political uncertainty and an institutional framework that has lost strength”.

Likewise, he adds that “greater pressures are seen on the public expenditure side, mainly due to the constitutional proposal, which commits greater resources, which would dominate over the article that aims at sustaining fiscal responsibility”.

On this point, Lehmann highlights “particularly the autonomy that would be given to the regions in this matter, without sufficient control. In the latter, in addition, the government is recognized as giving aid to face the higher inflation, but without an adequate focus”.

Felipe Alarcón, an economist at Euroamerica, argues that “there is an international component to this trend; several countries in the region raised their CDSs in July, although many of them reduced them later.

To a lesser extent, Chile and Peru have tended to be slightly higher than at the beginning of that month.

Alarcón explains that “the difference compared to the other countries may have been in the high local exchange rate volatility, which finally triggered the intervention of the Central Bank and which in the eyes of investors may be a differentiating factor compared to the rest of Latin America”.

LyD researcher, Tomás Flores, adds that “there is a contagion effect from a neighborhood where economic policies are deteriorating substantially, and uncertainty about different reforms that the government wants to implement and that will have an impact on our potential growth must be reduced”.

GLOBAL RISK

Despite this rise, Chile has the lowest risk in the region. Its closest follower is Peru, with an average of 237 points in July, followed by Brazil with 358 points, Colombia with 447 points, and Mexico with 473 points.

In Latin America, the average country risk for July is 543 points, above the 472 points recorded by the global risk. In Asia, the Embi averages 272 points and in Europe 790 points.

WHAT’S AHEAD

Economists’ perspectives on Chile’s country risk behavior are uncertain but with an upward bias. Although Alarcón maintains that “we should normalize like the rest of the countries, the process in Chile may take a little longer given our particular local scenario, among them the exchange intervention and the plebiscite for the new Constitution”.

For Lehmann, “the evolution of the risk premium will depend to a large extent on how we approach the constituent process after the referendum. Beyond the result, changes will be necessary, either to the constitutional proposal or the current constitution”.

The economist stresses that it is key how “fiscal responsibility is addressed in a context of greater social rights. It will be decisive for the fiscal outlook. It will also be important how the government responds to pressures for greater public spending in a context of economic recession, which seems inevitable”.

With information from La Tercera

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