Chile Upgrade By Moody’s Highlights Divergence Within Emerging Markets

Moody’s upgraded Chile to Aa3 (equivalent to AA-), citing its “financial resilience” after the Feb earthquake.  Moody’s also praised years of solid macro policies, the fiscal surplus rule, and low debt as other factors behind the move.  We are not often surprised by ratings, but this one did.  Yes, we like Chilean fundamentals, but our sovereign ratings model showed Chile  to be correctly rated at A1/A+.  S&P rates Chile at A+ and Fitch at A.  Still, the move underscores the real divergence being seen between developed and emerging countries.  Many developed countries are facing or will face downgrade pressures in the coming months, whereas EM (with the exception of Eastern Europe) is enjoying strong economic fundamentals and mostly upgrade pressures.  We thought Peru would see the next upgrade in the region, as our model rates it BBB+/Baa1/BBB+ vs. actual ratings of BBB-/Baa3/BBB-.

Meanwhile, Chile’s central bank surprised the markets with a larger than expected 50 bp hike Wednesday to double the policy rate to 1%.  A 25 bp hike was expected.  The bank downplayed risks from the earthquake and the European crisis, calling them “limited”, and instead focused on falling unemployment and strong domestic demand as reasons to start withdrawing stimulus.  It added that the pace of withdrawal will depend on unfolding domestic and external macro conditions, and will act to keep inflation anchored around 3%.  So Chile now joins Brazil and Peru in the Latin American tightening cycle.  We continue to believe that Colombia and Mexico are further behind in the cycle, with rates hikes unlikely until Q4 or even 2011.  Risk appetite continues to swing back and forth, but initial targets for USD/CLP on the downside are 528.4 (38% retracement level of the 2010 rise) followed by 520.69 (50%).  The peso is supported by strong economic fundamentals and should outperform if EM sells off again.  Meanwhile, higher yields in the coming months should prove attractive for investors.  Market was looking for a year-end policy rate of 2.75% before the hike, and should adjust expectations higher now.

Source:  Bloomberg

Win Thin
Senior Currency Strategist
Brown Brothers Harriman & Co.

  1. Olivier Travers says

    Bear in mind that we had crazy FX volatility in 2008 (and peak/bottom copper). We went from about 430 CLP bottom to 670 top in less than 6 months. The 10-year average is around 530 which doesn’t hurt non-copper exports too much (as sub 500 does) and doesn’t make foreign goods too expensive (as above 600 does).

    Chile is one of a dozen or so countries with no net national debt. They’re all pretty much commodity-driven, and most are oil producers. For that type of country sovereign ratings don’t mean much unless and until they suddenly try to flood markets with new debt. A strong and growing contrast with the older, debt-ladden “first world” that the rating agencies can no longer ignore.

    Only shadow in this picture is that Chilean consumers use a lot of expensive credit for day-to-day consumptions (from retailers more than banks, for the most part).

    And Chile doesn’t have the education levels and human capital of a Canada or Australia. Still ways to go before becoming fully “developed”, but that’s the ambition the country is setting for itself.

    1. Edward Harrison says

      Good points, Olivier. Thanks for adding your perspective from Chile.

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