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Central Bank easing
Owing to the benign inflationary setting,
markets had expected the Central Bank to further lower interest rates on
the ordinary board meeting on 9 May. In fact, the board decided to lower
the benchmark lending rate for the fourth time this year from 4.75% to
4.00%. The 75 basis point cut was at the upper limit of market
expectations; most observers had projected that the Bank would lower rates
by 50 basis points. The Central Bank stated that the weaker than expected
recovery of the domestic economy has facilitated an improved inflation
outlook in the medium term. Moreover, officials claim that while there is
no financial contagion, the complex regional outlook has adversely
affected trade and domestic economic activity. Panellists have factored
the monetary loosening into their projections and have again lowered their
year-end interest rate forecast.
Sovereign bond issuance at favourable interest rates as S&P upgrades
outlook
The benign domestic interest rate environment
is reciprocated on an international level, which prompted authorities to
access international capital markets in April. Chilean bonds are
currently trading at spreads barley 100 basis points above comparable US
treasuries, the lowest in the region. On 18 April, Chile issued US$ 600
million and € 300 million in sovereign bonds at a rate of 5.685% and 5.31%
respectively. The disbursements will in part be used to refinance
existing bond obligations that hold interest rates of 7% to 8%. The
government expects the refunding to generate interest savings of over US$
30 million for the public sector. In a credit rating analysis preceding
the bond issuance, the international credit rating agency Standard & Poor’s
(S&P) upgraded Chile’s outlook from “Stable” to “Positive”, while keeping
the foreign currency ratings unchanged in “A-“. The agency highlighted
the strengthening of the macroeconomic policy mix as a main reason for the
improved outlook, since it is providing policymakers with the ability to
adopt non-destabilizing counter-cyclical policies. In addition, S&P
asserted that authorities have managed to restore fiscal discipline, in
spite of the electoral cycle and the cyclical downturn, which helped
officials meet the 1% structural budget surplus target in 2001. In
addition, on the monetary front, S&P lauds the Central Bank’s willingness
to cut interest rates even in an environment characterized by excessive
volatility in the Chilean peso and highlighted monetary official’s
compliance with the stated inflation target for 2001.
The change in outlook is the first step for a
possible upgrade of Chile’s foreign currency rating, which could climb to
‘A’. According to S&P, improvements in creditworthiness depend on a
reduction in Chile's private-sector external debt and the ability to
return to strong economic growth close to the levels observed in the
1990s. This, in turn, depends upon the continued diversification of
exports, deepening of the local capital markets, as well as investment in
human capital and infrastructure. In the eyes of the rating agency, the
adoption of free-trade agreements with both the European Union (EU) and
the United States would constitute important milestones in furthering
trade diversification and would encourage investment.
Free
trade agreement with European Union reached; agreement with the US stalled
Chile’s negotiations for a free trade
agreement (FTA) with the European Union are in an advanced stage. On 26
April, the trading partners announced that they had reached a broad
political and commercial accord in all matters except for some small
points, which are still pending to be defined. The FTA covers all sectors,
contains a separate accord to encourage foreign direct investment flows in
both directions and a free trade agreement in services. The deal closed
two years of intense negotiations, which had been complicated by the EU’s
agricultural protectionism. The European Union accord could spur
negotiations over a FTA with the United States underway for some 17 months
now. The accord is stalled in the United States by the Bush
administration’s failure to obtain trade promotion authority (TPA,
formerly fast-track authority) from Congress, needed to seal trade
agreements. TPA has been stuck in Congress since Democrats demand to
include labour and environmental standards in any agreement. Nevertheless,
even without TPA, a deal could be signed this year but would require a
more thorough approval process in the United States.
Note:
The above text is an abridged version of the LatinFocus Consensus Forecast
briefing on Chile. For more details please click here.
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