Weaker Fiscal Position Likely To Prompt Bond Issuances

BMI View: We forecast that Chile's nominal budget surplus will narrow in the coming years amidst weaker revenue inflows as economic growth cools, and an uptick in counter-cyclical spending by the centre-left Chilean government. Moreover, in order to help fund its policy agenda, we expect the incoming government to increase its debt issuances, abetted by a new law aimed at encouraging foreign participation in the country's bond markets.

We forecast that Chile's gross nominal budget surplus will shrink to 1.8% and 1.6% of GDP in 2014 and 2015 respectively, from our estimate of 2.9% of GDP in 2013, based on our view that revenue inflows will remain relatively weak as the economy cools, while spending will tick up as the government seeks to stimulate growth, as well as fund education reform. Moreover, we believe that Chile's net fiscal balance, which includes transactions of non-financial assets, flipped into deficit in 2013 for the first time in three years, and we expect it will remain in the red through 2015. Indeed, we forecast net budget deficits of 1.1% and 1.2% of GDP in 2014 and 2015, respectively, compared to our estimate of 0.6% of GDP in 2013. Supporting our view that Chile's net and gross fiscal balances have passed their peak, recently released data from the central bank indicate that total revenue inflows fell by 2.2% in 2013, the first time that government inflows have contracted since 2009. This was primarily due to a 28.1% drop in gross copper revenues, and only modest gains in tax collections. At the same time, expenditures rose by 5.0% last year, although we estimate that expenditures as a percentage of GDP remained relatively constant at 17.5%, only a slight uptick from 17.4% in 2012.

Looking forward, we believe that the incoming, centre-left administration of President-elect Michelle Bachelet will pursue a counter-cyclical increase in outlays in order to stimulate real GDP growth, which we forecast will moderate to 3.7% in 2014, from our estimate of 4.3% in 2013, amidst weakening mining sector investment and a slowdown in household consumption in H114 ( see 'High Frequency Data Point To Slowdown In 2014', February 7). In addition, Bachelet's proposal to expand public education is likely to cost between 1.5-2.5% of GDP, requiring an uptick in spending. As such, we forecast that government expenditure will rise by 12.0% annually in the next two years, outpacing growth in revenues of 5.0% and 10.0%, which will be capped by a continued drop in industrial metals prices as demand from China wanes. Our Commodities team forecasts average LME copper prices of US$6,800/tonne in 2014, down from US$7,350/tonne in 2013.

Nominal Surplus To Continue Narrowing
Chile - Central Government Revenue And Expenditure, % chg y-o-y 12ma And Budget Balance, CLPmn 12-Month Rolling

BMI View: We forecast that Chile's nominal budget surplus will narrow in the coming years amidst weaker revenue inflows as economic growth cools, and an uptick in counter-cyclical spending by the centre-left Chilean government. Moreover, in order to help fund its policy agenda, we expect the incoming government to increase its debt issuances, abetted by a new law aimed at encouraging foreign participation in the country's bond markets.

We forecast that Chile's gross nominal budget surplus will shrink to 1.8% and 1.6% of GDP in 2014 and 2015 respectively, from our estimate of 2.9% of GDP in 2013, based on our view that revenue inflows will remain relatively weak as the economy cools, while spending will tick up as the government seeks to stimulate growth, as well as fund education reform. Moreover, we believe that Chile's net fiscal balance, which includes transactions of non-financial assets, flipped into deficit in 2013 for the first time in three years, and we expect it will remain in the red through 2015. Indeed, we forecast net budget deficits of 1.1% and 1.2% of GDP in 2014 and 2015, respectively, compared to our estimate of 0.6% of GDP in 2013. Supporting our view that Chile's net and gross fiscal balances have passed their peak, recently released data from the central bank indicate that total revenue inflows fell by 2.2% in 2013, the first time that government inflows have contracted since 2009. This was primarily due to a 28.1% drop in gross copper revenues, and only modest gains in tax collections. At the same time, expenditures rose by 5.0% last year, although we estimate that expenditures as a percentage of GDP remained relatively constant at 17.5%, only a slight uptick from 17.4% in 2012.

Nominal Surplus To Continue Narrowing
Chile - Central Government Revenue And Expenditure, % chg y-o-y 12ma And Budget Balance, CLPmn 12-Month Rolling

Looking forward, we believe that the incoming, centre-left administration of President-elect Michelle Bachelet will pursue a counter-cyclical increase in outlays in order to stimulate real GDP growth, which we forecast will moderate to 3.7% in 2014, from our estimate of 4.3% in 2013, amidst weakening mining sector investment and a slowdown in household consumption in H114 ( see 'High Frequency Data Point To Slowdown In 2014', February 7). In addition, Bachelet's proposal to expand public education is likely to cost between 1.5-2.5% of GDP, requiring an uptick in spending. As such, we forecast that government expenditure will rise by 12.0% annually in the next two years, outpacing growth in revenues of 5.0% and 10.0%, which will be capped by a continued drop in industrial metals prices as demand from China wanes. Our Commodities team forecasts average LME copper prices of US$6,800/tonne in 2014, down from US$7,350/tonne in 2013.

However, as we have previously noted, key to Chile's medium-term revenue will be a proposed tax reform package, which we believe is likely to pass in some form in the first half of 2014 following the new government's inauguration on March 11. This reform package is centred on an increase in the corporate tax rate from 20% to 25%, as well as the elimination of certain loopholes that allow foreign companies to defer tax payments on reinvested earnings ( see 'Bachelet's Tax Proposal: Initial Thoughts', December 4 2013). While we have incorporated our expectation of an uptick in tax revenues into our 2015 forecast, we may adjust our forecasts further based on the shape of the final agreement.

Government Likely To Take Advantage Of Low Borrowing Cost
Latin America - US$ Global Government Bond Yields, %

Uptick In Debt Issuances Likely Amidst Search For New Sources Of Financing

Faced with weaker revenue inflows, we believe that the Chilean government may seek to issue more debt, both domestically and on international credit markets in the coming years, as it seeks to diversify its public financing sources and fund a moderately expansionary spending agenda. Indeed, given strong investor perceptions of Chile's creditworthiness, which currently afford it the lowest borrowing cost among major economies in Latin America ( see chart above), we believe that the government will continue both with the uptick in domestic bond issuances seen since 2008, as well as issue more externally traded bonds ( see 'Credit Risk To Remain Low Despite FX Sell-Off', January 24). As such, we forecast that Chiles' stock of external public debt will increase to 11.8% of GDP by 2015, from our estimate of 9.1% of GDP in 2013.

New Law To Pave Way For Increased Debt Issuances
Chile - Central Government Debt, % of GDP (LHS) & Debt By Currency, % of Total (RHS)

The process of issuing more public debt will be abetted by a new law - the Investment Funds Act - passed late in 2013 and currently in the implementation process that is intended to increase foreign participation in Chile's fixed income markets. We believe that the new law, which simplifies the regulation surrounding asset management in Chile and reduces capital gains taxes, will see foreign participation in the bond market increase from around 1.0% of holdings, where it is currently estimated to be by Chile's Ministry of Finance, towards the 35.0%-40.0% foreign participation seen in Chile's equity markets.

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Related sectors of this article: Economy, Finance, Fixed Income, Fiscal Policy, External Debt
Geography: Chile
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