Itaú BBA - Fitch downgrades Chile, outlook revised to Stable

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Fitch downgrades Chile, outlook revised to Stable

August 11, 2017

The move itself is not unexpected as the country’s fiscal standing deteriorates, but it does arrive ahead of schedule.

With information available until 6:30pm Brasilia time

Highlights

  • Fitch lowers Chile’s rating to A from A+, with a Stable outlook. The move itself is not unexpected as the country’s fiscal standing deteriorates, but it does arrive ahead of schedule. The downgrade follows S&P’s lowering of Chile’s long-term foreign currency rating to A+ from AA-, with a Stable outlook. The market has for some time priced Chile alongside countries with A ratings, in spite of Moody’s (and S&P until recently) holding an AA- rating for Chile (see Macro Backdrop). 
  • Most LatAm pairs posted gains after the weak US CPI print. By the time of writing, the MXN is outperformed in the region (+0.79% to 17.8321/USD). The COP appreciated 0.66% to 2,977/USD and the CLP strengthened 0.21% to 646.80/USD. The BRL bucked the LatAm trend, closing at 3.1937/USD (-0.55%). 

Macro Backdrop

MEXICO
  • Industrial production growth was nil in 2Q17 (year-over-year), once calendar effects are taken into account. The industry was supported by manufacturing output but dragged by mining (largely oil) and construction activities. Industrial production fell 0.3% year-over-year in June - below our forecast (0%) and median market expectations (0.3% expansion) - which implied a contraction of 1.1% year-over-year in 2Q17 (from a 0.5% expansion in 1Q17). According to calendar-adjusted data reported by the statistics institute (INEGI), however, which adjusts for the negative calendar effects of the Easter holidays (April), industrial production expanded at a nil pace in 2Q17 (only slightly above the -0.1% year-over-year contraction recorded in 1Q17). Likewise, using calendar-adjusted data, manufacturing growth remained around the same level (3.8% year-over-year in 2Q1 7, 3.9% in 1Q17), mining output contracted sharply (-8.5% year-over-year, -10.6% previously), and construction weakened (-0.5% year-over-year, 0.4% previously).
  • We expect industrial production’s year-over-year growth to remain modest throughout 2017, but it will start to recover gradually on a sequential basis. Manufacturing exports will likely be solid, boosted by the dynamic growth of the US economy (even though the appreciation of the MXN observed in 2017 has reduced the cost-advantage benefitting Mexican manufacturers). Oil output seems to be falling by less, in spite of the fiscal consolidation (which has negative effects on both oil output - through the reduction of PEMEX’s capex - and construction activity). Moreover, the moderation of the uncertainty surrounding the Mexican economy - with more clarity on the future course of the Nafta renegotiation and more optimistic views from the rating agencies (S&P and Fitch recently revised Mexico’s credit rating outlook to stable, from negative) - will likely curb the slowdown of investment, and thus give some support to the construction sector. An important risk for investment (and construction), however, is the proximity of the presidential elections (July 2018), which could bring uncertainty and affect business confidence down the road. Full Report
CHILE
  • Fitch lowered Chile’s long-term foreign currency rating to A from A+, with a Stable outlook. Growth and the rapid rise in government debt are key drivers in the rating amendment. Explaining the rating change, Fitch highlights the lengthy period of economic weakness and lower copper prices, which has contributed to a sustained deterioration in the sovereign balance sheet. In Fitch's view, growth is unlikely to recover to levels consistent with per-capita income convergence with A peers. Meanwhile, government debt to GDP remains well below the A median but has risen considerably from the low levels that underpinned Fitch’s upgrade of Chile to A+ in 2011, and is on a path to converge with the A median as a share of revenues. The rapid rise in government debt has drawn concern from all of the main rating agencies and was flagged by S&P when it made its recent rating adjustment. The metric has risen from 3.9% of GDP in 2007 to 21.5% as of 1Q17. Fitch expects it to continue to rise to 25% of GDP this year and 30% by 2019. 
  • Chile’s credit ratings also include a stable outlook from Moody’s (Aa3), but the latter recently raised concerns about the country’s higher debt levels. With public debt likely to keep rising, we cannot rule out Moody’s takes similar action to S&P and Fitch in coming months. Full Report Below

COLOMBIA

  • According to the minutes from the July monetary policy meeting, the board sees the policy rate nearing its neutral level. As previously revealed, the board voted 6-1 in favor of a 25-bp rate cut to 5.5% at the meeting. The dissident board member noted that although growth is low, there remains a long way for inflation to reach the 3% target. Hence, this member preferred to accumulate further data on the two variables before acting. Meanwhile, within the majority, there were differing opinions on the scope for further rate cuts. Because Finance Minister Cárdenas recently indicated there was room for only one additional rate cut, the board is likely divided between no further easing and one additional rate cut. The discussion among the board members acknowledges that the inflation convergence to the target over the policy horizon is occurring, as evidenced by the fall of all core inflation measures in the month of June. Meanwhile, the growth rate of activity in the 2Q17 was likely stable from 1Q17 (1.1% yoy), but the outlook is for an improvement in 2H17. 
  • This month, we expect the central bank to implement the final rate cut of the year (25-bp to 5.25%). A pause will follow as inflation will rise towards yearend (aided by a low base of comparison). However, given that the policy rate is not expansionary, and considering our forecasts for lower inflation and weak growth, we expect further rate cuts in 2018 (to 4.5%). Full Report
Market Developments 
  • GLOBAL MARKETS: Treasuries narrowed (5-year: -3bps to 1.74%) after weak US CPI print. The headline came in at 0.11%, below market expectations (0.2%). The Fed funds futures implied probability of another rate hike this year fell to 29% from 38% as of Thursday. Global Markets Tracker
  • CURRENCIES & COMMODITIES: Commodities were mixed in the session. In one hand, oil posted gains (WTI: +0.33% to USD 48.91/bbl). However, iron ore dropped 4.99% in the session. In currencies, most LatAm FX posted gains on a weak USD day (DXY: -0.35%). By the time of writing, the MXN is outperformed in the region (+0.79% to 17.8321/USD). The COP appreciated 0.66% to 2,977/USD and the CLP strengthened 0.21% to 646.80/USD. The BRL bucked the LatAm trend, closing at 3.1937/USD (-0.55%). FX & Commodities Tracker
  • CDS SPREADS & EXTERNAL BONDS: LatAm credit spreads traded range bound in the session. CDS in Chile and Colombia stood flat at 65bps and 129bps, respectively. In Mexico, country risk inched down 1bp to 105bps. At last, Brazilian spreads narrowed 2bps to 205bps. External Bonds and CDS Tracker
  • LOCAL RATES – Brazil: The Brazilian curve bull flattened (Jan18x21: -5bps) ahead of the weekend. In DI futures, the Jan-18 inched down 1bp to 8.17% and the Jan-21 narrowed 6bps to 9.37%. Brazil Rates Tracker
  • LOCAL RATES - Mexico: The Mexican curve shifted 1bp downwards in the session. In TIIE swaps, the 1-year went down 1bp to 7.29% and the 10-year decreased 1bp to 7.13%. Likewise, breakevens went down (5-year: -4bps to 3.64%). Mexico Rates Tracker
  • LOCAL RATES – Chile and Colombia: In Chile, the front end of the curve widened. In Camara swaps, the 1-year went up 3bps to 2.41% and the 5-year increased by 1bp to 3.37%. Chile Rates Tracker In Colombia, yields traded lower at the margin. In IBR swaps, most rates were stable once again (1-year at 4.99%) and the 7-year fell 3bps to 5.92%. Colombia Rates Tracker

Upcoming Events

  • In Brazil, the key economic activity releases will be June’s retail sales (Wed.) and the Service Sector Survey (PMS) (Thu.), two important indicators for 2Q17 GDP forecast. We expect a 0.4% increase in core retail (month-over-month, seasonally adjusted), and a 1.3% growth in the broad segment, which includes vehicle sales and construction material. For June’s PMS we expect the headline to fall 3.5% year-over-year. Furthermore, the BCB will release its monthly activity index (IBC-Br) for June (Thu.) and CNI will release its industrial business confidence for August (Fri.). Moreover, the government may announce changes to its primary fiscal targets for 2017 and 2018 during the week. Also, July’s tax collection may also be released, for which we forecast BRL 108.3 billion, or a 1.8% y/y decrease in real terms. The market is also looking into the reforms being discussed in Congress. In that regard, the TLP (new Long Term Interest Rate) report can be read by this week in the joint commission (Lower House and Senate) built to discuss this topic. In addition, the Lower House Commission may finish the vote on the political reform. 
  • In Chile, the BCCh will hold its August monetary policy meeting (Thu.). With July’s inflation coming in slightly above market expectations and activity not deteriorating further, we expect the board to keep the policy rate stable at 2.5% in another split decision. Of interest would be whether the communication announcing the decision re-introduces an easing bias. We currently expect two additional 25-bp rate cuts this year. Moreover, the central bank will publish the National Accounts data for the second quarter of the year (Fri.). At the margin, we expect GDP to gain 0.7% from 1Q17, leading to annual growth of 1.0% year over year (0.1% in 1Q17). Then, the central bank will also publish the 2Q17 current account balance (Fri.). We expect a USD 1.2 billion deficit, up from the USD 1.0 billion deficit in 2Q16, mainly on the back of a smaller trade balance surplus (USD 1.3 billion in 2Q17, after USD 1.7 billion in 2Q16) as mining production gradually recovers from the 1Q17 strike.
  • In Colombia, activity indicators for the month of June are on the market’s radar (Mon.). In May, activity indicators came in below expectations and consolidated the view that activity in the second quarter of the year will continue to show weakness. We expect industrial production to fall 4.5% year over year (-0.6% in May). Meanwhile, retail sales likely saw growth of 1.0% in twelve months (-0.5% previously). Moreover, the national statistics authority will publish the supply-side breakdown of GDP growth for 2Q17 (Tue.). Based on activity indicators for the quarter, we estimate activity increased 0.7% from the previous quarter, resulting in annual growth of 1.4%, up from the 1.1% in 1Q17. Following the publication, the statistics agency will release the coincident activity indicator (ISE) for the month of June (Tue.). May data remained weak but there were signs of stabilization. Then, think-tank Fedesarrollo will release the July consumer confidence (Wed.). The weak consumer confidence levels hint that a fast recovery of private consumption is unlikely. Still, the trade balance for the month of June will be published (Fri.). We expect a trade deficit of USD 922 million, larger than the USD 771 million deficit recorded one year ago. As a result, the trade deficit would come in at USD 2.3 billion in 2Q17, narrowing slightly from USD 2.5 billion in 2Q16. Finally, Banrep will present its quarterly inflation report (Fri.). The central bank will likely implement a downward revision to growth forecasts for this year (currently 1.8%), while confirm the expectation that inflation will accelerate through the remainder of the year. Meanwhile, the report will likely also indicate that room for further easing is narrow, a message already being communicated by various board members. 

Latam Macro Calendar

For details, refer to our Monthly Strategy Report.

For details on Brazilian markets, refer to our Handbook - First edition.

Today's editors: Eduardo Marza, Pedro Correa


Macro Reports

CHILE – Fitch downgrades Chile one notch to ‘A’, stable outlook


Fitch lowered Chile’s long-term foreign currency rating to ‘A’ from ‘A+’, with a Stable outlook. The move itself is not unexpected as Chile’s fiscal standing deteriorates, but it does arrive ahead of schedule. The downgrade follows S&P’s lowering of Chile’s long-term foreign currency rating to ‘A+’ from ‘AA-‘, with a Stable outlook. The market has for some time priced Chile alongside countries with ‘A’ ratings (as shown by Chile’s 5-year CDS spread of 65), in spite of Moody’s (and S&P until recently) holding an ‘AA-’ rating for Chile.

Growth and the rapid rise in government debt are key drivers in the rating amendment. Explaining the rating change, Fitch highlights the lengthy period of economic weakness and lower copper prices, which has contributed to a sustained deterioration in the sovereign balance sheet. In Fitch's view, growth is unlikely to recover to levels consistent with per-capita income convergence with 'A' peers. Meanwhile, government debt to GDP remains well below the 'A' median but has risen considerably from the low levels that underpinned Fitch’s upgrade of Chile to 'A+' in 2011, and is on a path to converge with the 'A' median as a share of revenues. The rapid rise in government debt has drawn concern from all of the main rating agencies and was flagged by S&P when it made its recent rating adjustment. The metric has risen from 3.9% of GDP in 2007 to 21.5% as of 1Q17. Fitch expects it to continue to rise to 25% of GDP this year and 30% by 2019.

Fitch notes that the economic recovery following the end of the mining super-cycle has been slower than expected. Fitch projects growth will ease to 1.4% this year from 1.6% in 2016 (Itaú: 1.6%), in contrast with prior forecasts for a moderate recovery this year. Fitch then does see a recovery to 2.4% in 2018 (Itaú: 2.5%) and 2.8% in 2019 on improvement in external conditions and growth.

Regarding the new rating, Fitch notes that Chile's 'A' rating and Stable Outlook are supported by strong governance and a credible policy framework, which has preserved macroeconomic stability. Fitch expects a broadly disciplined policy framework to be maintained after 2017 elections, and that recovery in growth and copper prices (albeit to more moderate levels) and gradual consolidation efforts will contain public debt metrics in a range consistent with the 'A' rating.

Concerning the possibility of future negative rating actions, Fitch listed the following factors: sustained growth under-performance relative to rating peers, leading to further divergence in per-capita income relative to the 'A'-category median; faster-than-expected increases in the government debt burden; and/or erosion of fiscal credibility. On the other hand, the following risk factors individually, or collectively, could trigger a positive rating action: improvement in growth prospects and economic diversification that narrows the per-capita income gap with peers; improvements in the country's fiscal and external balance sheets.

Chile’s credit ratings also include a stable outlook from Moody’s (Aa3), but the latter recently raised concerns about the country’s higher debt levels. With public debt likely to keep rising, we cannot rule out Moody’s takes similar action to S&P and Fitch in coming months.

João Pedro Resende, Miguel Ricaurte, Vittorio Peretti



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