Chile’s well-funded pension scheme has been a major factor in the country climbing the global economic ladder. And minister of finance, Felipe Larraín Bascuñán, claims that in these tough economic times Chile’s strength will be ‘part of the solution’. Christopher O’Dea spoke to him
Chile is on the move. Most of the world’s emerging markets lie between the Tropic of Cancer, north of the equator, and the Tropic of Capricorn, to the south. But those are imaginary lines based on the requirements of astronomy. With global growth still sputtering three years into the financial crisis, several European Union economies are at risk of falling into emerging-nation status by almost any prudent financial measure.
Meanwhile, against the backdrop of the great recession, Chile stands out as one emerging market not just determined to break into the ranks of the developed world, but the one actually achieving the financial, fiscal, and political results that have brought it within striking distance of matching OECD standards of income, literacy, poverty reduction, education, retirement provision and public financial strength.
An economy famously built by the ‘Chicago Boys’ who applied the free-market principles of Milton Friedman through the 1980s, it is fitting that Chile could become the first country in this century to break into the ranks of developed nations.
Chilean minister of finance Felipe Larraín, who is leading the financial charge in what may be Chile’s final ascent to developed-market status, recently outlined his programme to meet the challenges of this move during a discussion with the Dean’s International Council of the University of Chicago’s Harris School of Public Policy in Santiago. The Harvard-educated Larraín is balancing the costs of major policy initiatives like continued educational advancement and development of Chile’s energy production and distribution resources against the external pressure of global economic weakness, the EU debt crisis and uncertainty over the future of commodity prices - a critical factor for a country that still derives more than half its export revenue from copper.
Having steered the country back onto a sound financial and economic development footing after Chile suffered the fifth-worst earthquake on record, Larraín is now working to maintain Chile’s growth rate at a pace quick enough to reach developed status by 2018 or 2020. To do that, he will need to enact financial, tax, trade and savings policies that will enable Chile to continue the rapid growth of the past 30 years without igniting inflation, jeopardising currency value, or risking Chile’s strong sovereign debt position.
Admitting Chile faces a slowdown from its targeted 6.0-6.5% GDP growth rate, Larraín also faces the prospect that weak employment conditions might strain Chile’s bedrock pension savings system and slow its progress towards the goal of becoming an international financial centre.
It is a challenging agenda. But having rebounded from the earthquake with a surge of activity that sometimes topped a 15% annualised GDP growth rate, Larraín notes Chile’s strong fiscal and budgetary position: a debt-to-GDP burden of just 10% (compared to 36% for the average AA-rated sovereign); wage increases of only 2.5-3.0% in a strongly growing economy; and a projected 2011 fiscal surplus of 1.2% of GDP.
In terms of its financial structure and capital markets, Chile not only stands apart from its Latin American neighbours, but in the past year has notched up a series of financial milestones too easily overlooked in the flood of bad news from Europe. For starters, at Aa3/A+/A+, Chile is the highest-rated country in the region, and Larraín is making good use of that status. Chile’s most recent auction of $1bn of 10-year dollar-denominated government debt was snapped up at just 130bps over US Treasuries - at 3.3%, the lowest rate ever paid by a Latin American government borrower.
The market demand for Chilean government debt validates the assessment that major rating agencies made in mid-2010 when Chile returned to the international debt market after a six-year absence. Moody’s said it upgraded Chile thanks to the government’s strong fiscal position and favourable debt profile, but also to “reflect the country’s demonstrated economic and financial resilience even in the face of major adverse shocks, including February’s historic earthquake”. Standard & Poor’s noted that “many years of prudent economic management have given [Chile] greater capacity to use countercyclical measures to cushion the impact” of external shocks.
A lynchpin of the economic success behind Chile’s current standing in the global financial market is its pension savings system. Fully-funded and mandatory, the pension system has been an integral part of Chile’s progress, creating the institutional demand and liquidity essential to any capital market.
“We started this with the social security reform in the early 1980s,” Larraín says. Noting the conundrum facing most other pension systems, he adds: “Before that, if you stopped the flow of people into the PAYG system, you’d get a deficit.”
Opting for a fully-funded mandatory pension saving regime has made all the difference, Larraín said, enabling the government to constrain the use of debt to make annual pension contributions that are now hobbling several EU member states. In Chile, “fiscal policy is on [a] structural rule,” he said.
Chilean pension funds are buyers of Chilean government bonds, and that “can help with deepening financial markets,” says Larraín. The results of that pension policy choice are evident today: Chile is steadily becoming a liquid, international debt market not just for the Chilean government, but for Chilean companies, and increasingly for issuers based in Latin America and other emerging markets.
The results are not being left to chance - the finance ministry is orchestrating the development of a liquid capital market attractive to international and local institutional investors and issuers alike. The government’s debt issuance programme is a critical plank in that platform, tapping the investment appetite of Chile’s pension system to provide a baseline of demand and liquidity in the institutional debt market, while providing an attractive benchmark rate for issuers and a reliable supply of outstanding debt balanced between dollar- and peso-denominated issues.
Chile’s sale in September of dollar- and peso- denominated debt demonstrates the strategic aspects of the program. The 10-year dollar issue created additional supply in that sector of the Chilean yield curve, gaining credibility for the country; ongoing liquidity was one of Chile’s policy goals when it returned to the international bond market in 2010 with a dollar and peso issue that marked the first global Chilean peso bond from a Chilean issuer.
Chile’s increasing consistency and programmatic development of the curve are helping to create a debt capital market that can be tapped by numerous users, while giving the government added flexibility that comes from having regular access to international credit market. The September sale was an example of the counter-cyclical approach that impressed S&P: at the time of issuance, the finance ministry noted that acquiring funds at such favourable rates gave Chile added liquidity for contingencies if the economy got worse.
The successful sale of 10, 20, and 30-year Chilean government inflation-indexed bonds in early December 2011 illustrate how Chile is diversifying its issuance programme in a way that reflects investor demand. Banks were buyers of 37% of the 10-year bonds, 55% of the 20-year bonds, and nearly 40% of the 30-year bonds; pension funds bought most of the remaining debt. Chile’s economic progress and the capital-market acumen of its finance ministry “give people who invest in Chile a strong horizon,” Larraín says.
Another bright spot on that horizon is the increasingly robust corporate market. Again, the vitality in this sector is no accident. In 2011 the finance ministry took steps to relax the rules for companies, multi-lateral institutions and foreign governments seeking to float ‘huaso’ bonds - peso-denominated debt issued in Chile. Named for the Chilean word for cowboy, huaso bonds were the focus of a finance ministry roadshow to present the new rules to companies in Latin America that might be able to raise money at lower cost in Chile than in their home countries.
Peso-denominated bonds, introduced in 2006, got off to a slow start, with only three issues, totalling less than $500m outstanding today. The requirement that issuers should be located in countries rated triple-A has been removed. At the time of the finance ministry’s roadshow in 2011, Banco de Chile, the country’s second-largest private institution, reported interest from around 20 potential issuers of huaso bonds, including companies from the mining, services and telecommunications sectors, as well as some Latin American governments.
The policy change has implications for the pension funds that have been instrumental in the development of Chile’s capital market. With more than $140bn in assets under management, pension funds are seeking alternatives to Chilean assets, so enabling non-Chilean entities to issue debt on the local market would provide a source of credit diversification for these funds’ fixed income portfolios.
Chile is also seeking to reap the benefits of its strong pension system in the arena of fund management. The pension system has not only helped Chile finance its growth. Minister Larraín is also working on a Single Funds Law that would enable Chile to take its next step of development in the financial sector by standardising and simplifying the regulatory and tax regimes concerning the establishment and management of funds and fund companies. As he describes the initiative to prospective international investors, Chile intends to “become a financial platform - an exporter of fund management services”.
While current global economic stress and the potential for weaker or volatile copper prices could certainly slow Chile’s progress, Larraín observes that the pension policy reforms of the 1980s have had fundamental effects that promise to underpin the Chilean economy and capital markets during tough times. At a time when most industrial countries are feeling the pain of unfavourable demographic and savings patterns, the reforms of the 1980s continue to pay dividends for Chile, Larraín says, noting a positive effect on Chileans’ attitudes to saving - more than 2.5m Chileans now have voluntary retirement savings accounts of some type, nearly 20% of the country’s population. It is that policy outcome that is propelling Chile’s financial system towards global status.
Understandably proud of his country’s positive performance despite global turmoil, Larraín nicely summarises Chile’s place in the global financial markets: “We’re part of the solution.”