Further reductions to our growth forecasts for Chile (A/Negative) and Colombia (BBB-/Negative) due to the coronavirus pandemic will mean faster increases in budget deficits and public debt this year, Fitch Ratings says. The ability to develop credible medium-term plans to reverse these trends will be one important factor in resolving the Negative Rating Outlooks.
Fitch now expects real GDP in Chile to contract by 3.9% in 2020 compared with their previous forecast of negative 1.9%. For Colombia, the ratings firm forecasts a contraction of 4.5%, compared with negative 2% previously. Both revisions reflect the extension of domestic lockdown measures with a large impact on consumption and investment as well as the coronavirus pandemic’s broader effects on lower commodity prices, higher funding costs and capital outflows for emerging markets overall. In Colombia, the likely fall in oil production will also hit growth.
Deep recessions are magnifying fiscal deterioration. Fitch forecasts Chile’s 2020 deficit to widen to nearly 10% of GDP and Colombia’s central government deficit to rise to 7% compared with their previous forecasts of 9.3% and 5.5%, respectively. Chile’s debt-to-GDP will rise to 36% and Colombia’s to 55%, up more than 8 pp and 10 pp, respectively, from 2019.
As with other sovereigns, Fitch’s forecasts are subject to higher than normal uncertainty around the pandemic’s duration and intensity, creating further downside risks to growth. Both countries’ governments look to stimulate economic activity. Chile has announced an additional fiscal package to provide cash transfers to the most vulnerable, while the Colombian government recently announced further support measures including wage subsidies for some companies and deferring income tax payments until December, as well as increasing fiscal stimulus spending to 2.4% of GDP from 1.4%. Both countries’ central banks have lowered policy rates and provided liquidity to credit markets through bond-buying programs among other measures.
Lack of fiscal consolidation that allows government debt to continue rising is a negative rating sensitivity for both sovereigns (for Chile, the erosion of fiscal buffers provided by sizable sovereign assets is also a sensitivity). Deficits were under pressured heading into the crisis, partly due to Chile’s increased social spending and Colombia’s expected fall in tax revenues. Colombia’s finance minister has mentioned possible tax reform next year, and Chile passed tax reform in early 2020 to fund new social spending and created commissions to provide proposals to reduce tax exemptions and rationalize spending. However, continuing deterioration in near-term economic and fiscal prospects increases the importance of formulating credible medium-term plans, including fiscal reforms on the revenue or expenditure side, to sustainably restore growth and stabilize debt.
Chile’s debt ratio would remain lower than the ‘A’ rating category median in 2020 under Fitch’s revised forecasts, but social pressures may test the authorities’ resolve to maintain planned structural fiscal consolidation. Although the ratings firm expect a significant bounce in growth in 2021 as both countries’ domestic and external demand revives, failure to address the risk of lasting economic damage stemming from the current crisis would intensify pressure on the rating. The possibility of a longer-term hit was highlighted by Chile’s Experts Advisory Council, which recently reduced its annual trend growth forecasts by nearly 1pp through 2024. Weaker growth prospects would adversely affect debt dynamics and could exacerbate social tensions, in Fitch’s view.
Colombia faces challenges raising tax revenues over the medium term, especially given the expected loss of oil-related revenues worth over 1% of GDP in 2021 and reduced tax revenues due to the 2019 Economic Growth Law. Both countries face social and political pressures to increase pension, healthcare and education spending, highlighted by protests between October and November 2019.
Elections in October 2021 in Chile and May 2022 in Colombia may narrow the window of opportunity for reforms. A referendum on Chile’s constitution scheduled for October 2020 could add to political uncertainty.