Diversification on Chile’s productivity agenda

President Michelle Bachelet is convinced that “in 10 years and hopefully before, with all the things we are doing with the productivity agenda, with growth, Chile is going to be a far more diversified economy.” This may seem to be good news for investors in this Latin-American (ILF) country. For instance those holding assets in the iShares MSCI Chile Capped ETF (ECH), the Global X FTSE Andean 40 ETF (AND), or the Guggenheim Frontier Markets ETF (FRN), which have exposures of around 94%, 49%, and 41%, respectively, to Chile’s capital markets. However, there is a flipside to this coin that investors in ECH and/or Latin America should take into account; the debt situation in Chile.

The country has about $162 billion in external debt, of which over 90% is US-dollar denominated. As the US dollar (UUP) appreciates, Chile could find it increasingly difficult to adequately service this debt.

Copper prices are still very low

Chile is the world’s largest copper producer, accounting for over a third of global copper output. Copper accounts for about 55% of all Chilean exports and generates 20% of the government’s revenues. Chile had once flourished under the copper boom between 2009-11, when the price of copper rose from $3330 per metric ton in Feb 2009 to $9500 per metric ton in March 2011. However, over the last five years, copper prices have slid by over 25%.The economy’s GDP (gross domestic product) growth rate has fallen from almost 10% in 2011 to 1.6% as of 3Q16.

Moreover, industrial boom in China (FXI) has been one of the major contributors to growth in Chile. China’s rapid industrialization made it the top consumer of copper, thereby also Chile’s top export destination. With industrial growth in China showing signs of tapering and China’s shift in growth model from an export-driven economy to a consumption-led country, we may continue to see copper demand dwindling down.

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