The economic and social costs of the COVID-19 pandemic will make it difficult for governments to gain political support for policies to stabilize public finances and sustain GDP growth prospects. This will be especially apparent in the Andean region, with national elections due in Peru, Chile and Ecuador in 2021 and in Colombia in 2022.
The rating trajectory of these four sovereigns will largely depend on their political response to the pandemic--both before and after the upcoming elections. The regional recession could worsen distrust of politicians, exacerbate political fragmentation, and encourage the rise of new parties and untested leaders. In turn, that could make it harder for leaders to negotiate across partisan lines on key economic policies, potentially worsening sovereign credit ratings.
- The common challenge facing the Andean region is to recover from the pandemic and restore economic growth while managing weaker public finances.
- The sovereign rating trajectory of Peru, Chile, Ecuador, and Colombia will largely depend on their political response to the pandemic.
- The recession could worsen the distrust of political leaders, exacerbate political fragmentation, and make it harder for leaders to agree on key economic policies, potentially worsening sovereign credit ratings.
The Andean sovereigns have a wide range of ratings. Chile has the highest long-term foreign-currency rating in Latin America at 'A+'. Peru is rated 'BBB+', Colombia 'BBB-', and Ecuador 'B-'. Since the start of the pandemic, we have revised our outlooks on Colombia and Chile to negative but kept the stable outlook on Peru. We also lowered our ratings on Ecuador to 'SD' in April 2020 and raised them to 'B-' in August after the completion of a distressed debt exchange.
Common Economic And Political Challenges
All four countries are small, open economies that rely on commodity exports. They suffered recession in 2020 and will enjoy only moderate recovery in 2021 (see Table 1). Moreover, none will likely return to its 2019 level of GDP until well after 2021. These poor near-term economic prospects follow only modest economic growth, or even contraction, over the past five years (see chart).
|Four Andean Nations' GDP Growth|
|(Year-over-year % change)||2020||2021|
The four countries face a common challenge in recovering from the pandemic and restoring economic growth while managing weaker public finances. We estimate that in 2020, net general government debt will have increased by more than 15% of GDP in Colombia, 12% in Chile, 10% in Peru, and nearly 12% in Ecuador. A higher debt burden poses greater risk in countries that rely more on external funding and on foreign-currency-denominated debt, which makes them more vulnerable to adverse external shocks. For example, non-residents hold 70% of government debt in Ecuador. In contrast. residents held almost 70% of total general government debt in Chile as of year-end 2019 and a slightly higher share in Colombia and Peru.
Poverty, anger at corruption, and income inequality sustain public discontent in all four countries. The region has higher income inequality than much of the world (see Table 2). A weak economic recovery threatens to increase poverty, exacerbate income inequality, and sharpen existing political and social divisions.
|Income Inequality (Gini Coefficient)*|
|*A value of 0 represents absolute equality, a value of 100 absolute inequality. Source: UNDP Human Development Report.|
The Colombian political system has expanded in recent years to include a wider range of politicians and groups. This was partly due to the impact of a peace agreement with the FARC, the country's largest guerrilla group, in 2016. In turn, that has encouraged the expression of pent-up social and economic demands. However, Colombian politics are anchored by strong political parties (compared with those of Ecuador and Peru) and by a history of stable economic policies.
The administration of President Ivan Duque suffered initial setbacks in advancing legislation through Congress. However, it has become more effective recently, gaining more cooperation from political parties that had earlier felt excluded from the government's decision-making process and its patronage. Mr. Duque's political coalition, in conjunction with other moderate parties, has enough clout in Congress to reduce the likelihood of the passage of potentially populist proposals that might emerge because of the pandemic.
Key risk: The recession and pandemic could exacerbate latent social tensions in the country. That, plus the administration's limited political capital, could constrain its ability to muster enough support in 2021 to pass an ambitious and difficult tax reform (prior to national elections in 2022). Fiscal reform, along with a return to GDP growth, is key to stabilizing the recent deterioration in public finances.
The economic model that emerged from the government of former president Alberto Fujimori (1990-2000) has endured, allowing Peru to enjoy one of the best long-term growth rates in the region. However, Peru has failed to develop a similarly robust political system based on stable parties, a strong judiciary, and civil service. Shortcomings in governance have sustained public discontent with the country's leadership, despite an impressive decline in poverty in the last 20 years.
Political fragmentation has led to frequent changes in leadership. Political disputes led President Martin Vizcarra, who assumed office in 2018 after the resignation of his predecessor, to dissolve Congress in late 2019. The new interim Congress, elected in early 2020, subsequently impeached Vizcarra and named a new president, who was forced to resign after five days of public protests. A new interim president, the fifth since 2016, will preside until the national elections in April 2021.
Congress recently voted to allow two rounds of early withdrawals from the private pension system, despite opposition from the president. The long-term significance of this measure is not clear, but the growth of private pension funds has played a key role in developing domestic capital markets in Peru (as in Chile and Colombia), offering an important source of domestic funding for sovereigns.
Key risk: The new leadership after the elections could face a fragmented Congress with populist demands. In addition, Peru's budgetary position could come under strain if economic recovery is much weaker than we expect. Potential political divisiveness could further delay major infrastructure and mining projects that are important for long-term growth, public finances, and the rating.
Since the return to civilian rule in 1990, Chile has enjoyed good GDP growth and falling poverty. Nevertheless, segments of the population have become alienated from the two traditional coalitions of the center-left and center-right that have governed since then. The alienation--reflecting inequality, uneven access to health and education, and perceptions of limited social mobility--led to massive and sometimes violent protests in October and November 2019 (prior to the pandemic). Subsequently, Chileans voted to write a new constitution, a popular demand from groups that reject the current one, which was written under military rule. In April 2021, Chileans will elect members of the new constitutional convention, which is scheduled to finalize the document by early 2022 and submit it for a national plebiscite in June of that year. Chile will also hold national elections in late 2021.
Political and economic developments since late 2019 have created uncertainty about future economic policies. Chile pioneered the creation of private-sector-managed pension plans, leading the shift in much of Latin America to defined-contribution plans from defined-benefit ones. However, public pressure nudged the administration of President Sebastian Pinera and the Congress (including center-right parties aligned with Pinera) to permit two rounds of withdrawals from the pension accounts, as in Peru. Chile could make further changes in its pension system in coming years, likely in line with growing government spending on social services. Based on current political debate, it appears that the new constitution would expand public services and the size of the social safety net, possibly adding pressure on public finances.
Key risk: Recent events have changed Chile's political dynamics. It remains to be seen if, and how much, the remarkable consensus of the past decades across the two political coalitions on key economic policies will change. Over time, changes fiscal and growth-related policies could erode some of the fiscal buffers that today support the current rating.
Among the four countries, Ecuador faces the most difficult task in stabilizing its economy, rebuilding public finances, and restoring economic growth. It has failed to create a stable policy framework to sustain economic growth since adopting the U.S. dollar as its currency in 2000 (the decision to dollarize was in response to previous economic crises). Weak political parties and polarized politics have resulted in frequent changes in government, leading to large swings in economic policies over the past couple of decades.
Current President Lenin Moreno was Vice President under previous President Rafael Correa, a leftist who governed for a decade until 2017. After winning office with Correa's support, President Moreno, facing a difficult economic situation, has reversed many of his predecessor's interventionist economic policies. Facing an economic crisis, the administration entered into an agreement with the IMF, pledging to undertake reforms. However, the government's decision to cut domestic fuel subsidies to meet fiscal targets sparked violent protests in October 2019, leading it to abandon its plans.
Ecuador recently entered a new IMF program, pledging to boost central bank autonomy and pass anti-corruption measures. The program includes reforms to raise revenues from higher VAT rates, an excise tax on gasoline, and other changes in corporate and personal income taxes.
Key risks: The sensitive tax measures contained in the IMF agreement have been postponed until after national elections in February 2021, raising doubts about the ability and willingness of the new administration to implement them. Social tensions and political divisions will persist after the elections, making it difficult to manage public finances within the constraints of the dollarized economy.
We would like to thank Tomas Marinozzi for his contributions to this article.
This report does not constitute a rating action.
|Primary Credit Analyst:||Joydeep Mukherji, New York + 1 (212) 438 7351;|
|Secondary Contact:||Roberto H Sifon-arevalo, New York + 1 (212) 438 7358;|
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