Chile: Opening the constitutional Pandora's box

CIO Global Blog

13 Nov 2019

Social unrest sees little respite

Since protests erupted in mid-October, the approval ratings of Sebastian Piñera's administration have plummeted to the mid-teens and forced him to respond by announcing numerous measures, the most notable of which is the opening up of the possibility to modify the constitution. In addition, Piñera announced a hike in the minimum wage, a tax increase for highincome earners, more health benefits, subway and electricity price freezes, and a reduction of working hours from 45 hours per week to 40 hours per week. The pension and tax reform packages that had been slowly making their way through Congress for most of the year have stalled and will likely be meaningfully adjusted. The latest discussions contemplate targeting higher pension payouts in the pension reform, and a more progressive tax system with higher tax rates on high-income earners when it comes to the tax reform. A comprehensive cabinet reshuffle was also announced that put in place officials who we believe are more in tune with the current social context of the country.

The announcement of a redrafting of the constitution was the most unexpected and carries with it the most uncertainty, likely for an extended period of time. In a recent Cadem poll released on 8 November, almost 80% of respondents agreed that the country needed a new constitution. The same poll showed that the two main motives for a new constitution were the desire for a new social contract and the current constitution's link to the Pinochet dictatorship in the 1980s.

While the announcement shows President Piñera is listening to protestor demands, it also raises execution risks. As it was announced, the framework stipulates that the constitution would be written by a congressional committee with citizen participation and that the final text would require approval through a plebiscite, or a referendum. Many crucial details about the plan are still lacking, however.

Figure 1 - Chilean pesodepreciating to all-time highsagainst the USD

Bloomberg, UBS, as of 12 November 2019

Figure 2 - Chilean assets have takena hit since social unrest began

Bloomberg, UBS, as of 12 November 2019

This week, Chilean equities are down 7.1% in USD terms and the peso has depreciated 4.8% against the US dollar, bringing the total losses to 15.5% and 9%, respectively, since the protests began. Sovereign bonds have proven to be more stable, with returns closer to broad emerging market credit indexes. Chile's sovereign bond spreads have widened less than 10 basis points since the protests broke out.

Ongoing developments will weigh on Chile's economic activity in the next few quarters, as consumption patterns are disrupted and investment spending suffers from much diminished confidence. Volatility in Chilean assets is likely to persist as long as protests remain elevated, also taking into account that the process of rewriting the constitution could last for months, if not years. Chilean domestic investors are strongly home-biased in their portfolios, and a rotation away from local to international assets cannot be ruled out in the near future.

That said, we continue to believe Chile's so-far strong fiscal position and institutional strength should prevent a material deterioration in the country's credit profile. We would also expect systemically important quasisovereigns and export-oriented corporate issuers to be more resilient to this unfortunate situation, but would avoid exposure to private sector entities highly dependent on domestic consumption.

Similarly, credit rating agencies have refrained from taking any negative actions. Moody's has said that "the government's very strong fiscal positions…continue to provide strong support to Chile's credit profile," while S&P has said its rating on Chile "reflects its ample monetary, exchangerate, and fiscal flexibility, as well as its low debt burden, growing prosperity, and our comparatively favorable assessment of its institutional effectiveness and governance." The agencies did note, though, that the protests and the government's reactionary measures are likely to have an economic cost. Although the balance of risks to the country's ratings remains tilted to the downside, rating actions don’t seem imminent.


Brennan Azevedo, Emerging Markets Associate Americas, UBS Financial Services Inc. (UBS FS)
Alejo Czerwonko, Emerging Markets Strategist Americas, UBS Financial Services Inc. (UBS FS)
Donald McLauchlan, Emerging Markets Strategist Americas, UBS Financial Services Inc. (UBS FS)

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