When Colbún, a Chilean electric company, needed to finance the construction of a large wind farm, it turned last October to the international capital markets to raise $600 million in its first green bond issuance.

It’s a common strategy in emerging markets. The international markets offer more financing and lower rates than at home. As Colbún says, it wanted to “take advantage of market conditions that continue to be advantageous for Chilean corporate issuers.” Indeed, the 10-year bonds were sold at a price to pay 3.15% interest.

Other companies are doing the same in Chile, such as Entel, a telecommunications company that sold $800 million worth of 11-year sustainability-linked bonds (SLBs) in September to fund its 5G rollout.

While there’s little surprise in this financing strategy, it’s a sign of how Chile, long the market darling in Latin America for its steady and robust economic growth, is facing unexpected challenges that could dash its dream of becoming a hub for financing projects at home – and in the region.

Until COVID-19 struck in March 2020, Chile’s capital markets were indeed riding high. In 2019, corporate issuance hit a record $4 billion as low interest rates and a bright economic outlook encouraged companies to refinance existing debts or launch for new investments. This helped make Chile the third largest capital market in Latin America behind Brazil and Mexico, even with less than an eighth of the population.

Not surprisingly, perhaps, Chile’s finance minister at the time, Felipe Larraín, vowed to make Chile a financial center for the region in the vein of Hong Kong and Singapore.

With legislative tweaks to make it easier for foreign companies to list shares and issue bonds in Santiago, Chile’s financial services industry could double in size, creating hundreds of thousands of well-paid jobs, he told investors in London in September 2019.

The agenda, however, was shelved only weeks later when Chile was rocked by social protests triggered by a hike in subway fares. The unrest didn’t calm until after lawmakers agreed a month later to hold a national referendum on rewriting the country’s four-decade old constitution. Political uncertainty has only increased since the start of the pandemic and in the run-up to this year’s presidential elections, in which 35-year old leftist lawmaker Gabriel Boric ultimately triumphed in December’s run-off.

A big blow

After the government of President Sebastián Piñera dithered in its support for households during lockdown, lawmakers passed a constitutional reform in July 2020 allowing participants in Chile’s privately-run pensions system to withdraw up to 10% (to a maximum of the equivalent of $5,500) from their private savings accounts, a move that has further delayed the country’s hopes of becoming a financial hub for Latin America.

Since their creation in 1981, the pension fund administrators, known as AFPs, have been the heart of the country’s financial system, distributing hundreds of millions of dollars in workers’ contributions each month into bonds and shares.

“The AFPs have been financing Chile’s development for the last 40 years,” says Leonardo Hernández, a finance professor at the Pontifical Catholic University of Chile’s Business School in Santiago.

But the low pensions paid out by the system meant that it has never enjoyed much support among Chileans, and as the pandemic threw millions of people into unemployment, many took up the chance to withdraw savings early.

Lawmakers have passed two additional withdrawal bills – in December 2020 and April 2021, allowing Chileans to withdraw more than $47 billion from pension funds so far, equivalent to over 20% of the assets controlled by the fund administrators in December 2019 and almost 17% of gross domestic product.

The result has been an orgy of consumerism. As stores reopened after the lockdown, retailers have struggled to keep up with demand, especially for consumer durables like household appliances. Retail sales surged 29% in the first 10 months of 2021 on the year, while car purchases shot up 37% over the same period, according to INE, the state statistics agency.

Driven by the pension withdrawals and government support for households, Chile’s central bank estimates the economy will grow almost 12% in 2021 after contracting by 5.8% in 2020. Inflation is following suit, surging to 6.7% in November, up from 3% in 2020 and the highest since 2008.

The impact on the capital markets has been even more brutal. Rather than supplying fresh money to the market each month, the AFPs have found themselves liquidating assets to finance the withdrawals. And with Chile’s largest institutional investors largely absent from the market, interest rates on medium- and long-term debt have soared. Real rates on central bank’s inflation-indexed bonds have surged from a negative 2% in February 2021 to almost 3% by October that year.

“It is not just that the interest rates were higher. In many cases, the demand was just not there,” Pablo Zamorano, head of corporate finance at investment bank BICE Inversiones in Santiago, tells LatinFinance.

To be sure, corporate bond sales volumes on the Santiago Stock Exchange tumbled to CLP1.1 trillion (US$1.3 billion) in the first 11 months of 2021 from CLP3.6 trillion in all of 2020 and a most recent record of CLP5.8 trillion in 2019.

The impact is already being felt in Chile’s housing market, where interest rates on mortgages have surged from around 2% to almost 5%. All banks have stopped offering 25- and 30-year mortgage loans. The result is that the monthly cost of servicing a mortgage has risen by almost 80%.

“Many people will have been priced out of the market,” says Felipe Larraín, the former finance minister.

It’s not just the pension funds that are under fire. The third bill, passed in April 2021, also permitted pensioners to withdraw up to 10% of their annuity, forcing insurance companies to liquidate assets. As a result, monthly investments by insurance companies have fallen by almost 30% in 2021, says Claudio Correa, general manager of Ohio National Chile, an insurer in Santiago.

MetLife, Ohio National, Principal and Zurich have all threatened the Chilean state with arbitration proceedings under its investment treaties for what they see as illegal expropriation.

Less capital

The impact on corporate borrowers is less clear. With many of them raised ample financing under the government-backed loan schemes during the pandemic and few are planning significant investments due to a rise in economic and political uncertainty, demand among borrowers is low. Rather than new issues, investment bankers have been busy renegotiating covenants, providing bank debt or overseeing mergers and acquisitions.

Those that can invest are raising funds abroad like Colbún and Entel, says Zamorano.

In September 2021, Banco Bci, the third-largest lender in Chile, raised $133 million in the sale of five-year bonds to private investors in Taiwan at a price to pay a 1.88% rate of interest, building on sales earlier that year of $54 million in 8.9-year green bonds in Europe and $100 million in 5.4-year bonds in Switzerland.

Political jitters

Whether Chile’s financial markets can regain their former vigor is unclear. In December, lawmakers narrowly rejected legislation allowing a fourth withdrawal from pensions funds and an even larger chunk of their annuities, but only because some supporters were out of the country at the time of the vote. The bill’s backers have promised to try again in the coming months.

There are also fears that a future government could make radical changes to the pensions system that would further impact capital markets. Four out of the seven candidates in this year’s presidential election promised to scrap the AFPs and while leftist candidate Gabriel Boric moderated his speech ahead of the second-round vote, doubts remain about what form his plans could take.

“There is some concern that funds could be channeled to finance government programs which would limit availability of long-term credit in Chile,” says Hernández, the finance professor.

Investors took some relief from the mixed results of the November 21 legislative elections. While left-wing parties held on to their control the Chamber of Deputies, right-wingers took half the seats in the Senate. This suggests that Chile’s next government after the December 19 runoff will have to negotiate any changes to the pension system.

Attention is also on the changes to the constitution by the Constitutional Convention, which is expected to produce a draft version by the middle of next year. The convention’s largely left-wing membership has proposed radical changes to Chile’s political and economic model, from reducing the autonomy of the central bank to enshrining rights to housing and education and increasing the powers of Congress.

In response, many local investors and entrepreneurs are voting with their feet by moving investments (and sometimes themselves) out of the country to Europe or the United States. Andrónico Luksic, head of Chile’s wealthiest family, recently relocated part of his family office from Santiago to Manhattan.

Meanwhile, companies on the Santiago Stock Exchange’s IPSA index of largest companies have announced dividend payments totaling a record $12.2 billion in 2021, up 70% from 2020, as they slow their capital expenditures and as their owners seek to diversify investments.

Still, financiers in Santiago remain hopeful that Chile’s capital markets will recover once the political situation becomes clearer.

“If we can avoid extreme situations, the capital markets have to return as companies will have financing needs,” says BICE’s Zamorano. LF