RaboResearch - Economic Research

Country Report Chile

Country Report


A new government took office in March 2014 and has been pushing through a bold reform agenda. In the meantime, the economy took a downturn, but economic activity is likely to improve in 2015. 

Strengths (+) and weaknesses (-)

(+)      Strong institutions

Especially by Latin American standards, Chile has strong institutions. The quality of governance is high and corruption is low.

(+)      Good fiscal position

The government has committed itself to a structural fiscal surplus rule since 2001. Fiscal prudence has led to small public deficits and has kept public debt low, at 15% of GDP in 2014. A high level of FX reserves and USD 23bn in sovereign wealth funds allow the government to be a net creditor.

 (-)      Dependence on commodity (copper) exports

Chile is the world’s largest copper producer and the metal accounted for 52% of total exports in 2013, while other commodities accounted for another 24% of exports.

(-)       Relatively high level of inequality

Although inequality has fallen in the past two decades, it remains relatively high. In recent years, there have been rising social demands, particularly in the field of education.

Key developments

1. New government, bold structural reforms, unfortunate timing?

In March 2014, a new cabinet of President Bachelet took office (Bachelet was already president between 2006 and 2010). The new government has an ambitious structural reform agenda, as it seeks to address Chile’s high level of inequality and raise the long-term trend growth. As the ruling Nueva Mayoría holds majorities in both the Chamber of Deputies and the Senate, it can easily implement reforms and deliver on its electoral agenda. In 2014, the government commenced reforms of the tax system, education, labour and energy.

The purpose of the already approved tax system reform is to increase tax revenues by 3% of GDP by 2018, in order to increase spending on education and social programs and to reduce the structural public deficit. This is achieved by gradually increasing taxes and by closing loopholes that facilitate tax avoidance, such as the tax deferral on undistributed earnings that is currently in place. The tax hikes are tilted towards the upper income brackets and business sector and thus increase the (currently low) progressivity of the Chilean tax system. However, the reform increases the corporate tax burden at a time of economic downturn, so the timing is rather unfavourable.

A labour reform proposed in December 2014, which reinforces collective bargaining and empowers labour unions, is also set to increase the burden on the business sector. That could further hurt business confidence, especially as the debate related to its content could last until the end of 2015 and thus result in a prolonged period of uncertainty. On the positive side, the labour bill could contribute to a more even distribution of income and, thus, higher private consumption. However, the law could be harmful for the business climate. Namely, by stipulating a preferential treatment for unionised workers, the law is poised to increase labour costs, make labour relations more contentious and increase labour market rigidity. The government’s education reform, on the other hand, should boost potential economic growth, because it improves access to education at all levels in a country where education access and attainment are strongly related to socio-economic background and where intergenerational social mobility is low. However, Chile’s education system also has a quality problem that needs to be tackled. The energy plan, which includes the construction of a new LNG terminal and aims to reduce energy costs and increase supply from renewable sources, is also a positive development, since deficient energy supply is a major impediment to growth. However, its implementation could be delayed by environmental regulation and local protests. All in all, the reforms  could help Chile to deal with important structural issues the country is grappling with. However, the timing and the simultaneous approach seem less fortunate, as some reforms  increase the cost of doing business for the private sector burden at a time of economic slowdown. Besides, policy uncertainty will persist as only the tax reform and some education bills have been approved.

2. Economic growth took a downturn, but next year should see some recovery

Economic activity took a downturn in 2014, as the economy adjusted to external shocks, while policy uncertainty hurt confidence. The outlook for 2015 is more favourable, but there are serious downside risks. Economic growth more than halved to 1.8% in 2014. Contracting gross fixed investments and decelerating private consumption growth were the main drivers, though a deterioration was visible across all components. The marked contraction in fixed investments is mainly a result of the fall in copper prices in recent years, which did not only affect mining output and exports, but also confidence across the board. The lower private spending in general also seems to be related to a deterioration of confidence due to policy uncertainty (there were fears of increasing interventionism) as well as the 16% depreciation of the currency in 2014. Chile’s free floating exchange rate serves as a shock absorber of detrimental external developments. In 2014, currency depreciation contributed to a smaller trade deficit, though weaker investments also played a role. The current account deficit halved to 1.7% of GDP in 2014.

Figure 1: Economic growth slows down
Figure 1: Economic growth slows downSource: EIU
Figure 2: CLP serves as external shock absorber
Figure 2: CLP serves as external shock absorberSource: Macrobond, London Metal Exchange

In 2015, the economy is expected to perform better and grow by around 3%, on the back of the economic recovery in the US, some improvement on copper markets and fiscal stimulus. Lower oil prices, improved competitiveness due to currency depreciation and an accommodative monetary stance will also support recovery. There are already some signs of a recovery. The leading economic activity index (IMACEC) of the Central Bank of Chile has improved since August, when it reached its lowest level since March 2010, and yoy growth of capital imports returned to positive territory for the first time since July 2013 in December 2014. However, both business and consumer confidence hit the lowest levels since 2009 in December 2014. Furthermore, risks are tilted to the downside, as a sharper than expected slowdown in China could hurt copper prices, while policy uncertainty could hurt private sector confidence and expenditure. The current account deficit is expected to stabilize at 1.5% of GDP in 2015, as both exports and imports are expected to pick up, and to remain comfortably covered by net FDI flows that are forecast at 3.7% of GDP.

Factsheet of Chile
Factsheet of ChileSource: EIU, Central Bank of Chile, CIA World Factbook, UN, World Economic Forum, Transparency International, Reporters Without Borders, World Bank.

Background information

With a per capita income of USD 14,139 (or USD 22,564 at PPP) in 2014, almost twice its level a decade earlier, Chile is one of Latin America’s richest countries. By regional standards, Chile has strong institutions, sound macroeconomic policies and a good business environment. Actually, Chile scores better than the OECD average on both the Ease of Doing Business and the WEF Global Competitiveness Index. Since the end of 1999, a full-fledged inflation targeting regime has been in place and the country is fiscally prudent. Chile’s economy is very open and diversified. Chile’s financial system is large, its assets being estimated at 205% of GDP in 2012. It is also strongly interrelated with both the domestic real economy and global markets, rendering Chile vulnerable to developments in international financial markets. Chile has concluded free trade agreements with many other countries. Furthermore, Chilean companies have strongly increased their investments in neighbouring countries in recent years.

In the late 1960s and 1970s, political polarization culminated in the 1973 coup d'état by the military that overthrew the Allende government. A military dictatorship led by general Pinochet ruled Chile until 1990. The political landscape has been dominated by centre-left governments ever since, bar the 2010-2014 period, when a centre-right coalition ruled. Since 1990, Chile has managed to reduce its traditionally high inequality, but the level remains high. In recent years, opposition to the economic and political elite has grown and support for the two voting blocks that have ruled Chile since 1990 has weakened. The large-scale 2011 student protest were a reflection of this trend. Nevertheless, politics has remained relatively consensual by Latin American standards.

Economic indicators of Chile
Economic indicators of ChileSource: EIU
Alexandra Dumitru
RaboResearch Netherlands, Economics and Sustainability Rabobank KEO

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