2015 First Half Report: A False Dawn

CHILE - Report 07 Jul 2015 by Igal Magendzo, Robert Funk and Alberto Etchegaray

Executive Summary

In the first months of this year, economic data gave us some hope. But the optimism did not last long. In addition, the absence of presidential leadership during the first half of this year has been noticeable and damaging.

In January we witnessed what could have been the beginning of the recovery of the economy. But one swallow does not a summer make. Sadly, that was the case.

Investment and consumption continued to decelerate. Imports of capital goods collapsed again, and the Monthly Construction Activity Index of the Chilean Construction Chamber was flat – this in spite of the government’s increase of investment expenditure at double-digit rates. Business confidence has been backsliding. The latest data on both retail sales and imports of consumption goods are discouraging. Throughout the year, the value of exports of goods has been trending lower.

For more than a year, the labor market had decoupled from the economic cycle. But so far in in 2015, the decoupling has ended, with the situation normalized, and the labor market worse.

In response to the deceleration, the government stepped on the accelerator. Total expenditure of the central government is growing at a double-digit pace. But government income is also growing, as a consequence of the implementation of the fiscal reform.

The new Minister of Finance, Rodrigo Valdés, was emphatic that fiscal spending will not expand next year as quickly as it did in 2015. But both the current and the structural deficit will also increase. This raises the issue of how (or whether) the government will be able to close the structural fiscal gap by the end of this administration.

So far, inflation has refused to fall below 4% and enter the Central Bank’s 2%-4% tolerance range. Inflation is expected to be around 3.7% by year-end. Nevertheless, we should not rule out a scenario in which inflation declines faster than currently expected.
Central Bank policy language has fluctuated back and forth between dovish and hawkish. This is a reflection of how volatile economic conditions have been. The volatility also reflects that there are opposite views inside the Central Bank Board. The most likely scenario is that the Central Bank will not change the Monetary Policy Rate this year. But we do not rule out a scenario in which rate increases will be discarded, and the door to further cuts will open up again.

On the political front, during the February southern summer holidays President Michelle Bachelet was informed that her son and daughter-in-law were involved in a scheme that suggested the use of political access for personal business dealings. Several months later, members of her governing coalition were implicated in a campaign funding scheme linked to SQM, a mining company run by General Pinochet’s former son-in-law.

The cabinet shuffle that was designed to stop, or at least reduce, the constant flow of bad news, ended by making matters worse, as one of the newly-named ministers was forced to resign when it emerged he had worked as a consultant for one of the companies being overseen by the congressional committee on which he sat.

If the institutions are questioned and distrusted by public opinion, who has the ability to govern? Who is able to propose and agree on a new set of rules?

In one of her most admirable moves, early this year President Bachelet introduced a bill meant to improve teaching standards by imposing regular testing on public school teachers. This was met, unsurprisingly, by protest and a national strike by the national teachers’ union. Now the government seems willing to backtrack on the reform, at least partially, in order to end the teachers´ strike.This is a sign of how the government has lost control of the agenda, even among its own allies.

Michelle Bachelet’s first year in office was legislatively productive. In the second half of her government the president aims to cement her legacy by opening an as-yet undefined process aimed at drafting a new constitution, while getting the economy back on track. To succeed, she will need to reassure a country worried about unemployment, never-ending strikes and a perceived rise in crime.

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