From False Dawn to Sunset?

CHILE - Report 27 Aug 2015 by Igal Magendzo, Robert Funk and Alberto Etchegaray

The Chilean peso is fifth among the emerging market currencies that fell the most in 2015. We can divide this currency slump into two periods with different drivers and implications. The first is the period in which the US dollar appreciated vis-à-vis almost every currency in the world, and the second is more recent and follows from the shift in expectations concerning the Chinese economy.

The National Accounts for the second quarter of the year show that the Chilean economy is flat. But we still expect some positive q-o-q growth for the rest of the year, so 2015 growth should come to something slightly above 2%. Long term growth prospects have also deteriorated. According to the committee of experts that determines potential GDP growth, the figure for 2015 and 2016 is 3.6%, down from the 4.2% determined the year before. We believe this is optimistic.

The public sector continues to make a relevant contribution to overall growth, but next year the growth rate of public spending will be much lower than this year. To make things worse, the construction sector is going through a small sales boom in anticipation of a tax increase. Next year this effect will fade away.

Private consumption decelerated in the second quarter of the year. An apparent acceleration in the durable goods sector might be a good signal. Imports of capital goods showed a similar pattern. But expectations do not seem to be recovering. On the contrary, both foreign and domestic (political) conditions and their impact on expectations are probably making a negative contribution to the economy.

The current account is nearly in equilibrium and there is no evident pressure on the currency coming from this front. From the perspective of the financial account, FDI continues to flow into the country.

Using our estimates we believe that the fiscal deficit for 2015 will be around 3.5% of GDP (USD 8.5 billion). The latest forecast from the Ministry of Finance was for a deficit of 3.1% of GDP (USD 7.6 billion). For 2016 we expect the deficit to be of a similar magnitude as a percentage of GDP.

The dilemma facing the Central Bank deepens. The perception of the international situation as well as domestic activity is worsening, while inflation is becoming more and more a concern. The Central Bank is in a new consensus of "wait and see". Looking forward, we must consider the potential effect of the recent devaluation of the peso against the dollar and the evolution of international fuel prices on short-run inflation, as well as potential second round effects due to indexation to past inflation.

On the political front, disagreements over pension fund regulation have made the headlines. Tamara Agnic, the head of the Superintendencia de Pensiones, the technical authority responsible for the supervision and control of the institutions involved in the Chilean pension system, faced some tough political opposition, both from Congress and the government. This is because she authorized Principal Financial Group´s acquisition of one of the biggest pension funds in Chile, and the operation was done in a way that resulted in a large tax credit.

It seems clear that the Chilean legal framework supports Agnic, but that has not kept members of Congress from issuing some nasty comments on her role and authority. Moreover, Ximena Rincón, the Minister of Labor and nominally Agnic´s boss (the Superintendencia is supposedly autonomous), publicly criticized Agnic’s criteria. Rincon, always flirting with a presidential candidacy, wanted to avoid being politically contaminated by this case.

The government´s approval ratings continue to slip, and disarray within the government coalition is deepening. When the governing Nueva Mayoría came to power, it claimed that its congressional majority endowed it with the political capital required to carry out its reform agenda. A year and a half into Bachalet’s mandate, however, people within and outside of government are wondering where it all went wrong, and this is leading many to ask whether she already is a lame duck.

After a Nueva Mayoría “conclave”, aimed at putting the internal house in order, the Ministers of the Interior and Finance announced that the government was committed to “gradualism”.Several days later, the President contradicted her two newest (and most prominent) ministers.

The Communist Party, part of the ruling coalition, is being investigated for links to the FARC, and the party’s president is also being investigated to confirm whether his partner lied in order to receive unwarranted government benefits. At the same time, the recent president of the Christian Democratic Party has been a constant critic of the way the Bachelet government is carrying out its reforms.

The result is that some twenty-seven months prior to the next national elections, candidates are beginning to position themselves, and the media is starting to evaluate those candidacies.The good news is that there is enough time to turn it all around. The bad news is that there are few signs President Michelle Bachelet is willing to do so.

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