Turn back to the center?
Executive summary
The recently appointed Minister of Finance, Rodrigo Valdés, rang the alarm: the fiscal situation is not as good as we may think. Fiscal discipline is in Valdés´s DNA. He convinced most relevant actors that there is not enough money to push the reforms as fast as previously expected.
Recently the Budget Office published the semi-annual revision of the projections for 2015. The Ministry of Finance cut its projection for income, expenditure was revised higher, and now the estimates are that the fiscal deficit for 2015 will be 3.0% of GDP.
Valdés has three reasons to be uneasy. First, the already worrying projection for a fiscal deficit of 3.0% is optimistic. Second, the structural balance calculated for 2015 is likely to be too large. Third, the state is moving from being a net creditor to being a net debtor.
Projections for GDP growth continue to decline. The latest revisions are motivated by the incoming data. Among other indicators, business confidence continues in negative territory and the 12-month variation of the Monthly Index of Economic Activity dove in May. Also, fundamentals are not looking bright. By the March-May moving quarter unemployment had increased. According to the Universidad de Chile the quality of jobs is deteriorating. At the same time, nominal wages continue to decelerate.
In June, inflation again surprised markets on the upside. Short-run and medium-run forces are pushing in different directions. On one hand, the devaluation drives inflation higher, on the other hand, the deceleration of the economy points to a lower inflation rate.
Fiscal policy will be supportive of growth this year, but not in 2016. The burden falls on interest rates and the exchange rate. If the peso devalues in tandem with other currencies with respect to the dollar, the Central bank will face a dilemma because the country will not gain much competitiveness, and at the same time inflation will move higher.
On the political front, the shift towards moderation has gained pace in Chile, driven by the acknowledgment that current economic conditions do not permit funding much of the government’s promised reform agenda, and also spurred by opinion polls. Not only is the President unpopular, her reform agenda is unpopular as well. The shift towards the center is an implicit admission that the centerpiece of its government program has failed.
As Bachelet and her new ministers try to mend bridges with the business community, people within her coalition are beginning to grumble. They were promised a transformational government. It won’t be long before the change in priorities starts to ruffle feathers.
In its first half, the government erred in thinking it could sacrifice growth while reducing inequality. Now, with economic growth in question, it seems to be signalling that inequality is somehow less of a priority. Both approaches are wrong.
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