Newly-elected Chilean President Sebastian Piñera faces a myriad of challenges - economic and otherwise
Chile’s economy is gradually picking up after a prolonged period of subdued growth brought on by lower copper prices and stagnant investment. Business and consumer confidence have risen sharply in recent months, there are incipient signs of a turnaround in the construction sector and prices for copper are now back near multi-year highs. Against this macroeconomic backdrop, center-right candidate Sebastian Piñera is set to be sworn in as Chile’s new president on 11 March, having previously governed the country from 2010 to 2014. He has pledged to boost the country’s competitiveness, stoke growth and alter some of Michelle Bachelet’s key reforms—notably the reform of the tax system.
The challenges facing the incoming government are, however, considerable. Fiscal room for maneuver will be constrained by the not-insignificant structural budget deficit. Furthermore, the parliament is fractured, and lingering weaknesses in education, health and infrastructure must be tackled if Chile is to truly become a developed country—an often-stated aim of Piñera.
To discuss the country’s economic situation in more detail, we spoke to Alejandro Fernández Beros, Chief Economist at Gemines.
Alejandro Fernández Beros is an economist with degrees from the University of Chile and the University of Rochester. As Chief Economist at Gemines since 1990, his work covers macroeconomic forecasts and analysis, with a particular focus on the Chilean economy. Gemines is Chile’s oldest consultancy firm specializing in economics, finance and market research and was founded in 1974. Gemines also forms part of the Latin-American Alliance of Economic Consultancies (LAECO), which among other things publishes a monthly report on the region’s ten largest economies.
FocusEconomics: Chile’s economy is being buoyed at the moment by higher copper prices. Do you see the copper price rally being sustained going forward, and how do you see Chilean mining production over the next few years? Are strikes a possibility?
Alejandro Fernández: It is always difficult to know what will happen with the price of copper, but my impression is that it is at an unsustainable level in the short and medium term, although I do not believe that it should decrease significantly. The effect of the current high price of copper is obviously positive on the Chilean economy, since it will help to reactivate investment and production. However, I am one of those who do not believe that the Chilean economy cannot grow without the copper impulse. The evidence of the nineties is clear in this regard. All in all, I believe that the growth prospects for copper production are modest this year and next, at least, since the main deposits in operation are all old and show a decreasing trend in mineral grades and an increase in the depth of operations. Strikes are always possible and, this year in particular, likely, since there are a large number of negotiations that must be carried out.
FE: The structural deficit was 1.7% of GDP in 2017 according to preliminary figures, and public debt is rising fast. Do you feel it is time to revise the fiscal rule?
AF: Definitely yes. The fiscal rule has been very useful for Chile since its introduction about 20 years ago. However, it is evident that it presents problems, and it is necessary to strengthen all the institutions that regulate it and make it useful because it has lost credibility, both due to the breaches of the goal and the adjustments to it that have made it incomprehensible and have led to its having lost its role as a reference for fiscal policy.
It is necessary to give legal existence and resources to the Fiscal Advisory Council so that it is a relevant counterpart of the Ministry of Finance and not an irrelevant body as up to now. It is also necessary to modify the form of calculation of the structural parameters that have generated a procyclical behavior of the fiscal policy, which is the exact opposite of what should happen.
FE: How do you see the fiscal deficit evolving under the new administration?
AF: I am convinced that the trajectory of the deficit, effective and structural, will be downward, but the speed with which this happens will depend on factors that are beyond the control of the authorities, such as the evolution of the price of copper and the magnitude of the expenses committed to the future by various policies that are in the process of being implemented. One of the key factors, in any case, will be the growth of the economy. If we can maintain a relatively dynamic expansion, that is, around 3.5% to 4% per year, which I think is feasible, the task will not be so complex and slow.
FE: What do you feel are the major economic reforms that the incoming government should focus on?
AF: I think one of the first concerns of the new government should be to correct the tax reform of 2014, whose complexity is gigantic, and turn to a fully integrated tax system. That is, the profits generated by companies should be used 100% as credit against personal taxes, and this should be the only existing system, not the two that exist now, in which one implies only a partial integration of the tax system. While this will result in a loss of revenue, you can try to offset these losses by adjusting some other taxes and/or eliminating some exemptions. I think it's very likely that something along these lines will come true.
I also think it is important to fix the labor reform that came into effect in 2017. Its effects are just beginning to be seen and are not good. Here the prospects for change are much more complex.
To the extent possible, it would be important to correct the educational reform approved during the current government, to emphasize the existence of financing in pre-school and basic education and fewer subsidies in the university system.
What requires immediate attention is the pension system. Although the existing one is structurally sound, due to deficiencies in the labor market, low contribution rates and an early retirement age, pensions are very low. This must be addressed with a reform that, within a reasonable timeframe, corrects these deficiencies, which necessarily requires a greater intervention of the state, but duly financed and with adjustments in the private system that increase the existing degree of competition there. It is essential that important advances are made in this area. It is also essential to initiate what should be a profound reform in the health system, which is not bad in its results but very expensive for a small part of the population, but very deficient and poorly funded for the rest. This is a reform that can take many years, but it is important to start it sooner than later and do it well. I doubt that much progress will be made on this issue.
FE: What more could the government do to diversify the economy away from the mining sector and boost the potential growth rate?
AF: It is difficult to be able to do things that have a significant or short-term effect. I think the main emphasis should be on improving the available human capital and its accumulation rate. The current on-the-job training system is very deficient and requires a significant adjustment. It is also important to expand the financing mechanisms for innovation and the opening of technology companies. But nothing is going to dramatically change the productive structure of the country. Today we are talking about an important potential in lithium and, perhaps, cobalt, that is, more of the same, but that is the reality of the country. Without a critical mass of human capital and some support to create new poles of development, it is difficult to diversify the economy. The state can play some role in facilitating contact between private parties and significantly improving the country's infrastructure.
FE: How do you judge the performance of the outgoing government on the economic front?
AF: I think the evidence is very clear. It has been a total disaster regarding our history and considering what was possible.
FE: How do you think the economy will perform this year?
AF: The evidence indicates that last year ended on something more solid than anticipated. Expectations have improved a lot after the final result of the presidential elections, so we expect a significant acceleration in growth, which could be around 3.5% this year.
FE: What are the major handicaps businesses currently face when operating in Chile?
AF: Probably, excessive regulation, but above all regulatory inefficiency, since the process of obtaining permits is slow, and it has been seen that it does not ensure anything, since many projects end up defining their execution in the courts. To this must be added relatively low rates of return and difficulties in finding qualified labor.
FE: Do you see the government being able to win other parties’ support in parliament for reforms? Which reforms are likely to generate consensuses, and which could cause more disagreements?
AF: The experience of Piñera's first government, in which he also faced a Congress controlled by the opposition, is that it is possible to reach agreements for specific projects. I think it will be easier this time, but it depends on how well the government handles the political negotiations.
I believe that in the tax and pension issues it will be possible to reach agreements with part of the opposition, as well as in health, if it is addressed. On the labor issue, I think it is very difficult, but in any case, it seems to me that the key is for the government to be able to negotiate and secure the support of public opinion. I think that, especially at the beginning of the government, this may be feasible; later the loss of support and the proximity of the municipal and governor elections (2020) will make it more difficult.
FE: How would you evaluate Piñera’s economic cabinet?
AF: I believe that the presence of Felipe Larraín in the Ministry of Finance is a guarantee of expert and solvent management. He already has the experience of Piñera's previous government and because of his character is sure to generate a lot of confidence.
Jose Ramon Valente in the Ministry of Economy is an option that generates more uncertainty since he has no experience in the public service, but this is a ministry that historically has not had much relevance, although due to its relationship with sectoral issues it should.
Rodrigo Cerda as Budget Director is also a very good appointment since he not only has experience with the previous government of Piñera, but has worked for many years with Larraín, which ensures a fluid relationship.
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Disclaimer: The views and opinions expressed in this article are those of the authors and do not necessarily reflect the opinion of FocusEconomics S.L.U. Views, forecasts or estimates are as of the date of the publication and are subject to change without notice. This report may provide addresses of, or contain hyperlinks to, other internet websites. FocusEconomics S.L.U. takes no responsibility for the contents of third party internet websites.
Date: March 1, 2018
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