Regardless of who wins the upcoming presidential runoff election on December 17, Chile is still facing many challenges on the economic front heading into 2018. The new administration will arrive at a time when Chile is struggling to recover after four years of below potential growth, which has left little room for further stimulus, either monetary or fiscal, while contributing to the deterioration of public finances. As a result, there will likely be limited room to enact costly agendas without further jeopardizing Chile’s privileged financial position.
Although market participants do not expect real GDP growth to surpass 1.5% in 2017, optimism has begun to rise, helped by rebounding commodity prices and anticipation of political change, perhaps in the spirit of other more pro-market administrations in the region. The IMCE business confidence index, as measured by iCARE, and the IPEC consumer confidence index, as measured by Adimark, have both reached their highest levels since 2014. The benchmark IPSA stock index has risen by 25% in CLP and 32% in USD year-to-date, as of November 22, in line with broader Emerging Markets indices, while outperforming most global indices.
Economic activity has shown some incipient signs of recovery in the second half of the year with real GDP growth reaching 2.2% in 3Q17, up from figures below 1% in previous quarters, mainly on the back of improved consumption and mining activity. As a result, forecasts for 2018 real GDP growth have also been rising, reaching 3% in the latest survey from the Central Bank.
Despite the more optimistic outlook, risks to growth remain. Externally, geopolitical tensions have risen, while China uncertainty has returned with leadership in that country now placing greater emphasis on quality over quantity, possibly leading to reduced activity for Chile’s primary trade partner. On the domestic front, investment remains subdued given a lack of clear incentives in many sectors with recovery likely tied to policy decisions of the new administration. In addition, the monetary easing cycle has likely ended and inflation has begun to pick up. As a result, further rate cuts have become less likely and the Central Bank could move towards policy normalization by the end of next year.
Perhaps more worrisome are the structural constraints that have emerged in the public finances. Below potential growth and reduced sources of revenue, coupled with continued spending, have resulted in a substantial rise in government debt to above 20% of GDP, the highest level the country has seen in more than two decades. Meanwhile the fiscal deficit has reached more than 2% of GDP with the structural balance declining to similar levels, placing a balanced budget further out of sight. Although by regional standards, Chile is still quite financially sound, the deterioration in these figures led to ratings downgrades by credit agencies in the past year.
With a new administration possibly looking to advance spending upon arrival, there may be limited room to maneuver without further affecting credit ratings, risk spreads and overall access to credit.