CHILE: How to manage expectations in Bachelet’s second term
The latest (11 February 2014) economic expectations survey published by the Banco Central de Chile (BCC – the central bank) was downbeat. Respondents are looking for an easing of policy this month: economic growth is slowing at a time that inflation is moderate. The overall environment is not germane for the education and tax reforms proposed by President-elect Michelle Bachelet, who will take office on 11 March.
One of the key features of global financial markets in January was an (aggressive) tightening of monetary policy by a number of emerging market central banks in response to current account deficits, slumping currencies and deteriorating perceptions. This did not include the BCC. At its meeting on 16 January, the BCC kept its key policy rate unchanged at 4.50%.
Moreover, the accompanying comments had a decidedly dovish tone. The BCC noted that “the Chilean economy has continued to lose strength. Domestic output and demand have grown somewhat less than assumed in the latest [December 2013] Monetary Policy Report, particularly in investment-related sectors. … Meanwhile inflation expectations remain around the target [of 3.00%] over the projection horizon and the pace of nominal wages’ growth shows a moderation in recent months.”
The BCC’s latest survey of economic expectations, published on 11 February, found respondents in a similarly downbeat mood. They are now looking for real annual GDP growth of 3.8% and 4.3% in 2014 and 2015 respectively, having revised down their expectations over several months. The consensus expectation is that the central bank will cut the benchmark rate by 25 basis points to 4.25% at its February meeting. This is at a time that the central bank’s IMACEC index of economic activity slipped to 2.60 in February, down from 3.00 in January. The index has fallen consistently on a month-to-month basis since October 2013, when it stood at 4.40, and more generally since March 2013, when it stood at 5.40 (see chart 1).
| Table 1: Chile: Expectations - Selected Items - % | ||||||
| Survey Month | Policy rate, current month | Policy rate, next month | IMACEC, One Month Ago | GDP Growth, 2014 | GDP Growth, 2015 | Dec 2014 Inflation |
| Mar' 13 | 5.00 | 5.00 | 5.40 | 5.00 | 4.80 | 3.0 |
| Apr' 13 | 5.00 | 5.00 | 4.80 | 5.00 | 5.00 | 3.0 |
| May 13 | 5.00 | 5.00 | 4.80 | 4.80 | 5.00 | 3.0 |
| Jun' 13 | 5.00 | 4.75 | 4.50 | 4.70 | 4.75 | 3.0 |
| Jul' 13 | 5.00 | 5.00 | 4.00 | 4.50 | 4.70 | 3.0 |
| Aug' 13 | 5.00 | 4.75 | 4.30 | 4.50 | 4.50 | 3.0 |
| Sep' 13 | 5.00 | 5.00 | 4.10 | 4.50 | 4.50 | 3.0 |
| Oct' 13 | 5.00 | 5.00 | 4.40 | 4.40 | 4.50 | 3.0 |
| Nov' 13 | 4.75 | 4.50 | 4.00 | 4.10 | 4.50 | 2.7 |
| Dec' 13 | 4.50 | 4.25 | 3.50 | 4.00 | 4.40 | 2.8 |
| Jan' 14 | 4.50 | 4.25 | 3.00 | 4.00 | 4.30 | 3.0 |
| Feb' 14 | 4.25 | 4.25 | 2.60 | 3.80 | 4.30 | 3.0 |
| Source: Banco Central de Chile, Expectations Survey | ||||||
As the BCC itself recognised, both the reality and expectations about the strength of the economy have fallen short of the official forecasts in the last Monetary Policy Report. For some time, most of the main macro-economic indicators have been moving in the wrong direction. Thanks in part to a steady fall in the global price of copper, Chile’s main export, the balance of trade has been deteriorating, and at a time that domestic demand has also been softening (see chart 2).
| Table 2: Chile: Official Forecasts, December 2013 | |||
| 2012 | 2013f | 2014f | |
| (Annual change, %) | |||
| GDP | 5.6 | 4.2 | 3.75-4.75 |
| National Income | 6.3 | 5.2 | 4.4 |
| Domestic Demand | 7.1 | 3.9 | 4.8 |
| Investment (GFCF) | 12.3 | 3.9 | 4.1 |
| Consumption | 5.8 | 5.4 | 4.7 |
| Goods & Services Exports | 1.0 | 5.3 | 3.1 |
| Goods & Services Imports | 4.9 | 4.4 | 4.6 |
| (% of GDP) | |||
| Current Account | -3.5 | -3.2 | -3.7 |
| National Savings | 21.4 | 21.1 | 20.6 |
| GFCF | 24.1 | 24.4 | 24.3 |
| (Other) | |||
| LME Copper Price (US cents/lb) | 361 | 332 | 310 |
| December CPI Inflation (%) | 1.5 | 2.6 | 2.5 |
| Source: Banco Central de Chile, Monetary Policy Report - December 2013 | |||
As we discussed in the December 2013 edition of Latin American Economy & Business, President-elect Michelle Bachelet has identified three main priorities for her incoming administration. One is a hike in the corporate tax rate from 20% to 25%. A second is wholesale education reform: this includes the introduction of free university education, even though this is rare (or non-existent) in most other countries. Bachelet believes that the increase in the corporate tax rate could boost government revenues by about US$8.2bn annually (in the context of a country whose 2012 GDP amounted to US$268.2bn) and fund her planned education reforms. The third priority is constitutional reform.
A slowing economy and higher taxes are not the only challenges facing Chile’s corporate sector. A wave of industrial unrest in the public sector (especially) in the final quarter of 2013 means that employers are having to sustain real increases in pay costs that are not necessarily being matched by higher productivity. In any event, labour productivity in Chile is lower than in any other country in the Organisation for Economic Cooperation and Development (OECD), apart from Mexico. Low labour productivity is one consequence of the deficiencies of Chile’s educational system. According to the World Economic Forum’s 2013-14 Global Competitiveness Report, Chile is the 34th most competitive country (out of 148 rated): however, it is in 74th place for the overall quality of its education system.
The demands of Chile’s students, which Bachelet hopes to meet with her education reforms, and the demands of workers, which have been partially met with pay rises, are symptomatic of a key structural problem: the inequality of income in the country. With a Gini Index* of 0.52, the distribution of income in Chile is less equal than in any other OECD country. (*The Gini Index measures the extent to which the distribution of income or consumption expenditure among individuals or households within an economy deviates from a perfectly equal distribution, with 0 representing perfect equality and 1 representing perfect inequality). Meanwhile, expectations have been boosted by the steady economic growth – the result of years of good governance and, prior to 2013, high or rising copper prices.
For now, there is a policy-making hiatus until the new administration is inaugurated on 11 March. Thereafter, Bachelet will have to try to fulfil the expectations of workers and (especially) students at a time that the economy is clearly weaker than it was on 15 December, when she won the second round presidential run-off vote in a landslide. One challenge for the new government arises from the fact that it will likely take years for new education reforms to be seen to be beneficial. Another arises from the possibility that higher corporate tax rates may have an adverse impact on jobs. As of December 2013, the official unemployment rate was 5.70%, on BCC data.
One possibility is that Bachelet attempts to buy time with a fiscal boost to the economy. The budget is broadly in balance. Total government debt, at about US$34bn, is low and is held overwhelmingly by domestic investors. As noted above, inflationary pressures (and expectations) are low. An increase in public sector consumption or investment would underpin overall economic growth until Chile begins to derive benefit from the clear recovery in the US and other developed economies. It could well be that economic conditions in Chile are much more conducive to the reforms that Bachelet envisages towards the end of her four year term. In the meantime, she will have to work assiduously to manage the (high) expectations of various sectors.
- Copper, peso
Copper was trading at US$3.25/lb. on 13 February, compared to just over US$3.7/lb. a year ago. The Chilean peso was trading at about CHP546.75/US$ on 17 February, from CHP525.43/US$ on 31 December 2013.