One of the world’s most dramatic post-Covid spending squeezes is expected to deliver a bigger-than-expected budget surplus for Chile’s leftwing government this year, pleasing investors who had worried about radical President Gabriel Boric’s expensive campaign promises.
“We are expecting a surplus of 1.6 per cent of gross domestic product this year,” said finance minister Mario Marcel. “It’s the first surplus in nine years. The current government has made an effort to be disciplined which means that our results this year will be better than expected.”
Marcel, a technocrat who gained a reputation for caution in his previous role as governor of the country’s central bank, is adamant that the Boric administration will not repeat the economic mistakes made by leftwing governments elsewhere in the region.
“Many times ambitious reforms have been put forward which aroused a great deal of hope among the population, but which later could not be continued because of weakness in the economy and a lack of state resources,” Marcel told the Financial Times. “That is not something we want to see ourselves exposed to.”
Chile’s prudence comes as officials and economists fear that a surge in interest rates will place governments under financial pressure. The volume of outstanding IMF loans is expected to hit a record high this year, while borrowing costs in several emerging markets and some advanced economies, such as the UK, have soared.
Analysts are concerned that, beyond next year, Santiago will struggle to deliver better public services without straining the budget.
“The biggest challenge is to implement a very ambitious social spending agenda in pensions, housing, education and the care system without affecting the sustainability of economic growth and investment,” said Sebastian Rondeau, southern cone economist at Bank of America. “That’s a big challenge.”
The government, however, believes it can lift spending by using tax reform to raise more revenue. Chile’s tax take is one of the lowest in the OECD at 19.3 per cent of GDP in 2020. Marcel said the planned changes would gradually raise tax revenue by around four percentage points of GDP by 2026.
“In Chile, there’s a very strong conviction in politics, particularly in the centre-left, that if you don’t have healthy public finances, you can’t make the reforms you want to pass sustainable,” Marcel said.
Investors have also been unsettled by a debate over Chile’s constitution, which began when the previous government agreed to a demand from protesters for a new document. A draft charter produced by an elected assembly dominated by the hard left was rejected by voters last month and discussions are continuing over how to move forward.
Marcel remains confident that the revised charter will not lead to turmoil. “What’s become clear is that we’re converging towards a more moderate constitutional setting,” Marcel told the FT in a separate conversation ahead of the plebiscite on September 4.
Boric’s government took office in March promising to spend more on health, education and pensions. But it has had to rein in the budget drastically after the previous conservative administration led by Sebastián Piñera unleashed a consumer spending boom with a lavish Covid support package worth 14.1 per cent of GDP, according to IMF figures. Early pension withdrawals further fuelled spending.
Growth surged, with the economy expanding 11.7 per cent last year, but inflation also jumped, prompting the central bank to tighten monetary policy. Chile first began raising rates in July 2021 while Marcel was central bank governor, eight months before the US Federal Reserve.
The Chilean central bank raised rates to 10.75 per cent in September and Marcel said he expected “probably one final increase before rates stabilise and we start to see more results on the inflation side”.
Analysts at Citi expect prices to rise 13.5 per cent this year and rates to peak at 12 per cent by December. They predict Chile’s growth will slow to 2 per cent in 2022 and the economy will contract 0.5 per cent next year.
“In one year we absorbed all of the huge deficit that we inherited last year,” Marcel told the FT. “We’re far more advanced in the stabilisation of our economy when compared to other countries.”
“If you compare the 2021 deficit with the surplus we will have this year, that means [a fiscal adjustment of] almost 10 percentage points of GDP,” he explained. “Public spending has been reduced by 24 per cent in real terms.”
After stabilising the public finances, the government is now planning a modest expansion of 4.2 per cent in spending next year, according to a budget proposal last week. Most of the extra money will be used to fund a better state pension for almost 2.3mn Chileans, with smaller sums for infrastructure.
Marcel was confident that the country could yield greater benefits from its natural resources to achieve its spending aims and move its economy to a more environmentally sound footing.
The South American nation is the world’s biggest copper producer and the second-largest producer of lithium. Mining, said Marcel, is “undergoing a major transformation from a so-called ‘dirty’ industry towards a clean one, using less water and more renewable energy. In our case that is reflected in the use of water and energy sources.”
The Boric administration wanted to channel some of the income from lithium into developing the production and export of environmentally friendly hydrogen, he said.
Chile’s northern desert and its long coastline offer some of the world’s most concentrated sources of solar and wind power. This opens the possibility of using abundant renewable electricity to produce pollution-free hydrogen, a green fuel. Marcel said the government was working with the World Bank and the Inter-American Development Bank to find ways of funding the ports and pipelines required to develop the fledgling industry.
Swift development will enable Santiago to pursue a sound fiscal policy, while delivering its ambitious social spending plans.
“Chile has traditionally been valued as a country with solid institutions, good macroeconomic policy and an open economy,” he said. “We aspire to add to that being an environmentally friendly economy, a green economy.”