Chile’s leftist government surprises with spending cuts

One of the world’s most dramatic post-Covid spending cuts is expected to generate a larger-than-expected budget surplus for Chile’s left-wing government this year, pleasing investors who had fretted over the radical president’s costly campaign promises. Gabriel Boric.

“We expect a surplus of 1.6 percent of gross domestic product this year,” Finance Minister Mario Marcel said. “It is 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 earned a reputation for caution in his previous role as governor of the country’s central bank, insists the Boric administration will not repeat the economic mistakes made by leftist governments elsewhere in the region.

“Many times ambitious reforms have been proposed that aroused a lot of hope in the population, but later could not continue due to the weakness of the economy and the lack of resources from the State,” Marcel told the Financial Times. “That’s not something we want to be exposed to.”

Chile’s caution comes as officials and economists fear a rise in interest rates will put governments under financial pressure. The volume of outstanding IMF loans is expected to reach a record level this year, while borrowing costs in several emerging markets and some advanced economies, such as the UK, have soared.

Analysts worry that beyond next year, Santiago will struggle to provide better public services without straining the budget.

“The biggest challenge is to implement a very ambitious social spending agenda on pensions, housing, education and the care system without affecting the sustainability of economic growth and investment,” said Sebastian Rondeau, economist for the southern cone at Bank of America. “That is a big challenge.”

Finance Minister Mario Marcel
Finance Minister Mario Marcel says Chile is taking a cautious line to avoid the mistake others have made by approving reforms that raise people’s hopes but then cannot be sustained © Cristobal Olivares/Bloomberg

The government, however, believes it can increase spending by using tax reform to raise more revenue. Chile’s tax collection is one of the lowest in the OECD at 19.3 percent of GDP in 2020. Marcel said the planned changes would gradually increase tax revenue by around four percentage points of GDP by 2026.

“In Chile, there is a very strong conviction in politics, particularly in the center-left, that if you don’t have healthy public finances, you can’t make the reforms you want to approve sustainable,” Marcel said.

Investors have also been unsettled by a debate over Chile’s constitution, which began when the previous government agreed to protesters’ demand for a new document. A draft statute drawn up by an elected assembly dominated by the far left was rejected by voters last month and discussions continue on how to move forward.

Marcel remains confident that the revised letter will not cause confusion. “What became clear is that we are converging towards a more moderate constitutional environment,” Marcel told the FT in a separate conversation ahead of the September 4 plebiscite.

Boric’s government took office in March with the promise of spending more on health, education and pensions. But it has had to tighten the budget sharply after the previous conservative administration led by Sebastián Piñera triggered a consumer spending boom with a generous Covid support package worth 14.1% of GDP, according to IMF figures. . Early pension withdrawals further boosted spending.

Growth soared, with the economy expanding 11.7 percent last year, but inflation also soared, prompting the central bank to tighten monetary policy. Chile first started raising rates in July 2021 when Marcel was governor of the central bank, eight months before the US Federal Reserve.

Chile’s central bank raised rates to 10.75 percent in September and Marcel said he expected “probably one last hike before rates stabilize and we start to see more results on the inflation side.”

Citi analysts expect prices to rise 13.5 percent this year and rates to peak at 12 percent in December. They predict Chile’s growth will slow to 2 percent in 2022 and the economy will contract 0.5 percent next year.

“In one year we absorbed all the huge deficit we inherited last year,” Marcel told the FT. “We are much further along in stabilizing our economy compared to other countries.”

“If you compare the deficit of 2021 with the surplus that 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 percent in real terms.”

After stabilizing public finances, the government now plans a modest spending expansion of 4.2 percent next year, according to a budget proposal last week. Most of the additional money will be used to finance a better state pension for nearly 2.3 million Chileans, with smaller amounts for infrastructure.

President Gabriel Boric delivers a speech at the launch of Chile's tourism program
President Gabriel Boric took office in March promising to spend more on health, education and pensions © Cristobal Basaure Araya/SOPA/LightRocket/Getty Images

Marcel was confident that the country could get more out of its natural resources to meet its spending targets and put its economy on a more environmentally sound footing.

The South American nation is the world’s largest copper producer and the second largest lithium producer. Mining, Marcel said, is “going through a major transformation from a so-called ‘dirty’ industry to a clean industry, using less water and more renewable energy. In our case, this is reflected in the use of water and energy sources.”

The Boric administration wanted to channel some of the lithium revenue into the development of green hydrogen production and export, he said.

Chile’s northern desert and extensive coastline offer some of the most concentrated sources of solar and wind power in the world. This opens up 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 to finance the ports and pipelines needed to develop the fledgling industry.

The rapid development will allow Santiago to pursue a sound fiscal policy, while meeting 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 to be an economy that respects the environment, a green economy.”

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