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Analysis & opinionSeptember 1 2017

Rodrigo Valdes: copper's bottom will not shake Chile

Chile has suffered an economic slowdown in the past few years as the price of its main export, copper, tumbled. However, efforts to diversify investment and increase competition are paying off. Now the country must leverage its reputation for stability and hold a steady fiscal course amid political elections in order to continue its hard-won progress, writes the country's finance minister. 
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Rodrigo Valdes

Chile continues to be a leader in Latin America. In the past 25 years we have successfully integrated into the world economy, reached a public-private partnership adjusted per capita gross domestic product (GDP) of $23,000, the highest in the region. We have decreased our poverty rate and made progress in income distribution.

We have become a globalised economy, with a wide network of trade agreements: 25 free-trade agreements with 64 countries, accounting for 94% of Chile’s exports, and more than 60% of our GDP is linked to trade. Chile’s long-standing political and economic stability, transparency and competitiveness, as well as its dynamic business community, have made the country an excellent destination for foreign investment.

Recent challenges

In recent years, however, we have faced challenging external conditions as well as some decline in business sentiment. Growth averaged 1.9% between 2014 and 2016, below the 4.7% observed in the previous 10 years. At the beginning of 2017 we faced a couple of one-off factors, which have delayed the recovery, but several indicators point to an acceleration of activity in the coming months.  

The slowdown in activity of the past few years was led by a fall in investment, particularly mining-related, reflecting, in turn, the end of the commodities supercycle. The price of copper, our main export by far, dropped from $3.7 per pound in mid-2012 to a low of $2 in early 2016.

Since then, prices have firmed up somewhat, especially in the past nine months. Mining investment peaked in 2013 and represented one-third of total investment. Since then, it has dropped almost 40% cumulatively, albeit with several signs of stability seen in the past few months. 

Notwithstanding this large cycle, when compared with other mining-rich countries, such as Peru or Australia, our investment total figures have suffered relatively less. In part, this is because non-mining investment continued to expand. Between 2013 and 2016, it increased 7.4% cumulatively, supported by public works, convenient financial conditions and real estate demand.

The macroeconomic adjustment of our economy has been quite healthy. The currency depreciated, inflation increased modestly and only temporarily, the current account deficit remained in check, and interest rates barely increased and are significantly lower today than four years ago. In this environment, the banking system has remained very profitable and credit risk has not changed appreciably.

Despite this successful macro adjustment, the fall in copper prices not only affected investment but also significantly impacted our public finances. In 2011, fiscal revenues from copper were equivalent to more than 4% of GDP; in recent years they accounted for only 0.5%. In 2015, we started a gradual consolidation path, improving our structural fiscal deficit by about one-quarter of a percentage point of GDP per year. We were able to stabilise the non-copper deficit early on, thanks to revenue and spending measures. However, both actual fiscal deficits and public debt increased.

This fiscal challenge requires a steadfast approach. Given the new reality of revenues, I believe the key issue is how to adjust and respond to the new scenario. In this sense, the government has adjusted – simultaneously – all available margins, reducing the structural deficit by a quarter point of GDP per year using comparable parameters, decreasing and reassigning expenses, and pursuing fiscal austerity measures. The advantage is that we can do this gradually as global markets have confidence in our strategy, which has been reflected in our debt’s low cost.

This path guarantees public accounts sustainability in the medium term and its gradualness avoids the negative effects of a contractionary fiscal policy in the short term. Our policy framework, in turn, allows us to have low interest rates that favour investment, and a competitive exchange rate. We will persevere in this strategy when we submit the 2018 public budget in October, and until the end of this government.

Fighting inequality

During these years we have actively worked on measures to achieve a more prosperous and inclusive society. Although we have made important progress in this journey, there are still important challenges ahead. Inequality in Chile has remained too high for too long. Building the basis for an inclusive society has been the core aim of our government, through an educational reform from pre-school to tertiary, including incentives to raise teachers’ performance. Increasing the country’s human capital levels is a key factor to boost our productivity and move towards a more diversified economy.

We have also tackled head on the energy bottleneck our economy faced a few years ago. Thanks to regulatory changes and more competition, there is an impressive pipeline of unconventional renewable energy. Indeed, as of June 2017, 80% of the generation capacity under construction corresponds to renewable energy, and half of it is of the unconventional type. The entry of new competitors has allowed an important reduction of average supply prices, which decreased from $129 per megawatt hour (MWh) in the 2013 auction to $79.3/MWh in 2015 and $47.5/MWh in last year’s process, accounting for a reduction of 63% in three years.

Looking ahead, we expect the economy to gain momentum in the coming months as the effects of the supercycle runs its course and supportive macroeconomic policies help domestic demand. We also expect that the global scenario will remain positive, as copper prices firm up and the demand for our exports grow at a faster pace.

Internally, beyond maintaining our macroeconomic policies, we need to continue efforts to enhance productivity. It is essential to increase our potential growth and ensure its benefits reach everyone, through better quality jobs, higher salaries, and the delivery of good quality public goods and services.

Productivity a crucial aim

Productivity remains the key challenge to sustain growth in the long run. As mentioned, we have made significant progress in two critical bottlenecks: education and energy. But we are also pushing a productivity-enhancing agenda, which was launched in 2014.

This agenda has included key infrastructure to connect communities and businesses, along with several other measures to boost innovation, expand financing options and deepen and integrate our capital markets. We have made special efforts to foster public-private partnerships, submitted a bill to create an infrastructure fund, and capitalised several public companies.

We are also working with the private sector to increase public support for entrepreneurship and innovation, to define key productive sectors with high potential growth, and to reduce bureaucratic obstacles to investment. There are many areas that generate business opportunities, and several options for research and collaboration. An important step was the creation of the National Productivity Commission. This permanent, independent and participatory body will help to ensure that productivity is the focus of policy-making, and will recommend policies from a long-term perspective.

We should start seeing the effects of these measures and reforms in the coming years. These efforts will prove to be essential in the long run in order to secure inclusive and sustainable growth.

Better business confidence

On a different front, we have been working to improve our business and political confidence. A series of market misconduct cases – involving antitrust and inside trading, as well as political financing scandals – have severely affected confidence. The good news is that the institutional reaction was strong. We designed new rules for political parties and political financing, with more transparency to fight corruption, and we enhanced the powers of the competition authority and financial regulators to deepen competition and free markets.  

In a few months, Chile will choose a new president, and a new government will be elected for a four-year term taking office next March. As always, it will be an intense political process when observed from within; however, from outside I believe it is perceived as a less dramatic matter. The different views held by the main candidates should not be a cause of concern. Chile has a well established reputation of having both a stable economy and a strong democracy. I am sure we will continue our journey towards development.

Rodrigo Valdes is the finance minister of Chile.

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Read more about:  Americas , Analysis & opinion , Americas , Chile
Silvia Pavoni is editor in chief of The Banker. Silvia also serves as an advisory board member for the Women of the Future Programme and for the European Risk Management Council, and is part of the London council of non-profit WILL, Women in Leadership in Latin America. In 2019, she was awarded an honorary fellowship by City University of London.
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