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CHILE 1. General Trends in 2017, the Chilean Economy Grew by 1.5%, A

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CHILE 1. General Trends in 2017, the Chilean Economy Grew by 1.5%, A Economic Survey of Latin America and the Caribbean ▪ 2018 1 CHILE 1. General trends In 2017, the Chilean economy grew by 1.5%, a rate similar to the previous year’s 1.3%. The trend of GDP reflected the weakness of both investment and exports, which was not offset by consumption growth fuelled partly by heavier private-sector borrowing. The counterpart of this pattern was contractions in mining, agriculture and construction. The sectors that grew most strongly (communications; commerce; electricity, gas and water; and services) are precisely those most closely linked to consumption. Economic growth was too lacklustre to support an improvement in the fiscal accounts, which deteriorated slightly relative to the previous year (a deficit of 2.7% of GDP in 2016 widening to 2.8% in 2017), despite the higher copper price and the positive effects of the 2014 tax reform on income tax revenue. The wider central government deficit added to the external debt, which nonetheless remains low by international standards. In this context, current output was below potential, which, combined with the appreciation of the exchange rate and the slackening pace of wage growth, held inflation down, despite higher energy prices. The monetary authorities reacted countercyclically by implementing an expansionary 100-basis-point cut in the monetary policy rate. Externally, the current account deficit widened as the income balance became more negative, while the trade balance improved on the back of stronger copper prices, offsetting a reduction in export volumes. The income account balance reflects the repatriation of earnings from foreign direct and portfolio investment. Financial outflows responding to monetary policy normalization by the United States Federal Reserve also contributed to this result. The deficit was mostly financed by portfolio financial flows. Overall, the country’s net international investment position worsened. In 2018, the economy is expected to grow by about 3.3%, over twice the 2017 rate, thanks to the revitalization of investment —especially in the mining sector— which has been visible since the second half of 2016, and, to a lesser extent, buoyant consumption. This stronger growth will boost tax revenues, which, in conjunction with public spending restraint, will help to reduce the public deficit (forecast at 1.9% of GDP for 2018). Stronger growth will also attract additional imports, but this should be offset by export growth resulting from the higher international copper price. The current account is forecast to deteriorate owing to heavy profit repatriation. The economy’s two weakest flanks are the rising levels of private sector debt and reliance on portfolio flows to finance the current account deficit. 2. Economic policy (a) Fiscal policy In 2017, the central government deficit widened slightly to 2.8% of GDP (compared to 2.7% in 2016) implying a larger structural deficit than the previous year’s 2.0% of GDP. This is explained by a 2 Economic Commission for Latin America and the Caribbean (ECLAC) slight reduction in the tax burden (to 17.3% in 2017 compared to the year-earlier 17.5%)1, since the authorities managed to contain the increase in expenditure (23.7% of GDP in 2017 compared to the previous year’s 23.5%). The easing of tax pressure mainly reflected the trend of non-mining tax revenues (which dropped to 16.7% of GDP in 2017 from 16.8% in the previous year) and, in particular, revenue from income tax on non-mining activities (6.5% of GDP in 2017 compared to 6.6% in 2016), which represents 38% of the central government’s tax revenues. The behaviour of non-mining income taxes is explained by a reduction in the tax base that was not offset by the rate hike included in the 2014 tax reform. Tax revenues from private sector mining (2.7% of the total) tracked the rise in the copper price (from US$ 2.21 per pound in 2016 to US$ 2.55 per pound in 2017). The contribution of other taxes to overall tax pressure was unchanged from the previous year. Value added tax (8.3% of GDP in 2016 and 8.4% in 2017) expanded in line with economic activity and private consumption growth. The revenue obtained from excise taxes (1.5% of GDP in 2016 and 2017) reflects declining cigarette sales, higher fuel prices and a 15% hike in the tax on extraction rights provided for in the fishing law. On the spending side, the behaviour of central government expenditures is explained by the current spending component (19.9% of GDP) and, in particular, by expenditure executed by the ministries of education, health and labour, since capital spending retreated (-3.1% in real terms for 2017). The widening of the central government’s deficit added to its debt stock, which represented 23.6% of GDP in 2017 compared to 21.3% in 2016. For 2018, the authorities are projecting a reduction in the fiscal deficit by about one percentage point of GDP (to 1.9%, down from 2.8% in 2017), based on expenditure cuts (from 23.8% of GDP in 2017 to 23.3% in 2018), together with revenue growth (from 20.8% to 21.6% of GDP in 2018) supported, in part, by stronger economic growth and the higher international copper price. Expenditure will be targeted on education and health.2 (b) Monetary policy Against a backdrop of weak inflationary pressures owing to slack domestic demand and the appreciation of the exchange rate, the central bank adopted a countercyclical policy, involving a 100- basis-point reduction in the monetary policy rate from 3.5% in December 2016 to 2.5% in May 2017. As from the second half of the year, the Board of the Central Bank of Chile held the rate at 2.5%, in view of the economic recovery, reflected partly by the stronger performance of the mining sector, which accounts for roughly 20% of GDP and 25% of gross capital formation. The expansionary economic policy stance did not have a major effect on the interest rate structure in the banking system. In 2017, nominal interest rates for consumer, trade and housing loans averaged 22.1%, 7.3% and 3.4%, respectively, only slightly lower than in 2016 (23.1%, 7.4% and 3.7%, respectively). This did not affect domestic currency lending, which grew more slowly (7.5% in 2017 1 Does not include social security contributions. 2 These estimates are based on a GDP growth projection of 3.8% in real terms and a copper price of US$ 3.10 per pound. Economic Survey of Latin America and the Caribbean ▪ 2018 3 compared to the previous year’s 10%), reflecting slacker demand for credit in consonance with weak economic growth. Monetary policy is expected to remain expansionary in 2018, which will help consolidate more vigorous economic growth. This will depend partly on the buoyancy of domestic demand and the trend of the output gap. The determinants of nominal exchange-rate variation and the speed with which it is passed through to domestic prices will also affect this behaviour. Changes in the nominal exchange rate associated with interest rate spreads tend to have a greater impact than those deriving from international prices.3 (c) Exchange-rate policy The fall in interest rates did not noticeably affect the exchange rate, which appreciated in nominal terms (from 670.68 pesos per dollar in January 2017 to 615.44 pesos in December) and remained stable in real terms (103.1 and 103 pesos per dollar over the same period). This is explained in part by a benign external environment with less financial volatility and a greater appetite for risk among foreign investors, supported by rising international metal prices. In the first five months of 2018, the nominal exchange rate has behaved more erratically, first appreciating between January and February (from 615.4 pesos per dollar at the start of January to 595.2 pesos per dollar by late February), before reversing course in early March and especially from the third week of April, coinciding with a rise in the yield on United States Treasury Bills and the steep devaluation of the Argentine peso, which heightened the perceived risk of the region’s economies. The emerging market bonds index (the difference between the interest rates paid by dollar- denominated bonds issued by emerging countries and United States Treasury Bills, which are considered risk-free), which had been trending down in 2017 and early 2018 (157, 116 and 109 points in January 2017, December 2017 and February 2018, respectively), shows a rise in response to the hike in federal funds rates on 22 March and later in the third week of April, before peaking at 177 points at the end of May. By end-June, however, the index had come back down to 131 points. Nonetheless, this behaviour is not expected to affect competitiveness, since the real exchange rate is expected to remain stable throughout the year. (d) Other policies The measures to be introduced by the new government that took office in March this year include pension reform, with a view to encouraging greater competition in the pension fund administration (AFP) market and increasing pensions. Other reforms include the creation of specialist training for primary health care physicians and measures to reduce shortages in certain medical specialties; and a national education quality plan and a new solidarity-based system of access to higher education. 3. The main variables (a) The external sector 3 Central Bank of Chile, Monetary Policy Report, March 2018, p. 38. 4 Economic Commission for Latin America and the Caribbean (ECLAC) The balance-of-payments current account ended 2017 with a deficit of US$ 4.146 billion, or US$ 647 million larger than in the previous year.
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