Chile: The next president will inherit a bottoming out economy

On the 19th November, Chile will hold presidential elections. Immediate re-election is forbidden in the country, leaving President Michelle Bachelet automatically out of the running.

Her centre-left Nueva Mayoria alliance is backing Alejandro Guillier, who is technically running as an independent. According to recent voter intention polls, Mr Guillier – a nationally-recognised TV journalist and senator – stands to finish the race in second place with 17% of votes. He has defended his candidacy rejecting the political class and as a bridge between centre-left parties and the population.

The current frontrunner is former President Sebastián Piñera (2010-2014) from the centre-right Chile Vamos alliance, who is expected to gain 33% of the votes. Mr Piñera holds one of the largest fortunes of the country (estimated at USD 2.7 billion) and has the support of the local business community. He blames Ms Bachelet and her coalition for raising market uncertainty in the country through their reform agenda.

Beatriz Sánchez completes the leading candidates list. She belongs to the left-wing Frente Amplio coalition, which is made up of parties and political movements that want to end the two-party dominance (Chile Vamos and Nueva Mayoria). The winner will inherit an economy that, in recent years, has failed to recover its way back to robust growth.

Consumer and business confidence have remained pessimistic since Michelle Bachelet took office in March 2014. The weak indicators can be partly explained by external factors; specifically, the downside trajectory of copper prices during the first years of the current mandate, reaching its lowest level in January in 2016.

Copper plays an integral role in Chile’s economy. Chile is the world’s largest copper producer with the red metal representing roughly 9.2% of Chile’s GDP and a quarter of fiscal revenues. Moreover, as in other Latin American countries, corruption scandals also arose during the latter years.

One of the most notorious cases concerned President Bachelet’s son and daughter-in-law, who were involved in case of "insider" and "influence peddling”, after a millionaire real estate deal made by company Caval – with 50% of the company’s shares owned by President Bachelet’s daughter-in-law.

The president’s reform agenda has also taken a toll on confidence indicators. During her first year of government, a tax reform to finance the overhaul of the education system, assuring free university education and other social projects, was approved.

However, the reform, which the government estimates will bring in about 3 p.p. of GDP by 2018, was highly criticised by companies, who argue that it increases the cost of doing business in Chile because it basically consists of raising corporate taxes and cutting exemptions.

In addition, the education system reform has also failed to meet the population’s expectations. Rightists were against the reform’s ban of profits, tuition fees and selective admissions in privately-owned primary and secondary schools which receive state subsidies. On the other hand, leftist university students argue that the government is failing to make good on its campaign promises. Such dissatisfaction has led to widespread protests in the country.

The government has actually been forced to dilute the reforms, as it lacks the resources needed to ensure free tertiary education for all. Last but not least, the labour reform which entered into effect on April 2017 strengthened the power of unions. The new rules were criticised by business leaders, as it will make it more difficult for companies to replace striking workers. Furthermore, as some of its aspects were weakened during discussion in Congress, the reform left regulatory gaps in the collective bargaining framework that can lead to industrial actions.

These events help to explain the worst start of the year since 2009. GDP rose by barely 0.5% y-o-y in the first half (H1) of 2017. The weak outcome was mainly driven by a 44-day strike in the world’s largest copper mine. Preliminary figures for the third quarter (Q3) reveal, however, that activity has strengthened. The central bank’s IMACEC (Proxy GDP) increased by 1.8% y-o-y in September, after a climb of 2.4% in August.

Overall, the indicator increased by 2.2% in Q3 2017 compared with the same quarter of the previous year (up from 0.9% in Q2 2017). Growth has been mainly supported by the rebound in mining production (+7.6% in Q3 2017 y-o-y, up from -3% in Q2 and -13.8% in Q1). Moreover, non-mining activity also rose to 1.7% y-o-y in Q3, up from 1.3% in Q2 2017. Although construction remains a drag to activity, commercial, manufacturing and services are in better shape: they benefited from the cut in policy rate (currently at 2.5% down from 3.5% in January 2017) and low inflation (1.9% in 12 months accumulated until October 2017).

Risks

A potential runoff on December 2017 is likely, as the 50% threshold is unlikely to be reached. Despite this, runoff polls indicate that Mr Piñera would defeat either of the main challengers: either the ex-president would beat Mr Guillier by 48% to 40% (12% undecided), or would beat Mr Sanchez with 50% to 37% (13% undecided). Regardless of who wins, Chile's economy seems poised to somewhat recover its growth rhythm.

Copper prices have improved in 2017 and are not likely to ease in the short term. Additionally, the country has worked on developing its electric capacity, attracting important investments in renewable energy (mainly in solar and wind). This should help boost activity in the coming years, and help assure lower energy costs for companies in the long term. The above points have contributed to the recent rebound in confidence indexes (although they remain pessimistic). Polls showing Mr. Piñera, the market candidate, leading the race have also influenced confidence.

If elected, he has pledged to create incentives for SMEs, to simplify the tax system, and to make adjustments to President Bachelet’s labour reform. Along with simplified tax rules, he says that the first-category tax-rate for companies would be reduced from 27% to the OECD average (24-25%).

Contrary to other recent presidential races in Latin America, there is no risk of an extremist candidate assuming the Chilean presidency. Even if – against all odds – Mr Piñera is not elected, the remaining frontrunners are not expected to implement drastic changes to current economic guidelines. Mr Guillier supports the maintenance of the outgoing reforms, and of an economy stimulation package at a cost of USD 9.75 billion. According to him, funds would mostly come from the consolidation of the tax structure designed by President Bachelet.