A mild economic recession in 2023
GDP figures for Q1 2023 confirmed weak economic momentum this year. Activity dropped by 0.6% year-on-year (from -2.3% in Q4 2022) and rose by 0.8% quarter-on-quarter (from +0.2% in Q4 2022). Albeit the marginal expansion, the breakdown reveals a weak composition. Growth was fuelled by the external sector and was predominantly based on the softening of imports (-4.6% QOQ), while exports observed only a slight expansion (+ 0.5% QOQ). In contrast, domestic demand shrank for the fifth consecutive quarter (-1.5% QOQ) as household consumption (-2.5% QOQ) continues to normalise compared with the high levels reached in mid-2022. Investments also contracted in the period (-0.9% QOQ). In the next quarters, household consumption will continue to drag on activity, affected by the dry-up of excess liquidity relating to the withdrawal of pension savings, a weaker job market, durably and historically high inflation (albeit decelerating to some extent) and by tight credit conditions. While the central bank is likely to start cutting its policy rate (which stood at 11.25% per annum in early July 2023) in Q3 2023, the downward trend should be gradual.
In addition, tight credit conditions also tend to affect gross fixed investment (24% of GDP) and are influenced by investors that are somewhat cautious regarding the prolonged overhaul of the Constitution. Moreover, the recent approved mining royalty bill and the government’s April 2023 decision to limit future lithium contracts to public-private partnerships with state control could also somewhat undermine future investments. Conversely, exports are expected to bring a mild positive contribution, driven by relatively higher growth in China (the main destination of foreign sales) as the economy reopens after the Covid-19 lockdowns. Nonetheless, the Chinese trend has been led by the services activity, while demand for metal commodities has proved lacklustre (copper and lithium international prices YOY were on average lower in H1 2023, representing a downside risk for Chilean exports). Mining accounted for 57% of total foreign sales in 2022, with the red metal on its own representing 45% and lithium 8%.
External shortfall to strongly narrow and fiscal account to switch back to deficit
The large current account deficit registered in 2022 will improve significantly this year. Figures for Q1 2023 confirm that this movement is on track and is led by the widening of the trade balance surplus. The latter is underpinned by sliding imports amid softer domestic demand and relatively lower average oil prices, while exports continue to expand. In addition, the services deficit is decreasing as freight costs undergo a sharp correction and tourism pursues its recovery. Last, lower local economic momentum should also help curb the primary income deficit to some extent, thereby reducing foreign firms’ profit repatriation (albeit still high during the first quarter of the year). On the financing side, FDI could also weaken due to recent policy developments affecting the mining industry and the higher financing cost, but should be able to cover the lion’s share of the external shortfall. Furthermore, more volatile portfolio investment net inflows should fill the remaining gap, along with public, non-financial enterprise, and bank debt issuance. Importantly, after using 24% of its foreign exchange reserves in 2022 amid a wide external account deficit and higher political uncertainty at that moment, the central bank announced in June 2023 a one-year program to rebuild its buffers by USD 10 billion. As at June 2023, reserves stood at USD 39.6 billion (covering roughly 5 months of imports). In addition, in August 2022, the IMF executive board approved a two-year flexible credit line of USD 18.5 billion for Chile. Furthermore, the country’s negative net international investment position stood at roughly -16% of GDP in Q1 2021, mainly smoothed by the existence of relevant pension fund investments abroad (estimated at 23% of GDP). External debt stood at 68.7% of GDP in Q1 2023, 68% of which was owed by the private sector.
On the fiscal side, after a strong consolidation in 2022 in the aftermath of the phase-out of Covid-related stimuli, the budgetary deficit reappeared in 2023. The situation is underpinned by the economic slowdown and lower average mineral commodity prices, which have prompted a drop in tax collection, and higher financing costs. In addition, expenditure has also risen owing to higher pension payments and capital expenditures. After years of debate in Congress, a new mining royalty bill was finally approved in May 2023 that is expected to collect annually roughly 0.45% of GDP when fully phased in. In closer detail, the top tax rate will reach 46.5% for companies that produce over 80 thousand tonnes of fine copper a year. Additionally, a 1% ad valorem rate will also be applied for large copper producers.
Weak political base blocks government reforms
The popularity of President Gabriel Boric from the left-wing Apruebo Dignidad coalition weakened from 50% in March 2022 (when he took office) to 33% in June 2023. This can be attributed to more sluggish economic momentum in Chile and to pardons granted in December 2022 to some activists arrested during widespread social protests in Q4 2019 on charges such as robbery and looting. Moreover, the ruling coalition holds only 64 out of 155 seats in the fragmented Lower House and 18 out 50 of seats in the Senate. As a result, the incumbent party has struggled to pass reforms. These include a tax reform which the Lower House watered down in March 2023. The bill aimed at raising social spending through increased taxation of higher incomes and curbing tax exemption and evasion. In early June 2023, President Boric announced he would insist on the reform and push it through the Senate where it would need a two-thirds majority to pass. Meanwhile, a pension reform presented in November 2022, which would maintain the status quo on individual contributions and gradually increase employer contributions until they reach 6%, is being stalled in the Lower House.
In addition, in January 2023, Congress reached an agreement for a new constitutional process to rewrite the Constitution, this time considering a Council made up of 50 elected delegates (from 155 in the previous failed process) and 24 experts (in contrast to none previously). It also included 12 principles that must be respected in a new draft of the bill. Experts first drafted the new Magna Carta before the delegates’ election, which took place in May 2023. Importantly, the Council ballot led to right-of-centre parties winning a qualifying majority, diverging from a progressive majority that drafted the first text. Overall, this second constitutional process should lead to moderate changes in Chile's business-friendly environment. The national referendum with mandatory voting to approve or reject the new bill will take place on 17 December 2023.