A timid economic recovery
2023 ended with a slight decrease in GDP. The depreciation of the peso and the increase in oil prices in the second half of the year slowed down the disinflationary process, leading to a tightening of monetary policy (Central Bank of Chile's key interest rate still at 9% in October 2023) and a reduction of domestic demand. Unless there are setbacks in the Chinese economy (Chile’s main partner), a stronger impact of El Niño that could affecting agricultural (9% of exports in 2022) and mining (57%) production, or worsening geopolitical tensions, economic activity is expected to return to a slightly positive trajectory in 2024. The decrease in inflation should positively impact real wages and household purchasing power. However, investment growth will be anemic by Chilean standards, showing an annual increase of only 2.5% in 2024. The trend towards decline was already evident in 2023 due to stricter mining regulations (introduction of environmental criteria) and an increase in copper production costs (from 1.59 USD/lb in 2022 to 1.98 USD/lb in the first half of 2023). The implementation of reforms on lithium and copper in 2024 will further contribute to the national loss of attractiveness compared to Peruvian and Canadian competitors. Concerning copper, taxes for major producers (that generate more than 50,000 tonnes of copper per year) will be increased. The tax will consist of a fixed part (annual tax of 1% on sales) and a variable part (between 8 and 26% depending on profits). For the gray metal, the government will compel producers to surrender 51% of their operations to the State. Additionally, in the event of the rejection of the new constitutional proposal in December 2023, uncertainty about government policies (tax reform, retirement) may linger into 2024, further undermining investor confidence. Nevertheless, the mining sector will continue to support economic activity.
Foreign exchange reserves were tapped into, but benign twin deficits persisted
The current account deficit significantly narrowed in 2023. The increase in the trade surplus resulted more from a sharper decline in imports, due to weak domestic demand, than from exports, which faced the slump in copper and lithium prices. Following the same trend, the services deficit lightened, aided by the decrease in maritime and air freight costs, along with a rebound in tourism activity. Additionally, the primary income deficit slightly diminished. The economic slowdown effectively contributed to the reduction in profits repatriated by foreign companies. While net FDI inflows for the first three quarters of 2023 significantly exceeded the current account deficit for the period, the implementation of mining reforms may weaken these flows in 2024. Chilean pension fund investments abroad are more or less offset by foreign portfolio investments in Chile. The central bank’s foreign exchange reserves weakened after it had to use 24% of them to defend the peso in 2022. To address this weakness, the Central Bank of Chile (BCCh) adopted a 10-billion-dollar accumulation programme over 12 months in June 2023. However, the widening interest rate differential with the Fed forced a temporary suspension in October 2023, as pressure mounted for peso depreciation. Despite the IMF granting a 2-year flexible credit line of 18.5 billion dollars in August 2022, the foreign exchange reserves barely covered the 5 months of imports recommended by the IMF in October 2023. Moreover, the Chilean net external position accounted for 18% of GDP in September 2023. As for the country's external debt (76% of GDP at the end of September 2023), it would continue its downward trend in 2024, only for the private sector. 68% of the external debt is owed by the private sector and represents 22% in FDI.
On the budgetary front, the public account returned to a slight deficit in 2023, reverting to its pre-Covid level. Declining mining revenues and tax exemptions aimed at boosting investment and private consumption pulled down public revenues, while expenditures increased, impacted by the recession. However, for 2024, the public deficit is expected to narrow, driven by the collection of new mining taxes (0.45% of GDP when fully implemented). Finally, gross public debt will continue its upward trend in 2024. Its domestic portion (66% of the total, central government only) is equally denominated in pesos and UF (unidad de fomento, a peso indexed to inflation), while its external portion is in dollars (68%) and euros (30%). 98% of the total public debt is held % by private creditors.
A weak political base hindering government reforms
The popularity of President Gabriel Boric from the left-wing Apruebo Dignidad party and his government weakened in 2023. Despite some initial success with the population, such as an increase in the minimum wage, a reduction in the maximum weekly working hours to 40, and mining royalties, the government has faced major political and legislative setbacks since September 2022. The rejection of the initial constitutional proposal and the tax reform, deemed too left-leaning by a majority of the Chilean electorate and center-left parties in Congress, has led to ongoing challenges. These challenges are likely to continue into 2024, given the controversial nature of Boric's political agenda. The government has negotiated with the opposition to revise its tax proposal, which was rejected in March 2023. The updated fiscal pact would include measures from the previous reform, while omitting the most contentious points, such as the wealth tax and undistributed profits. The pension reform is also scaled back, with the reduction of private pension funds (AFP) to a simple mutual fund facing direct competition with the state-managed alternative and being replaced by a new public agency called the Administrador Provisional Autonomo. This revision may not garner majority support. However, the extension of coverage for the Pension Garantizada Universal (PGU), aimed at supporting low-income retirees, has a good chance of being adopted. The fate of these reforms is tied to the constitutional reform, subject to a referendum in December 2023, which could again be postponed, this time viewed as too conservative by voters. While the 2019 uprisings demanded progressive changes, the constitutional drafting council, responsible for the second proposal, was mostly dominated by opposition parties (66% of seats held by the right, including 44% by the far-right Partido Republicano). In this scenario, the fragmentation of the Chilean political landscape would make it difficult to implement Boric's reforms until the new general elections in 2025.
On the foreign front, Chile intends to strengthen ties with the EU and maintain relations with the United States. Boric's environmental and progressive agenda aligns with the European focus on promoting investments and trade relations with democratic countries. Chile's abundant reserves of lithium and copper and its renewable resources, conducive to green hydrogen, are particularly attractive within the framework of the European Green Deal. In December 2023, both parties decided to update their Free Trade Agreement (FTA) to include environmental clauses and encourage the EU to invest more in Chilean renewable energies. The agreement is expected to be ratified by the end of 2023, provided there is no opposition from the European agricultural sector. Chile will also uphold its FTA with the United States, ensuring its alignment with the Inflation Reduction Act (IRA) through tax credits for electric vehicle manufacturers and metal producers (copper, lithium)