Via Financial Times

There may be fewer protesters on the streets of Santiago this month, but the economic and political impact of the anti-government demonstrations that have engulfed Chile since October could deepen ahead of a vote on constitutional reform.

The Chilean peso has fluctuated wildly since the protests erupted — since the start of the year it has once again become one of the worst-performing emerging market currencies. Growth has been badly hit, with gross domestic product figures revealing that in October the economy suffered its worst monthly performance since the 2009 global financial crisis, worse even than in the aftermath of the devastating earthquake the following year.

Analysts expect further volatility ahead of April’s constitutional referendum that investors fear could lead to permanently higher spending and threaten the neoliberal “Chilean model” that powered four decades of economic growth. 

“The risk is that demonstrations could intensify ahead of [the vote on constitutional reform in] April as economic activity and employment suffers,” said Maria Luisa Puig, an analyst at Eurasia Group, a risk consultancy, who points out that the protests began when the economy was picking up in the third quarter of 2019. 

There are concerns that the economy will fall into a technical recession if its poor performance continues into 2020, she said. “So far the employment rate has remained resilient but this may well change.”

A $5.5bn stimulus package announced last year attempted to appease voters and mitigate the economic fallout from the protests by rebuilding public infrastructure, accelerating pension payments, and supporting small and medium-sized businesses through credit lines and tax breaks. The package came after previously announced increases in social benefits, including a rise in basic pensions and the minimum wage. 

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Such reforms initially helped the centre-right president Sebastián Piñera’s approval ratings edge up after hitting a historic low of 10 per cent in late November, but they have since slipped back again. 

Chile’s fiscal deficit will be hit by the higher spending, as well as lower growth, which fell by more than 3 per cent from the previous year in October and November, although economists caution that those figures only capture part of the impact of the social unrest. 

The government will raise spending by about 10 per cent this year in a bid to meet social demands. It expects continued higher spending to push public debt to almost 40 per cent of GDP within five years from less than 30 per cent now, and has revised its medium-term deficit target of 1 per cent by 2022 up to 2 per cent. 

Although Chile’s balance sheet is strong compared with its peers, and the government insists that higher deficits are temporary, some spending increases — such as higher pensions — are only partially offset by tax rises, according to analysts at Fitch Ratings. 

Ana Madeira, an economist at Bank of America Merrill Lynch, points out that Chile’s small, open and flexible economy tends to recover quickly from crises, which are usually triggered externally.

“This time, the source of the shock was domestic and risks changing the economic model via a new constitution, suggesting a slower recovery and prolonged subdued growth for the next couple of years,” she wrote in a recent research note, worrying that a reduction in working hours and a higher minimum wage could lead to higher labour costs and lower productivity. 

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The protracted unrest and its escalation into a full-blown political and economic crisis prompted Bank of America Merrill Lynch to lower its GDP growth forecasts to 1.4 per cent for 2019, down from 2.3 per cent. The bank expects growth to decelerate further in 2020, to 1.3 per cent, having previously expected growth of 2.7 per cent for next year. 

Some analysts think the economy is resilient. “Many Chilean investors are misinterpreting what is going on. Foreign investors are doing a better job at keeping things in perspective,” said Eduardo Engel, a Chilean economist, who “very much doubts” there will be a recession in 2020.

Much hangs on a new constitution, even if few expect it to be radically different from the existing version. 

That is because two-thirds majorities will be required for new laws, while polls suggest that most Chileans do not want the country’s economic model to be overhauled entirely, but simply for the country to be fairer and more equal.

More optimistic analysts argue that the pillars of Chile’s economic success — such as central bank independence, light regulation and fiscal prudence — are unlikely to be touched in any constitutional change.