Chile's economy brightens amid political gloom

Michelle Bachelet, Chile's president, is enduring one of the darkest moments of her political career, and has recently been forced to deny rumours she was considering resigning.

The leftist leader's popularity dived to record lows after her son was accused of influence peddling, putting a break on her ambitious reform agenda. One small consolation for her party is that the rightwing opposition is also in crisis, mired in a corruption scandal.

Yet despite Chile's political turmoil, the prospects for the country's stuttering economy are brightening, revealing a possible way out for a region stuck in a downturn.

While most countries in Latin America are still struggling to adjust to the end of the boom in commodity prices that propelled growth in the resource-rich region over the past decade, there are signs that Chile's economy may be turning the corner.

"If Chile's recovery turns out to be sustainable, then there is light at the end of the tunnel for some of its neighbours who are just entering the adjustment, like Colombia," says Luis Arcentales, an economist at Morgan Stanley.

"Chile has undergone the bulk of the adjustment," Mr Arcentales says. He adds that after a period of weak domestic demand when business confidence was hit by Ms Bachelet's reforms, the economy is now improving, helped by a weak currency that has boosted exports and easing inflation that has spurred consumption.

After gross domestic product growth fell to 1.8 per cent in the fourth quarter of 2014, which saw Chile's slowest growth since the global financial crisis, well below an average of 4.2 per cent over the past decade, economists at Barclays expect 2.8 per cent growth this year, and potential growth of 3.5 per cent in the medium term.

Chile, the world's top copper exporter, was the first country in the region to be hit hard by the end of the so-called commodities "supercycle", because copper prices began to fall earlier than prices of other commodities like oil. So it makes sense that Chile's economy should also be the first to recover, says Mario Castro, an economist at Nomura.

But the health of Chile's economy, often regarded as the best run in the region, is also attributed to the strength of its institutions and its free trade model, untrammelled by the heavy-handed state interventionism that has distorted the economies of countries like Argentina and Venezuela.

"Chile is an example of how credible institutions can smooth the economic cycle and make adjustments less traumatic," said Mr Castro, pointing to its widely respected and independent central bank and a well-established "fiscal rule" that gave officials the freedom to implement counter-cyclical policies.

The resulting depreciation of the peso, as Chile adapts to lower potential growth rates after the commodity boom, has provided a boost for exporting industries outside the mining sector. Mr Castro expects this boost in competitiveness for "tradable" sectors such as Chile's successful wine and salmon industries to be permanent.

Nevertheless, if Chile's economy is indeed on the upswing, the benefits have yet to be felt either by the president or the average citizen.

"If you look at the newspapers here, the story is not about economic recovery, it's about political corruption," says Robert Funk, a political scientist at the University of Chile. In any case, he says that "Chileans have become used to a certain level of economic stability that other countries are jealous of", so Ms Bachelet will need more than good economic results to boost her wilting popularity.

Furthermore, Mr Funk says that there is still "a lot of nervousness" about the effect of the government's tax reform approved last year, which aims to collect an extra $3bn each year mainly from businesses, and pending labour market reforms expected to make trade unions more powerful. "We just don't know what will come out of this process. It may be very healthy, but it may also have unpredictable effects," he said.

Indeed, many local economists question the optimism held by Wall Street analysts. "There are signs of the green shoots of recovery, yes. But it could turn out to be a dead cat bounce," says Michele Labbe, chief economist at Econsult in Santiago, referring to market jargon for a temporary recovery in a declining stock. She worries that without enough spare capacity in the economy, expansive fiscal and monetary policies could end up fuelling only inflation, not growth as well.

Crucially, investment remains low because of uncertainty over the outcome of Ms Bachelet's reforms, which are aimed at reducing inequality. Until the reform process has been completed - and many fear that it is being stalled by the political crisis - businesses may continue to refrain from making serious investment commitments.

And even if Chile's economy is outperforming the rest of the region, for many Chileans that is not enough.

"We are always going to look good if we compare ourselves to the rest of Latin America, which always makes the same old mistakes," says Ms Labbe, who adds that Chile does not come off so well when comparing itself to the world's best-performing countries. "It's best to compare Chile with itself, and the truth is we could be doing a lot better."

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