Chile is one of Latin America’s great long-term success stories, with fiscal rectitude and the strong savings culture, fostered by its pension fund industry, often cited as the roots of its success. In recent years though, it has underperformed most emerging markets including Brazil; its currency has proven vulnerable, and the stock of private sector debt has mounted. However, the country is undergoing some profound changes under the leadership of newly elected president Michelle Bachelet.
The changes reflect the nearly universal desire in Latin America to deal with the long-term issues of low public investment in infrastructure, sub-par education, and lack of social mobility. While dealing with these issues could help Chile break free from its ‘stuck in the middle’ status, it seems that few companies are prepared for the changes this will entail, and far fewer still, are able or willing to embrace the president’s vision.
Chile’s economy is slowing down rapidly as the spectre of tax and regulatory reforms from the new, more populist, Bachelet government have spooked corporations, both big and small. Chilean companies pay little tax on corporate profits provided they invest in practically anything; be it foreign acquisitions, company cars, groceries for employees or new plants — eventually it all counts as capital investment. This has led to widespread abuse and severe distortions in the economy, and a severe shortfall in tax revenue for the government. Reform means Chile could grow as little as 2.5% in 2014, which is well below its historic growth rate of 5‑6%. We feel this is a very similar situation to the impact that tax changes have had in Mexico but with perhaps more intense social repercussions.
The slowing economy should drive Chile’s interest rates lower; the central bank cut the policy rate from 4.5% to 4.0% in the first quarter. However, the differential in policy rates between Chile and Brazil has contributed to the peso’s 7.0% underperformance versus the Brazilian real in the last 12 months. Chile’s currency could be vulnerable as more rate cuts look likely in 2014.
Many companies are experiencing headwinds from areas as diverse as environmental protection, data protection, insurance/financial sales practices, and labour relations. Chile’s traditionally pro-business regulatory bodies are being transformed rapidly into much more progressive, proactive bodies. There is an unreal sense of denial amongst Chilean executives.
Meanwhile commodity markets are not particularly helpful for Chile. According to Deutsche Bank, the demand‑led commodity markets of 2002-08 have given way to the supply‑led markets of today. Only where supply is likely to be disrupted — as in the cases of nickel, coffee or platinum — is there likely to be much strength. Producers have excess capacity otherwise to provide rapid supply responses. Chile’s key commodity exports, copper and pulp, have been trendless but it is worth noting that Chile’s producers are generally right at the bottom of the cost curve.
To summarise, the new Bachelet government intends to use higher corporate taxation, stronger environmental protection, vigilance in consumer protection, and vastly higher spending on secondary and higher education to rebalance Chile’s unequal society. Few Chilean companies will see any immediate benefits — it will be particularly important to figure out which companies are getting ‘on side’. For example our research indicates that in Brazil companies such as Cielo and Smiles help the tax authorities with data collection, while Kroton is a beneficiary of big spending on education.
Opinion column by Chris Palmer, Director of Global Emerging Markets at Henderson Global Investors