It’s been a tough year so far for Chile. A sharp economic slowdown following last year’s rebound from the pandemic provided the backdrop for the popular rejection of a new constitution – a key electoral pledge of the new leftist administration of President Gabriel Boric. In a wide-ranging interview in New York, Chile’s finance minister, Mario Marcel, reflects on the policy implications of the referendum, the fiscal imperative following what he sees as years of slippage and the country’s international financial position. 

LatinFinance: What are the main implications of the outcome of the referendum on a new constitution? What are the implications for the administration and its priorities, and specifically how has your agenda changed since the result?

Mario Marcel: The referendum delivered very clear results whereby the people decided that they did not like enough the draft of the proposal of a new constitution that was drafted by the constitutional body. From the different opinions, and also especially because this was an election with a huge turnout – much larger than anything in the recent past because of the compulsory voting, the message we are getting is that people did not feel safe enough in terms of how change would be driven by the new constitution.

Given that most people are still supportive of a reform process, they are still in favor of a change to the text, but they would prefer a safer and more predictable change than the previous text proposed. This is a message that all political sectors are getting. The political right, which was against the text, acknowledges that the constitutional process must go on and must deliver a new proposal. And on the side of the government, or the parties that support the government, there is a general sense that the constitution appeared threatening to some people and that it created some uncertainties that after three years, after social unrest, after the COVID-19 crisis, after all the global uncertainty, people don’t want. People don’t want any more uncertainty. They want a road that looks much safer.

Image: Mario Marcel

“People don’t want any more uncertainty. They want a road that looks much safer.” 

LF: Nevertheless, the process of constitutional reform is ongoing and that process itself entails uncertainty, so if anything, that uncertainty has been prolonged. What does that mean for your policy priorities, especially given the significant deterioration in the macroeconomic picture this year?

MM: What that means to us at the Ministry of Finance is that we should keep working on reducing uncertainty in the economy. Fortunately, in my view we are very close to a turnaround in the evolution of inflation. The economy is cooling down and will continue doing so until the end of the year at least, but at the same time, given that the general drive is towards a more moderate constitution and given the steps we are taking to incorporate different views into the tax reform and into pension reform, I believe we would be able to support this drive towards a more certain future.

LF: What specific assurances can you provide when it comes to comes to such certainty in the domain of economic policy?

MM: What is closer to us at the Ministry of Finance is the management of fiscal policy. This year we will deliver the fastest fiscal consolidation among a large number of countries. I haven’t yet found any other country that is consolidating at the scale that we are. This year we will be moving from a headline deficit of close to 8% in 2021 towards a slight surplus in 2022 with a 24% drop in real spending and also an improvement in tax revenues. This does not end in 2022. We have drafted the path of fiscal consolidation in the years ahead which, with the figures for 2022 and with that path combined, will [allow us to] reach a ceiling of debt to GDP of 42% rather than the 45% we had originally set for ourselves. In terms of the management of fiscal policy, there is a very clear commitment towards responsible fiscal policy and to making fiscal policy contribute towards economic stabilization in the country and to partner with the central bank to bring inflation down.

LF: Is this commitment to fiscal sustainability well accepted and understood by investors today? What concerns are raised in this regard?

MM: First of all, you should be aware that there were many years when Chile did not deliver on its fiscal targets. Fiscal policy was very disciplined until 2007 right before the global financial crisis. Then, of course, there was a de facto escape of fiscal policy because of the crisis and in order to support the recovery of the economy. Over the next years, governments were either not specific enough in terms of their fiscal targets or they didn’t actually meet them.

So, for me, having been involved in the original design of the structural balance policy, the central issue is not so much what we say but what we deliver. This year will be crucial in that respect. Of course, investors fear that there may be mounting pressures, or political pressures, to spend more, but I think that the main demonstration that we are serious about this is that this year, despite facing this key constitutional referendum, we kept our fiscal policy orderly.

This didn’t mean that we didn’t take measures to compensate people or to support the people who were suffering the most or that we were not supportive of sectors that were at the risk of lagging behind the recovery. We have done many things. But we have done them in the context of the very disciplined and organized fiscal policy. We are about to submit the budget for 2023. That will be very much on the same lines.

LF: There’s an obvious trade-off between getting inflation under control and maintaining a healthy rate of expansion of the economy. How do you see that balance playing out for this year in terms of GDP growth?

MM: A very important element will be to rebalance private consumption and investment. So far, investment is adjusting faster than private consumption, despite the fact that the overheating of the economy last year was basically due to the huge boost to private consumption from government transfers and the pension reforms. So, looking ahead towards 2023, we are articulating a number of measures to foster investment, both private and public. We announced a package of measures that included a number of tax incentives to investment. We are creating a fund of tax credits for investments with a larger multiplier effect.

LF: This is the so-called Invest in Chile package that you announced recently?

MM: Yes. And we are combining those tax measures with some administrative measures to speed up approvals – the environmental, regulatory and municipal approvals of projects. In the budget for 2023, we will have a new increase in public investment. We will resolve a number of issues that have emerged because of inflation, which has created some problems for public investment. We will establish the number of working parties with the private sector to monitor areas where investment will be very crucial. So that is part of this agenda and what we expect from there is for investment to be 5% above where it would have been if things remained the same.

LF: What impact will this increased investment have on the growth rate in 2023?

MM: For 2023 that explains part of the difference between the midpoint that the central bank has in its forecast of GDP – the midpoint is -1% – and the figure we will release with the budget that will be something close to -0.5% of GDP for 2023

LF: And for 2022, how have your how have your expectations for GDP growth changed?

MM: This year we should grow by some 2%. But what is important to note is that the trajectory of GDP throughout 2022 will be going down gradually quarter on quarter. It should stabilize by the first quarter of 2023 and then start to recover. But when you take the averages, when you average out, 2022 looks higher because it started from a very high point and 2023 will look lower because it will start from a lower point.

LF: What are your expectations for the exchange rate following the significant depreciation of the peso over the past year?

MM: The exchange rate throughout 2022 was very sensitive to local developments, but in the last few months, of course, it has responded to global trends like every other currency. With the intervention of the central bank in July, I think that the market has calmed down. The exchange rate is now responding much more clearly to its fundamentals, but it still has a gap of some 12% or so compared to the fundamentals prior to the social unrest in 2019. So, I think that reflects the uncertainty that’s still in the air and that gap will probably shrink more clearly once the constitutional process is complete.

It will take us a little longer, but I think that things are moving in the in the right direction. We have a very productive agenda not just in terms of investment, but we will also be launching in a few weeks a strategy on productivity. We are also making progress on strengthening the domestic capital markets.

LF: What can you tell us about the moves to strengthen the domestic capital market following the disruption caused by the pension withdrawals?

MM: We have an agenda that has been developing that includes further efforts to internationalize the Chilean peso, to modernize the FX market. We have a fintech law that should be approved in the coming weeks. We have just submitted legislation to strengthen the resilience of our financial infrastructures by broadening the scope of services like the central bank.

Of course, the most important part of this would be pension reform. What is clear is that the proposal from the government will have four pillars. One will be a universal basic pension, financed by taxes. Then an individual capitalization pillar, similar to the current one but with some changes in the industrial organization of the sector. But we continue being an individual capitalization system, investing in the capital market. Then we will have a social security component that will help to address some of the inequalities that emerge from individual capitalization. But in order to be to be sustainable over time, that social security component will need to build reserves as well, and those reserves will be invested in the capital market. Then in the individual capitalization system we will add a number of incentives to contribute throughout working life, either reducing or increasing the contribution density.

All of that should allow us to rebuild within seven to 10 years what was lost in the assets of the pension system because of the pension withdrawals. So, it looks long but without this it would take considerably longer. So, capitalization and investing in the capital markets will be part of all these different components in the case of the basic pension because it would be funded by taxation, not by indebtedness – in the case of individual capitalization, because of investing the savings of workers, and in the case of the social security component, because of the accumulation of reserves.

LF: What are some of the implications of these reforms in terms of Chile’s approach to capital raising at the sovereign level? And what does it mean in terms of the balance of domestic versus international funding for the sovereign?

MM: Given that in 2022 our fiscal results have been better than expected, and given the path that is drawn ahead, our funding needs [in 2023] will be smaller. But of course, we need to keep refinancing expiring debt. But the clearest comparison is between a debt-to-GDP ratio by 2026 of 42% versus 45%. That makes a large difference. We estimate that as a result of this alone, we will be able to save $1.2 billion per year in interest payments. And we will continue issuing especially in the local market. Last year, and partly this year, we shifted a little towards foreign debt because the local capital market, because of the pension withdrawals, was very slow. But as it has recovered, we will continue to issue in the local market so as to achieve more or less the 20%:80% (local vs. international debt) ratio that we had before.

“We will continue to issue in the local market so as to achieve more or less the 20%:80% (local vs. international debt) ratio that we had before.” 

LF: What are the sovereign’s actual funding needs for 2023?

MM: It should be similar to, or probably a little smaller than, in 2022. We will also have the authority to rebalance and repay some debt in order to achieve this foreign to local debt benchmark.

LF: How relevant is the Moody’s downgrade to your financing plans on the one hand, and to investor perception of sovereign risk more generally?

MM: Moody’s was very clear that they’re basically responding to the deterioration of fiscal accounts during the 2020 to 2021 period. Those were two years with a fiscal deficit close to 8% of GDP each year that involved an increase in public debt. Now, when they refer to the current fiscal policy, they say that it is clearly going in the right direction. They maintain their stable outlook on that basis. So, I think that this downgrade is more the inheritance from the recent past and it’s the last in round of downgrades that both Fitch and Standard & Poor’s already undertook. I think that from this point on, things should stabilize and look increasingly better.

LF: When would you expect an upward revision of the ratings? What’s reasonable to expect?

MM: I think it’s reasonable that the rating agencies will want to see how things will evolve. They will not judge on the basis of one single year. They will probably want to see what happens to tax reform and the pension reform because they’re important in terms of their impact on fiscal policy and the capital markets. One has to be realistic. Rating agencies don’t change their assessments overnight. They prefer to take a look at what’s going on and usually markets move faster than the ratings agencies themselves.

We have already seen some stabilization in Chile’s financial indicators. For instance, long-term interest rates have remained pretty stable during the course of this year. The 10-year bond rate has remained very close to 6.5% throughout the year after jumping last year. Similarly, the exchange rate. So, I think that we will start to see some improvement there prior to what may happen with the rating agencies.

LF: To what extent has this latest reading agency move complicated your efforts, especially on the international funding realm?

MM: We do not foresee any major problems in funding partly because of the fact that the markets were already reflecting risk, and the evolution of risk, to the Chilean economy over the last few months. But of course, risk indicators and risk assessments are very important for us.

We live in a world where you cannot take anything for granted and you have to fight to bring more certainty into the economy, both for investors and for the people themselves.

“We live in a world where you cannot take anything for granted and you have to fight to bring more certainty into the economy, both for investors and for the people themselves.” 

Mario Marcel

LF: The global financial picture is strewn with risks the likes of which we have not seen in decades. What do you see for Chile as being the principal risk specifically of sharply tighter global financial conditions, and how might this have an impact on your outlook for the year ahead?

MM: What has been particularly damaging over the last year or so are all the headwinds with inflation because there were many forces that were combining all in the same direction of pushing inflation up. That then triggers central bank responses and so on. We are starting to see that things are beginning to stabilize a little bit in the US, although Europe will probably be more complicated in the next few quarters. But perhaps in the US, we will start to see an improvement. Usually in the US, recessions don’t last very long, and I think that that may be the case this time again.

LF: Do you expect the US economy to enter a recession this year?

MM: If inflation keeps stabilizing in the US and the effect of Fed policy goes through the economy, I think that the US may start recovering much faster than expected.

LF: But in terms of the impact of the global financial picture on Chile’s economy, you see the headwinds from inflation moderating by the end of this year and then next year what is your expectation?

MM: For an economy like Chile’s, an economy that is small and open, it is true that usually Chile looks vulnerable to global pressures. But when you look at our track record, you realize that we have a number of shock absorbers that are very helpful in facing these headwinds.

What is perhaps the most damaging is when we have been a dramatic deterioration in terms of trade. What we’re seeing now is that the jump in oil prices was the product of the geopolitical phenomenon. Cooper has remained pretty resilient given the state of the economy. This suggests that because of the structural change towards a greener economy, the price of copper may be more resilient than it was in the past. So, I think that these [facts] send some positive signals to the Chilean economy.

At this point we should concentrate on completing our domestic stabilization. The global environment, with the shock absorbers we have, is something that we can navigate through. But we have to do our own homework in a very committed way because time is of the essence in this process.

LF: How concerned are you that the Fed tightens much more aggressively and that has serious repercussions on capital flows to Chile?

MM: The Fed has shown that it’s prepared to act in a very decisive way. It looks like this is already having some impact on inflation and it should continue to do so. But perhaps more of a concern to us is how China is going to exit its zero-COVID policy. This has slowed down the Chinese economy in a way that we have not seen in many decades, and China is our main trade partner so what happens there is important. Financial conditions may be important, but we’re not so indebted as to be as concerned about that. Foreign trade is important to us, especially now that we have a rather large current account deficit and that has a lot to do with China, and, of course, domestic demand as well. They dynamics of exports vis-à-vis imports will be very important in narrowing the current account deficit in Chile

LF: What are your expectations with respect to China exiting from its zero-COVID policy – and, more fundamentally, the outlook for global trade as a consequence of China’s actions?

MM: It’s very difficult to guess China. But I’m afraid we are considering that we are already entering a time when most countries are declaring the end of the pandemic or of their own epidemics. I think that at some point China probably will declare victory over COVID and will move to something different. It will sound rather odd that the rest of the world starts normalizing and China remains with this zero-COVID policy.

LF: Does that mean to say that things can only improve in terms of the global trade picture?

MM: Things should improve and perhaps they could improve for us a little. Because of the crisis in Ukraine, Europe is accelerating its drive towards a greener economy and Chile is a supplier of copper and lithium. We are fast changing our energy matrix towards renewable sources of energy, possibly producing a green hydrogen in less than a decade. So, in the longer run the greener economy would be a benefit to Chile. In the short run, it will foster more investment in mining and energy in our country. This process is accelerating because of this “oil crisis” which the world faces and which, for Europe at least, is still continuing.

LF: Chile has been a trailblazer in terms of its green and ESG strategy and focus. What can we expect going forward from this administration specifically in terms of financial instruments or innovations that that could further accelerate this agenda?

MM: First of all, we are recirculating proceeds, revenue from the lithium industry towards green energy and particularly towards the green hydrogen industry. So, being an economy with a rather narrow productive base, we will be able to build on that and the government will be very strongly involved in that.

As the Ministry of Finance, we are finalizing a taxonomy on green investments in order to provide a stronger basis and a benchmark for the issuance of green bonds or sustainability-linked bonds in the future. As a government, we have already issued green bonds and sustainable bonds. The private sector is also doing that. But by building this taxonomy we will provide further reassurance for investors that green investments are for real and not greenwashing.

LF: And when can we expect more detail on this new green taxonomy?

MM: This work should be finished by the end of this year, so we should have some substantial news on that soon.

LF: Thank you.