Chile: What’s behind the only economy to fall in Latin America by 2023

All projections point to the Chilean economy falling by 2023. Estimates from the International Monetary Fund (IMF), the World Bank, and the Economic Commission for Latin America and the Caribbean (ECLAC) agree that the country will have the worst performance in the region next year.

It is not an isolated assumption; the Central Bank of Chile and the Ministry of Finance have already diagnosed a tough scenario for the coming months. The reason for the contraction is mainly related to the behavior of the Chilean economy in the last two years.

After the strong mobilization restrictions due to the Covid-19 pandemic, the country recovered faster than other Latin American nations – its Gross Domestic Product (GDP) expanded by 11.7% in 2021.

Economist Felipe Hernandez of Bloomberg Economics says that much of the difference in growth for 2023 is due to a correction after the Chilean economy grew more than others in Latin America.

“That explains why, in relative terms, Chile will be worse off next year than the rest of the region, and it’s because, in the last two years, it was better off than the rest.” It is an adjustment.

“Everything that goes up has to fall normally. That applies in the case of Chile, which after two years of growth much higher than the rest of the region will have a lower growth compared to its peers in Latin America.”

EXCESSES OF AN ECONOMY

What is behind the coming downturn and slowdown? Hernandez points to two major factors that would explain this:

1) AGRESSIVE MONETARY POLICY

The central bank began a cycle of adjustments in July 2021, which concluded with an increase of 50 basis points in the benchmark interest rate, to set it at 11.25% a few days ago.

With these increases, it tried to control inflation which, in September, recorded a year-on-year increase of 13.7%, easing for the first time since February 2021.

However, the collateral effect is a decline in economic growth.

2) TIGHTENING OF FISCAL POLICY

During the years following the harsh confinements, there was a “quite aggressive monetary, fiscal expansion in Chile”, says the economist.

Thus, there was a correction after very expansive fiscal and monetary policies that responded to a complex situation and, according to different analysts, were not sustainable in the long term. “That correction was expected.”

One only needs to take a look back. In 2020, Chile responded to the pandemic with a monetary policy rate of 0.5%, one of the lowest in Latin America. That same year its fiscal deficit reached -7.14% of GDP.

The very expansive fiscal policy lasted almost two years, unlike other countries, such as Brazil, where it lasted only one year.

A determining factor that explains this gap with other nations is the economic boost given, mainly by domestic demand and consumption derived from three rounds of pension fund withdrawals between 2020 and 2021 and state subsidies such as the Emergency Family Income (IFE).

“Hernandez explains that this implied an injection of significant resources for a concise period and was a measure with purely transitory effects,” Hernandez explains.

But the impulse of those withdrawals to consumption and domestic demand, to growth in general, are disappearing.

That also explains the fall in economic activity and why it will have the worst performance in Latin America in 2023.

“That helped Chile recover, but as that is lost, it also explains why the country is falling more than others.”

President Gabriel Boric’s government estimates that public spending will grow by 4.2% next year, leaving behind the 24.1% drop projected for 2022.

With information from Bloomberg

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