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Top Four Economic Challenges In Chilean Economy.

Top Four Economic Challenges In Chilean Economy.

Posted by José Peralta on March 14, 2014

If we talk about dynamic and open to the world economy country, Chile is the reference in Latin America. Only in 2012 it attracted almost 30% of foreign direct investment in the continent (representing more than U$S 30 billion). In relation to its GDP, it’s the market with more reception and export of capitals in Latin America.  To achieve this economic success, the Andean country has kept a policy of extreme commercial openness to the point that nowadays it is the country in the world with most Free Trade Agreements signed.

Backed by this historic trajectory, Chile is well oriented in the economic path and there is no doubts that it projects itself as one of the 2014 Latin-American countries with most foreign investment and development. However, the recently elected center left government of Michelle Bachelet will have to be extremely focused and pay special attention to the several economic challenges that the country is having and most important: they will have to consider very carefully which actions to take if they pretend to maintain Chile as a top world class economy.

The biggest clouds in the Chilean economic horizon are:

Economic Slowdown: this might be the most complex issue for the new government. The Bachelet Administration elaborated it’s program on the base of an economy growing in rates of 5% or more. Today, local and foreign analysts situate Chile’s growth in 3.5% for this year and 4% for 2015. Also, the official perspectives of growth have been systematically reduced since last year’s semester.

When talking about competitiveness, the exchange rate has plummeted 22% since last May and the stock exchange index that concentrates the top 40 companies in the country has fell 40%. There is also an increase in the inflation rate although it’s between expected boundaries.

This change in the economic projection presents a not so prosperous perspective in the short term for Chile, something that may turn out in various measures of fiscal adjustment. Among businessmen  and economists there is special concern about this worrying context and the possibility of losing their attractiveness for investment.

Copper price. Chile is the first producer of copper in the world. The red metal is the vertebral spine of it’s economy, representing almost 50% of the exports and it has reached a stunning 20% of government gross tax collection.  In the government perspective, it was expected that the price of copper fluctuated around the U$S3.25 the pound.

However, the international price of copper are in free fall and actually they are under the U$S3 the pound, the lowest price for the metal since 2010. This decay summed to higher costs of production due to lack of energy investments and higher labor costs can force a mayor adjustment in the tax revenues perspectives.

This is a very concerning situation because a lot of economic sectors depend on the copper industry growth to better situate themselves in the international markets. It’s very common in these cases that a country uses it’s “strongest” product to land in a new market and then facilitate the way for other industries to get into that market. If this fall in price keeps on going, Chile will have to reorient much of it’s commercial strategy and in particular it’s dependence over the red metal.

Tax Reform. It can be a decisive factor in the future of investment in Chile. Bachelet Administration has as one of it’s principal goals a tax reform that allows them to collect at least 3 more points of the GDP. For that purpose, they will increase taxes to corporations from 20% to 25% and eliminate one of the key instrument of savings for these organizations: the Taxable Income Fund ledger a tool that allowed companies to deduce taxes from retained profits.

Also, they analyze to derogate a 1974 law that guarantees foreign corporations a legal and tax frame for their investment. This normative has had a vital incidence in the increase of foreign investment in the country.

There is little doubt that the government will go on and pass this reform. The impacts of this in the short term will be of economic contraction because the increase of taxes will discourage investment. How much? It’s hard to say. The key will be in how the government uses the resources generated by this reform in the middle and long term.

Trade union conflicts. This is a source of enormous preoccupation for Chilean businessmen. The recent port strike that went on for more than 20 days cornered various sectors, specially the fruit one. These situations affect both imports and exports messing up agreements and delivery dates that are strictly fixed by contract.

Although the Piñera Administration managed to reach an agreement with the port Union, the new government already announced that they will “analyze” the salary rise agreed. If the agreement falls the unions will go again on strike. A new paralysation can affect Chile’s international image severely. Specially if international markets and investors start to perceive that the Trade Union issue is a permanent one. 

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