Photographer: Oliver Bunic/Bloomberg

Copper King's Era of Largess Imperiled as Budget Gap Widens

Chile is tightening its belt after at least 26 years of spending growth

By next year Chile's government may be forced into a policy that hasn't been seen in the South American nation for more than a generation — penny pinching to the point of austerity.

While the government has already cut spending plans for this year after raising taxes in 2014 to bring in more cash, Chile is still struggling to overcome a slump in the price of copper. The metal, its biggest export, dropped to a seven-year low this year as global demand waned. Meanwhile, President Michelle Bachelet's administration has promised free univeristy education for all and construction of dozens of new hospitals. 

With elections coming up in late 2017 and the economy currently in its third year of sluggish growth, Finance Minister Rodrigo Valdes has an uphill battle to contain budget demands. Any decline in government spending would be a first in at least 26 years for Chile.

"If we continue with this trend, believe me, we will be in trouble sooner rather than later," Valdes told lawmakers on Monday. 

Chile has a simple fiscal rule — the budget should balance if copper prices hit the government's medium-term forecast and the economy grows in line with trend.  But it hasn'et met that goal for the past nine years.

Now, Valdes is pledging to narrow the so-called structural shortfall by a quarter-point of GDP every year to get it to balance by about 2020.

The problem is, things aren't going in that direction at the moment. The gap between fiscal revenue and spending is widening, if one-time income from a levy on savings brought back from abroad is excluded. The drop in copper prices is undermining receipts, even after Congress approved tax increases two years ago that will raise fiscal revenue by 3 percentage points of gross domestic product by 2017.

"The room for real spending growth next year is very limited," said Nathan Pincheira, an economist at BanChile in Santiago. "If we don't see revenue growing strongly in real terms, not growing spending could be one option among others.''


Now, concern is mounting that S&P Global Ratings and Moody's will cut Chile's credit rating, the highest in Latin America at AA-, if finances get much worse.

The agencies "are maintaining the credit rating because they trust us to do what is possible for the structural balance to improve a quarter point each year," Valdes said. "That puts very significant fiscal restrictions on us going forward."


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