Chile’s Budget to Curb Investment to Fund Education: Valdes

  • Government will follow rule of cutting deficit by 0.25% of GDP
  • Education and health will see highest spending growth

Chile’s 2017 budget will limit public investment projects as the administration of President Michelle Bachelet increases funding for health care and the education reform, said Finance Minister Rodrigo Valdes.

Overall fiscal spending will grow from last year and investment won’t necessarily be cut, but some projects will be reassigned and others not started, Valdes said in an interview Tuesday at his office in Santiago. The government conducted expansive investment policies in 2014, 2015 and 2016, but it needs to limit outlays to meet its goal of cutting the so-called structural deficit by 0.25 percent of gross domestic product per year to balance it by 2020.

"There will be a certain normalization of investment policies, so there is space for other expenses," Valdes said. "The biggest increases will be in education and health, but there are also important expenses on security."

The slump in copper prices is undermining government income. In March, Valdes announced spending cuts, but the budget gap widened as the effects of a one-time levy on savings brought back from abroad wound down. Chile is enduring its third year of sluggish economic growth and experienced its first contraction in six years during the second quarter, when GDP shrank 0.4 percent from the previous three months. The central bank cut its growth forecast for 2017 in September to between 1.75 percent and 2.75 percent, from the June estimate of 2 to 3 percent.

"Every fiscal rule is perfectible, but ours is a good combination of flexibility and discipline," Valdes said. "Our policy of strictly following the fiscal rule is coherent with the credit rating that we have.”

Chile has the fourth-highest possible ratings from Moody’s Investors Service and S&P Global Ratings, placing it in line with China and Taiwan and one step below France.

Optimistic Forecast

Fiscal spending rose 2.7 percent during the second quarter, helping to compensate for a 0.4 percent drop in household expenditures. While the government will not cut fiscal spending, it is hopeful that private investment picks up and drives growth over the coming quarters.

"The adjustment of investment linked to mining has been deeper than anyone could forecast and it hasn’t reached rock bottom yet," Valdes said. "But it will happen at some point and that will stop dragging overall investment down."

Chile’s institutions, regulations and macroeconomic indicators are solid and there are reasons to be optimistic, Valdes said. But even if the recovery is near, potential GDP has slowed. One symptom is the 7.1 percent July unemployment rate, which is at a five-year high, but lower than the average 8.1 percent of the last 30 years. 

Trade-Offs, Reforms

"It is sweet and sour: historically low unemployment shows that capacity gaps in the economy are not that large, but on the other hand potential GDP grows slower," Valdes said. "What do you prefer: high unemployment and high potential GDP? Or the contrary? It is difficult to decide."

In July, when President Bachelet’s government was focusing on wrapping up legislation ahead of the campaign for the 2017 presidential election, hundreds of thousands of people marched across the country demanding changes to Chile’s pension model. Under the current system, Chileans contribute 10 percent of their income to private pension funds, which administer savings.

For more on Bachelet’s proposals to reform the system, click here.

Following the demonstrations, the largest in Chile in at least five years, Bachelet called for a broad agreement to reform the system and proposed that employers contribute an additional 5 percent to fund a so-called solidarity pillar that would top up current and future pensions. 

"It won’t be easy to reach an agreement, we are working on it," Valdes said. "It is clear that a completely individualistic solution doesn’t work, pensions need to be higher and employers will have to contribute. But the state can’t be absent."

The reform would cost the government, Chile’s largest employer, $1.5 billion, or 0.5 percent of GDP, Valdes said in August after Bachelet’s announcement. Additional contributions could also mean salary adjustments in the private sector, but not even trying is not an option.

"There’s no free lunch, everything has collateral effects, and we need to minimize them," Valdes said. "We can’t stop doing things because they’ll have collateral effects."

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