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Chile: Bachelet’s Problems

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Chile’s macroeconomic conditions are sound, but there seems to be a political power vacuum in Santiago.

BY WALTER T. MOLANO

Chile is benefiting from the changes in the global economy. The commodity boom is translating into higher copper prices, boosting the levels of economic growth and government revenues. The Chilean economy should grow more than 6 percent y/y in 2007. At the end of the first quarter, Chile’s unemployment rate fell to 6.7 percent  —  the lowest level in nine years. The fiscal impact from the increase in copper prices was even more impressive. The Chilean government posted a fiscal surplus of $11 billion in 2006, with Codelco contributing $9 billion to the bottom line. The fiscal surplus at the end of the first quarter of 2007 was $3.7 billion, putting the government on track for an even-larger windfall in 2007. Chile is impressive, sporting world-class infrastructure and institutional stability.

Unfortunately, Chileans are far from content.

President Michelle Bachelet is under fire, and she is trying to reinvigorate her administration. On May 21, President Bachelet gave her second state of the nation address. One of the highlights of her speech was a modification of the so-called Structural Fiscal Surplus rule. The rule was introduced in 2000, as a way to regain investor confidence. Chile’s fiscal accounts eroded during the latter half of the 1990s and the government hid the damage by obfuscating the results. The new fiscal rule worked well, and the public sector’s performance improved dramatically.

However, an increase in copper prices provided an additional windfall, leaving the government with too much money. Now, it is trying to spend some of the excess—particularly by boosting expenditures in health and education. President Bachelet announced that the surplus target would be reduced to 0.5 percent of GDP in 2008 from 1 percent of GDP. The measures will allow the government to increase spending by $750 million. Of the total increase, $650 million will be directed towards education. Finance Minister Andres Velasco said that the additional funds will be used to improve the quality of Chile’s academic programs and create a new agency, the Superintendency of Education, which will set national standards.

Despite the president’s promise to improve public services, Chileans were skeptical. A survey conducted after the televised speech showed that 45 percent of the respondents doubted that the president would deliver on her promises. The response was worse in Santiago. President Bachelet is suffering from several noticeable setbacks — most of which occurred prior to her assuming office.

The introduction of Transantiago, the new integrated public transportation system was a disaster — with too few buses, the absence of dedicated lanes and serious software glitches. Now, the cold winter in Argentina is adding to the president’s woes.

With the coldest May in more than 130 years, and an over-stretched energy system, the Argentine government is forcing Chile to bear the brunt of the crisis. Argentina halted gas exports to Chile in order to prioritize its own domestic demand.

To make matters worse, drought conditions in Chile are putting a strain on the country’s hydroelectric generating plants. Chilean electricity producers are raising prices in an attempt to control demand, and benefit from the situation. The Chilean government is also taking steps to reduce the country’s dependence on Argentina by importing Liquid Natural Gas (LNG), building new hydro-electric plants and perhaps nuclear reactors.

Chile’s macroeconomic conditions are sound, but the political environment is tense. There seems to be a power vacuum in Santiago. Chile has a long tradition of strong leaders and President Bachelet does not fit the mold. Perhaps, former President Lagos knew this all too well when he endorsed her candidacy. It could have been a way to highlight his own legacy—an administration that was rife with corruption, bereft of economic reforms and which was ultimately saved by an unexpected rally in copper prices. Whatever the case, Chile is a prosperous country. But, its leader has an approval rate of only 40 percent and two more years in office.

Walter Molano is head of research at BCP Securities.

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