OECD Economic Outlook, Volume 2022 Issue 1

Chile

Growth is projected to slow sharply to around 1.4% in 2022 and 0.1% in 2023. Elevated inflation, tighter financial conditions and the withdrawal of extraordinary fiscal measures will constrain household consumption. Tighter financial conditions and uncertainty surrounding the new constitution will likely damp firms’ investment. Headline inflation will moderate in 2023, but will remain high due to the impact on energy prices of the EU oil embargo on Russia.

Preserving fiscal sustainability will hinge on implementing the envisaged ambitious consolidation path. A lagging job recovery and higher global food and energy prices will require targeted and temporary fiscal support to the most vulnerable households. A fiscal reform addressing Chile’s structurally low public revenues and low tax progressivity is needed to address pressing infrastructure and social needs. More investment in renewables, coupled with an accelerated coal phase-out, can help to reduce energy dependence and costs. The central bank should continue tightening to ensure that inflation returns to target, but at a slower pace, given the economic slowdown.

The economy has slowed after a fast recovery

After surpassing pre-pandemic levels by 8% in 2021, driven by strong household consumption, economic activity contracted in the first quarter of 2022. Retail sales and economic sentiment declined in the first months of the year, with services contributing positively to activity, as the economy reopened. The labour market has been recovering although employment and participation levels remain below pre-pandemic levels. The unemployment rate has increased this year, reaching 7.7% in April, with more people returning to the labour force.

Chile: Economic activity and inflation indicators

1. Consumer Price Index (CPI) excluding energy and food products.

Source: OECD Economic Outlook 111 database; CEIC; and INE.

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Chile: Demand, output and prices

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Indirect effects of the war in Ukraine are already being felt through higher energy and food prices. These add to inflationary pressures from strong consumption demand, fuelled by extraordinary pension fund withdrawals and pandemic-related income support to households. In addition, the currency has depreciated amid domestic political uncertainty, pushing inflation expectations over the next two years above the central bank inflation target of 3%. Wages have increased to 7.4% annually in March driven by labour market mismatches, although real wages decreased by 2% annually. While higher copper prices could spur mining production and investment, these effects are outweighed by higher energy prices, leading to a deterioration of the terms of trade.

Monetary and fiscal policy are becoming more restrictive

The government has appropriately committed to an ambitious fiscal consolidation and is phasing out COVID-19 fiscal stimulus measures. The government intends to reduce the structural deficit of the public sector from 11% of GDP in 2021 to 3.3% of GDP in 2022 and by 0.75% of GDP per year until 2026, in line with the fiscal rule, in order to stabilise debt around 44% of GDP. The government has recently approved a fiscal package to mitigate high oil prices through higher subsidies to households and firms and to support employment and SMEs in lagging sectors. Targeted cash transfers have been increased to alleviate the impact of inflation on vulnerable households. Monetary policy has become restrictive after authorities implemented successive policy rate increases to 8.25% in May. Further but smaller increases in policy rates to 9.4% are expected during this year, with rates then remaining stable until late 2023.

Economic growth will remain weak given the uncertain environment

The unwinding of fiscal stimulus, a decline in real wages driven by strong inflationary pressures, and monetary tightening will weigh on economic growth during 2022 and 2023. Private investment is projected to remain weak, due to uncertainty surrounding the new constitution and higher interest rates. Pre‑pandemic employment levels will be reached gradually, supported by ongoing hiring subsidies, but labour informality remains a concern. Inflation is projected to ease driven by the slowdown of the economy but will remain elevated due to high energy prices following the EU embargo on Russian oil. Downside risks include sudden sentiment changes in global financial markets that could increase financing costs, widen the current account deficit and weaken the currency further. A depreciated currency could push up inflation, but more severe effects will be mitigated by large foreign-exchange reserves. Inflation could be higher than expected if inflationary pressures from energy and food prices last longer. A sharper slowdown in China, the main trading partner, would hurt investment and growth. Upside risks to growth are sustained higher copper prices and a faster resolution of global supply bottlenecks.

Enhancing energy security and boosting productivity should be priorities

Chile’s rich endowments in renewable energy sources provide strong export potential. More investment in renewables, coupled with an accelerated coal phase-out, can help to diversify the economy and boost productivity, while reducing energy dependence and costs. A recent National Green Hydrogen Strategy has the potential to decarbonise the economy, particularly the mining industry. Ensuring adequate funding for social and infrastructure spending will require raising tax revenues by further reducing tax evasion, increasing property and CO2-emission-related taxes and broadening the personal income tax base. Strengthening competition, encouraging the adoption of digital technologies and reducing the complexity of regulatory procedures would drive needed productivity gains and boost potential growth. Improving the quality of public education and professional training would mitigate the consequences of the pandemic and reduce inequalities. Reinforcing unemployment benefits and expanding coverage of cash transfer programmes for the vulnerable, while reducing their segmentation would strengthen the labour market recovery and enhance fairness.