Fitch: Chile Budget Shows Consolidation, Social Pledge Tradeoff
The 4.4% rise in real spending will outpace real GDP growth in 2016 (we forecast 2.7%) due to commitments to fund education and healthcare initiatives with revenues from last year's tax reform. But it is a significant moderation from last year's 9.8% increase, reflecting the authorities' desire to preserve fiscal buffers in the face of a structural economic slowdown.
Chile's low public debt (15.1% of GDP last year) and sizable treasury buffers (the Economic and Social Stabilization Fund amounts to around 6% of GDP) give it fiscal space to avoid greater pro-cyclical fiscal adjustments and adapt public finances gradually to a slower growth environment. New revenues from the tax reform have helped limit near-term fiscal deterioration, with the 2016 budget forecasting a deficit of 3.2% of GDP, almost unchanged from 2015's projected 3.3% deficit.
Nevertheless, sluggish growth and continued weakness in copper prices have created a more difficult tradeoff between fiscal consolidation goals and social spending objectives. The government has said it will not hit its original target of a structurally balanced budget in 2018. The new goal of lowering structural deficits by 0.25 percentage points of GDP per year is feasible following the tax reform and could slow the increase in public debt levels (which should remain among the lowest in the 'A' rating category).
Reductions in the independently estimated budget parameter for potential growth to 3.6% from 4.8% over the past two years highlight uncertainty about growth rates following the mining super-cycle. Any further reduction in potential growth could add to the challenge of reconciling social spending and consolidation. Falling copper prices present fiscal risks, but more via their impact on broader growth (and taxes) than direct fiscal copper receipts. Chile is the most commodity-dependent 'A' category sovereign, but its fiscal dependence on copper revenues has fallen in the last decade due to tax reforms and narrower margins at mining firms. Recent peso depreciation also cushions the fiscal impact from falling copper prices.
Chile's track record of fiscal responsibility suggests the authorities can maintain consolidation. However, Chile faces a more difficult test from weaker growth and rising social demands, and the authorities' policy response will be an important driver of the medium-term fiscal outlook.