Long seen as Latin America’s beacon of economic stability and prosperity, Chile is now struggling to balance the impact of low copper prices and a wave of domestic discontent about government reforms. Melodie Michel reports.

Copper represents no less than 49% of total Chilean exports, and is by far the biggest contributor to the economy. So when your breadwinner’s earnings drop by over 30% (from US$3.44 per pound in December 2013 to US$2.05 in June 2016), with no prospect for short-term recovery, your revenue is bound to take a hit.

All things considered, Chile’s economy has shown a lot of resilience: following its 2010-12 economic expansion, GDP growth fell to 1.9% in 2014 and 2.1% in 2015. It is expected to remain below 2% in 2016 and average 3.2% by 2017-20. This is partly due to the fact that after the last economic crisis, the government set up a stabilisation fund whereby when the copper price goes down, money is drawn from the fund to soften the impact on the economy, and when the copper price goes up, the fund is replenished.

“Chile is a very stable economy, although GDP growth is only around 1.5%, which is not that bad in European terms but for Chilean terms is low. But we have to remember that Chile is now a mature economy, not a developing one anymore,” says Robert von Oldershausen, senior relationship manager for Latin America at Commerzbank.

Economists don’t seem worried about the country, with inflation well managed through monetary policies and set to fall within the 2-4% target range by 2017 (from 4.3% in 2015). Moreover, copper prices are expected to start recovering from 2017 onwards, gradually lifting the country’s economic burden.

The banking sector is still healthy, with ample liquidity based on provisions made in the past year.

“In Q1 2016, most banks earned a lot of money despite the economic slowdown. I haven’t seen any major issue within the banking sector,” adds von Oldershausen, who represents Commerzbank as a correspondent bank for Chilean financial institutions supporting their corporate clients, mostly in trade with Europe.


Copper losses

But for copper companies, there is no denying times are tough. Alejandro Rivera, chief financial officer at Chile’s state-owned copper giant Codelco, tells GTR: “In our case, we have been affected strongly. At Codelco, each US cent per pound difference in the copper price is translated into plus or minus US$35mn in our annual returns, so our cashflow has been very much affected by that. Perhaps even more importantly, this downturn reached Codelco as we embarked on an important investment programme, so we’re having to deal with disembarkment to achieve our EBIDTA margins but, at the same time, trying not to affect our investment programme as this is what will give us growth in production and revenue in the future.”

Codelco has cut its investment programme by US$1bn a year over the past two years, and plans to cut it by another US$2bn in the coming two years, bringing the reduction to US$4bn. According to Rivera, the company is not cancelling projects, but postponing the ones that are not considered an immediate priority.

“To some extent our growth is going to be delayed, but not the key investments that are meant to maintain our facilities up and running and maintain our production through increasing productivity. Our production profile from now to 2020 is going to be roughly the same,” he adds.

In the meantime, Codelco has not faced any issue with attracting financing, partly because as a state-owned company, it benefits from Chile’s positive credit rating.

Rivera explains that appetite from banks and the capital markets has remained “very solid”, though pricing recently experienced an increase. “That is normal because rating agencies and the market have taken certain negative views about the situation and that has affected our spread, but to some extent we have received support from the state rating. And now it is easing and going back to the normal spreads we saw in 2015 when we placed our last bond,” he adds.

But while Codelco appears reassured about its prospects, others are less optimistic. Roger Braun Barends, managing director at financial consultancy Rockport Financial Services, believes that up to 90% of copper projects have been shelved, and many inefficient plants’ operations have been reduced to a minimum or even closed.

“Last week, I was in a meeting with two fund managers that started funds for investment in copper fields five years ago, and they both had to shut down and lost 100% of their investments. This is a very gloomy scenario for the managerial side of one of the main industries in Chile,” he points out.


Labour tensions

Perhaps more so than the copper prices, what is greatly affecting the Chilean economy is political and social tensions around labour and tax reforms being carried out by President Michelle Bachelet. As GTR went to press, the interior minister, Jorge Burgos, had just resigned following 13 tense months in office and multiple disagreements with the head of state, whose popularity ratings were at an all-time low of 24%.

“Chile is in a bit of a dilemma due to the populist government of Michelle Bachelet, who is promoting labour changes in the midst of this commodity price downturn. These factors are creating even further instability, and forcing entrepreneurs to reduce even more their willingness to take risks in new exploration projects,” says Barends.

Bachelet, who won her second mandate on a pledge to reduce poverty, is on a mission to reduce inequality through controversial reforms. For example last April, the Chilean congress (dominated by a coalition in favour of the president) passed a law that will give unions a lot more weight in wage and benefit negotiations. In parallel, a tax reform coming into force in 2017 will gradually increase corporate income tax from 21% in 2014 to 27% in 2018.

This is not great timing when the country’s corporates are already struggling to maintain investment through the economic downturn. Moreover, labour laws are already very much in favour of workers in the country – a prime example of that is the law according to which Chilean employees are entitled to a bonus for ending a strike.

In September 2015, BancoEstado workers negotiated salary increases of 1% for high incomes, 2% for medium incomes and 3% for the bank’s lowest-paid employees, but on top of that, scored a 6.3mn (almost US$10,000) “end of conflict bonus” per employee – a whopping 91% of the bank’s profits in the first semester of that year.

In light of Chile’s considerable tax income gaps, this use of resources has been widely criticised in the business community, which believes worker benefits decisions made in times of commodity-driven prosperity should be toned down to help companies deal with the downturn. “Chile still has a very solid foundation compared to other Latin American countries, but it’s paying the price for being negligent with its public expenses,” Barends says.

Codelco’s Rivera avoids controversy in his answer to GTR’s question about labour costs: “Recently we have seen that those cost pressures have reduced to some extent. Last year we had some important union bargaining, and I would say that our employees in the labour unions are very much aware of the situation and we have a strong relationship with them.

Last year we even signed a sort of agreement to jointly face this situation and to seek ways to increase productivity. The current labour situation has been easing compared to the last few years,” he says. But although he doesn’t mention it, no doubt the laying off of almost 4,000 workers at the end of last year also contributed to this “easing” of labour cost pressures.

In any case, this wave of reform is making businesses unhappy, while the economic downturn and tax increases (which do not only apply to corporates but also to individuals) are creating discontent in the general public.

This is not helped by a corruption scandal affecting Bachelet’s son and daughter-in-law, who allegedly leveraged their political connections to take out a US$10mn bank loan which they used on a possibly illegal real estate transaction. The president denies having had any knowledge of wrongdoing by her family members, but recent popularity polls suggest few people believe her.

Though most experts agree the risk of Brazil-like escalation is low, previous experience has shown that in Latin America, political coups can spread like wildfire, and contagion risk should not be overlooked. “The current situation is to deal with the government for another two years and then the opposition would win and the country would grow a little bit further. The current government is not really helping Chile to grow economically,” says von Oldershausen.

But Barends worries that the opposition may not be “strong enough to put a good candidate out there”. He adds: “It is comparable to the one in Brazil for example: not a very effective opposition due to internal divisions, which have made it a homerun for left-wing parties.”

Diversification efforts

Fully aware of its dependency on the copper sector, Chile has made efforts to diversify its economy in the past few years, and the low commodity price cycle has shone a light on the most promising industries to achieve that goal.

Salmon woes
Chile’s third-largest export sector has been struggling to compete against its Norwegian competitor, and recently its share in the US market (its largest customer) has been cut due to the price-competitive export push performed by Norway following the devaluation of the krone.

According to government officials speaking at the OECD Forum in June 2016, the implementation of the Trans-Pacific Partnership (TPP) should help level the playing field, but a recent toxic algae epidemic that killed millions of salmon has been another blow to the sector, which already suffered from controversy over its use of antibiotics. Chilean salmon prices are currently at three-year lows.

Wine promises

Chile’s wineries recently benefited from China’s crackdown on corruption, which has led corporates to stop offering expensive French wines as gifts, and turn their attention to cheaper Chilean brands. As a result, exports of bottled wine from the country to China have boomed, going from less than US$100mn in 2010 to around US$220mn in 2015.


According to Robert von Oldershausen, senior relationship manager for Latin America at Commerzbank, retail is another source of hope for Chile’s diversification. “There are three big retailers in Chile which have now opened in Argentina, Peru, Colombia and Mexico, so it’s a promising export sector for Chile as well,” he says.
But some believe the governments should be more proactive in attracting investment in sectors other than copper, particularly through tax incentives. “The government has never really made spectacular efforts to promote new sectors but they are still being promoted by entrepreneurs who see opportunities. You don’t see an investment incentive for corporates that want to enter new sectors that could diversify the economy,” says Roger Braun Barends, managing director of Rockport Financial Services.

In fact, Chile’s recent tax reform, which is increasing taxes for everyone including foreign shareholders, is seen as a hindrance at a time when the government should be doing its best to seduce investors.