Ahead of Boric's inauguration on Friday, economists warn of recession on Chile's horizon

After besting free-market candidate Jose Antonio Kast in a presidential runoff election in December of last year, 36-year-old former student leader Gabriel Boric will take office on Friday – effectively becoming the South American nation’s most left-leaning leader since socialist Salvador Allende took office in 1971.

Boric will enter La Moneda, Chile’s presidential palace, at a turbulent time for the world’s leading copper producer – and will have to navigate ambitious political projects through a highly polarized society that has been rocked by country-wide protests and untamed terrorist violence in the country’s southern regions.

Since first launching his campaign, Boric has promised to move forward with the left’s thirst for reform – telling voters he will work to reform Chile’s prolific private pension funds (AFPs) and the market-friendly constitution, which has been in place since the years of General Augusto Pinochet’s military government.

But markets have reacted negatively to the Chilean left’s calls to erase all remaining vestiges of the “Chicago boys’” free-market economic model and on Friday, Boric will be charged with reviving an economy which was once considered the “Chilean miracle.”

Although Chile's economy enjoyed its strongest growth in history in 2021, growing at nearly 12% thanks in part to the Piñera administration’s successful post-pandemic recovery efforts, economic growth slowed to 9% year-on-year in January– nearly two points lower than was previously expected, Biobio Chile reported.

"One must consider that all the economic growth in 2021 is a product of post-pandemic recovery than real growth," said Ana María Vallina, an economics professor at the Catholic University of Valparaíso.

The Central Bank has also warned that growth is expected to slow to a figure between 1.5% and 2.5% in 2022 and fall between 0% and 1% in 2023.

But when Boric takes office on Friday, he will have to remember that a sluggish economy is not his only problem: he must also tackle the highest levels of inflation his country has seen in 15 years and the potential for stagflation on the horizon.

“Boric's biggest headache will be the sustainable reactivation of the economy amid a period of stagflation,” Vallina added.

Experts have also warned that the ongoing war in Ukraine could further complicate Chile’s economic recovery due to Chile’s dependence on foreign imports of basic commodities such as oil and wheat – both of which will be affected by sanctions against Russia.

Former OECD chief economist and professor of economics at Universidad del Desarrollo Klaus Schmidt-Hebbel recently told La Tercera that the extent of the economic consequences of the war in Europe depend on the duration of the conflict, but warned that there is a high probability that the Chilean economy will soon enter a recession.

The economist further warned that rising copper prices could push oil prices even higher. “For every 1% increase in the price of copper, the price of oil could increase by 5% or 7%,” he said.

Schmidt-Hebbel also warned that the economic impact of the war could also affect the Chilean peso – which has already been rocked by uncertainty surrounding Boric’s electoral victory.

“Another effect for Chile is the exchange rate. An international crisis and lower world economic activity tend to devalue the currencies of emerging economies,” he explained, adding that a devaluation could occur because of a movement of global portfolios into safe assets, a fall in global trade and/or a decrease in demand for Chilean exports.

“The combined effect of the increase in the dollar price of oil and the devaluation of the peso will generate more domestic inflation. But, again, I would like to emphasize that the magnitude and temporal extension of these effects will be subject to the duration and intensity of the conflict in Ukraine,” he added.

Schmidt-Hebbel also noted that the incoming government’s monetary regime will be key in determining the country’s economic recovery.

“The first thing to say is that if there are pressures of higher inflation and, at the same time, lower activity, the Central Bank will be in a dilemma as to whether to accelerate or maintain the pace of normalization of the monetary policy rate. This dilemma is faced by every Central Bank facing stagflation,” he said.

“The new government will be in the dilemma of whether it wants to face an eventual recession, increasing its spending, or whether it wants to initiate a path of fiscal stabilization. In my opinion, it should do the latter, because Chile must return to fiscal sustainability, stabilizing its debt to GDP ratio in the medium term.”

But as Boric and his cabinet prepare to take office on Friday, Chileans can breathe a little bit easier knowing that the president-elect appointed former central bank chief Mario Marcel to be his administration’s finance minister.

The Cambridge-trained economist previously held positions at the World Bank, the Interamerican Development Bank and the Organization for Economic Cooperation and Development and news of his appointment was applauded by economists on both sides of the political isle. 

Strategists at Citigroup were quick to react to the appointment saying, "We believe that Mario Marcel's appointment as future minister of finance is definitely good news, as Marcel is someone with a high credibility who has supported the two pillars of Chile's macroeconomic framework: the independence of the central bank, and the structural fiscal rule.”

Miguel Angel Lopez, a public affairs professor at the University of Chile, also reacted positively to Marcel’s appointment, noting that “naming Mario Marcel as finance minister is a very good sign of economic stability, seen positively by markets.”

Isabel Aninat, dean of the law school at Adolfo Ibáñez University and director of the Chilean Society for Public Policy, said, “Marcel has shown, especially over the last few years as president of the Central Bank, a very strong commitment to fiscal responsibility, but also not afraid to express opinions even when they are unpopular.”

As Chile prepares to welcome its new president, one can only hope that social change does not blind policymakers from protecting the already endangered economy.