By Alicia Chavy for Global Risk Insights
As one of the most competitive economies and financial market in the region and worldwide, Chile projected itself as a strategic destination for foreign investments over the past two decades. Emerging from the disastrous Pinochet dictatorship in 1990, the Andean country established strict political and legislative safeguards to lower corruption levels and protect judicial processes, democratic values, and investments.
The new government’s efforts successfully created strong confidence in the new political system, improving transparency and corruption indexes, and solid financial and legal institutions. From these reforms, high inflows of FDI followed and Chile became the world’s 11th largest recipient of FDI in 2012.
Thus, over the past 10 years, it became clear that Chile had the potential to become a powerful player in the region, as its GDP grew at an average annual rate of 4.6% from 2005 to 2012. Chile’s flexibility to face international conditions was also proven during the European debt crisis in 2012, when its GDP growth expanded to 5.6%.
Influential institutions like the World Economic Forum recognized Chile as one of the top countries with the best macroeconomic environment. This ranking, among others, has reinforced the country’s economic stability and dynamic business climate hallmarks to investors.
Investors have benefited from Chile’s strongly legislated guarantees, such as protection on copyrights, and from its strategic trade agreements with 59 countries, including Free Trade Agreements.
With no restrictions on capital flows, promotion of private investment incited by tax exemptions, and a flat tariff of 6% on imports from other countries, Chile became the Golden Boy of Latin America for investments.
Trouble in Paradise
While the country proved its resilience in facing international crisis, its flexibility to address domestic problems has been challenged over the past year. Corruption and finance-related scandals in the public sector erupted, shaking Chile’s image as a regional role model.
As former government officials and top executives from Penta Group – one of the major holding companies in Chile – were arrested on the accounts of bribery and money laundering, President Bachelet’s direct family members were also involved in recent financial probes.
“Pentagate” and President Bachelet’s family scandal became a test for the 20-year-old judicial and democratic system in Chile. A recent article even stated: “Chile is going through its worst crisis since the end of military rule.”
Incoming accusations involving influential politicians in illegal campaign financing were the cherry on top. The Chilean Miracle became a mirage.
Thus, entering her second term, Chilean President Bachelet saw her approval ratings plunge to their lowest level ever this past month. Along with the political scandals and a harsh month of natural disasters, the President was sidetracked from implementing her reform agenda and addressing the economic slowdown.
Golden Boy has copper problems
As its main export is copper, Chile’s energy sector’s and economy’s health depends heavily upon commodities’ global development and the growth of its major consumer, China. Along with changing global energy policies, China’s demand for copper and commodities has slowed down, deeply affecting Chile.
Moreover, sharp declines in the price of copper weakened investments in the mining sector and GDP growth over the past two years. Economists have suggested that falling employment rates and limited monetary tools are dragging the economy down.
Consequently, major manufacturing and mining companies have expressed their concerns regarding Chile’s current economic environment. In particular, Louisiana-Pacific, a manufacturing company with a $70 million investment project in Chile, stated that it may delay its plans due to the economic decline.
Widespread economic problems have impeded investors from taking advantage of the country’s strategic position in the region and of its commitment to major trade agreements.
Still a better alternative than Brazil
To tackle the recent political and economic crises, Bachelet’s administration proposed several reforms. For instance, tougher regulations on government and public sector officials aim to reduce pervasive corruption in the public sector and help the president regain her popularity.
Furthermore, President Bachelet and economic experts remain optimistic that fiscal spending and monetary policies implemented by the Central Bank of Chile will speed up economic growth through 2015. Indeed, the Central Bank forecasts positive growth in GDP, from 2.5% to 3.5% this year.
Overall, Bachelet and her administration have sought to reassure investors in health, energy and other major sectors in recent months. Energy Minister Maximo Pacheco devised a plan to boost energy investment and stop the nefarious impact that drastic change in copper prices have had on the economy.
With clearer policy guarantees, new avenues are opening up in emerging industries, such as renewable energy.
Through early signs of economic recovery in January, Chile showed its aptitude in facing challenging domestic and international conditions. Even though the fallout from the political scandals hurt the President’s image and popularity, it did not have a large impact on investment prospects and the government’s capacity to implement stricter reforms.
Chile’s reputation as an ideal business destination and its institutional strengths remain largely spotless.
Despite the recent corruption scandals and financial problems, Chile remains an attractive investment destination. The promising transparency and open economy indexes, combined with Chile’s active work towards bilateral and multilateral trade agreements (ie. the Trans-Pacific Partnership) has allowed the country to consolidate its position as an important regional and international player.
In addition, investors need to look for an alternative to Brazil, which will likely face significant social and economic upheaval over the next five years. As Chile’s economic slowdown seems to be temporary rather than a structural problem, the Golden Boy offers better prospects than Brazil for short and medium-term business.