Nov 26, 2021
Tension has been simmering in Chile since the October 2019 protests (initially triggered by metro ticket price rises), which led to the start of the process to rewrite the constitution. Earlier this year, Chileans expressed their desire for political change in the constitutional assembly (‘Constitutional Convention’) elections, with the traditional centre-left and centre-right parties suffering a crushing defeat by left-wing independents. Given this body’s responsibility for rewriting the constitution, the shift to the left there – together with heavy fiscal spending and dipping into domestic pensions – has been a key source of uncertainty facing investors in this high-quality country’s debt.
As Chileans went to the polls on 21 November for the first round of the presidential elections, their distrust of traditional political parties was in evidence again: it is the first time in 30 years that neither the centre-right nor the centre-left will make it to the run-off. While the result (summarised in the box below) points to a more polarised society, there were several positive outcomes from the perspective of investors. First, the radical left-wing candidate, Gabriel Boric, failed to improve on his performance in the primaries, suggesting that Chileans have not undergone a permanent shift to the left. More crucially, though, was the surprise outcome in congressional elections, as discussed below.
In a significant positive from the perspective of markets, the right and centre-right did significantly better than expected in elections for Congress. Notably, they gained a number of Senate seats, taking their count to 25 out of 50. This will provide an important check and balance against any radical policy proposals from the eventual winner of the second-round election, and a welcome countering influence to the more left-aligned Constitutional Convention as it drafts the country’s new constitution.
In effect, it would make it very difficult for Boric to overturn the pension system, meaning the future of the private pension system (AFP) seems assured. Likewise, Kast would struggle to implement drastic tax cuts, which is a positive from a fiscal perspective.
It’s likely to be a very close result in the 19 December second-round election with various moving parts (what Parisi voters will do, whether turnout will improve, etc.) impossible to predict. That said, the election for Congress ensures a certain amount of relative stability - Chile’s long-term fundamentals and economic model are less at risk than we thought a few months ago and the positive market reaction seen in recent days reflects this.
This important political juncture for Chile makes it an opportune time for investors to revisit the broader investment case for Chilean bonds and there are various pressing matters to consider.
Turning to the fiscal side, whoever wins the election will inherit an economy that is running hot after an 18-month stimulus bonanza. Adding up fiscal support measures and pension fund withdrawals, stimulus injected into the economy was over 30% of GDP – this is higher than anywhere else in the world, including the US. Fiscal consolidation next year is unlikely to be as abrupt as currently forecast, whoever wins the presidency. While this should allow the country’s high level of growth to persist for longer, it will be at the cost of a higher future debt burden; investors should account for these dynamics when assessing the country’s bond market valuations.
Furthermore, the stimulus measures outlined above will continue to be the main driver of inflation pressures next year, forcing the central bank to increase rates above their neutral level. So monetary policy will be a key driver of the country’s bonds next year and inflation dynamics are an important area to watch. Given the extent of liquidity still available to households, there is a risk that inflation continues to surprise to the upside and takes longer to return towards the central bank’s target range than currently expected.
More positively, there is a general consensus in Chile for a constructive policy towards renewable energy; in contrast to some other emerging markets – Poland being an obvious example – this is cross-party (rather than polarising) issue. Regardless of who wins the election, Chile will continue to develop its green hydrogen potential, with the opportunity to become a leading exporter in this new sector. In addition, Climate Action Taskforce rates the country’s net-zero target as “acceptable”. Meanwhile, Chile’s ambitious reforestation programme is already looking set to help emissions peak as early as 2023. Many of these positive dynamics are reflected in our Net Zero Sovereign Index, where Chile is one of the top 15 countries (the index ranks both developed and emerging markets) – this is thanks in no small part to the country’s strong push into renewables. We also expect Chile to continue to be at the forefront of sustainable bond issuance in EM.
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