Companies should brace for rising volatility in Chile

As forecasted by FSG in January 2016, the Chilean government has recently lowered economic growth expectations for 2016 at a level below the growth experienced in 2015.

While Chile’s slowdown can be associated with record low investment expectations and low copper prices, Chile is likely to confront additional challenges in the coming months. These challenges are likely to drive growth down to a mere 1.5% – 1.9% in 2016, namely another wave of currency depreciation throughout the second part of the year, and falling investor confidence stemming from some of President Bachelet’s progressive reforms.

Only the government’s countercyclical policies, primarily geared towards boosting the infrastructure sector, could strengthen growth in the short-run. However, such policies will most likely not be enough to sustain growth in the absence of high copper prices. In an effort to move away from its dependency on copper, the government has been aggressively investing in renewable energies, though it will take Chile several years to make this sector an integral part of its economy, let alone a sector as large as mining.

Currency volatility is likely to increase in H2 2016

Despite the recent appreciation observed in the Chilean peso and other currencies in Latin America, multinationals should expect the peso to weaken against the US dollar again during the second part of 2016.

While financial markets are currently projecting a slightly higher than 50% probability that the Fed will increase interest rates by only 25 basis points by the end of 2016, it is our view that the Fed will adopt a slightly more hawkish stance and raise the Fed funds rate by 50 basis points in 2016. This means that future rate hikes are not fully priced into the current value of emerging market currencies. As such, the Chilean peso, as well as many other currencies in Latin America, is expected to depreciate against the dollar once the Fed starts raising interest rates later this year.

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Multinationals should anticipate a weakening peso and consider adjusting their pricing strategies to prevent a falloff in demand, and evaluate their distributors’ financial resilience and ability to absorb price increases.

Labor reform regulations are exacerbating multinationals’ investment contraction

The Chilean Congress recently approved new changes to its labor reform regulations. These changes are expected to significantly modify the current provisions addressing labor unions and collective bargaining proceedings, thus preventing the private sector from having flexible rules to adjust their headcount according to economic cycles.

Especially worrying for multinationals is the boost in the bargaining power of labor unions, namely those representing contractors, which could significantly raise labor costs. As a matter of fact, only 17% of companies present in the Chilean market are planning to increase headcount in 2016, mainly as a result of the passage of new labor regulations.

One of the sectors that is expected to be seriously affected by this reform is mining, which has been historically reliant on outsourced workers. In fact, 68% of the 250,000 direct jobs in the mining sector are outsourced workers. As the mining sector covers close to 10% of the Chilean labor force, the impact of labor reform will not only affect investment, but most importantly, it could potentially raise unemployment, which will have a perverse effect on consumer confidence and spending.

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As a result of the potential impacts of these new labor regulations, companies are advised to review their strategic and operating plans for 2017 in light of rising wages. Additionally, multinationals should try to negotiate with labor unions before the new reform is implemented, as the terms of any collective bargaining agreement will last for only two years instead of four, if the agreement is signed after the reform enters into force.

The Chilean government is aggressively encouraging the production and use of renewable energies

In an effort to diversify away from the mining sector and put Chile on a more stable growth pattern, the government has been aggressively investing in infrastructure, particularly in road connectivity projects and energy infrastructure, over the last five years. As a matter of fact, by the end of 2015, renewable energies represented 11.5% of the total energy produced, up from 1.9% only five years ago.

As Chile continues with the line of public investment in green energy, the government is now planning to become energy independent within the next two decades, aiming to generate 20% of Chile’s electricity through renewable sources by 2025 and 70% by 2050. If the government’s projections are accurate, Chile would be adding 500,000 direct and indirect new jobs to the economy over the next decade, a number that would significantly offset the rise in unemployment in the mining sector. However, the effects of the government’s energy policy will take some time to materialize, and will not be felt in 2016.

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As investments in renewable energy sources pick up, companies are encouraged to take a subnational approach towards market and customer segmentation, and shift resources toward regions such as the first, second and third, as they are more likely to concentrate new solar and eolic energy-generation projects. These regions will present direct opportunities to B2B and B2G companies, but also to consumer goods companies as jobs and real wages are expected to rise.

If you are a client and are interested in learning more about Chile’s current economic trends and implications for the country’s business environment, please click hereNot a client? Contact us to learn more.

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