by Armando Armenta, Senior Economist, AllianceBernstein
Late in 2019, Chile, Colombia and Peru saw an uptick in political turmoil that was unusual, given that they’re perceived as politically stable countries with “market-friendly” policies. With several key elections on tap in 2020, we’re watching closely for potential risk flare-ups.
The countries’ unrest shares common triggers: lower secular economic growth, high inequality, more demand for better provision of public goods and higher scrutiny of corruption. This shift in political tone is unusual because these countries adopted policies three decades ago that liberalized their economies and markets, while policies were focused on maintaining stability and improving productivity. However, the recent wave of populist backlash happened despite the countries’ recent relative success.
Could the recent return of protests and challenges lead to major changes in the institutional framework? Let’s take a closer look at each nation: how they got here, the risks and how authorities are responding.
Chile: Could a New Constitution Disrupt Chile’s Model?
Reforms by the Pinochet government some three decades ago are regarded as key to Chile’s economic growth, low inflation and modest public-debt increases. Pinochet’s rule ended without violence, and the return of democracy has delivered a stable political landscape.
The recent unrest ignited on October 18, 2019, after an erratic government response to student protests over a scheduled fare increase in Santiago’s light rail transit system. The discontent spread broadly—in many cases violently—and encompassed demands for increased government spending on health, pensions and education, as well as a process to replace the current political constitution.
After a few weeks of violent demonstrations, politicians compromised on increased spending and set the path for a new constitution. We believe the demand for constitutional change stems from growing support not only to remove Pinochet’s legacy but also to balance the constitution’s focus on market liberalization and a diminished state role in the economy with the need for spending on social services.
On April 26, 2020, Chileans will vote on two questions: 1) Are you in favor of drafting a new constitution, and if so, 2) should the current Congress be part of the group drafting it? A clear majority of Chileans seem to favor a new constitution, but opinion remains divided on whether Congress should be involved.
In our view, the increased polarization on this topic implies that recent turmoil hasn’t dramatically shifted the distribution of voters’ political preferences. If an overwhelming majority of citizens vote for a new constitution without Congress’s involvement, it might be construed as a larger rebuke to the current politico-economic system, with a more uncertain result.
In our base case, the constitutional process will increase the state’s role in providing public goods and meeting demands from minority political parties, but it won’t compromise the pillars of the politico-economic system. The process could reduce growth and investment and increase uncertainty, but Chile’s fiscal and credit buffers should support higher spending and public debt. Higher downside risk is possible, but it likely wouldn’t emerge until at least the end of 2021, when voters would need to ratify the new constitution. The path to a new constitution relieves pressure from the administration, but we can’t rule out new protests ahead of the elections to attract political support from opposition movements.
Colombia: Healthy Growth, but Still Vulnerabilities
Colombian politico-economic institutions have been stable over the past three decades despite facing major challenges, including battles with communist guerrillas, the illegal drug trade and a recent immigration wave from Venezuela.
After trying several approaches to address the ongoing conflict with rebel groups, including a botched peace process and a period of increased confrontation, President Santos signed a final agreement with the Revolutionary Armed Forces of Colombia, or FARC, in 2016. But the implementation has seen delays and attempted changes, creating the backdrop that spurred protests in November 2019.
Protests have long been a part of Colombia’s democracy, usually driven by organized interest groups. November’s protests were different, with broader support from the middle class for better-quality public goods and against potential structural tax and pension reforms. The president’s popularity dipped to around 20% before a recent recovery.
As with Chile, the extent of the protests surprised the political system, but there have been no demands to change the constitution or remove the president. Colombia’s constitution guarantees the state, when it sees fit, as a provider of social services, but the need for fiscal stability has in many cases trumped growing demand for social expenditure.
The current economic landscape features a large decline in oil revenues, with other factors bolstering domestic demand, including the influx of low-skilled Venezuelan migrants, a sustained increase in minimum wages above inflation, and tax deductions for corporations and investment. But more labor supply and a higher relative labor price has increased the unemployment rate and depressed earnings in the informal sector, fueling discontent despite relatively high gross domestic product (GDP) growth in 2019.
The government has responded by shelving structural reforms and a small 2020 fiscal package, eyeing budget freezes as well as extraordinary dividends from Ecopetrol and the central bank to fill the 2020 fiscal gap. Rating agencies and markets will be watching for growth disappointments or missed tax-revenue targets. Colombia isn’t as fiscally buoyant as Chile, with its government debt-to-GDP ratio up by about 15% from 2014, a BBB– credit rating from S&P and a BBB rating (with a negative outlook) from Fitch.
As we see it, the political polarization stoked by a government (and its party in Congress) trying to tinker with the peace process despite rejection from most of the political class has weakened the president’s position, and his vow to avoid sharing power has hampered his ability to lead economic policy amid dwindling government spending. We’ll be watching this behavior closely—if it continues, political instability is more likely to continue in coming months.
Colombia’s economy should continue growing at a relatively healthy pace, supported by domestic demand and stabilizing oil prices, but fiscal and balance-of-payments imbalances remain high, and the economy is still vulnerable to deterioration in the domestic and external environment.
Peru: Political Disruptions
President Alberto Fujimori’s economic reforms following a late-1980’s bout with hyperinflation and currency collapse ushered in a long period of nearly uninterrupted stable economic growth (averaging 4.6% year over the last quarter century). But social progress still lags that of Chile, and political turmoil has been a constant.
The market expects 2020 growth of about 3.2%, the Andean region’s fastest along with Colombia. Inflation expectations are well anchored, and strong fundamentals are keeping pressure from credit ratings. If anything, national and local governments’ technical shortfalls and fears of corruption investigations have led them to underdeliver on their investment budgets, reducing growth. But there’s a bright side to this situation: it implies less risk to economic stability from fiscal and external balances. Because Peru’s fiscal and external situation isn’t as fragile as Colombia’s, and the political stakes aren’t as high as Chile’s, asset prices have remained stable amid political upheaval.
In recent snap congressional elections, none of the parties obtained a significant majority, and the president will likely reach out to some of the center and center-right winning parties to form a coalition. However, the political fragmentations will make needed structural reforms unlikely. On the positive side, this also implies that the likelihood of major changes that put in danger the current market-friendly environment is low.
In our opinion, the biggest risk in the short-term is from anti-establishment candidates gaining support ahead of the April 2021 presidential elections. The political dysfunction, if it were to continue into 2021, would certainly take a toll on economic activity, increasing the possibility of a policy shift that could threaten the underpinnings of the long period of economic stability.
The Big Picture
Sound economic policy and political stability have underpinned improved credit metrics and valuations in Chile, Colombia and Peru for the better part of the last three decades. Despite a recent increase in political instability, we don’t expect major changes in the business-friendly environment or a major credit deterioration that would put downward pressure on asset prices. However, we continue to monitor the situation closely for any developments that could change the risk/return dynamic.
Armando Armenta is a Senior Economist at AllianceBernstein (AB).
The views expressed herein do not constitute research, investment advice or trade recommendations and do not necessarily represent the views of all AB portfolio-management teams.
This post was first published at the official blog of AllianceBernstein..
