What happened?
Chile has become the latest Latin American country to add to the growing list of those experiencing social unrest, highlighting that even countries so far perceived to be stable are susceptible to popular uprisings in a world of declining growth and rising inequality.
A 4% increase in subway fares triggered violent protests in Santiago, the capital, in recent days. Despite the decision to roll back the fare increase, Chileans continued to protest against inequality, the high cost of living, and a challenged pension system. According to media reports, over 15 people have died in clashes with security forces, and north of 2,000 have been taken into custody. Dozens of subway stations, hundreds of retail stores, and the headquarters of an energy company were all severely vandalized. There have also been reports of labor unions calling for strikes. In response, President Sebastian Piñera declared a state of emergency in Santiago and several provinces, put in place a curfew, increased police presence, and deployed soldiers in an attempt to calm the situation.
These demonstrations follow unrest that erupted in Ecuador earlier this month in response to a cut in fuel subsidies. The government of Ecuador similarly had little choice but to roll back its reform. Reports have suggested that leftist groups sparked this uprising, and Ecuador officials at the IMF meetings in Washington DC this past weekend said they had gathered intelligence of Venezuelan and Cuban involvement in protests in the country. A number of media outlets have also reported that the Foro de Sao Paulo alliance of leftists groups had gathered in Caracas in July, and the recent uprisings could have been planned by the more radical wings then.
Even if these reports help clarify the timing and degree of sophistication of the protests, we believe that deep structural trends are to blame for the social discontent currently manifesting in Latin American countries.
Near-term buffers, broader range of possible outcomes in the medium term
In the near term, the recent developments in Chile may have only a limited impact on its economy. The country has tools to address social tensions and discontent, including state institutions that are more similar in quality to that of developed countries than that of emerging countries (Fig. 1). It has a strong macro backdrop (Fig. 2) thanks to a record of prudent policy, and it benefits from a well-constructed fiscal framework, a strong external position, ample reserves, and relatively low levels of debt, the majority of which is denominated in local currency.
Figure 1 - Quality of Chilean institutions are closer to that of advanced economies than of emerging economies
World Bank Governance Indicators, ranging from about –2.5 to 2.5. Higher values correspond to better outcomes.
Figure 2 - Chile benefits from a very strong macro backdrop
Macroeconomic variables, actual and forecast
Despite initial missteps in handling the protests, the Piñera government called for a "social agreement" and will meet with leaders of every political party to explore future steps. In our view, the protests have reduced the administration's political capital and thus its ability to pass reforms, including the tax and pension reforms that have been pending congressional approval since late 2018. Business sentiment and economic activity could also decline amid still poor external demand.
Looking further out, developments in recent days need to be taken seriously. In our view, they likely point to a wider range of possible economic and political outcomes for Chile over the medium term. At the center of the social unrest is the high level of income and wealth inequality. The country ranks poorly in a measure of income disparity (Fig. 3). A major sticking point is its defined-contribution pension system, which faces unsustainably low replacement rates for many, especially women. In this context, the center-right coalition which favors the status quo could face a weaker mandate in upcoming local and general elections in 2020 and 2021, respectively. The political environment thus seems ripe for populists—be they from the left or from the right—to do better in the ballot, though it's too early to make a call with certainty. Social demands may, over time, result in a larger government participation in the economy. Whether this will be financed via larger deficits and debt levels, or through higher taxes, remains unclear at this point. Changes to the country's fiscal rule or even the constitution should be monitored very closely.
Figure 3 - Chile suffers from some of the worst levels of income inequality in the world
Gini coefficient. Higher values correspond to higher inequality.
Investment implications
Most Chilean assets sold off on Monday, with the peso depreciating 2.1% and equity markets down 6.8% in US dollar terms. Interestingly, sovereign bond spreads (EMBI) barely bulged and widened by just 1 basis point. Volatility may continue depending on the headlines and the length and severity of the protests. The near-term impact on Chilean assets will likely be limited, however.
Over the medium term, Chilean asset performance will depend on whether we observe a secular shift in the country's policy environment away from prudent macro policies and reform. Its strong institutions should act as a buffer to a quick and deep deterioration, however. Moderate pressure on the sovereign credit rating could emerge as a result of the increased uncertainty (Fig. 4).
Figure 4 - Select indicators on Latin American sovereign credit
Duration (in years), yield (in %), spread (in bps), returns (in %), and credit ratings
Author:
Brennan Azevedo, Emerging Markets Associate Americas, UBS Financial Services Inc. (UBS FS) Alejo Czerwonko, Emerging Markets Strategist Americas, UBS Financial Services Inc. (UBS FS)
This report has been prepared by UBS Financial Services Inc. (UBS FS). Please see important disclaimers and disclosures at the end of the document.
Appendix
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