(Updates with analyst comments starting in seventh paragraph.)
May 20 (Bloomberg) -- Chilean President Michelle Bachelet wants to assuage concern that higher taxes and increased government spending are crimping investment with the economy growing at the slowest pace in four years.
“We are not populist,” Bachelet, 62, said in an interview yesterday at the presidential palace in Santiago. We will avoid “dramatically increasing fiscal spending. We are optimistic and feel that the economy will recover.”
Bachelet, who came to office on March 11 for a second time, is proposing tax increases of $8.2 billion, mostly through higher corporate levies, to fund health and education spending, including the takeover of some privately-managed schools. Former Finance Minister Felipe Larrain blames the tax proposals for eroding confidence among corporate leaders.
The economy of Chile, Latin America’s wealthiest nation with a population of about 17 million, expanded 2.6 percent in the first quarter from the year earlier, down from 2.7 percent in the previous three months and 5 percent in the third quarter.
The tax plan includes an increase in the corporate tax rate to 25 percent from 20 percent and the elimination of a clause that enables shareholders to avoid paying taxes on profit that is reinvested in the company.
The proposals were approved by the Chamber of Deputies last week and now go to the Senate.
“No one likes high corporate taxes, but Chile is nowhere near resembling some of those other socialist, nationalist countries in Latin America,” Lars Christensen, head of emerging markets research at Danske Bank, said from Moscow. “These are left and right divisions within a very liberal economic framework.”
The plan and economic slowdown have had little impact on foreign appetite for Chilean assets. The cost of insuring Chilean debt against default in the credit-default swaps market fell to a one-year low of 70 basis points yesterday.
In another sign of confidence in the local economy, Abbott Laboratories agreed to pay $2.9 billion for CFR Pharmaceuticals SA on May 16, the biggest takeover of a Chilean company in at least 40 years, according to data compiled by Bloomberg.
Local business perception worsened in the first quarter though, according to a survey released by the central bank last week.
“It’s not realistic that the tax changes being proposed won´t have an effect in the economy,” Larrain, who was finance minister from 2010 to 2014, said this month, estimating the impact at 1 percent to 2 percent of gross domestic product.
Bachelet’s pledge to improve social services has won her popularity among voters in a country that while Latin America’s wealthiest, also has the highest income inequality in the 34- nation Organization for Economic Cooperation and Development. She was the country’s first female president during her first term in office between 2006 and 2010 and returns following three years of student protests over the quality and cost of schooling.
“This is a government that is proposing a free-market program, combined with greater social welfare,” said Alfredo Coutino, director for Latin America at Moody’s Analytics Inc. in West Chester, Pennsylvania. “That is very far from being populist.”
Plans announced by Bachelet yesterday would ban schools that are partially financed by the state from making a profit, with the state compensating owners for past investments. Bachelet stressed the extra spending would not be wasted.
“The first issue for us is quality,” she said. “People talk a lot about education being free of charge, but for us, the main issue is quality. We don’t want education that is free of charge, but bad.”
Two-thirds of the extra revenue from the higher taxes will go to education and health spending, while the rest is earmarked to balance the budget within four years.
“We will do both,” Bachelet said when asked whether balancing the budget or financing social spending was the priority. “It’s not a question of a or b. It is both.”
Higher taxes would be imposed gradually to “maintain governability and social cohesion,” Bachelet said. “We want to give business time to adjust, but also give the education system time to change.”
Chile’s economy has slowed as falling copper prices and rising costs halt an investment boom in the mining industry. Copper, which accounts for more than 50 percent of Chilean exports, has averaged $6,651 a metric ton ($3.02 a pound) since Bachelet came to office, compared with $7,920 per metric ton under President Sebastian Pinera.
Tax changes are “part of the social mandate Bachelet has always aspired to -- reducing inequality and focusing on poverty,” said Aryam Vazquez, senior economist for Latin America at Oxford Economics in New York. “But it’s very bad timing. It could stifle recovery.”
The government cut its forecast for economic growth this year to 3.4 percent yesterday from the 4.9 percent estimated by the previous administration.
The slowdown is crimping fiscal revenue at the same time that an earthquake in northern Chile and a fire in the port city of Valparaiso that left more than 8,000 homeless are pushing up spending.
“The reconstruction costs are huge,” Bachelet said. “Until now we have done it through reallocation, but we’ll probably need more money.”
The government is reviewing options to plug a $2 billion income gap from initial budget projections, Finance Minister Alberto Arenas said yesterday. Options include tapping financial assets held by the Treasury and money collected from state copper miner Codelco that’s held for military spending under the so-called Copper Law, he said. The reconstruction costs alone are $1.25 billion over the next three years.
Chile’s economic growth has averaged 5.2 percent over the past 30 years, pushing income per capita to about $19,000, the highest in Latin America, according to the International Monetary Fund.
The country’s Aa3/AA-/A+ sovereign credit ratings are the highest in the region and match those of China and Japan. The 3.07 percent average yield on its dollar bonds is the lowest in Latin America, according to Bloomberg indexes. Chilean companies also pay the lowest yields in the region.
The country’s economic success has withstood the transition from the military dictatorship of Augusto Pinochet to democracy in 1990. Bachelet was exiled to Australia and then East Germany after her father died under interrogation following the 1973 coup. Bachelet has said she was detained and tortured by the junta’s secret police before fleeing the country. She returned to Chile in the late 1980s.
Bachelet won 62.2 percent of the ballots in a second round of voting in December, the biggest majority since the end of the dictatorship. She had previously served as president from 2006 to 2010, before heading the women’s unit of the United Nations. Chile’s constitution bans two consecutive presidential terms.
During her first term, Bachelet set up two sovereign wealth funds and poured money into them after the price of copper soared. She then withdrew money from the funds in order to buttress the economy against the global recession.
The sovereign stability fund rose to $15.7 billion at the end of March from $15.4 billion three months earlier, while the pension reserve fund increased to $7.5 billion from $7.3 billion.
“The way I want to lead the country is to continue doing all the good things we have done in the past,” Bachelet said. “But on the other hand, deal with the challenges.”