Boston, MA -- (SBWIRE) -- 05/21/2014 -- We believe that weaker fixed investment amidst mounting external headwinds - namely, cooling external demand from China for copper - will negatively affect real GDP growth in Chile in 2014. That said, we expect that expansionary fiscal and monetary policies by the Chilean government will provide some support for the economy, underpinning our forecast for headline growth of 3.4% in 2014, down from growth of 4.1% in 2013.

We believe that the Banco Central de Chile's monetary easing cycle has now concluded following 100 basis points (bps) of cuts to the benchmark interest rate since October 2013, bringing it to 4.00%. That said, given our below consensus outlook on economic growth, we acknowledge downside risks to our end-2014 policy rate forecast of 4.00%, and we cannot completely rule out another 25 or 50bps of rate cuts.

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We expect a slight narrowing of Chile's current account deficit in 2014, due to more moderate income account and services balance shortfalls, combined with slight upside for non-mining exports. While weaker investment inflows could still leave the current account underfunded, leading to a drawdown in foreign reserves, we expect Chile's balance of payments position to remain broadly stable in the coming years as the economy

Michelle Bachelet's return to the Chilean presidency in 2014 will pave the way for a highly ambitious reform agenda, which seeks to raise taxes and introduce higher-quality free education in the country. However, due to an insufficient parliamentary majority, we believe that the centre-left coalition will need to compromise on reforms, ensuring that Chilean politics do not veer too far left over the coming years.

We forecast that Chile's primary budget surplus will shrink to 1.6% of GDP by 2015, from 2.9% in 2013, due to decelerating growth in revenues as economic growth weakens, and an uptick in public expenditures. That said, we believe that the government's tax reform bill, which will be gradually phased in over the coming years, will bolster revenues over the long term, prompting the primary budget surplus to widen again beginning in 2016.

Major Forecast Changes

We are revising down our 2014 real GDP growth forecast for Chile from 3.7% to 3.4%, as a sharp drop in fixed investment in Q413 points to weaker economic activity in the months ahead, particularly given the fall in the price of copper, Chile's key export, seen during the first quarter of 2014. While expansionary fiscal and monetary policies by the Chilean government will provide some support for the economy, we believe that the risks to our growth forecast remain weighted to the downside, particularly should copper price take another substantial leg lower.

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