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Chile risk: Macroeconomic risk
(RiskWire Via Thomson Dialog NewsEdge)COUNTRY BRIEFING
FROM THE ECONOMIST INTELLIGENCE UNIT
RISK RATINGSCurrentCurrentPreviousPreviousRatingScoreRatingScoreOverall assessmentCuPMacroeconomic riskB25B25Note: E=most risky; 100=most risky.SUMMARY
Annual economic growth averaging over 5% in 2006-07 will be supported by strong mining production and increased business opportunities arising from Chile's free-trade agreements, particularly those with China, the EU, the US and South Korea. These will strengthen confidence and boost investment, helped by the government's agenda of pro-growth regulatory changes. The current-account deficit will widen modestly in 2006-07 as Chile's terms of trade deteriorate. Inflation will remain within the Central Bank's 2-4% target range. The government will continue to pursue prudent fiscal policies, ensuring that its levels of indebtedness and debt servicing remain manageable.
SCENARIOS
Chiles economic growth lingers below its long-term trend (Low Risk)
Accelerating GDP growth has been driven by export growth and a recovery in domestic investment in 2004-05, and over 2006-07 a jump in job creation and an increase in demand for consumer and mortgage loans should bolster the outlook for consumer spending. Mining will continue to grow vigorously and the export sector will benefit from the trade agreements with China, the EU, the US and South Korea, and a trade preference agreement with India. These will underpin confidence and ensure that Chiles exporters attain improved access to these large markets. Firms should continue to monitor macroeconomic trends for indications that the economy remains on track for firm growth.
Faster than expected deceleration in global demand growth reduces growth prospects (Low Risk)
The main risks are external. As Chiles export-led acceleration of economic growth is reliant on global demand, a sharper than expected decline in global economic activity would have a significant impact on export earnings, fiscal revenue, and GDP growth. We currently expect GDP growth to remain strong in Chile in 2006-07, with stronger domestic demand offset by a gentle slowdown of demand in major markets such as the US and China, which will bring a decline in international prices for copper, Chiles main export, and a deceleration of export growth. However, there is a risk--given that the substantial external (in the US) and internal (in the US, the EU and Japan) imbalances have not been corrected and remain sources of vulnerability--of a more rapid than forecast slowdown in growth in major markets, creating greater downward pressure on commodity prices and reducing export demand. Firms should monitor external trends for indications that demand for Chilean exports remains on track.
BACKGROUND
(Background material is updated twice yearly. Last update: August 22nd, 2005)
Economic Structure
Main economic indicators2004Real GDP growth (%)6.1Consumer price inflation (av; %)1.1Current-account balance (US$ m)1,389.7Exchange rate (av; Ps:US$)609.4Population (m)16.4(a)External debt (year-end; US$ m)43,267.3(a)(a) Economist Intelligence Unit estimate.Source: Economist Intelligence Unit, CountryData.Chile is endowed with rich mineral resources that lie close to the sea. They have made it the worlds leading producer of copper, molybdenum and iodine and a substantial producer of nitrates, gold and silver among other metallic and non-metallic mineral products. Import substitution was abandoned in favour of free-market policies in the mid-1970s, more than a decade before the policy was rejected in the rest of Latin America. This move unleashed competition and productivity growth, and facilitated an expansion of Chiles traditional export industries, mostly mining and fishing. It also made possible the development of new goods export sectorssuch as cellulose and other wood-derived commodities, fruit, salmon, meat, wine, and methanoland facilitated the development of export services, particularly air transport, shipping and tourism. The strong and increasingly diversified export sector has been the main engine of growth in the past three decades.
Investment has traditionally been strong, and has recovered from the economic slowdown of 1998-2003. Annual average gross capital investment in fixed assets in that period was 23.1% of GDP, but rebounded to 25.2% of GDP in 2004 as economic growth accelerated to 6.1%. The share of private consumption in GDP rose steadily in the 1990s, to a peak of 64.2% in 1998, but has trended lower since, to 63.3% in 2004. There was also a strong rise in government consumption in the second half of the 1990s, from 8.5% of GDP in 1995 to a peak of 11.2% of GDP in 1999, but it has trended lower since, to 10.4% of GDP in 2004. On the supply side, services account for the bulk of GDP. Financial services accounted for 12.6% of GDP in 2004; other major components were trade and catering (10.8%); personal services, including healthcare and education (10.5%); transport (4.6%); and communications (3.2%). Chiles mining sector is particularly strong, accounting for 7.9% of GDP in 2004, while agriculture and forestry contributed 4.5% and fishing 1.5%. The share of manufacturing in GDP has fallen from a high of 17.2% of GDP in 1997 to 15.9% of GDP in 2004.
Economic activity is heavily concentrated in the central region. The 2002 census showed that 40.1% of the population lives in the Santiago metropolitan area and 10.2% in the adjoining Valparaso region. However, centralising trends appear to have diminished as a result of the mining boom in the north and the dynamic economy in the extreme south centred on salmon breeding, tourism and large-scale methanol production. Tourism and export agriculture are strong engines of growth in the centre-north, while forestry, tourism, fruit production and traditional agriculture are important to the centre-south regions.
Comparative economic indicators, 2004Chile(a)Argentina(a)Peru(a)Brazil(a)Mexico(a)GDP (US$ bn)94.1153.069.6604.7676.5GDP per head (US$)6,1213,9582,525(b)3,375(b)6,445GDP per head (US$ at PPP)11,71812,9645,541(b)8,570(b)9,711(b)Consumer price inflation (av; %)1.14.43.76.64.7Current-account balance (US$ bn)1.43.0-0.111.8-8.7Current-account balance (% of GDP)1.52.00.12.01.3Exports of goods fob (US$ bn)32.034.512.596.5188.6Imports of goods fob (US$ bn)-23.0-21.2-9.8-62.8-197.2External debt (US$ bn)43.3(a)160.829.6(b)220.8(b)145.0(b)Debt-service ratio, paid (%)21.8(a)26.225.3(b)51.0(b)16.5(b)(a) Actual. (b) Economist Intelligence Unit estimates.Source: Economist Intelligence Unit, CountryData.Economic Policy
At the point of the return to democracy in 1990, when the Concertacin de Partidos por la Democracia (Concertacin) coalition won power, average annual economic growth of 6.3% had been sustained for six years. This persuaded the new government to keep basic economic policies unchanged and there was consensus on the need to maintain a liberal market economy and prudent monetary and fiscal policies. Policy stability and the strong protection afforded to property rights reduced business risk and stimulated investment for much of the 1990s. The government of Ricardo Lagos, in power since 2000, has maintained this fundamentally pro-market policy direction, but has adopted a slightly more interventionist posture and adopted some populist measures in response to political pressures from elements within Concertacin. In particular, Mr Lagos has presided over a reform of employment legislation which has increased labour market rigidities.
Fiscal management was conservative and prudent in the 1980s and in the first half of the 1990s, yielding 11 years of budget surpluses and a contraction of the public debt. Policy has remained generally prudent, but excessive fiscal expansion in 1996-98, combined with an economic slowdown, pushed the fiscal accounts into the red in 1999. In response, and to justify the continuation of moderate deficits in the public-sector accounts at a time of global economic underperformance, the Lagos government introduced its fiscal rule in 2000. Designed to maintain market confidence while allowing a countercyclical fiscal policy, the fiscal rule committed the government to achieve a structural fiscal surplus of 1% of GDP. The structural accounts measure fiscal revenue at the level it would reach if GDP growth and the price of copper were at their medium-term trend levels, as estimated yearly by independent committees.
This fiscal rule allowed the government to run moderate cash deficits in 2000-03, when economic growth was slow and copper prices were at abnormally low levels. The real test of the governments commitment to the fiscal rule came in 2004, when the average copper price rose to US$1.3/lb and Chiles GDP growth reached 6.1%, yielding an 18.8% increase in government revenue in inflation-adjusted terms. The Lagos government maintained its credibility by limiting its real spending growth to 5.3%, which enabled it to achieve a fiscal surplus of 2.2% of GDP in accrued terms, and 1% of GDP in structural terms. The budget for 2005 authorised a 5.5% rise in real government spending to Ps15.5trn (about US$25bn). If this is maintained, it will yield a fiscal surplus similar to that of 2004.
The copper windfall of 2004 has allowed a further reduction in the public-sector debt, which is already low by international standards. In 2004 debt prepayments facilitated by drawdowns from the Fondo de Compensacin del Cobre (FCC, the Copper Compensation Fund) produced a decrease in the central government debt from 13.3% of GDP in 2003 to 11% of GDP in 2004, according to data from the Ministry of Finance. Further prepayments are projected for 2005, another year of high copper prices.
The pioneering move in 1980 to a pensions system based on fully-paid individual accounts managed by private pension funds (AFPs, see Financial services) is expected to help keep Chiles fiscal position structurally sound over the long term. The government still has significant pension liabilities because of the residual impact of the old system, and the rising minimum pension guarantees it has offered over the years: pension payments accounted for 29% of current spending in 2004. But unlike in most OECD countries, pension liabilities in the medium term are not expected to pose a large problem in Chile.
Monetary policy has been in the hands of the independent Banco Central de Chile (the Central Bank) since 1989. The policy aim is to keep inflation within a targeted range of 2-4% over the medium term. In the third quarter of each year the Central Bank announces an inflation forecast for the next year, which serves as the budget assumption, a move that has gained a high degree of credibility.
In July 2001 monetary policy became nominally based in a move away from inflation-adjusted target interest rates. The Central Bank replaced its real interbank rate of 3.5% with a nominal target interbank rate of 6.5%. With underlying inflation at 3%, the new nominal interest rate was identical to the old real target rate, leaving monetary policy unchanged. In line with international interest rate movements, and in an environment of low inflation, policy was aggressively expansionist between 2002 and 2004. In 2002 the Central Bank cut its nominal target interbank rate six times between January and August, from 6.5% to 3%. In January 2003 the Central Bank cut the rate further, to 2.75%, and at its December 2003 and January 2004 policy meetingsas the country was about to sink into a brief deflationary periodthe monetary authority opted for cuts of 50 basis points, reducing the interbank rate to an unprecedented 1.75%. Towards the end of 2004, the recovery of domestic demand and subsequent rise in inflationary pressures prompted the Central Bank to tighten monetary conditions. In September 2004 it raised its target rate to 2%, and then continued with increases of 25 basis points at its policy meetings of November, January, February and April, bringing the target rate up to 3%.
A gradual liberalisation of the exchange regime that began in the 1990s was completed, barring some information requirements, in April 2001. Despite the free float, the Central Bank will continue to intervene in exceptional circumstances in order to provide liquidity to the market and to iron out excessive daily fluctuations.
The public sector is generally honest and efficient. According to Transparency Internationals latest surveys, Chile is the least corrupt country in Latin America, and its standards in this respect are better than those of countries such as France, Spain and Japan. The government and opposition took strong action by undertaking fiscal and public-service reforms following a series of corruption scandals from late 2002 involving the alleged misuse of public funds. The reform package approved in May 2003 includes measures to increase fiscal transparency and establishes an apolitical civil service modelled on those with international reputations for best practice. The implementation of this major structural reform began in 2004 and is scheduled to be completed in 2010.
The economic policy reforms that rejected state intervention and inward-looking policies in favour of market liberalisation and export-led growth were adopted under the military regime in 1973-89. The democratic governments that followed have adhered to the liberal economic blueprint, with new policies retaining the same principles of a subsidiary role for the state and an emphasis on market solutions to economic problems.
The military regime led by Augusto Pinochet began by adopting a stabilisation plan to conquer hyperinflation that included trade liberalisation and the elimination of subsidies and price controls. It reprivatised firms nationalised under the presidency of Salvador Allende, cutting spending to reduce the public-sector deficit of 23.6% of GDP in 1973. Medium- and long-term economic strategies were drawn up by a group of economists trained in US universities, the so-called Chicago boys.
The most dramatic break with previous economic policy came in 1976 when Chile withdrew from the Andean Pact, a regional organisation whose protectionism and bias against foreign investment were incompatible with the countrys new development strategy. A new foreign investment regime, one of the most liberal in the world, and a new mining code established firm guarantees for property rights and offered long-term stability in the tax and labour regimes, and a radical reform of the labour code reduced payroll taxes and restrictive practices. A tax reform shifted the burden of taxes from production to consumption by applying value-added tax (VAT) at 16% to nearly all goods and services, while income taxes were lowered and simplified. Corporation tax was reduced to 10% and applied to distributed earnings only. Non-tariff barriers to imports were eliminated and import tariffs were brought down to a uniform rate of 10% from 1979. A major social security reform was carried out in 1981, under which personal pension accounts managed by private pension funds were established, leading to a steady increase in domestic savings and the development of the local capital market.
The authorities neglected to enact appropriate bank regulations, however, thereby allowing connected lending on a large scale, which was compounded by an exchange-rate policy that led to a rapid appreciation of the peso. Local banks financed large increases in consumption and investment, which drove a widening of the current-account deficit, and local producers found themselves unable to compete with cheap imports. After a collapse in copper prices and a sudden tightening of international liquidity in 1982, the government was forced to abandon the fixed exchange rate it had adopted in 1979 and to implement a maxi-devaluation. Most of the banks and large corporations that had borrowed heavily in US dollars were bankrupted, but the government rescued the banks, taking responsibility for the huge foreign debts they had contracted. The entrepreneurial empires built around these banks were liquidated, leading to the disappearance of several of the major economic groups, and in 1982 GDP contracted by 14%.
The Chicago boys lost credibility and were replaced by a more traditionalist economic team in 1984. VAT was raised to 20%, import tariffs were raised from 10% to 35%, agriculture received higher protection, and the new authorities resorted to a variety of discretionary measures to encourage economic reactivation. However, in early 1985, as soon as economic growth had resumed and public protests waned, Mr Pinochet replaced the traditionalist team with a new set of Chicago boys led by Hernn Buchi.
The reprivatisation of banks and companies rescued in 1982-83, together with a new privatisation programme covering telecommunications and most electricity companies, were used as instruments to regain popular support for free-market policies. Under a scheme promoted as popular capitalism, investors were able to buy shares by paying for them in instalments. Import tariffs were reduced once again, first to 20% and then to 15% in 1988. An innovative debt-for-equity scheme was devised to both reduce foreign debt and to stimulate foreign investment.
On the eve of the return to democracy, commercial banks debts to the Central Bank resulting from the rescue operations of 1981-83 were turned into subordinated debt. In 1989 an agreement was reached between the military government and Concertacin to make the Central Bank independent and to give it full control of monetary policy.
Chile pioneered trade liberalisation in Latin America in the mid-1970s, eliminating non-tariff barriers and simplifying tariff structures, which culminated in the introduction of a single import tariff rate from 1979. The policy of low import tariffs and a simplified trade regime was maintained by Concertacin after 1990. The uniform import tariff rate has been cut gradually, to 6% in 2003, but the countrys trade-weighted average import tariff rate fell to 2.1% in 2004 thanks to tariff concessions previously granted by Chile in trade preference agreements with several countries, including Mexico (1991), Venezuela (1993), Colombia (1993), Ecuador (1994), Canada (1997) and Peru (1998); an associate membership agreement signed in 1996 with the Mercado Comn del Sur (Mercosur, the customs union comprising Argentina, Brazil, Paraguay and Uruguay); and a free-trade area framework agreement signed in 1999 with Costa Rica, El Salvador, Guatemala, Honduras and Nicaragua, of which only those with El Salvador and Costa Rica had been ratified by April 2005.
A comprehensive economic, political, technological and cultural co-operation agreement with the EU became operational in February 2003, and, following 11 years of consultations and two years of intensive negotiations, a free-trade agreement (FTA) with the US came into force at the start of 2004. Chile is now focusing its efforts on liberalising trade with Asia. An FTA with South Korea became operational in April 2004, and in 2005 Chile started negotiations towards an FTA with China and a limited trade accord with India. It is also completing negotiations for a trilateral FTA with New Zealand and Singapore, and holding talks with Japan to assess the feasibility of an economic partnership agreement.
The radical privatisation process initiated by Mr Pinochet slowed under the first Concertacin government headed by Patricio Aylwin, but regained momentum under Eduardo Frei, whose government transferred most of the countrys main transport infrastructure to the private sector through build-operate-transfer (BOT) concessions. All commercially viable airports were tendered in 1996-98, and commercially viable roads were privatised by means of a similar scheme in 1997-99. Chiles main ports were privatised through BOT concessions in 1999, and a concession to build a new deep-water port at Mejillones was also granted. The privatisation of all 13 regional water utilities, which began in December 1998 with a tender for a controlling stake in Esval, the water company serving the Valparaso region, was completed in June 2004. A local group, Solari, tendered for and won 20-year concessions for the three water companies serving Regions I, IX and XII still in state hands. Solari bid US$172m and committed to invest US$85m within 24 months. Plans to tender the completion of the primary drainpipe grids to collect rainwater in the countrys main urban centres are well advanced, but these projects are worth about US$1.5bn in total and will probably be left to the next government.
The idea of privatising the Corporacin Nacional del Cobre de Chile (Codelco, the state-owned copper company), by far the largest company in the country, remains unpopular, and the ruling Concertacin coalition has no intention of doing so. Codelco is required by law to retain total ownership of its traditional divisions, Chuquicamata, El Teniente, El Salvador and Andina, and to develop on its own its two richest copper mineral deposits, Radomiro Tomic and Mansa Mina. However, the company has been given considerable operational autonomy since 1993, which has enabled it to undertake a gradual privatisation of its non-core assets. In 1994 it entered a joint venture as a passive partner with Cyprus-Amax to develop the US$1bn El Abra copper mine, which has been in production since 1996. It also sold a controlling stake in its old Tocopilla thermoelectric plant in 1995. These moves enabled it to raise funds to develop new projects such as the construction of a US$588m copper mine, Radomiro Tomic, which started production in 1998.
Codelcos exit from non-core businesses continued at the end of 2003 with the sale of its Coya and Pangal hydroelectric plants to Australias Pacific Hydro for US$86m. The company is also considering selling its 49% stake in El Abra to raise funds for other projects. It has increased planned investment for 2000-06, up from US$3.6bn to US$4.5bn, in order to bring forward the development of its Gaby Sur and Mansa Mina mine projects. It also plans to build a smelter and refinery at Mejillones at a cost of US$1bn, and will invest US$800m in its Andina division to raise the capacity of its mineral concentration plant from 64,000 tonnes/day to 135,000 tonnes/day.
Codelcos strategic plan for 2001-06 aims to double the companys value; to contribute US$1.4bn/year to the government, based on an assumed long-term copper price of 97 US cents/lb; to expand abroad by acquiring mining assets elsewhere in Latin America; to remain the worlds leading copper producer by raising capacity by about 250,000 tonnes; and to remain one of the worlds lowest cost producers. Thanks to rocketing copper prices, Codelco achieved pre-tax profits of US$3.3bn in 2004, 444% higher than in 2003 and a new record. This yielded US$1.6bn for the Treasury, US$598m (10% of sales) earmarked to the military, and US$1.1bn in net profits.
Economic Performance
GDP growth averaged 4% per year in 2000-04 at 1996 prices, down from an average of 5.4% in 1995-99 and 7.3% in 1990-94, because of less favourable external conditions and an increasingly rigid labour market. Exports of goods and services continue to be Chiles main engine of growth, and accounted for 35.3% of total GDP in 2004, up from 31.4% in 1999. Annual average private consumption growth fell from an unsustainable 7.7% in 1994-98 to 3.7% in 2000-04, which helped to reduce import growth from an annual average of 13.4% in 1994-98 to 8.9% in 2000-04. Import growth was however, a strong 17.7% in 2004 and will remain at high levels in 2005 as high copper prices strengthen confidence. The domestic savings rate is also rising, from an annual average of 20.7% of GDP in 1999-2003 to 25.5% of GDP in 2004, and is likely to remain high in 2005 as a result of still-favourable terms of trade. Gross investment in fixed assets fell from an average of 27.7% of GDP in 1994-98 to 23% in 1999-2003, but reached 25.2% of GDP in 2004, while the current-account deficit moderated from an average of 3.9% of GDP in 1994-98 to 1% of GDP in 1999-2003 and moved to a surplus of 1.5% of GDP in 2004. By sector, fishing and communications were the most dynamic in 2000-04. Both sectors posted average annual growth of 8.8% in the period. They were followed by agriculture and forestry (5.8%), transport (4.7%) and electricity, gas and water (4.4%), manufacturing (3.5%), mining (3.3%), and construction (3.1%).
Growth in gross domestic product(%; at 1996 prices)20042000-2004 (annual av)Private consumption5.63.7Government consumption3.02.9Gross investment in fixed assets12.76.6Exports of goods & services13.56.7Import of goods & services17.78.7Agriculture & forestry7.05.8Fishing21.38.8Mining6.93.3Manufacturing6.93.5Electricity, gas & water3.84.4Construction5.03.1Trade & catering6.83.9Transport5.64.7Communications3.28.8Financial services5.94.2GDP6.14.0Source: Banco Central de Chile.A highly credible inflation-targeting regime helps to anchor inflationary expectations. Inflation averaged 2.8% per year in 2000-04, falling slightly below the middle of the Central Banks 2-4% medium-term target range. Inflationary pressures have been rising modestly since mid-2004 to within the Central Banks target range of 2-4%, driven in large part by rising energy prices and strengthening domestic demand. Year-end inflation was 2.4% in 2004, up from 1.1% in 2003. Wages and salaries rose by an average of 1.6% per year in inflation-adjusted terms in 2000-04, and by 1.8% in 2004 following a rise of just 0.9% in 2003. The national unemployment rate averaged 8.8% in 2004, up from 8.5% in 2003, yielding an average of 9.1% in 2000-04.
Inflation and wage rises(%; end-period)20042000-2004 (annual av)Consumer prices2.42.8Wholesale prices7.87.0Real wages1.81.6Source: Instituto Nacional de Estadsticas.
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