Chile shows great strength in recovery from disasters
Published: 31 August 2011
Demand expands after financial shock, earthquake and tsunami
The Chilean economy recovered with great strength from the two significant shocks that hit it in recent times, the global financial crisis of 2008-09 and the tragic earthquake and ensuing tsunami from late February 2010. GDP grew 6.8 per cent y-o-y as of Q2 2011 and thus stands 8.2 per cent above the Q2 2008 level.
The resurgence has been particularly strong for domestic demand, which expanded at two-digit annual rates throughout 2010 and has only moderated marginally, to a 9.4 per cent y-o-y pace in Q2 2011.
We believe that domestic demand will continue decelerating, approaching the pace of overall economic activity.
The full impact from monetary policy tightening on the overall economy takes several quarters to develop and should only now be reflected in domestic demand. Moreover, as economic activity prospects for advanced economies are frail we also expect external demand to moderate. This will be particularly relevant for non-mining export industries, which are located mainly in the areas most affected by the 2010 earthquake and which, after enduring hard times, have shone since the second half of last year.
Inflation readings have been lower than envisioned
As economic activity improved, a rise in inflation was duly expected, also fuelled by the upswing in commodity prices at the beginning of the year. However, inflation readings have been lower than envisioned. Headline inflation stood at 2.9 per cent y-o-y in July while a "core inflation" measure that excludes fresh fruits and vegetables and energy prices increased 1.9 per cent y-o-y.
In truth, the 12.6 per cent appreciation of the currency over the last 12 months played a substantial disinflationary role and thus the prices of tradable goods rose only 2.4 per cent y-o-y, buffering in part higher external prices.
We expect the currency to fluctuate around current levels. On an annual basis, the effect of the exchange rate strengthening will start to dissipate, but we expect the same to happen with commodity prices. On the other hand, non-tradable prices should continue marching close to the 4.1 per cent y-o-y pace seen in July, as domestic inflation pressures will endure.
Unemployment rate shows tight labour market
The unemployment rate, in the vicinity of 7 per cent since Q3 2010, nears levels usually considered full employment for Chile and is a testament to a tight labour market that should continue supporting a strong domestic demand and positive real wage inflation. In sum, although we still see annual inflation rising it will continue to lie within the Central Bank's 2 to 4 per cent target range.
Monetary and fiscal policy stimuli were significant after the onset of the crisis and played an important role in fostering the ensuing upturn. The monetary policy rate was brought down to 0.5 per cent in 2009, then raised by 475 basis points in little more than a year, until the Central Bank of Chile settled at the current 5.25 per cent in June. We believe that monetary policy stands now at a 'neutral' position.
Fiscal policy, however, didn't achieve such a level of consolidation. The fiscal balance deteriorated 8.7 percentage points (pp) of GDP in 2009, followed by a 4.0pp improvement in 2010. We expect an additional 0.9pp improvement in 2011, to a fiscal surplus near 0.5 per cent of GDP.
The Chilean government pursues a structural balance target that adjusts for the effects on fiscal revenues of the business cycle and the deviation of present copper prices from their long-term levels. That target has been progressively lowered from a 1 per cent of GDP surplus up to 2007 to a 1 per cent deficit in 2011, and current authorities project that the structural balance will stand below that target until 2014.
The Chilean economy stands at an enviable position to deal with the present challenges of the global economy
We currently forecast a 6.4 per cent GDP expansion in 2011 and a slowing down to 5 per cent in 2012, a rate still marginally higher than our notion of potential GDP growth for the Chilean economy. A word of caution, though, is due. The Chilean economy's relatively high openness to the global economy is both a virtue and a vulnerability. The recovery of developed economies appears to be taking place at a very slow pace. This will certainly influence Chile's economic performance. Consequentially, policymakers and observers are watching the ongoing developments closely to assess whether the baseline scenario should be modified and counter-cyclical policies should be implemented.
In that regard, monetary authorities moved out of the tightening bias that their policy meeting statements were carrying until last July. We see that as a preliminary step to be ready to start easing if global conditions worsen.
Increasing social demands add to pressure
Fiscal authorities continue to emphasise their goal of bringing down the level of fiscal expenditures with respect to GDP. However, in recent months we have witnessed an increase of social demands in Chile, regarding the speed of the post-earthquake reconstruction effort, environmental issues and, most notably and with potentially bigger budget implications, the state of the educational system. Abiding by those demands may conflict with the above-mentioned goal and may bring forward the need for increasing tax revenues.
Negotiations with student representatives will take place in the following weeks and the budget presentation is due at the end of September. At the moment, there is no clear path for resolution nor an estimate of the actual fiscal cost of a reform to the educational system in which the division of public and private funding will be on the table.
This higher demand for permanent fiscal expenditures may be coming at a time in which the outlook is also calling for transitory fiscal largesse. It has, then, the potential to result in another round of fiscal deterioration.
Even with the current debates, the Chilean economy stands in an enviable position to deal with the present challenges of the global economy, in good part thanks to its well-established macroeconomic stability. Improving its human capital could be a further way to secure sustainable development and it's a welcome development to see those issues being discussed.
Jorge Morgenstern
Jorge Morgenstern is an economist with the Latin America Research Team based in Argentina, covering Argentina, Chile, and Uruguay.
Mr Morgenstern received a graduate degree in economics from the Universidad Torcuato Di Tella and holds a bachelor in arts from the Universidad de Buenos Aires, where he teaches macroeconomics.
Before joining HSBC, he worked for a local consulting firm and the Center for Financial Research at the Universidad Torcuato Di Tella.
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