Chile’s Economy: Playing the Long Game

Chile is a small country that is highly exposed to the global economy because of its trade openness and dependence on exports of raw materials, especially copper. But the economic impact of the current global crisis, triggered by the debt crisis in the euro zone, has so far been limited.

“There has been some impact, for example on exports to Europe, but the effects have been relatively insignificant,” said Rodrigo Vergara, the president of Chile’s Central Bank, at an AmCham breakfast at the Radisson Hotel on September 28.

In fact, Chile’s Gross Domestic Product grew 5.4% in the first half of this year versus the same period of 2011, which is “very significant growth within the current international context,” he said.

But that doesn’t mean Chile has been immune. Although demand remains strong, Vergara expects growth to average between 4.75% and 5.25% in 2012 (down from 6% in 2011) including a “moderate slowdown” in the second half of this year.

Globally, there have been some positive signs in recent months but “let’s not fool ourselves, it’s still a very complicated situation and there is a long way to go,” said the Harvard-trained economist.

He noted that while fiscal measures announced recently by Spain and Germany have helped to reduce sovereign risk premiums in these countries, they are unlikely to reduce market volatility in the medium-term. Recent popular protests in Spain and Greece, as well as political divisions within the euro zone, have not helped to restore confidence.

Meanwhile, the rest of the world is showing signs of weakness. Growth in the United States has been sluggish with unemployment hovering around 8%. The Federal Reserve’s new QE3 asset purchase program, combined with historically low interest rates, is part of an expansive policy that is expected to continue for some time, said Vergara.

China, for its part, has cut its growth target to 7.5% in 2012 which, while still very strong, is less than the average two-digit growth seen over the last decade.

“Whatever happens in the Chinese economy is very important for Chile, especially in terms of the demand for commodities.”

As for the other BRIC countries, there has been a slowdown in India and, more importantly for Chile, in Brazil. In the rest of Latin America, the outlook is “reasonably positive” for the Pacific Rim countries, namely Mexico, Colombia, Peru and Chile, said Vergara.

In Chile the economy continues to show solid growth driven by consumer demand and a high level of employment, while inflation remains low. In fact, the Central Bank forecasts inflation of just 2.5% for 2012 and sees it staying under its target of 3% in the long term.

“There are still medium term risks since the labor market is tight and the capacity gap has been closing, which means we have to be very cautious,” said Vergara.

As for the real exchange rate, he pointed out that Chile is not alone in facing the weakness of the US dollar, which has affected all emerging economies to differing degrees. The dollar has been further weakened by fiscal stimulus measures in the United States, but despite the strong appreciation of the Chilean peso in 2012, over a longer time period the increase is in line with the regional average, he noted.

And it could be worse. A portion of Chile’s copper income is saved in an offshore sovereign wealth fund, which helps to mitigate the impact on the exchange rate. But that’s not much solace for fruit exporters that are calling for the Central Bank to intervene.

“The value of the dollar is at the lower end of its long-term fundamentals, which means we have not ruled out intervention if it is justified,” he said.

But there is no “magic bullet” and intervention also has its costs, he pointed out. The Central Bank has maintained its benchmark rate at 5% since January and, while a temporary reduction could alleviate the effects of the exchange rate, it would also pressure inflation going forward.

“The Central Bank makes decisions based on long-term trends rather than short-term variations,” Vergara explained.

But there are non-exchange rate measures that could improve Chile’s competitiveness. For example, energy costs are an important challenge since industrial electricity prices in Chile are above the OECD average. “The authorities have to take measures to bring energy costs into line with our level of development,” he said.

The current labor shortage is another issue facing employers. “This is good news on the one hand because it means higher wages and better income distribution in the medium term, but it must be supported with job training so that salary increases are accompanied by higher productivity.”

Chile also has one of the lowest rates of female labor force participation in the OECD, which needs to change for Chile to boost its competitiveness, Vergara said. Other challenges include removing bottlenecks in transport infrastructure and controlling public spending.

With Chile’s Congress currently considering the 2013 fiscal budget, the government and the private sector should be wary of the economic impact of higher spending, said Vergara.

But fiscal discipline is not enough. As Chile’s per capita income nears developed country standards, the economy will naturally become costlier and producers will have to increase their productivity to compete better. “Innovation and diversification of markets are essential elements in this,” Vergara concluded.

Julian Dowling is Editor of bUSiness CHILE

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