Central Bank cuts rates again.  The sudden drop in inflation and the unexpected rise in unemployment have prompted the Central Bank to further ease monetary policy.  In an extraordinary meeting on 2 March, the Central Bank decided to cut lending rates by 50 basis points to an inflation-adjusted 4.0%.  The move represented the third rate cut in five weeks and the benchmark rate is now at its lowest level in 13 years.  The Bank argued that the recent data releases confirm a scenario characterised by lower inflationary pressures than previously expected.     

While the rate cut will not serve as a short-term relief to the slowdown in economic growth, it may help to ease the costs for debt-ridden smaller companies and thus bolster economic growth in the medium-term.  However, the Central Bank also runs the risk of provoking the contrary of the desired stimulus.   Since the lingering pessimism is at the centre of the problems, further easing may add to the gloom-and-doom mood prevailing in the market instead of restoring confidence among consumers and investors.  Thus, the rate cut may further feed the vicious circle of pessimism that currently is holding its grip on the Chilean economy.   

Peso weakens.  The surprising rate cut prompted a substantial weakening of the peso.  In addition, some investors have moved assets from inflation-indexed instruments to US$ denominated assets after the release of the February inflation data indicated a sharp drop in returns.  As a result, the peso weakened to a new all-time low of 589 pesos per US$ on 6 March and remained at that level, closing on 9 March at 588 pesos per US$. 

Current account deteriorates.  According to preliminary Central Bank data, the current account deficit reached US$ 989 million in 2000 (1999: US$ -78 million).  The current account gap was more than compensated for by a surplus in the capital account balance, which accrued US$ 1.2 billion (1999: US$ -764 million).  Thus, international reserves increased by US$ 200 million after taking into account errors and omissions of US$ -12 million.  The current account deficit was the result of a lower trade surplus, which dropped from US$ 1.7 billion in 1999 to US$ 1.4 billion last year, as a 16.3% increase in exports was offset by a 19.9% growth in imports.  The surplus in the capital account resulted from “other capital” inflows, particularly short-term bank credits, whereas foreign direct investment plummeted from a 1999 surplus of US$ 4.4 billion to a US$ 1.1 billion deficit in 2000.  The decline in foreign direct investment is disconcerting, since healthy inflows in the 1990s constituted a major driving force behind economic growth and persistent absence of capital flows could prompt a shift towards a less favourable growth pattern in the medium to longer term.   

Government announces debt relief program.  On 7 March, the government announced a package of measures intended to alleviate the financial situation of highly indebted small and medium-sized enterprises. The main objective is to provide financing facilities for the rescheduling of loans.  Key to the US$ 2 billion programme is the provision of loan guarantees. The measures also will extend terms for tax and pensions payments.  According to the government, the programme will not affect fiscal surplus targets.  While the business community has welcomed the announced measures, the plan is unlikely to put an end to the pessimism.  Rather, the government would have to push its labour reform through Congress and thus eliminate the lingering uncertainty. 

Note:  The above text is an abridged version of the LatinFocus Consensus Forecast briefing on Chile.  For more details please click here.

For five-year forecasts, please click here.