Chile - Economic Briefing January 2003

Moderate Recovery This Year Despite New Free Trade Agreements

The assessment of Chile’s near-term economic future is seen increasingly negative, as the global outlook continues to be revised downward. As the region’s most open economy, the country’s fortunes depend largely on the developments in the global economy and a lack of global demand typically affects the country twofold, via lower export volumes and by exerting downward pressure on commodity prices.

October growth exceeds expectations slightly
In October, the monthly indicator for economic activity (IMACEC, Indicator Mensual de Actividad Económica) expanded by 2.4% compared to the same month last year and was thus slightly ahead of last month’s market expectations. The annual growth rate registered in October was also ahead of a 2.1% expansion observed in September. However, the October data were partially inflated by seasonal factors, as October this year counted an extra working day compared to October 2001. Nevertheless, according to seasonally adjusted data, the economy advanced 0.13% compared to the preceding month, after a 0.46% decline in September.

November industrial production data uninspiring
The favourable economic development observed in October was propelled by a buoyant industrial sector. In October, industrial production increased at an annual 7.1% clip. In November, however, industrial activity decelerated again, expanding a meagre 0.2% over November 2001. The dismal reading was in part due to one working day less compared to the same month last year and was in line with the erratic patterns the sector has been exhibiting during the past months. Nevertheless, trend growth, which had been on the rise in the three previous months, declined again. According to the National Statistical Institute (INE), the moving annual average rate of industrial production growth has dropped from 2.0% in October to 1.8% in November. The November slump in industrial production was mostly prompted by a 27.6% annual decline in capital goods output. The drop represented the second lowest reading in 2002 and was in line with very weak readings observed since August of last year. In part, the slump in capital goods is due to a high comparison base since the subsector performed particularly strong in the second half of 2001. On the other hand, however, the performance also indicates a reluctance of domestic businesses to return to healthier investment patterns of past years and may foreshadow a weaker performance of the Chilean economy this year.

Unemployment drops but only due to seasonal hiring
Unemployment also failed to boost confidence for the remainder of 2002. While the 8.8% rate registered for the moving quarter up to November represented a 0.8 percentage points drop compared to the preceding quarter, the decline was almost entirely due to seasonal hiring. Compared to the same month in 2001, unemployment dropped only 0.1 percentage points, too little to provide the domestic economy with a growth impetus in the current setting of subdued global demand.

Short-term outlook clouded by global economy but long-term perspectives improve due to FTA with the United States
As a result of the dismal November data, Consensus Forecast panellists are sceptical about the overall economic performance in the final two months of 2002. In November, the economy is likely to have expanded by just 1.8%, rising to 2.7% yoy in December. As a result, fourth quarter growth is likely to come in at 2.5%, leaving the expansion for the full year 2002 at 1.9%. With this result, Chile has ceased the number one spot in the region in terms of economic growth, which it had held throughout most of the 1990s with average growth rates of 7%. Nevertheless, the annual rate still compares favourably to other economies in the region that are deeply mired in economic and political crisis. Moreover, while the short-term outlook remains clouded by the subdued outlook for the global economy, mid- to long-term perspectives are brightening.

On 11 December, the government announced that it had concluded the two-year negotiations for a Free Trade Agreement (FTA) with the United States. According to the government, 87% of Chilean exports to the U.S. will enter free of tariffs from the moment of entry into force of the agreement. This percentage will rise to 94.8% in the fourth year following the entry into force of the FTA. The balance of the products will receive tax-relief according to their sensitivity over a term of no longer than twelve years. The agreement opens an important market for Chile. In 2001, almost one fifth of Chile’s total exports were directed to the United States. Moreover, the FTA with the United States adds to other agreements with the European Union and Korea, completed in April and October of 2002 respectively. Naturally, these agreements will not boost economic growth in the short-term. Consensus Forecast panellists have lifted their projections for GDP growth in 2003 only one tenth of a percentage point from 3.1% expected last month to 3.2%. However, increasing trade liberalization and integration of Chile into the world economy – on 1 January tariffs were reduced from 7% to 6%, as part of the tariff reduction program implemented in 1999 -- will boost growth in the medium term. The government estimates that the beneficial impact resulting from the agreements will add 1.5 percentage points to GDP growth. The positive assessment of the medium-term growth perspectives is shared by most analysts. In 2004, the Consensus sees the economy growing by 4.4% and rising to above 5% growth in subsequent years.