Chile - Economic Briefing March 2003

Sluggish Global Economy Weighing Down on this Year’s Outlook  (continued)

Consumer prices spike sharply in February propelled by higher oil price
In February, consumer prices rose 0.80%. The consumer price increase blasted expectations of 0.22% and represented the highest increase since October last year. In January consumer prices had increased a much more moderate 0.10%. The February price hike was mostly driven by higher fuel prices, which registered an 8.32% month-on-month jolt. As a result, those price categories, which include elements of fuels, such as transport and housing, exerted the highest upward pressure on the general price level. Health prices also spiked, contrasted by lower prices for clothing, food and household equipment. The annual headline inflation rate mushroomed from 3.0% in January to 3.8% in February and even the core inflation index, which excludes the fuel price movements rose from an annual 1.7% in January to 2.1%. Moreover, wholesale prices indicate further pent up pressure on consumer prices, currently being held back by sluggish domestic demand. In February, wholesale prices surged by 2.78%, taking the annual rate from 13.2% in January to 15.8%. The rapid surge in consumer prices has taken annual headline inflation close to the upper limit of the 2% to 4% target range set by the Central Bank. This is a rapid reversal in the trend considering that as recently as June of last year inflation was touching the lower end of the range. With core inflation still remaining very subdued, the Central Bank is unlikely to tighten its monetary policy stance at least as long as domestic demand remains in check. Moreover, most analysts still believe that a war with Iraq would be short and that oil prices will drop from their current highs by the end of the year. Thus, the main inflation driver would loose force in the second half of the year, which is reflected in the Consensus Forecast for inflation. Even though the Consensus has hiked its year-end headline inflation outlook a notch since last month, the anticipated 2.9% remains well within the Central Bank’s target range and is also well below the current rate.

2002 fiscal deficit better than expected as tax take improves towards end of the year
In 2002, the central government incurred a deficit equivalent to 0.8% of GDP. Last year’s deficit figure compares favourably to the 1.1% expected by the Consensus. However, the deficit was a notch ahead of the government’s objective of 0.7% of GDP and significantly above 0.3% of GDP deficit registered in 2001. The fact that the full year deficit fell only slightly short of the original plan is rather remarkable since the actual economic data came in well below the assumptions underlying the budget. Growth was less than half the projected 4.5% and copper prices averaged 71.2 cents per pound compared to the projected 78 cents per pound. However, these detrimental effects were compensated for by a better-than-expected tax take, which profited from the Tax Evasion Law approved in 2001. As a result, the performance of public sector finances improved notably throughout 2002. The tax take reverted from a 0.8% decline in the first half to a 7.9% increase in the second (3.4% for the full year), as the effects of the tax reform kicked in, whereas government expenditures exhibited a reverse development. Consequently, the fourth quarter deficit came in at only 0.3% of GDP, the lowest fourth quarter deficit since 1997. This trend is likely to persist throughout the first half of 2002. Nevertheless, the Consensus seems to doubt that the recent development will persist, estimating this year’s fiscal deficit to come in at 0.8% of GDP.

Fitch Ratings downgrades Chile’s long-term local currency rating as structural growth impediments could require tighter fiscal stance
Concerns about the country’s fiscal position were also a key factor in the decision of international rating agency Fitch to downgrade Chile's long-term local currency (Chilean peso) rating to 'A+' from 'AA-' on 24 February. The agency confirmed the long-term foreign currency rating of 'A-' and the short-term rating at 'F1' with a stable outlook. Nevertheless, the agency is concerned that recent sluggish economic growth performance could partially reflect structural factors in the Chilean economy, in addition to cyclical and external factors. Fitch believes that Chile may have to tighten its fiscal policy if structural impediments to growth prove long-lasting. The foreign currency rating was left unchanged since the agency assesses Chile’s external position as robust. However, Fitch notes that external finances are not invulnerable to pressures, as potential claims on official foreign exchange reserves could emerge in the private sector. In fact, external debt has risen sharply in recent years, largely due to higher external borrowing of the private sector. In December 2002, external debt reached US$ 40.4 billion, up from US$ 37.8 billion at the end of 2001. Moreover, due to the erosion of the peso value, the debt-to-GDP ratio has deteriorated even more from 57.0% at the end of 2001 to 62.6% at the end of last year. However, even though the exchange rate weakened in the first two months of the year, the peso is expected to strengthen again – panellists see the currency at 717 pesos to the US$ by the end of the year – and the medium-term outlook for the currency is very stable, according to the Consensus Forecast. Therefore, given the improving growth perspectives in the medium term and only moderately increasing debt levels, the debt-to-GDP ratio is unlikely to deteriorate further.