Chile - Economic Briefing March 2004

Global Rebound and Buoyant Copper Prices Drive Economy (continued)

Central Bank to maintain interest rates at low levels
The Central bank is well aware of the deflationary risks to the Chilean economy and has successively lowered its policy rate to 1.75% in January, the lowest rate ever.  In its 10 February meeting, the Central Bank board stated that it expected the current price trend to persist for several months but sees inflation approaching the 3% target towards the end of its 24 month horizon.  Consensus Forecast panellists share the assessment of the Central Bank and see inflation rising to 2.2% by the end of the year and to 2.9% by the end of 2005.

Peso experiences volatile trading
In February, the peso remained virtually unchanged versus the US$.  After reaching 597 pesos per US$ at the end of January, the Chilean currency began to strengthen to 571 pesos per US$ on 19 February only to weaken again to 594 pesos per US$ by the end of the month.  The main determinants of the current development in the foreign exchange markets are the Central Bank’s accommodative stance, which tends to weaken the peso, on the one hand, and the resilient copper price, which serves as a stabiliser of the currency on the other hand.  Consensus Forecast panellists expect the currency to end the year at 604 pesos to the US$.  Exchange rate stability will also carry over into 2005, when the currency is expected to depreciate only marginally to 615 pesos to the US$.

Fiscal deficit in 2003 in line with expectations
In 2003, the central government incurred a fiscal deficit equivalent to 0.8% of GDP, corresponding to a negative balance of 417,224 million pesos (approximately US$ 603 million).  The reading was in line with the Consensus Forecast and allowed for compliance with the 1.0% structural surplus rule, which mandates a 1.0% surplus assuming growth at full potential. 

Copper revenues drop despite higher prices
Revenues remained 2.9% below the total revenues estimated for the year, as the government had anticipated stronger growth than the actual 3.0% registered for the year.  Revenues remained below expectations due to lower tariff collection in the wake of the free trade agreement (FTA) with the European Union. In addition, income tax collection did not grow over 2002 in contrast to expectations.  However, the revenue shortfalls were partly compensated with higher collection of value added tax (VAT), in part explained by the increase in this tax from 18% to 19% in October 2003.  Ironically, revenues coming from copper suffered a 3.6% reduction compared to the previous year, despite higher copper prices.  The increasing copper prices during the second half of the year forced the government to reduce withdrawals from the Copper Stabilization Fund which could not be compensated with higher revenues from state-owned copper miner Codelco because the company reduced its production levels during 2003.  

Government optimistic for 2004
Central government expenditures increased 3.3% in real terms compared to 2002, 2.0% below the planned level.  For 2004, the Finance Ministry indicated that the actual deficit could be below the planned 0.6% of GDP target.  In fact, the fiscal balance this year could end in the positive due to the fact that current economic conditions have improved since the budget was presented in October.  In particular the copper price has risen sharply since then, leaving the budget assumptions well behind.  The Consensus remains more skeptical about the government’s ability to stay clear from red ink this year and expects a fiscal deficit of 0.3% of GDP.  As of 2005, however, the government is expected to return to budget surpluses again that have earned Chile its current reputation as a model of fiscal prudence in the region.