Country Report Chile
Chile’s economy has continued to perform well in 2012, as it is estimated to have grown by 5.4%. Growth was driven by consumption and investment. This has resulted in a strong increase of the current account deficit. However, the current account deficit is still more than covered by large net FDI inflows. The Chilean economy is expected to continue to do well in 2013. Chile’s labor market is very tight and while inflation has fallen below the lower bound of the inflation target zone in 2012, it may start to rise again. For Chile, 2013 will be an important political year, as presidential and congressional elections will take place in October. One of the main tasks of both the current and a new government is preventing an energy crisis, as lack of investment in the past may result in shortages in the medium term.
Political and social situation
For Chile 2013 will be an important political year, as both congressional and presidential elections will be held on 17 November 2013. In 2009, the center right Coalición por el Cambio (Coalición) led by current President Sebastián Piñera won the elections. According to the polls the government and the president enjoy low approval rates at the moment. However, most members of Piñera’s administration enjoy high approval ratings. The most likely candidate for Coalición is Laurence Golborne, the minister who supervised the rescue of trapped miner in 2010, and is right now the second-most-popular politician of Chile. Meanwhile, the popularity of Piñera, who is not allowed to run, as the Chilean constitution does not permit two consecutive terms, has been increasing lately. Meanwhile, the other political block in Chile, the center-left Concertación de Partidos por la Democracia (Concertación) coalition, is even less popular than the Coalición. It will participate in the election hand in hand with the Communist Party, which may deter some voters. However, its likely presidential candidate, former President Michelle Bachelet (2006-10), remains by far Chile’s most popular politician. The overall impact of a change of leadership is likely to be limited, as support for the current macroeconomic policy mix is strong within all political parties.
In 2012, there has been some controversy about poverty statistics. Government statistics indicated that poverty (according to the national poverty line) fell from 15.1% in 2009 to 14.4% in 2012. However, there are accusations that the government has muddied the methodology and two of the officials who worked on the latest poverty survey left their job afterwards. What seems clear is that poverty has increased since 2006, when 13.7% of the population lived below the national poverty line, and that the improving trend from before 2006 has thus stopped. Meanwhile, income inequality remains high in Chile, with the country having a Gini-index of 52.1 in 2009. Nevertheless, the middle-class has grown over the last decades and has become more vocal. During 2011, there were widespread student protests, with students demanding free education for all. Without fully giving in to their demands the government has reduced the cost of student loans and has increased education spending. In 2012 the student movement lost part of the popular support it enjoyed in 2011, but there is still some frustration. In recent decades crime and violence were on the rise in Chile, which has resulted in security issues becoming one of the most important concerns of the population. Recently however, crime has started to fall.
In the past two decades Chile has successfully stabilized its economy. The country has established a good inflation track record. Since the end of 1999, a full-fledged inflation targeting regime has been in place and since 2007 the inflation target has mostly been 3%, with a 1% plus-or-minus tolerance band. High commodity prices resulted in year-on-year inflation peaking at 9.9% in October 2008. Afterwards, inflation has fallen and since mid-2010 inflation has only been above the upper boundary between December 2011 and February 2012. In the course of 2012, inflation even fell below the lower boundary to a low of 1.5% in December 2012. However, that same month non-tradable inflation was 0.8% month-on-month, which suggests that inflationary pressures are increasing. Nonetheless, inflation is likely to remain within the target range in the short run. In January 2012 the central bank decreased its policy rate by 25 basis points to 5%. Since then it has kept its main policy rate at that rate.
Chile has been fiscally prudent. The government has committed itself to a structural fiscal surplus rule since 2001. The purpose of this rule is to ensure that the government has a fiscal surplus in the medium-term by estimating fiscal revenues and adjusting these for the impact of the business cycle and copper prices. Until 2007 the structural surplus was set at 1% of GDP. High commodity prices resulted in the budget surplus peaking at 8.4% of GDP in 2007. This prudent stance allowed the government to stimulate the economy in 2009, 2010 and 2011, when Chile was first hit by the global financial crisis and later by a major earthquake. In 2012, the fiscal surplus is estimated to have been 1.4% of GDP. At end-2012, public debt was low at 10.1% of GDP, while the government had accumulated USD 20.9bn in its two main sovereign wealth funds.
Since the end of 1999, a floating exchange rate regime has been in place. In early 2011, the central bank launched a USD 12bn foreign exchange accumulation program to counter upward pressure on the peso, but this program ended in December 2011. In the second half of 2012 and in January 2013, the Chilean peso appreciated again. Both President Piñera and his Finance Minister Felipe Larrain have indicated that they watch the exchange rate closely, given fears that a high exchange rate could damage the performance of export sectors. However, there are no indications that the central bank is about to intervene. If the pressure on the peso increases, the central bank may start a new foreign exchange buying program, but Chile is unlikely to introduce capital controls.
The Piñera government has tried to raise productivity and boost investment by a number of microeconomic reforms. For example, it has been made possible to set up a company online in one day and free of charge. Efforts to make labor regulations more flexible have failed after trade unions walked away from talks with the government. In early 2013 the government is focusing its reform efforts on introducing legislation that will make it easier to build energy infrastructure. This is welcome, given the energy challenge is facing, as we mentioned above.
Balance of payments
In the past two years, Chile’s current account has swung into a deficit. While the country posted a surplus of 1.8% of GDP in 2010, this turned into a deficit of 3.8% of GDP in 2012. The deterioration of the current account was primarily the result of the booming domestic economy and high imports thanks to earthquake reconstruction and infrastructure projects. Meanwhile, export growth was very modest, as Chile had to cope with a decline of the price of copper, its main export product. Overall, Chile maintained a sizeable but declining surplus on its trade surplus. Meanwhile, the large deficit on the income account grew. The deficit on this account is for a large extent related to repatriations by multinational companies. Meanwhile, net inflows of foreign direct investment (FDI) remained very large. As net FDI was equal to 4.1% of GDP, it more than covered the current account deficit. Although net FDI inflows were particularly strong in 2012, Chile has structurally been able to attract a lot of FDI. Net FDI inflows have not fallen below 2.79% of GDP in the past ten years and are expected to remain strong. This strongly reduces balance of payments risk. Meanwhile, the fact that Chile is stashing part of the copper income in sovereign wealth funds is resulting in net outflows of portfolio investment. As the foreign exchange intervention program of the central bank, launched in early 2011, ended later that year, Chile’s foreign exchange reserves hardly grew during 2012. Overall, the biggest risk to balance of payments position is a prolonged period of low copper prices.
Chile’s foreign reserves were equal to nearly 6 months of imports and covered 85% of the debt service at end-2012. However, next to foreign reserves, the government also has two large sovereign wealth funds which contained about USD 21bn of liquid USD, Euro and Yen assets in December 2012. As result the government is a net creditor. At end-2011 Chile did have a small negative Net International Investment Position of 9.6% of GDP. The risk profile of the external position is low, as 58% of the external liabilities exist of foreign direct investment stock, while Chile’s foreign assets are relatively liquid, with foreign reserves accounting for 17% of foreign assets and (other types of) portfolio investment accounting for 42% of foreign assets.
Economic structure and growth
In 2012, Chile’s economy has continued to grow rapidly. The economy is estimated to have grown by 5.4%, after two years in which it had grown by 6%. Both investment, which was boosted by the reconstruction activity following the 2011 earthquake, and consumption continued to boost growth. Just like in 2010 and in 2011, the services sector in particular grew rapidly in last year. In 2013, we expect the Chilean economy to continue to do well and to grow by 4% to 5%. Chile’s labor market is tight. Unemployment is now at historically low levels, there are report of labor shortages in some sectors and real wage growth has been strong. Since the 2008/2009 global financial crisis, strong employment growth, with the labor force participation increasing by 4% per year, has allowed the economy to grow relatively quickly. There is still some room the increase the participation of female and young workers, but with unemployment now at historically low levels, increasing productivity is getting more important. This will be a challenge, as labor productivity growth declined from 4.8% in the 1990s to 1.5% in 2006-2011, according to the IMF.
It is hard to overstate the importance of the copper sector for Chile’s economy. Copper exports accounted for 54% of the total exports in 2011 and 18% of GDP and copper revenues accounted for 19% of total government revenues. Other important export products are fresh fruit, cellulose and fish, but together these account for just 14% of total exports. The dependence on copper income is a vulnerability, although Chile’s prudent macroeconomic policies strongly mitigate this risk. Another weakness of the Chilean economy is its relative small size. Furthermore, energy is also an important issue. Due to a lack of investment in energy generation in the past, spare capacity is very low. Meanwhile, the expected increase in mining activity will strongly boost demand for energy. Energy experts have warned that Chile may face electricity rationing and blackouts in 2016 unless the country speeds up the construction of new energy generation facilities. Unlike most of its neighbors, Chile has to import most of its oil and gas consumption, while environmental regulations and protests make it difficult to build hydroelectric plants. The government indicated in late 2012 that it plans to investigate in 2013 whether nuclear energy could be an option, although this type of energy has become more controversial in earthquake-prone Chile after the 2011 Fukushima disaster.
The quality of non-energy infrastructure is good in general. In fact, Chile has the most developed infrastructure of Latin America. Furthermore, the country has a favorable business climate, strong macroeconomic and political institutions and low levels of corruption. On Transparency International’s Corruption Perceptions Index Chile ranks number 20 (out of 176 countries), making it the country that is considered to be the least corrupt of Latin America, together with Uruguay. The banking sector is relatively sound. Banks are profitable and capital and liquidity ratios are relatively high, while non-performing loans are low. However, real estate prices have increased rapidly recently, which prompted the central bank to state in December 2012 that developments in the mortgage and real estate market need to be monitored closely.