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The thesis that as economies mature, growth tends to slow is dismissed – more or less out of hand – by Sebastián Piñera, Chile’s president since March. His promise during his election campaign was that he would make Chile grow at 6% annually – effectively, twice its average for the past four years. His finance minister, Felipe Larraín, takes a similar line: “Our diagnosis was that the economy had lost a lot of steam,” he says. “If we could achieve an average 6% annual growth and create 200,000 jobs a year, wages would grow and we would be able to make a significant dent in poverty. It would leave Chile poised to become a developed country by 2018.”
For this year and next, it looks as if the new government may come close to achieving its growth target. Recovering more quickly than expected from the earthquake and tsunami that devastated a large part of central Chile in February, growth in the second quarter surged to 6.5% year-on-year and, according to preliminary indicators, has since accelerated further.
As a result, the autonomous central bank anticipates that, even with the dent made by the earthquake in the economy’s first-quarter performance, growth over the whole year will reach 5.0–5.5%, before rising to 5.5–6.5% next year. Moreover, according to central bank governor José de Gregorio, Chile can expect a prolonged period of strong growth.
In another forecast, also released in early September, JP Morgan suggested that, in 2011, Chile and Peru, with expansion rates of 6% a year, could emerge as the world’s fastest-growing economies after China and India.
Chile would regain the position it enjoyed in the 1990s as a star international performer.
Most of the present acceleration is, however, a lagged effect of last year’s expansive fiscal and monetary policies, says Oscar Landerretche, an economist at the University of Chile who was chief economic adviser to Eduardo Frei, Piñera’s main rival in the presidential elections. “The international recession had less effect on Chile than expected so, with hindsight, there was perhaps an overshoot in fiscal and monetary stimulus,” he says.
Ironically, after the initial shock, the earthquake has helped by boosting spending on the repair and reconstruction of roads, ports and factories. The central bank reckons investment will surge by 21% this year and just under 14% in 2011.
At the same time, unemployment has shown a sustained decrease, bucking its typical winter increase. By July, the national unemployment rate was running at 8.3%, down from 9.0% in March, and had begun to drop even in the Biobío Region, one of the areas worst hit by the earthquake.
PROBLEM START
Although the economy was strengthening, the new centre-right government had a difficult start. It took longer than usual to get into gear, says Joaquín Vial, chief economist for South America at BBVA Research. That was partly inevitable: it took office after two decades in opposition and its inexperience was tested by the aftermath of the earthquake, which occurred just 12 days before its inauguration.
There are some question marks over its estimate of the cost of the earthquake damage. The overall figure of $30 billion, originally floated by a US-based risk management company, was so rapidly adopted by Piñera that many surmised he had given his ministers the answer before they had had time to do the sums.
There is, however, broad consensus that the plan the government announced in April for raising $9.3 billion to deal with the damage is a sensible one. “It’s a balanced package that, most importantly, includes a tax component,” says Vial.
That was a key consideration in putting the plan together, says finance minister Larraín. The new government inherited a sovereign wealth fund worth $11 billion and could simply have dipped into those savings. “But there’s a big difference between financing out of income and out of the piggy bank,” says Larraín.
For businesses faced with a temporary increase in taxes, there was also good news. In July, Chile placed two 10-year sovereign bonds, raising a total of just over $1.5 billion, in an exercise designed to help finance reconstruction while also providing a new benchmark for Chilean corporate bonds.
Chile had been absent from the sovereign market since 2004 and its previous bonds were too illiquid to serve as a benchmark. Moreover, for the first time, one of the new bonds was peso-denominated, opening the way for local companies to use the international debt market without incurring exchange-rate risk.
The business community, however, is ambivalent about Piñera. Ostensibly one of them, he is, nonetheless, regarded as an outsider who amassed his fortune – estimated by Forbes magazine at $1 billion in 2009 – largely through astute financial investments, rather than the grind of building a company.
He is also regarded as impetuous, a trait seen in August when, after obtaining its environmental go-ahead for a proposed coal-fired power plant in northern Chile, France’s GDF Suez received a call from him telling them that the plant’s location – near a marine sanctuary – was not acceptable. In response to business complaints, he has since promised that this was a one-off decision but, if investment in energy projects were to halt, the government’s growth target would certainly be at risk.
LONGER-TERM CHALLENGES
Another issue worrying businesses and, particularly exporters, is currency appreciation. Although this is common to other emerging markets, it has been exacerbated in Chile by the strong price of copper, by far the country’s largest export, and, since early July, the free-floating peso has appreciated almost 10% against the dollar.
Piñera has insisted that he is committed to a “competitive, stable peso”, but there has been talk of Dutch disease, where increases in exploiting natural resources coincide with a decline in manufacturing. That is an exaggeration, says Landerretche – “it’s more a case of a Flemish head cold.”
However, the real exchange rate is only slightly stronger than its average for the past 15 years. “And, if you have a strong economy, then you’ll get a strong currency,” says the central bank’s de Gregorio.
Moreover, the problem should be self-correcting – at least as regards the private sector – with the impact of currency appreciation on domestic purchasing power and, therefore, imports automatically exerting downward pressure on the peso. Chile will post a structural deficit of of 1.8% of GDP in 2011, based on an estimate of the of the country’s annual potential growth rate of 4.8%.
Still, there are doubts as to Chile’s longer-term growth performance. Leonardo Suárez, chief economist at LarraínVial, a local investment bank, is sceptical about the prospects for the last two years of the government’s four-year term. “As from 2012, even 4% growth will be a challenge,” he says.
According to Larraín, the main reason for Chile’s weaker growth over the past four years was declining productivity. That partly reflected an energy shortage caused by a dwindling supply of natural gas from Argentina, since remedied by the construction of two terminals for the import of liquefied natural gas (LNG).
Further increases will, however, hinge mainly on tackling long-standing bottlenecks such as poor educational standards, outdated labour laws and an inefficient public administration – and these are political rather than economic issues.
Moreover, without a majority in the Senate, the new government would find it difficult to pass the necessary reforms and, even if it did, it is unlikely that the benefit in economic performance would be seen within its term in office.