Thursday, April 4, 2013

Bite This Chile, Miguel!

Chile’s Economy Grows 9.8% in Q1 2011, the most in 15 years, as The Nation rebuilds after a quake. So far, so good. However, The Government now needs to make an extra effort in fiscal adjustment in order to deactivate the risk of destabilising Imbalances that are threatening The Chilean Economy.

Chile’s economy expanded at the fastest pace in 15 years in the first quarter of 2011 (America’s fifth-largest economy expanded 9.8% in the first quarter, after an increase of 5.8% in the previous quarter and only 1.7% one year before) as consumer spending jumped and manufacturing recovered from the biggest earthquake in 50 years. Sounds astounding for an economy that had contracted 2% in March 2010 after the devastating earthquake (on February 27, 2010) made an estimated $30 billion dent in the $164 billion economy. But there lies a catch!

Although the economy is re-accelerating this year (mainly boosted by expansionary policies to support post-earthquake reconstruction), growth has now reached an overheating speed. As per Banco Central de Chile (Chile’s central bank), the economy expanded 5.2% last year, the fastest pace in five years, and could expand 5.5% to 6.5% in 2011. Even, according to projections made (in January 2011) by the Economic Commission for Latin America and the Caribbean (CEPAL), and the World Bank, Chile is one of the three countries (the other two countries are Peru and Colombia) in Latin America that will lead in growth in the region for 2011. This certainly indicates that the country’s policymakers are bound to a have a tough time going forward, reining in the uncontrolled Chilean growth.

It’s not that the policymakers are not aware of the situation. In fact, to neutralise the overheating economy, Chile’s central bank has increased interest rates in 11 of its past 12 monthly meetings, from a record low of 0.5% in May 2010 to 5.25% at present, but all in vain. What’s more? Chile’s economy is firing on all cylinders. The economic activity in this Latin American nation continues to advance faster than potential, keeping the economy in overheating territory. In fact, in May 2011, the index of economic activity reported an annual growth of 7.3%, after an increase of 6.3% in April 2011, advancing at an average rate of 6.8% in the first two months of Q2, 2011.

Further, excess demand, the upward inflationary trend, and increasing imports are some prominent signs that indicate Chile is overheating. For instance, excess demand in Chile is hovering at about 16% of GDP at present, after reaching 20% in December 2010. This clearly shows that strong domestic demand is not fully satisfied by national production, and as such is finding accommodation in increased imports and higher consumer prices. Although inflation (at 3.44% in June 2011) remains just above the 3% target at present, an increasing trend in headline and core components is clearly visible (annual inflation reached 3.44% in June 2011 from 3.26% in May 2011 and 3.21% in April 2011 respectively), which makes the situation more worrisome. In fact, the relatively controlled inflation is mainly the result of excess demand mostly accommodated in imports rather than in prices, as well as domestic prices benefiting from lower international prices. Also driving strong demand for imports (which have grown by 36.8%, 26% and 20.6% in Q3 2010, Q4 2010 and Q1 2011 respectively) is a strong peso that has appreciated 8% against the US dollar since the beginning of the year, and robust private consumption (private consumption has grown 12.6% in Q1 2011), which is the result of credit growth and low unemployment (unemployment rate in Chile has come down from 8.8% in June 2010 to 7.3% in July 2011).


Source : IIPM Editorial, 2012.
An Initiative of IIPM, Malay Chaudhuri
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