Enviable Economic Performance

Let us begin taking stock on the performance of Chile’s economy in the past two years compared to the US and the EU16 in order to see that while the crisis indeed has been global (and still is) notable divergences are present.

Chile’s economy contracted through three quarters from Q4-08 to Q2-09 but has since returned to  growth and, crucially, seems to have returned to trend growth unscathed from the fangs of the economic crisis which will have wide repercussions in the rest of the OECD for many years. In this sense, Chile entered the crisis unlevered and with sound demographic fundamentals which precisely gives the economy the ability to reach escape velocity and quickly resume positive output growth. As a backdrop it is exactly this pulling power which many economies in the OECD don’t have which again means that for us to find a solution to this we have to find a way to export our way out of trouble but since this is not possible for everyone at the same time it does represent us with a unique challenge.

This is not the case however in Chile where the economy expanded at a heaty pace of 11.3% and 13.7% in Q4-09 and Q1-10 respectively (yoy), numbers which are bound to be considerably lower going forward especially since the effect of the earthquake in February will cast a shadow over Q1 GDP figures which may still be revised down considerably once the full effect has been factored in. The alternative is that the effect will be moved forward into Q2 numbers, but this is ultimately an accounting question.

Moving closer to real time developments the main activity index (the IMACEC) indicates a steady and ongoing expansion of Chile’s economy even after the blip which occurred as a result of the earthquake (showing up in the March reading as it happened in end February).

In May, the IMACEC stood at 130.9 (2003 = 100) which is the strongest reading in the index’ history and further encouragement has also come from the fact that May was the first month in which industrial production showed a proper increase on an annual basis after having moved sideways in Q1-2010; industrial production expanded 3.3% on the year. This points to an economy on a strong footing although some might note that at this pace and with the headwinds currently facing the global edifice the only way from here is down. I would agree in the main here as Chile may well give back some of the fine H01-10 performance as we move into H02-10 but Chile should be able to stand its ground  and will expand at a healthy clip in 2010.

This view is supported by recent upward adjustment of economic expectations across the board even if the current expectations of continuing interest rate tightening may be overdone.

Regards, the evolution of GDP in 2010 the expectations remains fixed at around 4.5% to 4.8% which is around trend output according to the central bank’s estimations. The 4.25% target for the monetary policy rate in 12 months implies a steep tightening schedule from the current level of 1.5% and many analysts have voiced caution that interest rate will climb this much in a 12 month horizon. This view reflects both the fact that the central bank may be too linear in the way it has set its 12 month target interest rate as well as it reflects the market’s perception that appreciation of the Peso may become an issue as the yield advantage of Chile increases relative to the USD and Euro.

Strong Fundamentals

So, I am arguing that Chile is doing fine and that she is likely to continue the recent impressive expansion which is likely to put Chile even more at odds with what is expected to be a slowdown in the developed world. However, do the fundamentals back this?

Indeed they do and the focus should be on two aspects; demographics and a sound management of copper windfall.

If we begin with the former there are naturally many ways to spin a story on the graph below.

One could for example point to the fact that the population share of 20-49 is  peaking right at this moment and is set to decline hereafter which means that Chile might just be running on the last fumes of full capacity. But this would be missing the big picture I think. In this sense, I think the main point to take away here is the remarkable stability of the population share aged 35-54 throughout the next 40 years (estimated of course, but we are fairly sure that this fits unless we get some kind of exogenous shock). I am emphasizing this because this particular age group has been found [1] to correlate well with GDP per capita levels and growth. The key to Chile’s relatively stabile demographic trajectory is to be found in a very favorable demographic transition (at least when it comes to economic growth). Consider then that from 1983 to 2009 fertility in Chile decline from 2.5 children per women to around 2 in 2009. This trajectory is actually what one would expect if applying basic transition theory, but in the real world only a few economies have made the transition to achieve a somewhat stabile level at replacement fertility. The general rule is that fertility undershoots replacement level and has mighty difficulties recovering if at all.

This, more than anything, makes Chile stand out and as an emerging economy turning developed this aspect of the Chile’s economy and thus the absense of a very quick and steep fertility transition is, to me, a key reason for Chile’s success.

Another reason for Chile’s strong economic performance is its copper reserves but more than anything the proper management of this to avoid dutch disease and to build up a strong fiscal position and indeed a sovereign wealth fund in which large chunks of the copper windfall has been stashed away. Naturally, this does not make Chile less dependent on copper as such, but it means that the economy has been able to avoid adverse effects from the volatility in growth that often comes from relying on commodities for revenue (and growth). In numbers, Chile has historically aimed at an annual fiscal surplus of 0.5%/GDP to act as a counterweight to the incoming copper revenues. Between 1996 and 2006, Chile’s public balance averaged 1.5% of GDP a position much better than that held by its peers in East Asia and Latin America. From 2005 to 2007 the structural surplus as a percentage of GDP was 1% and around 0.5% in 2008. However, the pure fiscal surplus, in 2008, as a percentage share of GDP stood at 8.1% which is quite extraordinary on any measure. Although the crisis and the earthquake are sure to have made a dent in these impressive figures the fact remains that on a gross basis Chile’s government debt remains very low (6% of GDP in 2009 and 2010) whereas the net debt level is firmly negative (i.e. book value of financial assets exceed that of financial liabilities).

Upwards and Onwards

Does this mean then that there is nothing stopping Chile? Actually, yes.

A renewed severe global slowdown or even a relapse into the financial crisis as well as continuing uncertainty surrounding Chinese momentum and thus copper prices are all factors that could derail Chile’s economy in some way or the other. However, it is fair to assume that in the event of an external shock Chile should fall less and rebound more strongly than many other economies and this means that Chile is likely to perform well in relative fashion.

Certainly, I don’t want to come of off as complacent but looking at the evidence before and with the qualifier that Chile is not hit by a surge of severe earthquakes (which of course will accumulate in the loss of output) I really cannot see where the stumbling block lies for Chile. In this sense it seems, for now, to be steady as she goes in Chile.

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[1] – See this for example.

In fact, in 2007, according to the U.S. Department of Commerce’s Office of Travel and Tourism Industries (OTTI), the number of Americans traveling abroad grew by 1% from 2006 to 2007, increasing for the fourth year in a row. However, the first quarter of 2008 could hint of change as the economy continues to weaken and the euro strengthens. Combined with higher fuel prices, and hence higher airline prices, travel to the Continent is starting to get quite expensive.

OTTI reports a .2% decline for American travelers to Europe in the first quarter of 2008, as compared to the same period last year. Interestingly, however, in a few areas where the dollar remains relatively strong, such as South Africa, Mexico and South America, travel has increased. Americans traveling to Central and South America have increased in numbers by over 6% from last year, Mexico is up more than 8% and visitors to Africa are up a whopping 47.9% over 2007.

Against All Odds

And while many Americans who choose to vacation abroad are still traveling, that trend is likely to drop off especially if the economy continues to limp along. The Air Transport Association has reported that jet fuel prices have increased a head-spinning 70% through July 3 in comparison to 2007.

The New York Times reports that airlines industry analysts expect cuts in flights by nearly 10% for the year. And what about those economic stimulus checks? The Y Partnership, a travel industry PR firm, in cooperation with the Travel Industry Association, found in a recent survey that one in six of those receiving a check would spend it on travel.

So where are Americans choosing to vacation? For luxury travelers, high-end hotels, African safaris and River cruises in Europe are still popular. But for the average traveler who cannot afford the currently expensive euro, destinations such as Central and South America are looking very good. Many, however, are also choosing to stay in the States. Travel + Leisure magazine’s latest issue may be the harbinger of travel trends to come. Typically aimed at an upscale market of travelers, the July 2008 issue is draped in red, white and blue, and the headline reads “50 Fabulous U.S. Travel Ideas.” The editor’s regular column acknowledges the precipitous drop of the dollar against the euro and offers ideas for meaningful travel within the 50 states.

Travel Bargains

Arthur Frommer, long known for his budget travel guides and magazine Arthur Frommer’s Budget Travel, presented with his daughter Pauline at the April 2008 Atlanta Travel Expo. Their topic was travel bargains. Among the top picks were China, Vietnam, Kenya and Panama in addition to the American system of National Parks.

Exploring less frequented areas can offer a more authentic view of culture as well as a more favorable cost. Panama, which had an iffy reputation for travelers back in the 1980’s Noriega years, has transformed itself into a country ripe for visitors, with both rainforest jungles and sparkling beaches. (Disclaimer: travelers to foreign countries should always check with the State Department before departing.) The Panama Canal, which was handed over to the Panamanians by the U.S. in 1999, has experienced its busiest year ever in 2007. Furthermore, even though Panama uses the Balboa as currency, U.S. dollars are widely accepted, dispensing with the whole issue of currency exchange. With a beer that can easily cost under $1 and a wide range of tropical activities, Panama is becoming a popular destination.

Africa is becoming popular as an alternative to Europe too. For visitors who stay in a standard tourist hotel, rooms can be had in South Africa for under $50 per night, according to solotravel.org which offers cost guides for a number of countries. This is in sharp contrast to France, where a mid-range hotel will easily run you over $100 per night. Travelers who enjoy going abroad can also find great deals in other areas around the globe – such as a tourist hotel in China for about $30 or less and $20 in Vietnam.