GROSS DOMESTIC PRODUCT

The effects of the Asian financial crisis, along with the impact of the El Ni?o phenomenon and the remarkable drop in prices of its main export commodities, were reflected in the economic performance of Chile last year. The crisis and the severe adjustments in economic activity that followed, however, are now gone and Chile has started its recovery, albeit at a slower pace than desired.

REAL GROSS DOMESTIC PRODUCT (GDP)

Despite the 1.1 percent contraction of the GDP in 1999, the Chilean economy started to recover in the second quarter and, more clearly, in the second half of 1999. Both external and internal threats have been removed, allowing the economy to return to its long-term growth trend.

The most affected sectors were commerce and construction, which contracted by 3.5 percent and 10 percent, respectively. In expenditure terms, hardest hit was gross capital formation, which suffered a 17.4 percent reduction, caused mainly by a 35.5 percent decline in capital assets imports. Notwithstanding this, some sectors showed positive performance, e.g., mining (+16.2 percent), housing (+2.9 percent), and transport and communications (+2.7 percent).

Recovery began in September 1999, with a 0.7 percent increase of the IMACEC (Monthly Indicator of Economic Activity) compared to the same month of the previous year. Since then, the IMACEC has shown only positive figures, with the greatest increase since the beginning of the recovery registered in July at 8.1 percent.

INFLATION

Inflation in 1999 was 2.3 percent, which is lower than the Central Bank target and continued the declining trend of previous years. This is explained mainly by a 10 percent decrease in internal demand, which started to increase during the year but did not create inflationary pressures.

As a consequence of the economic recovery and the continued increases in international oil prices, inflation in 2000 will be higher than in the previous year. Prices remain stable at around 3 percent and the Central Bank has set a range of between 2 percent and 4 percent as the medium-term inflation goal. Ampleness of capacity in internal markets will be the main factor to hold down inflationary pressures during the next two years, compensating for the greater push from demand and imported prices.

These limits are signals for the Central Bank not to modify its monetary policy so long as the consumer price index remains within this range.

EMPLOYMENT

Unemployment reached its highest rate for the nineties in 1999, with the average reaching 9.7 percent and peaking at 11.5 percent in the moving quarter ending August. Said average rate was higher than the average level of 7.3 percent posted during the nineties. The economic recovery and government policies have, however, reduced this rate to 8.5 percent during the moving quarter ending April 2000 and all relevant indicators show Chile should gradually recover and return to its previous unemployment levels.

TRADE ACCOUNTS

The current account deficit declined from 5.7 percent of GDP in 1998 to 0.1 percent of GDP in 1999 as a result of imports contraction, exports expansion and deterioration in terms of trade. Merchandise trade registered a surplus of US$1,664 million, while trade in services recorded a deficit of US$2,196 million (financial and non-financial).

Imports contracted by 19.6 percent in 1999 over the previous year, while exports rose by 5.3 percent in the same period.

Meanwhile, the capital account deficit stood at 0.1 percent of GDP as it was strongly influenced by the first quarter situation. The deficit was due to a high increase of Chilean investments abroad, reduction on mid- and long-term loans, and short-term capital outflows.

GROSS EXTERNAL DEBT

Foreign debt reached US$34 billion in 1999, representing almost 50 percent of GDP and an increase of 7.8 percent over the previous year. Most of the amount was mid- and long-term liabilities, which account for 88.5 percent of total foreign debt.

As to the business/private sector, its debt increased by 9.1 percent, representing about 82.9 percent of foreign debt. On the other hand, the public sector debt increased by only 2.0 percent.

EXCHANGE RATE

In September 1999, after widening the exchange rate band, the Central Bank decided to indefinitely suspend the limits of the band, which has the practical effect of moving to a floating regime. This decision was based on the greater stability of financial markets (internal and external) and on the desire to allow bigger and better possibilities for portfolio diversification, risk coverage and inflationary control.

The national currency, the peso, depreciated by 5.5 percent in real terms in 1999, breaking the appreciation trend of the last decade. However, this trend has been reversed since September, and the peso has appreciated in real terms by 0.5 percent from September to June 2000.

The nominal exchange rate is expected to evolve over an intermediate path between that implicit in future prices and the one compatible with a stable real exchange rate. That means a real exchange rate depreciation of around 2 to 3 percent within the projection line with respect to the observed value of the first quarter of 2000.

FISCAL POLICY

In 1999, fiscal policy had an expansionary effect over demand as a way of supporting economic recovery. As part of its recovery policy, the government implemented job-creation programs and tax incentives for new house acquisitions.

This expansionary policy and the reduction of fiscal incomes as a result of economic cycle contraction led to a fiscal deficit of 1.5 percent for the first time in years. However, this deficit should be reversed by this year due to an increase in fiscal revenues caused by privatization, economic growth, and the strong political commitment of the economic authorities to achieve a structural surplus of 1 percent by the end of next year. This evolution is clear in the Budget 2000 Law, which imposes an upper limit of 3.3 percent for government expenditure growth. If the tax burden remains unperturbed, a government expenditure growth rate of less than 1 billion pesos will be needed. For this reason, fiscal policy is expected to be very tight during the current and coming years.

MONETARY POLICY

Monetary policy was also expansionary in 1999. The monetary stance was substantially reduced during the first half of 1999, reaching 5 percent in June. This year, the Central Bank has raised the level twice (by 0.25 percent each time), increases that were made to avoid transitory cost pressures like those linked to oil prices, to stabilize the inflationary trend and to meet the expectations of economic agents. At the end of August 2000, the Central Bank decided to return to the monetary rate levels that prevailed at the end of last year (5 percent), due to the slow reactivation process in internal demand in recent months.

MEDIUM-TERM OUTLOOK

The Chilean economy has benefited from firmer global activity, a turnaround in primary commodity prices, a relatively low interest rate at home, eased fiscal stance, growing confidence, and solid economic fundamentals. All these elements will confirm a clear upswing in economic activity in the next months.

Moreover, Chilean macroeconomic policy is being reviewed in the light of recent experiences. Fiscal policy is clearly committed to restoring in the short run the strength that showed for more than a decade. Monetary policy has adopted a more transparent and forward-looking framework by improving the inflation target scheme. The flexible exchange rate regime is functioning as expected, with continuous low inflation and deeper financial markets offering adequate hedging mechanisms. The financial system remains sound, resting on well-capitalized banks, strong management and supervision. Finally, the international financial integration continues as a gradual process that needs to be carefully monitored.

CHILE: OVERALL ECONOMIC PERFORMANCE