The Chilean economy has not been immune to the effects of the world financial crisis. These effects have been stronger as of the second half of last year and are still present during the first half of this year. At the same time that Chile was undergoing an adjustment process in its economy, the country was also facing other problems, which contributed to increasing financial crisis troubles. Amongst these problems were the worst drought of the century, which has affected agricultural and electrical sectors; the presence of the El Niño current, and the fall in the prices of the main export products. Nevertheless, it is necessary to remark that the Chilean economy, despite the financial crisis, had a positive growth rate during last year.

In 1998, Chilean GDP growth rate was 3.1%, which is lower than the 1997 rate and the previous years' average. This reflects the effects of the financial crisis on the economy. As of the third quarter of 1998, some economic indicators began to register a contraction of the economy, caused in part by the adjustment process made in order to control the current account deficit. In fact, GDP contracted by 2.8% in the last quarter of 1998 and by 2.3% in the first quarter of 1999.

The forecast for GDP growth for this year is approximately 0.5%. During the first semester, growth rate will be negative. However, the economy should start a strong recovery as of the second. According to most international forecasts, Chile will be one of the few Latin-American countries with a positive growth rate during this year.

Regarding investment, during 1998 gross fixed-capital formation represented 31.7% of GDP. This rate is slightly higher than that of the previous year.

Chilean exports last year totaled US$14,895 million, which is 12.5% lower than 1997. They were seriously affected by the drop in prices of major export products caused by the contraction of demand in most of the main trade partnerships. On the other hand, imports fell 4.5% with respect to 1997, mainly due to adjustment measures taken by the monetary authorities, which tended to reduce the internal consumption.

Inflation in 1998 was 4.7%, the lowest in the last 38 years, accomplishing the central bank’s goal for last year. The inflation target was 4.3% for 1999, but due to lower than expected inflation rates in the first months of the year, it is expected to reach a lower percentage. The declining inflation trend of the past few years is being sustained.

The unemployment rate has been increasing. In 1998, the average unemployment rate was 6.3%, which is 0.2% higher than in 1997. However, unemployment reached 9.8% in May. This situation is expected to revert, and it is anticipated Chile will gradually recover previous unemployment levels.

Last year, the current account deficit represented 6.2% of GDP. Although this is a high rate, it is expected to fall to between 3% and 4%. The main reason for the deficit is the decrease in the economy’s income due to low export prices of copper and other raw materials.

The trade balance had a negative result of US$2.495 million caused by a strong increase in imports, especially during the first quarter, and the drop in the value of exports. This deficit should be substantially reduced this year as imports have dropped 28% in first five months, and the volume of exports has continued to increase.

The capital account had a positive balance last year that represented 4.3% of GDP. This was mainly caused by a decrease in net portfolio investment inflows due to lower ADR and bonds emissions.

Foreign debt reached US$31,546 millions in 1998. This was an increase in absolute terms with respect to previous year, although a decrease in relative terms. The business/private sector is responsible for 81.8% of foreign debt.

Mid and long term liabilities account for 94.9% of foreign debt. It is important to remark that since 1994, the central bank had no liability with the IMF. On January 1999, foreign debt represented 43% of GDP. If international reserves are discounted, it is equivalent to a little more than one year's exports.

Despite the convoluted international situation, foreign direct investment increased by 6.4% during last year. This is notable because investors kept their trust in the stability, safety and profitability of long-term projects in the Chilean economy.

The real exchange rate depreciated by 3% last year. This was a change in the real peso appreciation trend of the last eight years.

In 1998, and after continuous cuts, fiscal expenditure increased by 6.2%, a lower rate than previous years. The fiscal budget closed with a 0.4% surplus, which although lower than previous years, is still positive, despite the reduction in government incomes.

Interest rates were progressively increased during last 1998, as a way to adjust the economy, reduce excess consumption and counteract financial crisis effects. This is how the monetary stance reached 14% in September 1998 after which it started to fall steadily. This rate is used as a reference by the financial sector to set the rate in which their operations are done. It was increased to reduce the gap between rates, and after that to begin to push both of them down. In June 1999, the central bank reduced it to 5%, a rate lower than the one before the crisis. This is expected to contribute to an acceleration of the economy’s recovery process.

GDP is expected to grow by around 5% this year. However, next year the economy should expand between 4% and 5.5%. Unemployment is likely to increase over last years’ average, although this situation will be temporary and should begin to fall when the economy starts its recovery.

Last year’s economic adjustment corrected the excessive current account deficit. For this reason, this year’s deficit will oscillate between ranges considered acceptable by the economic authorities. The export sector will continue facing low prices for its main products during this year. However, due to the fast recovery of some trade partners, the volume of exports may increase. On the other hand, it is not likely that imports will achieve last year’s level because of the slow-down in world and local economy. We can also expect an increase in real exchange rates, which will favor exports and limit imports.

It is important to state that Chile has not made its structural reforms as a consequence of the financial crisis. Some adjustments have been made, such as transitory increases in interest rates and a reduction of bank reserves. However, Chile has not made modifications in its exchange rate and financial systems, nor has it asked for IMF cooperation.

Chile has made several structural reforms in recent years. Some of them were privatizations. Chile has privatized most public utilities and is promoting private investment in infrastructure. For instance, the majority of infrastructure projects, needed for the development of the economy, are being financed with private capital, and telecommunications, electricity, and air transportation are completely private. Also, in the short-term, the privatization process of ports, plus water and sewerage services must be completed.

Chile continues to be committed to trade liberalisation. In 1998, parliament approved a unilateral tariff reduction across the board. After this, tariffs will be reduced from 11% to 6% on a 1% annual basis. The Chilean economy has continued with its commercial policy, expanding already existing trade agreements.

Parliament has also approved a Safeguard Law. Its objective is to put into effect protection measures, allowed by the World Trade Organization (WTO), which could be used if a specific product is being imported in such increased quantities and conditions as to cause, or threaten to cause, serious damage to the domestic industry. Safeguards shall be applied for one year, renewable only for one additional year. The Chilean Safeguard Law is completely consistent with the WTO, in fact, it does not use all the provisions contemplated by this organization.

As a way to accelerate the economy’s recovery process, the government announced further measures in June. These measures include the advance launching of some investment projects, tax benefits for new house-buyers, incentives for hiring young people, and a protection program for unemployed workers. These measures are aimed at fighting unemployment, especially in the most sensitive sectors.

Finally, the educational system is undergoing reform led by the government. Although this may not be classified as a structural reform of the economy, it will have positive economic effects because it will allow the economy to operate with a better qualified and thus more productive labor force.

Source: Data are as submitted by member economies, unless otherwise specified.

Table 2. Forecasting Summary (% change from previous year)

Note: The IMF forecast is from the World Economic Outlook (IMF, April 1999).