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Chile: No Rest for the Weary

The Pinera Administration is moving fast to introduce the necessary reforms that will make Chile into a stronger economy.


With the economy growing 5.1 percent through the end of September, Chile is on its way to grow more than 7 percent in 2010. Copper prices soared this year, but the main source of GDP growth was domestic demand. It expanded 18.2 percent y/y during the third quarter. Residential construction, retail activity and industrial production were the principal drivers.

At the same time, the traditional engines of growth, exports and investment, were muted. It is true that copper prices flew in 2010, but the red metal is more of a bellwether of consumer sentiment rather than a determinant of economic activity.

In reality, Chile’s current account is barely in the black. Imports are pouring in at the same pace that exports are rising. Automobile imports, for example, surged 141 percent y/y in September. Low interest rates helped Chilean households acquire more expensive items and housing. At the same time, the appreciation of the currency made the Chilean economy more dependent on copper exports.

The result is a surreptitious vulnerability to a downward shift the trajectory of the Chinese economy. Although the Pinera Administration is not highlighting these concerns, it is taking important steps to reduce this risk by introducing important reforms to make the country much more competitive.

Education reform is one of the hallmarks of the Pinera Administration. A package of legislative measures was introduced to improve the quality of the country’s schools. Although Chile is a relatively wealthy country, it has been hampered by the country’s labor unions which put an emphasis on quantity over quality. The new laws will allow the government to retire 17,000 teachers and replace them with better-paid and higher quality instructors. An improvement in the skills of the workforce will allow Chile to focus on more complex sectors, such as technology and information processing. Consequently, it will produce more value-added positions that will generate higher pay.

Likewise, the Pinera Administration is trying to reform the budgeting system for the Chilean armed forces. Currently, the military receives its funds directly from copper revenues, thus giving the civilian authorities very little control over the budgeting process. Given the recent surge in copper prices, the Chilean military went on a shopping spree--purchasing new F-16s, submarines and destroyers. Today, Chile may have the most modern military forces in Latin America, but it was also an inefficient use of government resources. Those funds could have been put to better use.

In addition to reforming the education system, Chile needs to improve the road system in the north in order to tie together the cities of Arica, Antofagasta, Calama and Iquique with the rest of the country. It needs to modernize the port system to reduce shipping and transportation costs. Chile needs better border crossings with Argentina, Bolivia and Peru to facilitate trade flows. Last of all, it needs to revamp its railroads. There is no reason why such a narrow strip of land, such as Chile, could not be interconnected by a high-speed rail network.

The interesting thing is that Chile has the resources to do all of these things. Today, Chile is a source of investment capital rather than a destination for investment. With more than $140 billion in the pension fund system, Chilean portfolio managers are forced to funnel a good chunk of the savings abroad. As of the end of September, 47 percent of the funds were invested internationally--with more than half of them in emerging markets assets. On top of that, dozens of billions of dollars are sloshing through hundreds of mutual funds, hedge funds and family offices. The reason why so much of these funds are channelled abroad is because there is a lack of opportunities domestically.

However, the government needs to create the incentives for more of that capital to stay at home. By creating the legislation and reforms to modernize the country’s workforce and infrastructure, Chile can reduce its vulnerability to the swings in copper prices. Although the Chilean economy is booming, thanks to the spike in copper prices, all signs show that the Chinese economy is overheating. Chinese consumer prices are on the rise and Beijing is taking measures to cool things down. Most of the economies across Asia already started slowing down during the third quarter of this year. It is only a matter of time until this deceleration spreads into the commodity markets and reaches out across the Pacific. Therefore, there is no time to waste.

Instead of resting on its laurels after rescuing the 33 miners that were trapped deep below the Atacama Desert, the Pinera Administration is moving fast to introduce the necessary reforms that will make Chile into a stronger economy.

Walter Molano is head of research at BCP Securities.


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