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Viewing cable 06SANTIAGO710, CHILE'S ECONOMY IN 2005: GOOD GROWTH, LOW

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Reference ID Created Released Classification Origin
06SANTIAGO710 2006-04-06 15:35 2011-08-25 00:00 UNCLASSIFIED Embassy Santiago
VZCZCXYZ0002
RR RUEHWEB

DE RUEHSG #0710/01 0961535
ZNR UUUUU ZZH
R 061535Z APR 06
FM AMEMBASSY SANTIAGO
TO RUEHC/SECSTATE WASHDC 8829
INFO RUEHBR/AMEMBASSY BRASILIA 3136
RUEHBU/AMEMBASSY BUENOS AIRES 2978
RUEHCV/AMEMBASSY CARACAS 0915
RUEHLP/AMEMBASSY LA PAZ APR LIMA 4522
RUCPDOC/DEPT OF COMMERCE WASHDC
UNCLAS SANTIAGO 000710 
 
SIPDIS 
 
SIPDIS 
 
COMMERCE FOR SARA MCDOWELL 
DEPT PLEASE PASS TO USTR FOR MARY SULLIVAN 
 
E.O. 12958: N/A 
TAGS: ECON ETRD EINV CI
SUBJECT: CHILE'S ECONOMY IN 2005: GOOD GROWTH, LOW 
INFLATION AND DECLINING UNEMPLOYMENT 
 
1. Summary: 2005 was another good year for the Chilean 
economy.  Chile enjoyed real GDP growth of 6.3 percent, 
slightly better than in 2004.  GDP per capita topped USD 7000 
for the first time.  Record prices for copper together with a 
sharp increase in domestic demand were the main growth 
factors.  Inflation remained within the 2-4 percent target 
and unemployment hit an eight-year low at the end of 2005. 
The overall trade surplus was USD 9.2 billion, but export 
growth moderated compared to recent years.  Import growth 
remained strong.  There are issues to watch:  foreign direct 
investment showed a sharp drop; the Chilean peso strengthened 
enough to cause concern about export competitiveness; the 
country continued its dependence on energy imports; and 
exports lacked diversification.  Most forecasts predict GDP 
growth in Chile in 2006 to be again in the 5.5-6.25 percent 
range.  Chile is not expected to alter any of its major 
economic policies under President Michelle Bachelet, who took 
office on March 11, 2006.  End summary. 
 
Good GDP Growth Thanks to Copper and Domestic Demand 
--------------------------------------------- ------- 
 
2. In 2005, Chile enjoyed real GDP growth of 6.3 percent. 
Growth was strongest in the first and second quarters, at 6.6 
percent and 7.2 percent respectively.  The drop-off to 5.8 
percent growth in the third and fourth quarters was caused 
mainly by a decline in copper production due to an earthquake 
in northern Chile.  The overall GDP effect of the drop-off in 
copper production highlighted Chile's heavy dependence on 
copper as the engine of economic growth.  In 2005, copper 
represented 43 percent of Chilean exports.  Another key 
factor in Chile's good GDP growth rate was a surge in 
domestic demand by 11.4 percent.  There was a significant 
expansion of both private (8.2 percent) and public (4.5 
percent) consumption, leading to an overall increase in 
consumption of 7.6 percent. 
 
Investment - A Clear Drop 
------------------------- 
 
3. According to Chile's Foreign Investment Committee, foreign 
direct investment in 2005 was USD 3.7 billion, a nearly 50 
percent drop compared to USD 7.1 billion in FDI in 2004.  The 
mining, transportation and telecommunications sectors were 
the main investment recipients.  Among the sources of FDI in 
2005, Australia ranked first (27 percent of FDI), Mexico 
second (26 percent) and the UK (13 percent).  FDI from the 
U.S. totaled just under USD 80 million, a ten-year low. 
Despite the lack of U.S. investment in 2005, the U.S. remains 
the most important source of FDI in the 1974-2005 period, 
accounting for 26.5 percent of total FDI in Chile.  There has 
been curiously little government or public reaction to the 
lower FDI numbers.  From those few who have commented on ways 
to attract more FDI, there have been calls to increase 
spending on research and development, to improve Chile's 
education system, to add flexibility to notoriously rigid 
labor laws, and to improve protection for intellectual 
property rights. 
 
International Trade - New Heights 
--------------------------------- 
 
4.  Chile's international trade in 2005 totaled $69.8 
billion.  This marked a 28 percent increase over 2004, with 
international trade USD 15.1 billion higher than 2004. 
Exports in 2005 totaled USD 39.5 billion and imports reached 
USD 30.3 billion, the highest levels in Chilean history.  The 
trade surplus grew slightly in 2005, to USD 9.2 billion as 
compared to USD 9 billion in 2004.  Over the last three 
years, exports have grown by an average rate of 30 percent 
and imports by 24 percent.  This growth in trade occurred 
mainly with countries with which Chile has signed trade 
agreements over the last three years.  Chile boasts no fewer 
than fifteen trade agreements.  Some are full-fledged free 
trade agreements (such as with the U.S.) and deal with trade, 
services and investment.  Others are much more limited (the 
agreements with India and China) and cover primarily trade in 
goods sectors. 
 
5. Chile witnessed growth in trade with all of its partners, 
whether it had a trade agreement or not.  Chile's top trade 
partners in 2005 were the United States, China, Japan, and 
Korea.  China moved up from the third to second spot, and 
 
2005 marked the first time three of Chile's top four trading 
partners were Asian countries.  There were significant 
increases in trade with Europe (24 percent), North America 
(29 percent) and Asia (29 percent).  Trade with regional 
trade blocs also saw increases of 25 percent with MERCOSUR 
and 34 percent with NAFTA.  Chile signed trade agreements 
with China and India in 2005, though neither had been 
ratified as of March 2006, and in early 2006 it began formal 
negotiations with Japan.  According to the head of the GOC's 
negotiating team, Chile hopes to complete an agreement with 
Japan in 2006. 
 
6. Over the course of 2005, the Chilean peso appreciated 
considerably, especially against the U.S. dollar.  The 
peso-dollar exchange rate ended 2005 at 512 pesos to a 
dollar, from an initial ratio of 557 pesos/dollar and a 
mid-year peak of 592 pesos/dollar.  For comparison, the 2004 
peso to dollar average was 610.  A six-year low of 510 pesos 
to the dollar was reached in December 2005.  Record high 
prices for copper were generally seen as the main driver 
behind the strengthening peso.  The elevated value of the 
peso has led to growing concerns among Chilean exporters. 
However, to date there has not been a measurable decline in 
export growth attributable to the stronger peso -- with the 
possible exception of fruit. 
 
Composition of Exports 
---------------------- 
 
7. Despite the expansion of trade ties, Chile's exports have 
yet to achieve a great degree of diversification.  Sixteen 
products represented 72 percent of total exports.  The most 
important exports in 2005 were copper, molybdenum, salmon, 
wood pulp, wood, wine, fresh grapes and methanol.  The 
overall rise in exports was driven by mining sales, which 
reached USD 21.2 billion.  This was up from USD 16 billion in 
2004 and just USD 7.9 billion in 2003.  Copper accounted for 
the bulk of the increase in mining sales, with exports of 
copper alone hitting over USD 17.4 billion.  In dollar terms, 
copper exports in 2005 represented 43.8 percent of the total 
value of Chilean exports.  Copper prices in 2005 were 27 
percent higher than in 2004.  Sales of molybdenum, Chile's 
second largest source of export earnings, totaled USD 3.4 
billion in 2005, up from USD 1.5 billion in 2004. 
 
8. By contrast, the forestry industry faced relatively weak 
demand and prices in 2005.  The total export of wood products 
increased only three percent and prices declined by two 
percent.  Total fish exports, mainly salmon, reached new 
highs in 2005 totaling over USD 3 billion.  In 2005, the 
salmon industry increased its total volume by 13 percent and 
its price by 9 percent.  Wine increased its volume 4 percent 
and prices 3 percent.  Over the first three months of the 
2005-2006 fruit export season (which opened September 1 with 
its reverse season), sales showed a drop of 10 percent.  This 
was caused in part by crop damage from unusually wet weather 
during the Chilean spring, but many observers suspect the 
stronger peso has also hurt fruit exports. 
 
Imports -- Dominated by Oil and Capital Goods 
--------------------------------------------- 
 
9. The purchase of intermediate goods, particularly oil, rose 
to over USD 17 billion in the first 11 months of 2005.  This 
was up from USD 13 billion in the same period in 2004. 
Almost half of the increase in the value of intermediate 
goods was due to the higher price of oil.  Chile is almost 
entirely dependent on imports to meet its hydrocarbon energy 
needs, and oil accounted for 13 percent of Chile's total 
imports in 2005.  The import of capital goods was up sharply, 
increasing by 56.5 percent to USD 6.5 billion in the first 11 
months.  Over the same period, imports of consumer goods 
increased by 19.6 percent to USD 4.3 billion.  The greatest 
increases in imports in 2005 came from Europe with imports 
growing by 39 percent (representing 18 percent of Chile's 
total imports).  They were followed by Asian imports, which 
grew 35 percent (19 percent of total imports), and the U.S. 
with a 30 percent increase in imports (representing 56 
percent of total imports).  Overall, total imports grew by 33 
percent in 2005.  The main countries of origin for imports 
were the United States (6 percent), Brazil (4.5 percent), 
Angola (3.4 percent), China (3.1 percent), Argentina (3.0 
percent), Peru (1.8 percent), Korea (1.7 percent), Germany 
 
(1.6 percent) and Finland (1.4 percent). 
 
U.S.-Chile Free Trade Agreement 
------------------------------- 
 
10. The second year of the U.S.-Chile FTA saw further strong 
growth in bilateral trade.  Trade between the United States 
and Chile grew 38 percent during 2005, compared to the 31 
percent increase in 2004.  Overall, since the start of the 
FTA on January 1, 2004, bilateral trade is up 85 percent. 
Total trade for 2005 reached about USD 11 billion, 
representing 16 percent of Chile's total trade.  In 2005, 
Chilean exports to the United States grew 40 percent, 
reaching about USD 6 billion.  Imports from the U.S. in 2005 
increased by 44 percent to USD 5 billion.  Despite the 
phenomenal growth in bilateral trade, there has not been an 
accompanying increase in U.S. investment in Chile.  While the 
U.S. remains the number one destination for Chilean 
investment abroad, U.S. investment in Chile in 2005 hit a 
ten-year low.  The drop in U.S. investment mirrored the 
decline in overall FDI in Chile. 
 
Improved Employment Picture 
--------------------------- 
 
11. In 2005, Chile experienced a further steady decline in 
the average unemployment rate.  The yearlong average 
unemployment rate dipped to 8 percent from 8.8 percent in 
2004.  The labor force increased by 0.6 percent to just over 
6.3 million, while the number actually employed reached about 
5.8 million, up 1.7 percent from 2004.  There was a net gain 
of just under 100,000 new jobs from the creation of 153,000 
new salaried positions.  The most active sectors in creating 
jobs were financial services, with almost 48,000 new jobs, 
and retail accounting with 23,000.  At the same time, 39,000 
jobs were lost in the manufacturing sector, mainly in the 
textile industry.  For the November 2005)January 2006 
quarter -- when employment traditionally rises due to 
seasonal factors affecting the agricultural, tourism and 
construction sectors -- unemployment dropped to 7 percent. 
This represented the lowest unemployment rate in eight years. 
 
Monetary Policy Tightening 
-------------------------- 
 
12. With real GDP growth strong and steady, the Central Bank 
began tightening monetary policy in September 2004, when 
interest rates stood at 1.75 percent.  Since then, the 
Central Bank has raised its benchmark interest rate to 4.75 
percent.  In a recent public statement, the Central Bank 
called monetary conditions "still significantly expansive," 
strongly implying the rate increases would continue in 2006. 
Annual inflation for 2005 was 3.7 percent, which still was 
within the Central Bank,s target range of two to four 
percent, although clearly at the high end of that scale.  By 
the end of February 2006, the twelve-month moving inflation 
rate had hit 4.1 percent.  All indications are that the 
Central Bank's inter-bank lending rate will rise to 5.5 
percent by the end of 2006.  As further incentive for the 
Central Bank to continue its tightening, the money supply 
finished 2005 with further expansion.  M1A grew significantly 
in December 2005, reversing a trend of lower growth during 
most of 2005.  It ended the year recording a real growth rate 
of 7.3 percent.  M2A finished 2005 with a real annual 
expansion of 18.9 percent. 
 
13. Commercial bank lending also showed evidence of 
significant growth.  According to the Superintendency of 
Banking and Financial Institutions, total net loans in 
Chile's banking sector, which includes 26 financial 
institutions, rose 13.8 percent in 2005.  Net profit rose 
12.7 percent, or USD 1.51 billion, in 2005.  Consumer lending 
rose 20.33 percent and home mortgages grew 16.24 percent. 
Business lending rose 12.51 percent.  It is doubtful these 
high rates of expansion will continue as the impact of higher 
and rising interest rates are felt in 2006. 
 
Business Confidence Steady 
-------------------------- 
 
14. Chile's most widely-read monthly business confidence 
index, the Adolfo Ibanez University report, stood in February 
2006 at 62.37.  Any score over 50 is considered indicative of 
 
business optimism about economic activity for the next three 
to six months.  Over the last twelve months, beginning in 
February 2005 at 64.43, the average for 2005 was 61.19, 
slightly higher than the 2004 average. 
 
Financial Markets 
----------------- 
 
15.  Chile's main stock market, Santiago's Selective Share 
Price Index (IPSA) showed a gain of 9.4 percent in 2005. 
This followed gains of 21 percent in 2004 and 48.5 percent in 
2003.  After a strong start in the first two quarters of 
2005, the market consistently lost ground in the last two 
quarters.  The Central Bank's tighter monetary policy is 
generally viewed as the main factor in the declining rate of 
returns in 2005.  The stronger peso is also seen as a factor 
in limiting share returns.  Despite these factors, and the 
limited return compared to the two previous years, the value 
of share trading in 2005 reached an all-time high of USD 20 
billion. 
 
Comment: Challenges Remain 
--------------------------- 
 
16. While Chile's all-around economic performance remains the 
envy of many developing countries, there are important 
caveats.  The economy remains dependent on energy imports. 
While there is no short-term expectation that it will not be 
able to afford this dependency, it must think strategically 
to develop a long-term energy plan.  Unemployment touched an 
eight-year low when it hit seven percent in February 2006, 
but reducing unemployment further, along with addressing 
income inequality and shoring up Chile's privatized pension 
plan, will remain major challenges for the Bachelet 
administration.  While employment figures are up, so are 
anxieties about the economy's ability to sustain this level 
of employment.  An early 2006 poll showed that fully half of 
all Chileans were worried about losing their job in the next 
year.  Strong real GDP growth, booming exports and sound 
fiscal and monetary policies have not translated into 
psychological economic security for the majority of Chileans. 
 Much of the positive economic numbers in Chile stem from 
growing world demand and record prices for copper.  If/when 
this demand slackens, there could be serious consequences 
throughout Chile's economy as government budgets and domestic 
spending shrink. 
KELLY