Global Insight Perspective

Significance

GDP rose by 5.7% year-on-year (y/y) in the first quarter, driven by an impressive acceleration in domestic investment, which expanded 26.1%. Purchases of machinery and equipment increased substantially as firms executed new projects and updated technology. The Chilean economy continues to show strong growth rates supported by a sound macro-economic framework and a favourable international environment.

Implications

High domestic investment not only pushes domestic demand and overall economic activity, but also guarantees future economic growth. On seasonally adjusted terms, GDP grew 1.4%, which confirms that the economy is still at the peak of the business cycle.

Outlook

The outlook for Chile remains bright, since higher investment (also called gross capital formation) permits higher output in the short and medium term. In addition, external conditions remain very favourable and are allowing the government to post substantial fiscal surpluses that guarantee future government consumption. Sound monetary policy coupled with a strong fiscal position will continue to provide a stable economic environment. Global Insight's latest forecast calls for GDP to grow 6.1% in 2005.

Investment Accelerates

Investment in Chile has been growing quickly since late 2003 and increased further to double-digit rates in the second half of 2004. In the first quarter of 2005, investment jumped 26.1%, pushed by purchases of machinery and equipment, which expanded 44.7%, while investment-related construction grew 13.6%. The Corporation for Technological Development of Capital Goods estimates that the portfolio of private investment projects for the period 2005-2009 is 25% higher than one year ago. Mega-projects in the energy and mining sectors, in addition to several medium-sized industrial projects (in which investment is US$5-20 million) and real estate developments, account for the majority of programmed investment. High copper prices and the energy crises resulting from gas-export restrictions from Argentina to Chile have prompted the construction of hydroelectric plants and the expansion of copper mines. In the first three months of the year, external demand (volume of exports) increased 6.7%, a significant drop over the previous two quarters, during which export volume grew 15.6% on average.

Copper Prices Remain High

In the first quarter of 2005, copper prices increased almost 20% compared with the similar period in 2004. They were also higher than during the last quarter of 2004 (up 6%). For Chile, these unexpected high copper prices represent not only higher exports, but, most importantly, higher government revenues and a strong reinforcement of the business sentiment that is leading to higher investment. The Budget Secretariat (DIPRES) reported that in the first three months of 2005 the fiscal surplus amounted to 859 billion pesos (US$1.5 billion), which is equivalent to 1.4% of the full year's GDP. The fiscal budget estimated a surplus of 1.2% of GDP for the whole year, but first-quarter results already exceed this target. In theory, the government may have deficits in the next three quarters and still comply with the budget. However, more surpluses are expected in the following quarters of the year, since expenses will be limited by the Structural Fiscal Surplus Rule. This rule forces the government to save money during strong years so that it can spend it later, when copper prices drop and revenue derived from copper decreases. In this way, future government consumption is guaranteed, at least in the medium term.

Construction Sector Leads Growth

From a supply perspective, GDP expansion was driven by the construction, commerce and transport sectors, which grew 11.5%, 7.9% and 6.0% y/y, respectively. Meanwhile, mining expanded 5.0%, since copper output was encouraged by high international prices. Agriculture's growth rate slowed to 4.2%. However, this deceleration is due to a statistical effect, since this sector grew strongly in the past four quarters. Manufacturing grew 3.4%. This sector was heavily affected by seasonal factors, since Easter fell in March this year but in April last year.

Outlook and Implications

Seasonally adjusted data suggest that the Chilean economy continues at the peak of the business cycle, since the benefits of higher copper prices are now spreading to other sectors of the economy. Strong investment is expected to continue over the medium term. Therefore, robust output growth should remain. Current fiscal surpluses guarantee consistent moderate growth in public consumption even if external conditions are not favourable. For the remainder of the year, the outlook for exports is very positive, since international copper prices are expected to remain high and non-copper exports have proven to be a dynamic sector. Although volume exported may not grow as fast as in 2004, the positive effect of higher commodity prices will be spread to the rest of the economy through taxes on higher profits, new investment, and demand for goods produced in other sectors. After growing an estimated 6.1% in 2004, up from 3.7% in 2003, the Chilean economy is expected to continue its strong growth path in 2005. Global Insight's latest forecast calls for a 6.1% expansion.