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DE RUEHSG #0909/01 2841154
ZNR UUUUU ZZH
O 101154Z OCT 08
FM AMEMBASSY SANTIAGO
TO RUEHC/SECSTATE WASHDC IMMEDIATE 3795
INFO RUEHWH/WESTERN HEMISPHERIC AFFAIRS DIPL POSTS
RUEHSO/AMCONSUL SAO PAULO 0777
RUEATRS/DEPT OF TREASURY WASHDC
RUCPDOC/DEPT OF COMMERCE WASHDC
RUEKJCS/SECDEF WASHDC
RUEAIIA/CIA WASHDC
RHEHNSC/NSC WASHDC

UNCLAS SECTION 01 OF 03 SANTIAGO 000909 
 
STATE PLEASE PASS TO USTR KDUCKWORTH/MSULLIVAN 
STATE FOR EEB/TPP/BTA-BMUNTEAN AND WHA/EPSC-FCORNEILLE 
TREASURY FOR MMALLOY/RJARPE 
COMMERCE FOR KMANN 
 
SENSITIVE 
 
SIPDIS 
 
E.O. 12958: N/A 
TAGS: ECON EFIN ETRD EINV ECIN PGOV PREL CI
 
SUBJECT:  CHILE'S ECONOMY:  STRONG BUT BEGINNING TO FEEL THE IMPACT 
OF THE GLOBAL FINANCIAL CRISIS 
 
¶1. (SBU) SUMMARY:  Chile's economic fundamentals remain strong, but 
economic growth will likely slow, negatively impacted by declining 
trade and investment, relatively high inflation, falling commodity 
prices, especially copper, and tightening liquidity.  The peso's 
fall against the dollar, low foreign debt, fiscal discipline, and 
Chile's Sovereign Wealth Funds can help cushion negative economic 
effects. END SUMMARY. 
 
Declines In Copper, Currency, And The Stock Market 
--------------------------------------------- ----- 
 
¶2. (SBU) Chile has seen a week of precipitous drops in the price of 
copper, the exchange rate, and the stock market.  The price of three 
month copper contracts on the London Metal Exchange has dropped 11% 
this week, and copper has hit is lowest price since February 2007 
(dropping from a record high of $4.07 per pound in July 2008 to 
$2.45 per pound this week).  The value of the U.S. Dollar has 
increased against the Chilean Peso by 43 Pesos in the last week (a 
depreciation of almost 8% for the Peso).  The Peso has also dropped 
to its lowest level against the Dollar in four years.  The IPSA 
index (Chile's equivalent of the Dow Jones Industrial Average) has 
lost over one fifth of its value in the last five days, falling 
almost 5% in one day alone, and reaching its lowest point since 
¶2006. 
 
Economic Growth Will Probably Slow But Remain Positive 
--------------------------------------------- --------- 
 
¶3. (SBU) GDP grew 3.3% in the first quarter of 2008 and 4.3% in the 
second.  The Monthly Index of Economic Activity, which compares 
variations in economic activity for the same month from year to 
year, increased 6.2% in July 2008, but only 2.4% in August (much 
lower than expected).  The Ministry of Finance had forecast 5.4% 
growth in the third quarter, with annual growth at close to 4.2% for 
2008 and 4% in 2009.  However, the global financial crisis has 
caused many independent experts (and even some in the GOC) to revise 
their forecasts downward.  Morgan Stanley recently decreased its 
estimate for Chile's 2008 GDP growth to 3.8%.  Some analysts have 
said Chile will be lucky to grow by 3% in 2009. 
 
A Global Economic Downturn Would Hurt Chilean Trade 
--------------------------------------------- ------ 
 
¶4. (SBU) Trade has been one of the prime engines of growth for 
Chile, particularly given the huge role of copper exports (copper 
accounted for almost 64% of exports in 2007, equivalent to roughly 
25% of GDP).  The vertiginous rise of copper prices in recent years 
has helped Chile run consistent trade surpluses until last month, 
which registered the first trade deficit since 2002.  This was 
likely due to lower levels of copper production and high oil prices 
(Chile imports almost all of its oil).  Chile's export sector is 
continuing to diversify, as trade volumes in non-copper products 
increase, but mostly in other commodities (e.g., woodpulp).  Experts 
believe Chile must begin exporting more value-added products, which 
are starting to appear (e.g., firearms) but remain insignificant 
when compared with commodities. 
 
¶5. (SBU) Many Chileans fear the current crisis will lead to a global 
economic downturn, which would reduce demand for Chilean exports. 
In 2007, 41% of Chile's exports went to Asia and 15% went to China 
alone (Chile's leading export destination).  Copper products 
accounted for almost 90% of all exports to China.  If Chinese growth 
alone were to slow, it would have a significant, negative impact on 
Chilean exports.  Lower commodity prices could reinforce the impact 
(copper dropped to a 30 month low this month).  Banks in Chile have 
reportedly calculated that a change of one cent in the price of 
copper will increase or decrease Chile's trade by approximately $70 
million. 
 
Depreciation Of The Peso Could Cushion Negative Effects 
--------------------------------------------- ---------- 
 
¶6. (SBU) Since March 2008, the Chilean Peso has steadily fallen 
against the U.S. Dollar, accelerating during the financial crisis, 
to reach a 4 year low this month (a depreciation of nearly 20% in 
2008).  The Central Bank had embarked in April on an $8 billion 
program to purchase dollar reserves, which it halted when the 
 
SANTIAGO 00000909  002 OF 003 
 
 
financial rescue package was unveiled in the U.S.  The lower 
exchange rate will be a boon to exporters and may help cushion some 
of the effects of lower demand for Chilean products overseas. 
 
Investment Has Been Healthy, While Consumption Slows 
--------------------------------------------- ------- 
 
¶7. (SBU) Investment has been steadily rising in Chile.  In the 
second quarter of 2007, gross fixed capital formation grew 13% on 
the previous year, whereas the second quarter of 2008 showed a 23% 
increase for the same period.  Consumption has slowed down.  In the 
second quarter of 2007, total consumption registered an 8% increase 
on the previous year, but in the second quarter of 2008 it increased 
less than 6%.  Sales of consumer goods also slowed, expanding 8% in 
the first half of 2007, but increasing only 4% during the same 
period in 2008.  Rising inflation, tightening credit standards, and 
slower job creation were the main causes.  In the second quarter of 
2008, gross capital formation exceeded domestic savings for the 
first time in many quarters, possibly pointing to a move toward 
foreign savings as a source for investment.  However, most analysts 
fear Chile will see a decrease in investment due to less domestic 
liquidity (more below) and a possible global economic downturn. 
 
Inflation Is High, Monetary Policy Is Tightening 
--------------------------------------------- --- 
 
¶8. (SBU) Relatively high inflation continues to dog the Chilean 
economy.  In September 2008, inflation was 9.2% (as measured by the 
consumer price index) triple the Central Bank target rate.  Core 
inflation reached 0.7 percent in August totaling a 9 percent 
increase in 12-months.  In September, the Central Bank continued to 
tighten monetary policy, raising the interest rate to 8.25 percent, 
the highest rate since 1998.  According to the President of the 
Central Bank, the increase was necessary to ensure convergence of 
inflation toward 3% over the policy horizon.  Inflation expectations 
point to a slow decline in inflation over the next year.  The 
Central Bank has repeatedly called inflation an "imported problem" 
linking it to persistent, high commodity prices (especially oil and 
agricultural products imported by Chile).  A global downturn may 
help ease price pressures, but a continued depreciation of the 
Chilean Peso will also affect prices.  Maintaining a contractionary 
monetary policy may prove difficult if the negative impact on the 
real economy is significant. 
 
Less Liquidity In Banks May Hurt Domestic Companies 
--------------------------------------------- ------ 
 
¶9. (SBU) Although there have been no reports of exposure to 
mortgage-backed securities, liquidity has become a concern for 
Chilean banks.  Before the crisis, the spread on international loans 
to Chilean institutions was relatively small (LIBOR + 10 basis 
points).  Many international banks began to lend less or pull out of 
Chile in search of better returns.  The spreads have increased 
(currently LIBOR + 27 basis points), but foreign banks have been 
slow to return.  Anecdotal evidence indicates international lines of 
credit to Chilean institutions are drying up now.  Chilean banks 
have tightened credit and raised interest rates on deposits to 
attract more capital.  The week of October 6, the Central Bank 
announced a $500 million currency swap program to improve dollar 
liquidity and the Finance Ministry injected $1 billion into Chile's 
four largest banks. 
 
¶10. (SBU) Large companies (especially multinationals) are reportedly 
taking out loans simply to ensure they have extra liquidity on hand 
in case it becomes necessary.  This make liquidity even tighter for 
small- to medium-size enterprises (the majority of Chile's private 
sector), many of which depend on the loans for operating capital. 
Analysts fear this effect may accelerate, causing some Chilean 
businesses to curtail operations or even close, likely impacting 
unemployment.  Chilean industrial production fell 3.1% in August 
2008 compared with the same period in 2007 (mostly due to lower 
copper production).  In August, unemployment was 8.2%, up from 7.2% 
in January. 
 
Fiscal Discipline, Sovereign Wealth Funds May Help 
--------------------------------------------- ----- 
 
 
SANTIAGO 00000909  003 OF 003 
 
 
¶11. (SBU) Chile's fiscal discipline has been an ongoing strength of 
its economy.  The GOC is required to run a structural fiscal surplus 
of 0.5% of GDP (changed in 2007 from 1%).  Chile has run budget 
surpluses for most of the past two decades.  In 2007, the fiscal 
surplus represented 8.2 percent of GDP. 
 
¶12. (SBU) The GOC has wisely chosen to keep windfall copper revenues 
(from the state-owned CODELCO copper company) outside of the economy 
in Sovereign Wealth Funds.  In 2006, the Government created the 
Pension Reserve Fund (FRP) and the Economic and Social Stabilization 
Fund (FEES), estimated currently at a combined $21 billion.  The GOC 
has also announced plans to create a third fund for education. 
Chile's fiscal discipline, relatively low foreign debt levels (35% 
of GDP in the second quarter of 2008), mounting reserves (11% of GDP 
in the second quarter of 2008), and Sovereign Wealth Funds, will 
likely protect the country from some of the effects of an economic 
slowdown. 
SIMONS