The post-earthquake economic scenario in Chile

Experts have estimated that the impact of the natural disaster will be felt in the short term in indicators like unemployment and economic growth. However, there is consensus that Chile’s solid macroeconomic position will allow it to recover swiftly.

There is consensus among Chilean as well as international experts that the financial recovery and reactivation will be quick and effective
There is consensus among Chilean as well as international experts that the financial recovery and reactivation will be quick and effective

The Central Bank had estimated that Chile would grow 6% in 2010. This was because no economist had even considered the idea that a natural disaster could affect the country’s productive capacities, much less so a tragedy on the magnitude of the mega-earthquake that hit central-southern Chile (Maule and Bio Bio Regions), an area that produces close to 13% of the country’s GDP.

The first economic consequence of earthquake measuring 8.8 on the Richter scale was for the estimated economic growth rate for Chile to be scaled back to between 4.25% and 5.25% this year, according to the most recent Central Bank projection.

“The catastrophe’s immediate effects on activity will predominate over the growth caused by reconstruction efforts,” explained José de Gregorio, president of the financial institution. “A counterfactual exercise of projections that only considers events up to 26 February, reveals that the level of predicted growth for this year would have been one percentage point higher,” he added.

Short-term effects

As De Gregorio has acknowledged, the consequences of the fifth-most-powerful earthquake in the history of seismology will be felt with particular intensity in the initial months following the tragedy, due to the fact that the reconstruction effort will not be strong enough on its own to overturn the damage done to the country’s productive capacities.

Unemployment in February was up to 8.5%, according to the National Statistics Institute (INE) and the earthquake undoubtedly had an effect on employment. “We have to brace ourselves, because the numbers for March, April and May, as well as the rest of the first half of the year, are probably not going to be good (…). We will have to wait a few months to see the recovery take effect,” FinanceMinister Felipe Larrain affirmed.

Labor Minister Camila Merino shares this view. “We are going to have problems with unemployment in the coming months; many companies have suffered infrastructure damage and are in a critical situation. That is why we are implementing employment programs. We are giving hiring bonuses to retain workers so we can deal with these complicated months ahead,” she said. Thus, unemployment could rise as high as 10% in the coming months.

For its part, the Central Bank projection also notes that economic growth will be affected. The Monthly Economic Activity Indicator (Imacec) for February, a month with only 2 days of stoppage from the earthquake, was only 2.7%, far from specialists’ projections of an average growth of 4.6%.

Economists adjusted their projections for March after hearing of these numbers. Even before the data had been revealed some experts had already said that growth would be zero or only slightly positive in the third month of the year.

Jorge Selaive, chief economist at the Banco Crédito Inversiones, had initially expected 3.8% growth for February and says that the Central Bank report “was a surprise and clearly reflected a greater adjustment from the earthquake.” His forecast for March is between -1% and 1%.

Cristián Gardeweg of Celfín Capital believes the correction will be greater. Once he heard of the Imacec for the second month of 2010, the expert rectified his prediction of a 3% drop to -5%. According to Gardeweger, growth in February should have been 5.3%.

For his part, BanChile chief Rodrigo Aravena, who had bet on growth being around 4.3%, also scaled back his projections for March to around -1% growth. Furthermore, Arevena said that the trade balance for February “does not reveal the heavy damage, so information was clearly missing.”

Economic recovery and reconstruction

While the short term outlook for the Chilean economy is negative, there is also consensus among Chilean as well as international experts that the financial recovery and reactivation will be quick and effective, with its first effects making themselves felt in the second half of the year.

The risk classifier Goldman Sachs has estimated that the country’s recovery will be “V” shaped. “The physical damage and interruptions caused by the earthquake will affect activity in March and during the second quarter of the year, but we expect the gradual resumption of activity and reconstruction to bring a strong recovery during the second half of 2010 and in 2011,” it said in a report issued after the earthquake.

The institution also highlights the country’s macroeconomic solidity and stability to deal with this challenge, which is why it anticipates that the Chilean peso will continue to be “an attractive currency for financing other foreign currency operations,” all backed by the decision to expand public spending with due backing by inflows of foreign capital.

The analysts at Standard & Poor agree, highlighting that Chile’s low indebtedness “opens up the possibility of increasing spending on reconstruction efforts,” though they recognize that initially “growth will suffer a significant blow – as will the recovery that had already begun – in the first half of the year,” but that “reconstruction efforts will probably stimulate economic activity.”

The finance minister is of a similar opinion. “Despite the economic difficulties we will face in the short term, we are optimistic about the second half of the year, a strong time in terms of economic activity, and we are precisely working on the financing packages to make that happen,” Larraín affirmed.

His counterpart in the Economy Ministry, Juan Andrés Fontaine, agrees with this assessment. “We expect the economy to begin its recovery phase in the second half of the year, but at a faster rate than initially forecast before the earthquake, because reconstruction efforts will have an invigorating effect on economic activity,” he explained.

“Our recovery will pick up the pace from that moment on and growth in 2011 will probably also be stronger,” he added.

Regarding the measures to rebuild the country, the government is considering different alternatives, including a moderate and transitory increase in corporate taxes, the reallocation of US$ 700 million in the Chilean budget, changes to the law on donations, and the sale of certain dispensable state-owned assets.

Likewise, instruments like internal and external debt are being evaluated, in addition to the repatriation of moderate sums of funds in the Social Economic Stabilization Fund (FEES), currently estimated at a total of US$ 12 billion, as bringing in large sums of dollars would harm the exchange rate and therefore the country’s exporters.

When asked about the measures that the executive might take, De Gregorio said that “none of the options is free; they all carry a cost and assume that the Executive will make a balanced effort,” while monetary policy contributes to the situation by “guaranteeing a stable environment so that reconstruction does not put our economy under strain.”

“This is going to be a good year for the Chilean economy, despite the catastrophe, though there are obviously costs. All economic sectors will grow this year to greater or lesser degrees,” he concluded.