Can Chile Stand The Heat?

After two quarters of fast growth, Chile's economy continues on a brisk pace. However, strong domestic demand is worsening the trade deficit as well as helping to raise the inflation rate.

The latest sign of robust growth comes from Chile's monthly index of economic activity, reported under the acronym IMACEC. The August IMACEC rose 7.3% from a year ago, lifted by surging imports. The rise was much lower than the 9.5% gain in July--the biggest in 2 1/2 years--but the reading still implied a fast, yet sustainable, rate of economic growth (chart). Real gross domestic product grew by 7.5% in the year ended in the second quarter, the strongest rate in two years. The official forecast is that real GDP will grow 7.5% in 1995 and slow to 6.5% in 1996.

One problem for Chile is waning export growth. Third-quarter exports were up 33% from a year ago, below the 42% gain of the second. The highest copper prices in five years helped to boost commodity exports, but since mid-August copper prices have fallen 9%. And the peso strengthened against the U.S. dollar in 1995's first half, putting most exporters at a price disadvantage.

Meanwhile, healthy domestic demand is bringing in a wave of imports. Third-quarter imports rose 37% from a year ago, faster than the 30% pace in the second. As a result, Chile has run a monthly trade deficit from June to September.

Chileans have lived through double-digit inflation or worse for the past 60 years, but it's an experience most want to forget. That's why the recent runup in inflation is a worry. On Oct. 18, the Central Bank lifted its forecast for the October increase in consumer prices to 0.6%, double its previous estimate. That would mean that inflation is running at a year-over-year pace of about 8 1/2%, well above the Bank's 1995 target of 8%. The possibility of tighter monetary policy has weakened Chile's financial markets. Some calm returned after the August IMACEC, but higher interest rates may be the best way for Chile to avoid another devastating inflation spiral.

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