Country Report Chile August 2008

Outlook for 2008-09

• There are signs that a realignment of Chilean politics is underway, which may bring to an end two decades of centre-left rule under the Concertacion Democratica (Concertacion) coalition.
• The centre-right Alianza por Chile (Alianza) opposition is well-placed for the presidential and congressional elections in December 2009.
• With an open economy and a fiscal policy based on a structural fiscal surplus rule, Chile's macroeconomic policies will remain mostly sound in 2008-09.
• Fiscal policy will be more expansionary in the forecast period, but continued high prices for copper will enable Chile to post strong surpluses.
• Monetary tightening and above-target inflation will slow private consumption and investment growth and the external balance will weaken, slowing GDP growth to 3.6% in 2008, with only a mild recovery in 2009, reaching 3.8%.
• We have made an upward revision to our inflation forecast for end-2008 to 7.9% (from 6.3% last month). Inflation will ease later in 2008, but will remain above the ceiling of the 3% (1 percentage point) target.
• The current account will move into deficit in 2008 as the trade surplus falls in line with easing copper prices and the services and income deficits rise.

Monthly review

• Signs of a realignment of Chilean politics continue to emerge, with the Concertacion disunited and opinion polls pointing to gains for the Alianza.
• Former members of the Concertacion have banded together to form a new centrist coalition, but the process has proved difficult, and the coalition potentially unstable.
• The Central Bank has tightened monetary policy sharply, with a second successive 50-basis-point rate rise in an effort to reanchor inflation.
• Despite warnings over its potentially inflationary effect, the government plans to increase spending ahead of the original budgeted amount this year, raising fears that fiscal policy will further stoke inflationary pressures.
• Leading production indicators suggest a further slowdown in the second quarter, which in the current high-inflation environment has brought with it fears of stagflation.
• Strong import growth has reduced the first-half trade surplus, though strong Latin American demand has offset a fall in demand from the US for Chileanexports.