Country Report

Chile

Chile at a glance: 2005-06

OVERVIEW Presidential and congressional elections due in December 2005 will continue to dominate the political scene. The ruling centre-left Concertación coalition will benefit from strong economic growth and from the popularity of the current president, Ricardo Lagos. Its candidate, Michelle Bachelet, is well ahead of the two Alianza candidates, Joaquín Lavín and Sebastián Piñera, in opinion polls. Mr Piñera’s decision to stand in the presidential election has altered the dynamics of the campaign. Nevertheless, the Economist Intelligence Unit expects Ms Bachelet to win the election. Legislative activity will slow as congressmen focus on re-election, but, despite this, we still expect policy to remain essentially sound. After reaching 5.8% in 2005, GDP growth will slow to 5.1% in 2006 as monetary policy is tightened and the external environment becomes less favourable. Monetary tightening will keep 12-month inflation within the 2-4% target range set by the Banco Central de Chile (the Central Bank) in the forecast period. The stability of the peso will be underpinned by continued growth in export earnings and sustained foreign direct investment (FDI) inflows. The current-account balance will turn to a small deficit in 2006, reflecting deteriorating terms of trade.

Key changes from last month Political outlook • The Alianza’s campaign has been shaken by Mr Piñera’s decision to stand against Mr Lavín. Soledad Alvear has withdrawn from the Concertación primary, which was due in July, meaning that Ms Bachelet will be the only Concertación candidate. Economic policy outlook • As expected, a mining royalty has been introduced. Chile will still be one of the world’s most attractive investment locations for mining companies. Economic forecast • We have revised up our forecast for export earnings and the import bill for 2005, following strong growth in both over the first five months of the year.

July 2005

The Economist Intelligence Unit 15 Regent St, London SW1Y 4LR United Kingdom The Economist Intelligence Unit The Economist Intelligence Unit is a specialist publisher serving companies establishing and managing operations across national borders. For over 50 years it has been a source of information on business developments, economic and political trends, government regulations and corporate practice worldwide. The Economist Intelligence Unit delivers its information in four ways: through its digital portfolio, where the latest analysis is updated daily; through printed subscription products ranging from newsletters to annual reference works; through research reports; and by organising seminars and presentations. The firm is a member of The Economist Group.

London New York Hong Kong The Economist Intelligence Unit The Economist Intelligence Unit The Economist Intelligence Unit 15 Regent St The Economist Building 60/F, Central Plaza London 111 West 57th Street 18 Harbour Road SW1Y 4LR New York Wanchai United Kingdom NY 10019, US Hong Kong Tel: (44.20) 7830 1007 Tel: (1.212) 554 0600 Tel: (852) 2585 3888 Fax: (44.20) 7830 1023 Fax: (1.212) 586 0248 Fax: (852) 2802 7638 E-mail: [email protected] E-mail: [email protected] E-mail: [email protected]

Website: www.eiu.com

Electronic delivery This publication can be viewed by subscribing online at www.store.eiu.com Reports are also available in various other electronic formats, such as CD-ROM, Lotus Notes, online databases and as direct feeds to corporate intranets. For further information, please contact your nearest Economist Intelligence Unit office

Copyright © 2005 The Economist Intelligence Unit Limited. All rights reserved. Neither this publication nor any part of it may be reproduced, stored in a retrieval system, or transmitted in any form or by any means, electronic, mechanical, photocopying, recording or otherwise, without the prior permission of The Economist Intelligence Unit Limited. All information in this report is verified to the best of the author's and the publisher's ability. However, the Economist Intelligence Unit does not accept responsibility for any loss arising from reliance on it. ISSN 0269-5197

Symbols for tables “n/a” means not available; “–” means not applicable

Printed and distributed by Patersons Dartford, Questor Trade Park, 151 Avery Way, Dartford, Kent DA1 1JS, UK. Chile 1

Contents

Chile

3 Summary

4 Political structure

5 Economic structure 5 Annual indicators 6 Quarterly indicators

7 Outlook for 2005-06 7 Political outlook 8 Economic policy outlook 9 Economic forecast

13 The political scene

19 Economic policy

25 The domestic economy 25 Output and demand 26 Employment, wages and prices 28 Financial indicators 30 Sectoral trends

33 Foreign trade and payments

List of tables

9 International assumptions summary 10 Gross domestic product by expenditure 12 Forecast summary 16 Opinion poll results 2005: who would you like to be the next president of Chile? 20 Evolution of economic expectations 20 Central government finances 21 Stock of government debt 21 The mining royalty tax 25 Gross domestic product growth by demand 26 Gross domestic product growth by sector 27 Price and wage trends 28 Employment trends 29 Bank results, May 2005 29 Stockmarket performance 30 Results of the main annual crops in the 2004/05 season 31 Meat exports, 2004 33 Imports of cars and LCVs by origin, 2005

Country Report July 2005 www.eiu.com © The Economist Intelligence Unit Limited 2005 2 Chile

34 Foreign trade 34 Balance of payments 35 Net international reserves 35 Foreign debt

List of figures

13 Gross domestic product 13 Consumer price inflation

Country Report July 2005 www.eiu.com © The Economist Intelligence Unit Limited 2005 Chile 3

Chile July 2005 Summary

Outlook for 2005-06 Presidential and congressional elections due in December 2005 will dominate the political scene. The ruling centre-left Concertación coalition will benefit from strong economic growth and from the popularity of the current president, Ricardo Lagos. The Economist Intelligence Unit expects its candidate, Michelle Bachelet, to win the election. Despite a slowing of legislative activity as congressmen focus on re-election, we expect policy to remain essentially sound. After reaching 5.8% in 2005, GDP growth will slow to 5.1% in 2006 as monetary policy is tightened and the external environment becomes less favourable. Inflation will stay within its target range. The peso will be under- pinned by growth in export earnings and sustained foreign direct investment inflows. The current-account balance will turn to a small deficit in 2006.

The political scene The announcement of Mr Piñera's candidacy was the final blow for Ms Alvear, who subsequently withdrew her candidacy, leaving Ms Bachelet as the Concertación’s sole presidential candidate. Juntos Podemos has registered its presidential candidate, Tomás Hirsch. The armed forces are continuing its modernisation and deepening its integration. Funding for large military purchases is likely to change. There has been some controversy over environmental protection. A new penal justice system has been introduced.

Economic policy Slow monetary tightening has continued. The fiscal surplus reached 1.4% of GDP in the first quarter. A mining royalty has been passed. There will be no partial privatisation of the state copper company, Codelco. A deal with Minmetals caused some controversy. Pacific-4, which includes a free-trade agreement (FTA), has been signed with Brunei, New Zealand and Singapore. Chile will adopt international financial reporting standards.

The domestic economy GDP growth slowed to 5.8% in the first quarter. Inflation is in the centre of the target range. Real wages are rising at a moderate pace and unemployment trending lower. Codelco has issued a local bond. Yields of agricultural crops have improved and meat exports are booming. The Spence copper mine will boost BHP Billiton. Tourist arrivals are expected to reach 2m and automotive sales will reach a new record this year.

Foreign trade and payments The trade and current-account surpluses narrowed in the first few months of 2005. Net international reserves are on the rise. Foreign debt increased by 3.3% in the first four months of 2005.

Editors: Martin Pickering (editor); Fiona Mackie (consulting editor) Editorial closing date: July 14th 2005 All queries: Tel: (44.20) 7830 1007 E-mail: [email protected] Next report: Full schedule on www.eiu.com/schedule

Country Report July 2005 www.eiu.com © The Economist Intelligence Unit Limited 2005 4 Chile

Political structure

Official name Republic of Chile

Form of government Presidential system, based on 1980 constitution

The executive The president, elected for a period of six years, is head of state and appoints the cabinet

National legislature Bicameral legislature (Congress): a 48-member Senate, comprising 38 elected members, nine members appointed for eight-year terms and one senator for life, Eduardo Frei; and a Chamber of Deputies, with 120 members elected for four-year terms

Legal system The 21 Supreme Court judges are appointed until retirement (compulsory at 75 years) by the president and confirmed by a two-thirds majority in the Senate; 16 regional courts of appeal and the members of the lower courts are appointed by the Supreme Court

National elections January 2000 (presidential), October 2000 (municipal), December 2001 (congressional); next elections due December 2005 (presidential and congressional)

National government Ricardo Lagos, who is recognised as leader by both the PPD and the PS, heads the Concertación coalition; he took office as president on March 11th 2000

Main political organisations Government: Concertación de Partidos por la Democracia coalition (Concertación), comprising the Partido Demócrata Cristiano (PDC), the Partido Radical Social Demócrata (PRSD), the Partido Socialista (PS) and the Partido por la Democracia (PPD) Opposition: Alianza por Chile (APC, the Alianza), comprising Renovación Nacional (RN) and the Unión Demócrata Independiente (UDI); La Izquierda, comprising the Partido Comunista (PC) and its allies; Partido del Sur (PdS)

President Ricardo Lagos (PPD-PS)

Key ministers Agriculture Jaime Campos (PRSD) Defence Jaime Ravinet (PDC) Economy & energy Jorge Rodríguez (PDC) Education Sergio Bitar (PPD) Finance Nicolás Eyzaguirre (PPD) Foreign affairs Ignacio Walker (PDC) General secretary of the government Osvaldo Puccio (PS) General secretary of the presidency Eduardo Dockendorff (PDC) Health Pedro García (PDC) Housing & national property Sonia Tschorne (PS) Interior Francisco Vidal (PPD) Justice Luis Bates (independent) Labour Ye rko Lj ub e t i c ( P DC ) Mining Alfonso Dulanto (PDC) National service for women Cecilia Pérez (PS) Planning & co-operation Ya s n a P rov os t e (P DC ) Public works, transport & telecommunications Jaime Estevez (PS)

Central Bank president Vittorio Corbo

Country Report July 2005 www.eiu.com © The Economist Intelligence Unit Limited 2005 Chile 5

Economic structure

Annual indicators 2000a 2001a 2002a 2003a 2004a GDP at market prices (Ps bn) 40,575 43,537 46,342 50,731 57,357 GDP (US$ bn) 75.2 68.6 67.3 73.4 94.1 Real GDP growth (%) 4.5 3.4 2.2 3.7 6.1 Consumer price inflation (av; %) 3.8 3.6 2.5 2.8 1.1 Population (m) 14.7b 14.9b 15.1 15.2b 15.4b Exports of goods fob (US$ m) 19,210.2 18,271.8 18,179.8 21,523.6 32,024.9 Imports of goods fob (US$ m) 17,091.4 16,428.3 15,794.2 18,001.7 23,005.7 Current-account balance (US$ m) -897.4 -1,100.3 -580.1 -1,102.2 1,389.7 Foreign-exchange reserves excl gold (US$ m) 15,034.9 14,379.0 15,341.1 15,839.6 15,993.8 Total external debt (US$ bn) 37.3 38.7 41.2 43.3 44.7b Debt-service ratio, paid (%) 24.8 27.8 32.6 30.2 20.2b Exchange rate (av) Ps:US$ 539.6 634.9 688.9 691.4 609.4 a Actual. b Economist Intelligence Unit estimates.

Origins of gross domestic product 2004 % of total Components of gross domestic product 2004 % of total Services 47.1 Private consumption 57.7 Industry 46.6 Gross fixed investment 20.6 Manufacturing 32.4 Government consumption 11.6 Agriculture 6.3 Change in stocks 1.1 Exports of goods & services 41.0 Imports of goods & services -31.9

Principal exports fob 2004 US$ m Principal imports cif 2004 US$ m Copper 14,359 Intermediate goods 14,384 Fresh fruit 2,025 Capital goods 4,684 Cellulose, paper & printing 1,631 Consumer goods 3,958

Main destinations of exports 2004 % of total Main origins of imports 2004 % of total United States 14.3 Argentina 17.1 Japan 11.5 United States 14.1 China 10.0 Brazil 11.2 South Korea 5.6 China 7.1 Netherlands 5.2 Germany 3.3

Country Report July 2005 www.eiu.com © The Economist Intelligence Unit Limited 2005 6 Chile

Quarterly indicators 2003 2004 2005 2 Qtr 3 Qtr 4 Qtr 1 Qtr 2 Qtr 3 Qtr 4 Qtr 1 Qtr Central government finance (Ps bn) Revenue 2,426 2,395 3,051 2,798 3,202 2,970 3,517 3,561 Expenditure 2,601 2,556 2,875 2,487 2,740 2,721 3,130 2,670 Balance -175 -161 176 311 461 250 386 892 GDP at constant 1996 prices (Ps bn) 9,847 9,521 9,951 10,200 10,369 10,184 10,674 10,795 GDP at constant 1996 prices (% change, year on year) 4.1 4.1 2.8 4.7 5.3 7.0 7.3 5.8 Industrial production index (2000=100)a 110.4 108.3 109.1 114.4 117.8 117.6 117.9 117.8 Industrial production index (% change, year on year) 1.5 2.9 0.7 7.1 6.7 8.5 8.0 3.0 Employment, wages and prices Employment (end-period; '000) 5,517 5,451 5,675 5,640 5,550 5,558 5,863 5,834 Employment (% change, year on year) 3.9 2.7 2.6 1.5 0.6 2.0 3.3 3.5 Unemployment rate (% of the labour force) 9.1 9.4 7.4 8.1 9.6 9.7 7.8 7.9 Nominal hourly wage index (Apr 1993=100) 232.2 233.8 235.7 238.4 239.1 240.4 242.0 246.8 Nominal hourly wage index (% change, year on year) 3.7 3.8 3.6 3.1 3.0 2.8 2.7 3.5 Consumer prices (Dec 1998=100) 114.8 114.8 114.4 114.0 115.3 116.5 117.0 116.6 Consumer prices (% change, year on year) 3.7 2.7 1.1 0.0 0.5 1.5 2.3 2.3 Wholesale prices (Jun 1992=100) 201.9 204.1 196.4 194.3 207.6 214 213.7 211.1 Wholesale prices (% change, year on year) 8.8 5.1 -1.9 -6.1 2.8 4.9 8.8 8.7 Financial indicators Exchange rate Ps:US$ (av) 710.34 693.45 624.95 586.87 629.04 628.17 593.39 578.71 Exchange rate Ps:US$ (end-period) 697.23 665.13 599.42 623.21 636.59 606.96 559.83 586.45 Deposit rate (av; %) 2.7 2.9 2.7 1.8 1.7 1.8 2.4 2.9 Lending rate (av; %) 6.1 6.5 6.2 5.4 5.0 5.1 5.0 5.9 M2 (end-period; Ps bn) 17,970 18,195 19,120 19,475 20,245 20,374 20,699 21,689 M2 (% change, year on year) 1.1 6.1 8.1 6.8 12.7 12.0 8.3 11.4 IGPA Gen stockmarket index (Dec 1980=100; end-period) 5,967.5 6,991.6 7,336.7 7,474.3 7,518.8 8,561.9 8,956.3 9,412.6 IGPA Gen stockmarket index (% change, year on year) 19.0 48.9 46.8 47.8 26.0 22.5 22.1 25.9 Sectoral trends Manufacturing production index (2002=100) 104.0 104.1 108.3 112.1 111.0 114 117.4 116.1 Manufacturing production index (% change, year on year) 5.0 6.2 3.5 7.3 6.7 9.5 8.4 3.6 Copper mining index (1990=100) 301.2 300.2 320.2 298.0 330.8 345.2 365.4 308.4 Copper mining index (% change, year on year) 6.9 9.0 2.5 5.2 9.8 15.0 14.1 3.5 Copper production (metal content; ‘000 tonnes) 1,212 1,214 1,292 1,210 1,338 1,392 1,472 1,241 Foreign trade (US$ m) Exports fob 5,283 5,153 5,805 7,484 7,927 7,933 8,681 9,203 Imports cif -4,847 -4,901 -5,078 -5,404 -5,730 -6,624 -7,113 7,298 Trade balance 437 253 726 2,080 2,197 1,309 1,568 1,905 Balance of payments (US$ m) Merchandise trade balance fob-fob 783 605 1,085 2,495 2,606 1,811 2,107 2,445 Services balance -178 -217 -67 -77 -164 -285 -55 -83 Income balance -1,103 -1,135 -1,344 -1,878 -2,046 -2,027 -2,149 -2,280 Net transfer payments 133 150 180 149 391 254 259 287 Current-account balance -365 -596 -147 688 787 -248 162 369 Reserves excl gold (end-period) 15,486 15,649 15,840 15,953 15,844 15,832 15,994 15,365 a Source: Sociedad de Fomento Fabril (Sofofa). Sources: Banco Central De Chile, Boletin Mensual; Ministerio de Hacienda; Instituto Nacional de Estadíticas; Sociedad de Fomento Fabril; IMF, International Financial Statistics; World Bureau of Metal Statistics, World Metal Statistics.

Country Report July 2005 www.eiu.com © The Economist Intelligence Unit Limited 2005 Chile 7

Outlook for 2005-06

Political outlook

Domestic politics The Concertación’s presidential candidate, Michelle Bachelet, a member of the Partido Socialista (PS), is the favourite to win the presidential election, the first round of which is on December 11th 2005. This would enable the centre-left Concertación coalition to complete 20 consecutive years in power. By the end of June the Partido Demócrata Cristiano (PDC)—the largest of the political parties within Concertación—had not yet formally confirmed its support for Ms Bachelet as a way to press its partners for concessions on the congressional electoral list. Congressional elections are due to be held together with the presidential election. However, following the announcement on May 24th by the PDC’s presidential pre-candidate, Soledad Alvear, that she was withdrawing her nomination and backing Ms Bachelet, the PDC’s president, this appears a formality. Mr Alvear’s withdrawal from the presidential race was precipitated by her fall to fourth place in the polls—with her support down to single digits—following a dramatic political coup carried out on May 14th by Sebastián Piñera, a former president of the centre-right party Renovación Nacional (RN), part of the opposition Alianza coalition. The other Alianza candidate in the presidential election will be Joaquín Lavín of the Unión Demócrata Independiente (UDI). Mr Piñera will hope to court votes from the centrist PDC and to precipitate a radical political realignment in the country, leading to the creation of an RN- PDC centrist alliance capable of sidelining both the left-wing of the Concertación and the UDI, which is on the right-wing of the Alianza. Although the PDC is divided, the goal of all its factions is to maximise their positions of power, which they have greater chances of achieving by staying in the Concertación under Ms Bachelet than by aligning themselves with Mr Piñera. Nevertheless, Mr Piñera's advances towards the PDC could increase the party’s chances of success in persuading the Socialist wing of the Concertación to grant the PDC concessions to retain its support. Paradoxically, although Mr Piñera’s presidential campaign has divided the Alianza centre-right opposition, it will energise RN’s congressional campaign, increasing the chances that the combined forces of the two centre-right parties will maintain a tight balance of forces in Congress. It will also prevent an absolute majority for Ms Bachelet in the first round, forcing a second round on January 15th. Mr Lavín and Mr Piñera are committed to support whichever of the two reaches the second round, maintaining the possibility of a presidential victory for the centre-right. However, Ms Bachelet remains the favourite to win because, with the economy growing strongly for the second consecutive year, national income being inflated by unusually favourable terms of trade and a popular incumbent Concertación president, Ricardo Lagos, the electorate is unlikely to consider an alternative political leadership. Also, the polls indicate that the mutual animosities that have been building up between Lavinistas and Piñeristas in

Country Report July 2005 www.eiu.com © The Economist Intelligence Unit Limited 2005 8 Chile

the centre-right will lead significant proportions of their supporters to abstain or to vote for Ms Bachelet in an eventual second round, rather than vote for the other centre-right candidate. Congress has approved a constitutional reform that will cut the presidential term from six years to four from 2006, maintaining the ban on immediate re- election. It also puts an end to the institution of unelected senators, reducing the Senate to 38 members, which will eliminate the residual participation of the military in political decisions, helped by a redefinition of the powers and composition of the National Security Council, the introduction of tight restrictions on the conditions, powers and duration of a state of emergency; and the restoration of the presidential power to remove commanders-in-chief of the armed forces, merely having to inform the Senate of the reasons.

International relations Relations with neighbouring countries have been more problematic than usual in recent years, owing to Argentina’s restrictions on its gas exports to Chile in violation of their gas treaty, and the questioning of long-standing bilateral border agreements by both Bolivia and Peru. However, relations are likely to improve in the forecast period, helped by growing crossborder trade and investment, including a project to increase energy co-operation in most of Latin America through the so-called energy ring. It will enable Peru—and eventually Bolivia, if it wants to join—to export natural gas to Chile, Argentina, Uruguay and Brazil. Chile will continue to support multilateral trade liberalisation, but, in the absence of multilateral progress, it will continue to further its integration in the world economy through more bilateral deals. On June 3rd it signed a Trans-Pacific Co-operation Accord with Brunei, New Zealand and Singapore— the so-called Pacific-4 accord, which includes a free-trade agreement (FTA), and is likely to sign a limited trade accord with India in 2005. This will be followed in 2006 by an FTA with China and possibly one with Peru.

Economic policy outlook

Policy trends The broad economic policy direction will remain fundamentally sound over the forecast period. However, in 2005 legislative activity will slow as legislators concentrate on re-election and there is a danger of the government putting forward some populist legislation. In June the government secured the passage of a controversial law raising property taxes by around 10% from 2006. It is also keen to get Congress to approve a capital market reform designed to encourage the development of a risk capital industry in the country through capital gains tax exemptions and the direct participation by the government’s development agency, Corfo, to finance up to 40% of the risk capital funds. Following national elections at the end of the year, the country’s broad policy direction is not expected to change, as orthodox economic policy is supported by both of the two main political coalitions. However, legislative activity will pick up: the restructuring of the country’s civil service to improve its efficiency, transparency and accountability will gather speed in 2006, as will implementation of a recently passed healthcare reform, an important element of the current administration’s programme. A substantial educational reform will be launched

Country Report July 2005 www.eiu.com © The Economist Intelligence Unit Limited 2005 Chile 9

as part of a package of policies intended to reduce poverty, and a reform introducing greater flexibility in the labour market is expected.

Fiscal policy Irrespective of the outcome of the presidential and congressional elections in December 2005, Chile will maintain fiscal orthodoxy over the forecast period. This will continue to be based on the government’s commitment to maintaining an average annual structural fiscal surplus equivalent to 1% of GDP (derived by measuring fiscal revenue at the level it would reach if GDP growth and the price of copper were at their medium-term trend levels). Following a non-financial public sector (NFPS) surplus equivalent to 2.2% of GDP in 2004 on an accrued basis (1% of GDP in structural terms), the NFPS surplus will be around 2.5% of GDP in 2005—honouring again the structural norm—despite a substantial increase in spending. This will be a result of rapidly rising tax and copper revenue. This surplus is likely to contract to around 1.5% of GDP on an accrued basis in 2006, owing to the impact on revenue of a slowing economy and a substantial fall in copper prices. Ms Bachelet has hinted that, if she wins the presidency—as the Economist Intelligence Unit forecasts—she will maintain the structural surplus rule of the past five years, but at a lower target level than the current 1% of GDP. Substantial long-term budget commitments to education and healthcare will be accompanied by rising pressures to increase fiscal revenue. This will produce some tax-rate rises and a further broadening of the tax base in the forecast period.

Monetary policy At its monthly policy meeting on July 12th, the Banco Central de Chile (the Central Bank) raised its target interbank rate by a quarter of a percentage point to 3.5%, the seventh time it has increased the rate since September 2004, when it began to tighten monetary conditions. It will stick to interest rate rises of no more than a quarter of a percentage point each to avoid shocks, but their frequency will probably increase marginally on account of rising inflation and booming domestic demand growth, to reach a target interbank rate of 4.25% by the end of 2005. This rate will represent a fairly expansionist monetary policy, since it will imply a real overnight rate of around 1.2%. This is why the gradual monetary normalisation will continue in 2006, raising the nominal interbank rate to around 5.5% by the end of the year. The monetary authority will maintain its wide inflation target range of 2-4%, ignoring pressures to adopt a lower target in view of the increasing rigidity of the labour market.

Economic forecast

International assumptions International assumptions summary (% unless otherwise indicated) 2003 2004 2005 2006 Real GDP growth World 3.9 5.1 4.2 4.0 OECD 2.0 3.3 2.3 2.3 US 3.0 4.4 3.2 2.8

Country Report July 2005 www.eiu.com © The Economist Intelligence Unit Limited 2005 10 Chile

International assumptions summary (% unless otherwise indicated) 2003 2004 2005 2006 Exchange rates ¥:US$ 115.9 108.1 107.4 103.0 US$:€ 1.13 1.24 1.22 1.26 US$:SDR 1.40 1.48 1.47 1.50 Financial indicators € 3-month interbank rate 2.33 2.13 2.05 2.00 US$ 3-month LIBOR 1.21 1.62 3.46 4.77 Commodity prices Copper (US cents/lb) 80.3 129.5 143.0 119.0 Oil (Brent; US$/b) 28.8 38.5 50.5 46.5 Food, feedstuffs & beverages (% change in US$ terms) 6.6 9.2 -6.5 -1.5 Industrial raw materials (% change in US$ terms) 13.0 21.0 4.2 -6.2 Note. Regional GDP growth rates weighted using purchasing power parity exchange rates. Global growth will slow in 2005-06 as a result of higher oil prices, signs of a Japanese economic slowdown, and the damage caused to business sentiment in the EU as a result of the rejection by the French and Dutch electorates of the proposed constitutional treaty. We expect the world economy measured at purchasing power parity rates to grow by 4.2% this year and 4% in 2006, down from 5.1% in 2004, and world trade growth to reach 6.8% in 2005 and 6.9% in 2006, down from 10.8% in 2004. Inflation in the OECD countries is expected to average 2.1% this year, up from 1.9% in 2004, falling back to 1.9% in 2006. Worries about the US external deficit are still expected to drive the dollar down in the longer term, but the immediate focus of financial market participants will be on economic and political failings within the euro zone. We currently expect only a gradual softening of copper prices from the second half of 2005, which would leave the average 2006 price at US$1.19/lb, significantly above the 1998-2003 annual average of 75 US cents/lb. A steeper than expected fall in Chinese demand would bring prices down more steeply, to the detriment of Chile’s external accounts.

Economic growth Gross domestic product by expenditure (Ps bn at constant 1996 prices; % change year on year in brackets unless otherwise indicated) 2003a 2004a 2005b 2006b Private consumption 24,846.8 26,242.1 28,189.2 29,868.5 (4.1) (5.6) (7.4) (6.0) Public consumption 4,258.6 4,385.0 4,516.6 4,652.1 (2.4) (3.0) (3.0) (3.0) Gross fixed investment 9,251.1 10,427.4 11,991.6 13,190.7 (5.7) (12.7) (15.0) (10.0) Final domestic demand 38,356.5 41,054.6 44,697.3 47,711.4 (4.3) (7.0) (8.9) (6.7) Stockbuilding 412.1 786.9 762.0 400.0 (0.5)c (1.0)c (-0.1)c (-0.8)c Total domestic demand 38,768.6 41,841.5 45,459.4 48,111.4 (4.8) (7.9) (8.6) (5.8) Exports of goods & services 12,970.0 14,625.7 15,326.0 16,435.6 (5.9) (12.8) (4.8) (7.2)

Country Report July 2005 www.eiu.com © The Economist Intelligence Unit Limited 2005 Chile 11

Gross domestic product by expenditure (Ps bn at constant 1996 prices; % change year on year in brackets unless otherwise indicated) 2003a 2004a 2005b 2006b Imports of goods & services -12,678.5 -15,039.9 -16,955.3 -18,500.4 (9.5) (18.6) (12.7) (9.1) Foreign balance 291.5 -414.2 -1,629.3 -2,064.8 (-1.0)c (-1.8)c (-2.9)c (-1.0)c GDP 39,060 41,427 43,830 46,047 (3.7) (6.1) (5.8) (5.1) a Actual. b Economist Intelligence Unit forecasts. c Percentage contribution to GDP growth. Following GDP growth of 6.1% in 2004, the economy expanded by 5.9% year on year in the first quarter of 2005 and is forecast to grow by 5.8% over the year. With annual growth of 15%, investment in fixed assets is forecast to remain the main engine of economic growth. This is a result of high confidence levels derived from record copper prices and strong global demand for Chile’s non- copper exports as the country benefits from its multiple FTAs. In addition, fears of an energy crisis this year as a result of cuts in the contracted natural-gas supplies from Argentina have been dispelled by an unusually wet autumn and forecasts of similarly abundant rain in the winter months. This guarantees ample hydroelectric generation in 2005-06 as reservoirs fill and snow accumulates in the Andes. Since the value added by hydroelectric generation is higher than that of generators running on imported fuel, this will yield a large increase in output by the electricity sector. Consumer confidence has strengthened as a result of the same factors, and will be further boosted by falling unemployment, which will benefit construction and the retail sector. Demand for new homes and other big- ticket items such as motor vehicles, whose acquisition tended to be postponed in the lean years of 1999-2003, is booming. Import growth will remain at extremely high levels throughout 2005, whereas export growth will slow to a pace below GDP growth—despite a strong rise in non-copper shipments—owing to a fall in copper export volumes. GDP growth will slow to 5.1% in 2006, with slowdowns in fixed-capital investment, private consumption and import growth, and slightly fas te r expo r t growth.

Inflation Consumer price inflation is forecast to be just under 3% at end-2005, in the middle of the Central Bank’s target range of 2-4%, after closing at 2.4% in 2004 and 1.1% in 2003. This upward trend will be owing to a sustained rise in oil prices and upward adjustments in regulated tariffs, particularly electricity, whose average cost to consumers will rise by around 20% this year, reflecting the lack of cheap natural-gas supplies from Argentina. Core inflation, which ignores the volatile prices of fuel, fruit and vegetables, will remain significantly below 3%. Headline inflation is likely to remain at around 3% in 2006. Firms will try to widen their margins, helped by the strength of domestic demand; the Central Bank will respond by keeping interest rates gradually rising.

Exchange rates The peso strengthened in relation to the US dollar from an all-time low of around Ps750:US$1 in February 2003 to around Ps580:US$1 by mid-2005. It is likely to achieve small additional gains in the second half of 2005, closing the year at around Ps575:US$1. This is owing to Chile’s strong economic fundamentals, including its likelihood to complete in 2005 a second

Country Report July 2005 www.eiu.com © The Economist Intelligence Unit Limited 2005 12 Chile

consecutive year with both its fiscal and current accounts in surplus. The peso will weaken marginally against the US dollar in 2006, closing the year at around Ps585:US$1 as the current-account switches back into a small deficit. However, the average exchange rates in 2005 and 2006 will vary little. Any volatility will be owing to the peso being used as a proxy to hedge Brazilian risks, taking advantage of Chile’s liquid currency market and low hedging costs.

External sector Merchandise exports are forecast to reach US$37.5bn in 2005, up from US$32bn in 2004, despite a slight fall in copper export volumes. Non-copper export growth will be led by exports of pork, poultry, beef and lamb, which achieved growth of 59% year on year in the first four months of 2005, to a total of US$357m. Agricultural exports increased by 17% in this period to US$2.5bn, and forestry exports by 22.6% to US$1.4bn. Merchandise imports are forecast to reach as much as US$29.4bn this year, up from US$23bn in 2004, which will reduce the trade surplus to US$8.1bn. Chile’s deficit in services is forecast to be cut to US$558m, helped by rising tourist inflows and rapid growth in service exports by LAN Airlines and a local shipping company, CSAV. The country’s traditional income deficit will remain at just over US$8bn, as a result of continued strong profits by foreign investors and a rise in foreign debt service. With Chile’s surplus in unilateral transfers at US$1.1bn, the overall outcome will be a current-account surplus of around US$580m (0.5% of GDP), down from US$1.4bn in 2004. The current account will switch into a deficit of around US$1bn in 2006, despite continued strong growth in non-copper exports and a substantial moderation in the growth of merchandise imports. This will be mostly as a result of a fall in the average price of copper, which will reduce copper export earnings to around US$14bn.

Forecast summary (% unless otherwise indicated) 2003a 2004a 2005b 2006b Real GDP growth 3.7 6.1 5.8 5.1 Gross fixed investment growth 5.7 12.7 15.0 10.0 Industrial production growth 1.7 7.6c 6.0 5.0 Unemployment rate (av) 8.5 8.8c 7.2 6.2 Consumer price inflation (av) 2.8 1.1 2.7 2.9 Consumer price inflation (year-end) 1.1 2.4 2.9 3.2 Short-term interbank rate 6.2 5.1 6.4 8.0 Central government balance (% of GDP) -0.8 2.1c 2.0 1.2 Exports of goods fob (US$ bn) 21.5 32.0 37.5 38.5 Imports of goods fob (US$ bn) 18.0 23.0 29.5 32.1 Current-account balance (US$ bn) -1.1 1.4 0.5 -0.4 Current-account balance (% of GDP) -1.5 1.5 0.5 -0.3 External debt (year-end; US$ bn) 43.3 44.7c 46.5 48.7 Exchange rate Ps:US$ (av) 691.4 609.4 579.7 580.7 Exchange rate Ps:US$ (year-end) 599.4 559.8 575.5 585.8 Exchange rate Ps:€ (av) 782.9 757.9 708.7 731.7 Exchange rate Ps:¥ (av) 5.97 5.64 5.40 5.64 a Actual. b Economist Intelligence Unit forecasts. c Economist Intelligence Unit estimates.

Country Report July 2005 www.eiu.com © The Economist Intelligence Unit Limited 2005 Chile 13

Gross domestic product Consumer price inflation (% change, year on year) (av; %)

Chile Latin America Chile Latin America 7.0 12 6.0 10 5.0 8 4.0 3.0 6 2.0 4 1.0 2 0.0 -1.0 0 01 02 03 04 05 06 01 02 03 04 05 06 2000 2000

The political scene

Following the withdrawal of Soledad Alvear of the Partido Demócrata Cristiano (PDC) in May, Michelle Bachelet of the Partido Socialista (PS) is now the only candidate from the ruling centre-left Concertación de Partidos por la Democracia (Concertación) coalition for the presidential election due on December 11th 2005. The centre-right opposition coalition, the Alianza por Chile (APC, the Alianza), will have two candidates standing in the election: Joaquín Lavín, of the Unión Demócrata Independiente (UDI) and Sebastián Piñera, of Renovación Nacional (RN).

Mr Piñera enters the Until mid-May it had been assumed that Mr Lavín would be the sole candidate presidential race from the Alianza. He had long trailed Ms Bachelet in opinion polls, with voters reportedly concerned that he was too far to the right of the political spectrum. As a result, Mr Piñera, from the more centrist RN, entered the race and will seek to gain votes from Concertación voters who are allied to the more centrist PDC. A wealthy businessman and former RN senator, Mr Piñera was president of RN between May 2001 and March 2004. The RN had long supported Mr Lavín's candidacy, but in mid-May Mr Piñera persuaded the RN’s General Council to support his own candidacy. This was an astonishing change for a party whose political commission had voted by 40 to two only six weeks earlier to reaffirm its support for Mr Lavín’s candidacy. In a move that caught the Lavinistas in RN by surprise, the Piñerista majority went on to force a vote to nominate Mr Piñera as RN’s presidential candidate by 250 votes to 88. Mr Piñera also persuaded the General Council to give RN’s supreme tribunal the power to expel RN members who work for non-RN candidates. Mr Piñera, who has never seen eye-to-eye with Mr Lavín, rejected Mr Lavín’s offer to hold an Alianza primary election on July 31st, the date on which the Concertación had been to hold its primary, arguing that the first round of the presidential election on December 11th would be the most democratic of primaries. He played down any talks of a split within the coalition, highlighting that the RN and the UDI will have a common list for the congressional elections—whose slots are shared 50:50 between the two—and that he and

Country Report July 2005 www.eiu.com © The Economist Intelligence Unit Limited 2005 14 Chile

Mr Lavín have agreed that whoever reaches the second round will have the other’s full support. Although Mr Piñera has moderated his anti-UDI rhetoric since he won RN’s presidential nomination, he still appears to be gambling on a radical political realignment by courting the PDC vote. His hope is for a centrist alliance capable of sidelining both the PS wing of the Concertación and the UDI, which is on the right-wing of the Alianza. Immediately after his candidacy was announced, Mr Piñera announced that, if elected, he would invite Soledad Alvear (PDC), a Concertación presidential pre-candidate who withdrew her candidacy in late May, to be a member of his cabinet. Ms Alvear had previously caused some concern in the Concertación’s socialist wing by saying that, if elected president, she would invite Mr Piñera into her cabinet. Mr Piñera has also said that he has political affinities with “the most progressive sectors of the PDC”, among whom he mentioned a former budget director, José Pablo Arellano, and a former labour minister, René Cortázar, who represent the most liberal and pro- market wing of the PDC.

Mr Piñera’s candidacy was the Ms Bachelet had always held a strong lead over Ms Alvear for the final blow for Ms Alvear Concertación’s candidacy, and Mr Piñera’s entry in the race proved the catalyst for her to withdraw her candidacy in late May, two months before the Concertación’s scheduled primary election. A poll taken by Opina on May 17th- 18th (days after Mr Piñera’s announcement) and published on May 22nd found that her support in the event of a first-round election had fallen to 7.2%, from 13% in March and April, putting her in fourth place in the presidential race. The poll also found that only 12.8% of Concertación supporters wanted Ms Alvear as their candidate, compared with 81% who backed Michelle Bachelet (PS), who also enjoyed the backing of the other two parties that make up the Concertación, the Partido por la Democracia (PPD) and the Partido Radical Social Demócrata (PRSD). With Ms Bachelet so far ahead in the polls, on May 24th Ms Alvear withdrew her candidacy and gave her support to Ms Bachelet, hinting at a lack of support from the PDC’s leadership. Her withdrawal was a blow to the PDC’s president, Adolfo Zaldívar, who had wanted to negotiate her withdrawal in exchange for a PS-PPD commitment to nominate weak candidates in some constituencies to aid the re-election of vulnerable PDC senators and deputies. Mr Zaldívar confirmed on June 3rd that the PDC will formally proclaim Ms Bachelet as the Concertación’s presidential candidate as soon as her government programme and the common congressional list are agreed. He also pressed her to get the PS and the PPD to adopt a more flexible position on the congressional list, but Ms Bachelet refused to get involved in these negotiations, which she said were a matter for the parties to settle.

The PDC is at a low ebb Supporting a PS presidential candidate for the second consecutive election will carry some electoral consequences for the PDC, which has been weakened in recent years by scandals. The party was recently shaken by a Gemines poll taken in the first week of June that investigated party preferences. The UDI, with 11.1%, was found to be the most popular single party, followed by RN

Country Report July 2005 www.eiu.com © The Economist Intelligence Unit Limited 2005 Chile 15

(7.9%), the PPD (7.8%), the PS (6.8%), the PDC (5.1%), the PC (2.8%), the PH (1.6%) and the PRSD (0.7%). With its confidence low, the PDC is urging its Concertación partners to help prevent a collapse of its congressional representation, arguing that this would be disastrous for the coalition’s ability to control the centre ground of Chilean politics. Worried by Mr Piñera’s efforts to woo the PDC, the PS and the PPD have shown a certain willingness to make concessions. On June 25th a PS deputy, Carlos Montes, withdrew his candidacy for a Senate seat representing east Santiago in favour of Ms Alvear, who decided to run for it after dropping her presidential candidacy. However, the PS and the PPD regard the PDC’s demands as exaggerated.

The PRSD supports Following months of efforts to negotiate their support for Ms Bachelet in Ms Bachelet exchange for concessions from the PS-PPD axis in the Concertación’s congressional list, the General Council of the Partido Radical Social Demócrata (PRSD) decided on April 23rd to support her anyway. The PRSD president, José Antonio Gómez, said the party’s support must be understood as a political accord that should give the PRSD the possibility to participate in Congress with two senators and 13 deputies, as it has been demanding.

Ms Bachelet remains in the Ms Bachelet remains the firm favourite to win December’s presidential election, lead in the presidential race according to the latest opinion polls. An Opina poll carried out on June 18th- 21st in Santiago, Valparaíso and Concepción, the three main urban centres in the country, found that Ms Bachelet would have received 42.2% of the vote if the elections had been held then, followed by Mr Lavín with 23.1%, Mr Piñera with 17%, and Mr Hirsch—the candidate supported by the Partido Humanista (PH) and the Partido Comunista (PC)—with 2.4%. The poll found that Mr Piñera would have been most popular among high- income people (33.4%), followed by Mr Lavín (29.1%), Ms Bachelet (13.4%) and Mr Hirsch (0%). Among low-income people, the poll predicted that Ms Bachelet would win 50%, Mr Lavín 22.1%, Mr Piñera 6.5%, and Mr Hirsch 2.7%. In the crucial middle-income demographic, Ms Bachelet won with 42.8%, followed by Mr Lavín (22.6%), Mr Piñera (21%) and Mr Hirsch (2.3%). In a second round opposing Mr Lavín, Ms Bachelet would have won by 45.1% to 31.3%, with 23.6% of votes blank and void. Facing Mr Piñera, Ms Bachelet would have won by 43.4% to 31.3% with 25.3% of votes blank and void. The high proportion of invalid votes in the second round could reflect a reluctance by significant factions of supporters of Mr Piñera and Mr Lavín to support the other centre-right candidate if he reaches the second round, or a large number of undecided voters. Other polls taken since Mr Piñera's announcement have backed up the results of the Opina poll.

Country Report July 2005 www.eiu.com © The Economist Intelligence Unit Limited 2005 16 Chile

Opinion poll results 2005: who would you like to be the next president of Chile? (%) Jan Mar Apr May Jun IDEP CEP Timeresearch CERC Opina Gemines Opina Michelle Bachelet 33 36 45 34 35.1 36.2 42.2 Soledad Alvear 9.3 11 13 13 7.2 - - Joaquín Lavín 28 27 28 30 21.5 23.7 23.1 Sebastián Piñera - - - - 14.1 18.6 17

Source: Press reports.

Mr Lavín widens his distance In early May Mr Lavín, whose chances of winning the presidency have been from General Pinochet fading over the past year, sought to distance himself from the former dictator, General Augusto Pinochet, by stating that the recent revelations about the extent of the human rights violations during the military regime, and about General Pinochet’s foreign bank accounts, have caused him to feel a disaffection for General Pinochet. He added that, had he known about this at the time of the plebiscite of 1988, he would have voted against General Pinochet’s continuation in power.

Juntos Podemos registers a On June 5th Juntos Podemos, a radical-left coalition formed by the PC, the PH presidential candidate and a dozen smaller groups, nominated Mr Hirsch, a former PH president, as its presidential candidate. An independent sociologist, Tomás Moulian, who was the PC’s original presidential nominee, withdrew his candidacy on May 22nd, leaving the field open for Mr Hirsch. In return, the PH agreed to support the PC’s Jorge Insunza as Juntos Podemos’s candidate for a congressional seat in Illapel, the constituency in which the extreme left has the best chance of winning a seat in Congress if the PS-PPD co-operates. Indeed, the PC’s readiness to support a weaker presidential candidate, such as Mr Hirsch, was interpreted by many as evidence of a deal between the PC and the PS-PPD to help the PC gain congressional representation in exchange for its help in minimising Ms Bachelet’s vote losses from the Left. This hypothesis will be confirmed if the PS-PPD nominates a weak candidate in the Illapel constituency.

Modernisation and greater Following years of debate, the government is finalising a bill to deepen the integration in the armed forces integration of the armed forces by centralising strategic military planning for all branches in a new Estado Mayor Conjunto (Joint Chiefs of Staff). This would limit the roles of the commanders-in-chief of each branch to administrative management and advising the minister of defence. In addition, if the country faces an imminent military conflict, the president of the Republic would have the power to nominate a Conductor Estratégico, a strategic commander for the entire armed forces. The bill would also simplify the Ministry of Defence, with a single subsecretary for the armed forces replacing the current subsecretaries for the army, the navy and the air force. The country’s new defence structure will also turn the Consejo Superior de la Defensa Nacional (Consudena, a council of ministers and commanders-in-chief that rubber-stamps purchases of major pieces of military equipment previously authorised by the defence and finance ministers), into a body genuinely able to offer second opinions on these matters, with its own staff of experts in weapon systems. This new institutional framework is meant to yield greater

Country Report July 2005 www.eiu.com © The Economist Intelligence Unit Limited 2005 Chile 17

transparency and a more thorough debate on strategic challenges and equipment modernisation. The debate on hardware modernisation that has taken place in recent years has been open and transparent, helped by the government’s policy of confidence- building with neighbouring countries, which includes keeping them informed about military procurement and exercises. The army has recently reported that it is examining offers to acquire around 100 second-hand Leopard II tanks, while the air force is considering the acquisition of around 20 second-hand F-16 fighter planes to complement the 12 new F-16s due to be delivered from 2006, replacing its old Mirages. The navy is conducting the most ambitious modernisation, being due to replace its obsolete fleet in its entirety in 2004-08. By the end of this period it will have a fleet of eight frigates whose average age will be only slightly over 15 years, compared with 33 years at present. The navy is also due to receive in 2005-06 two new submarines to replace two submarines that were decommissioned in 1998 and 2001. It will also build in its own Asmar shipyard two 1,600-ton patrol ships in 2006-08, and a tanker within ten years. All this will create a relatively modern fleet that is meant to remain unchanged for around two decades.

Funding for large military Funding for the current round of equipment modernisation will not be a purchases is likely to change problem, owing to the Ley Reservada del Cobre (the Copper Reserve Law), an arrangement that provides for a 10% tax on sales by the state copper company, Codelco, to fund acquisitions of military hardware. Since early 2004 firm output growth from Codelco and extraordinarily high copper prices have enabled the armed forces to prepay more than US$500m in old debts. This has enabled them to borrow long-term to acquire their new equipment at relatively low interest rates. This defence spending regime will be reformed through the integration of the strate gi c planning of the ar me d fo rces by the j oint chie fs of staff. However, the Ley Reservada del Cobre itself has outlived its usefulness and is likely to be brought to an end under the next presidency (2006-10). There is political consensus on the need to offer secure long-term funding for large military purchases through normal budgetary procedures, and on the need to bring to an end this extraordinary regime that circumvents congressional controls and limits transparency. Ms Bachelet, Mr Lavín and Mr Piñera have all signalled their intention to correct this anomaly if they are elected.

Controversy over The credibility of Chile’s environmental protection institutions—the Comisión environmental protection Nacional del Medioambiente (Conama) and its regional arms, Comisiones Regionales del Medioambiente (Corema)—has been damaged by a saga concerning the US$1.2bn Valdivia cellulose plant, inaugurated in February 2004 by Celulosa Arauco y Constitución (Celco). The involvement of government ministers, effectively overruling the environmental protection institutions, has led to charges of official arbitrariness and government abuse. The plant was built in compliance with regulations stipulated by one of the most environment-friendly cellulose plants in the world, as measured by its effluents, which undergo three different purification processes. However, only

Country Report July 2005 www.eiu.com © The Economist Intelligence Unit Limited 2005 18 Chile

eight months after it started operations, it was noticed that many black-necked swans were migrating from the Anwandter reserve, as a result of a rapid decline in the presence of the aquatic plant on which they feed, luchecillo. Many were too weak to migrate, and the resulting images of dead swans caused a wave of public indignation that was soon directed against Celco. Corema ordered the closure of the Valdivia plant between January 18th and February 17th 2005, arguing a lack of compliance with maximum emission limits and ordered Celco to pay for a permanent monitoring of its effluents by two independent environmental auditing firms, one local and one multinational. Corema, Celco and the Ministry of Foreign Affairs each commissioned independent studies on the reasons behind the fall in the amount of luchecillo. The report commissioned by Corema blamed the Valdivia plant for the increase in the iron content in the Anwandter wetland, and on the basis of this report alone, the Valdivia Court of Appeals ordered the closure of the Valdivia plant on April 19th, while Corema got the state’s defence council to start legal proceedings against Celco, demanding that it returns the wetland to its previous state and pay appropriate damages. This ignored the conclusions of the report commissioned by Celco, which found no scientific evidence to single out Celco’s plant as the main culprit. The report commissioned by the foreign ministry coincided with that commissioned by Celco, but its findings were held back for two months. This report noted that there are 20 other manufacturing operations discharging their effluents into the Cruces river, and that their cumulative impact had probably put the wetland near its tolerance limit before the opening of Celco’s plant. It concluded that Celco’s plant might have been the catalyst for the fall in luchecillo, but stressed that there is no scientific evidence to substantiate this hypothesis. Supported by public opinion, the government has kept the pressure on Celco; on June 8th Celco backed down and closed the plant, and Celco’s chief executive officer, Alejandro Pérez, announced his resignation the following day. The government has been accused by some opponents of shifting the responsibility for the Anwandter ecological disaster from Corema to Celco to prevent the incompetence shown by the government’s environmental authorities becoming an issue in the election campaign. However, it realises that the country will not be able to sustain its export-led growth without the creation of a more credible environmental protection system, which is why Mr Lagos announced in his last state-of-the-nation address to Congress, on May 21st, that he intends to create a superintendency for the environment before his term ends in March 2006.

A new penal justice system The introduction of a new penal justice system, a process that has been is introduced gradually implemented across the regions since 2001, was completed on June 16th 2005, when it was launched in the Santiago metropolitan area. Except for the cases that were already being processed, this brought to an end the penal system inherited from colonial times, in which a single judge investigated, prosecuted and passed sentence; this often led to trials dragging on for years. The new system is oral, adversarial, public and transparent, and has

Country Report July 2005 www.eiu.com © The Economist Intelligence Unit Limited 2005 Chile 19

proved efficient in terms of the time it takes: a trial lasts on average seven months according to evidence accumulated so far, which compares with about three years under the old system. Several investigators who have been assessing the implementation of the new system in the regions have warned of the incompetence of many prosecutors and defence lawyers and the unimpressive average quality of the justice, problems which will now be assessed. The new system operates on the basis of a new code of penal procedures, with a total of 809 judges, of whom some are in charge of ensuring that the rights of the accused, the victims and witnesses are respected, and the rest are members of collective tribunals made up of three judges each, who direct the debates during the oral trials and then decide on the culpability or innocence of the accused. The Ministerio Público (office of public prosecutions) includes 640 prosecutors, and the Defensoría Pública (legal aid service) has 430 lawyers. This modernisation of the justice system has required massive investment in new infrastructure, whose completion in the case of Santiago is behind schedule. Only one of the nine towers being built in the new Centro de Justicia de Santiago had been completed by mid-June. Another is expected to be ready in August, and the other seven in February 2006. In the meantime, most of the new penal justice system in the capital is operating from rented facilities.

Economic policy

Monetary policy continues to The Banco Central de Chile (the Central Bank) raised its target interbank rate by be tightened at a slow pace a quarter of a percentage point to 3% at its policy meeting on April 7th, and by a further quarter point on May 12th. Having left the rate steady in June, the monetary authority raised it by a further quarter point in its July meeting. This was the seventh quarter-point rise since September 2004. Strengthening inflation and buoyant domestic demand have triggered the gradual tightening; 12-month consumer price inflation reached 2.7% in June, and domestic demand increased by 10.8% year on year in the first quarter. In May the Central Bank raised its projection for year-end inflation in 2005 to 2.8% in its Informe de Política Monetaria (Ipom, the monetary policy report published every four months), above the 2% projected in January’s Ipom. The president of the Central Bank, Vittorio Corbo, explained that this was a result of changes in regulated tariffs and the impact of high international oil prices, rather than an increase in domestic inflationary pressures. The Ipom’s GDP growth projection was left unchanged from its January forecast of 5.25-6.25%, a wide range that reflects the prevailing uncertainty about the evolution of the world economy in the second half of 2005. However, the projection for growth of gross fixed investment this year was raised from 11.9% to 14%, which would yield an investment ratio of 27% of GDP. Mr Corbo noted that this would raise the country’s long-term annual average growth potential to 5% and—in a thinly veiled message to presidential candidates who have been making various promises that they claim would be financed by annual GDP growth of around 7%—he said that raising the country’s growth potential back

Country Report July 2005 www.eiu.com © The Economist Intelligence Unit Limited 2005 20 Chile

to 7% would require a long period of increased investment and improved productivity.

Economic expectations have The Central Bank’s monthly survey on the economic expectations of three not changed dozen leading local economists carried out in June found few changes in relation to previous months, except for a perception that year-end inflation will reach 2.9% this year, rather than the 2.4% expected in March. This has been accompanied by marginally higher projections for the Central Bank’s overnight target interest rate at the end of both 2005 and 2006. The consensus among the local economists is that GDP growth is now expected to reach 5.8% in 2005 and 5.1% in 2006.

Evolution of economic expectations 2004 2005 Jun Sep Dec Mar Jun Inflation (end-period; %) 2005 3.0 3.0 2.9 2.4 2.9 2006 - - 3.0 3.0 3.0 Overnight target rate (%) Dec 1sr 2005 3.5 3.1 3.5 3.8 4.0 Dec 1st 2005 - - 4.8 4.8 5.0 Exchange rate (Ps:US$) In 2 months 630 621 585 580 590 In 11 months 620 638 600 590 598 In 23 months 640 650 620 605 610 Annual GDP growth (%) 2005 5.0 5.0 5.3 5.8 5.8 2006 5.0 4.8 5.0 5.0 5.1 2007 - - - 5.0 5.0 Note. Consensus of expectations taken at quarterly intervals. Source: Banco Central de Chile.

The fiscal surplus reached 1.4% The central government recorded a surplus of Ps1.3trn (US$2.2bn) over the first of GDP in the first quarter five months of 2005, helped by a 24.5% rise in total revenue, to Ps5.7trn, led by tax revenue growth of 25.5% year on year. Central government expenditure increased by 7%, including a 7.8% increase in personnel-related expenses to Ps963.1bn (US$1.27bn), a 39.2% rise in purchases of goods and services to Ps317.7bn, and an 8.3% increase in subsidies and grants, to Ps1.3trn.

Central government finances (Ps bn; Jan-May) 2004 2005 % change Current revenue 4,575.6 5,695.3 24.5 Net tax income 3,849.6 4,832.1 25.5 Current expenditure 3,508.1 3,789.1 8.0 Interest payments 22.3 25.6 14.9 Current balance 1,067.5 1,906.2 78.6 Capital revenue 5.9 6.8 14.7 Total revenue 4,581.5 5,702.1 24.5

Country Report July 2005 www.eiu.com © The Economist Intelligence Unit Limited 2005 Chile 21

Central government finances (Ps bn; Jan-May) 2004 2005 % change Investment expenditure 322.1 345.7 7.3 Capital transfers 311.7 296.1 -5.0 Total expenditure 4,142.0 4,430.9 7.0 Overall balance 439.5 1,271.2 189.2

Source: Dirección de Presupuestos.

In view of the higher than expected copper price, whose average for 2005 is now officially projected at US$1.39/lb, rather than the budgeted US$1.1/lb, and upward revisions in other important assumptions, including GDP growth (from 5.2% to 5.9%), domestic demand growth (from 6.6% to 8.8%) and import growth (from 12.7% to 22.2%), the Ministry of Finance raised its projection for this year’s central government surplus to 2.2% (compared with 1.2% in the budget), unchanged from 2004. Since 2000 government debt has trended up at a modest pace in nominal terms, from US$9.8bn to US$11.1bn at the end of 2004. However, except for a brief rise in 2001-02 caused by the devaluation of the peso, the total debt burden has continued to trend lower as a share of GDP, reaching 10.9% of GDP in 2004.

Stock of government debt (year-end; US$ m unless otherwise indicated) Domestic debt Foreign debt Total debt (% of GDP) 2000 7,224.5 2,580.3 9,804.8 13.8 2001 7,035.5 3,007.6 10,043.1 15.2 2002 6,490.9 3,737.2 10,228.1 15.7 2003 6,389.4 4,701.9 11,091.2 13.3 2004 6,171.9 4,949.0 11,120.9 10.9

Source: Ministerio de Hacienda, Dirección de Presupuesto.

Mining royalty is passed On May 18th after two years of congressional debate, and nearly a year after the defeat of the government’s first royalty bill, Congress approved the so-called Royalty 2 law, creating a tax of 5% on the operating profits of mining groups with an aggregate annual output totalling more than 50,000 tonnes of fine copper equivalent. Mining holdings with an annual output of less than 12,000 tonnes of fine copper will be exempted, and the tax rate for those producing between 12,000 and 50,000 tonnes will rise gradually from 0.5% for an annual output of between 12,000 and 15,000 tonnes per year, to 4.5% for companies producing between 40,000 and 50,000 tonnes.

The mining royalty tax Annual output (tonnes of fine copper) Tax on operating profits (%) Less than 12,000 0.0 12,000-15,000 0.5 15,000-20,000 1.0 20,000-25,000 1.5

Country Report July 2005 www.eiu.com © The Economist Intelligence Unit Limited 2005 22 Chile

The mining royalty tax Annual output (tonnes of fine copper) Tax on operating profits (%) 25,000-30,000 2.0 30,000-35,000 2.5 35,000-40,000 3.0 40,000-50,000 4.5

Source: Press reports.

The new tax will be applied from the start of 2006, and is expected to yield over US$150m per year. This revenue will go to a technological innovation fund that will allocate 20% of its annual budget to projects in the mining regions, 10% to regions other than metropolitan Santiago, and 70% to so-called deserving projects, irrespective of their regional location. The law entitles the Servicio de Impuestos Internos (SII, internal revenue service) to control transfer prices between related companies in order to minimise the risk of tax avoidance. The original bill the government sent to Congress was also intended to give the SII the power to control the prices paid by mining companies for inputs sold to them by third parties. This was vetoed by Congress, which also eliminated all limits to the application of this tax based on profitability or the value of sales. The mining companies claim that the tax will have an adverse effect on mining investment in the country, but admit that the final version of this law is not as damaging as what had been proposed in the government’s original bill, which was blocked by Congress in July 2004. This would have also introduced charges for non-copper mining, including the production of non-metals such as nitrates, iodine and the limestone used to produce cement. This was eventually set aside by the government, owing to its technical complexity and their limited tax revenue potential compared with the political costs involved. Although the new mining tax only affects copper mining companies, it is calculated on the basis of total operating profits, which are partly the result of mining and refining other metals contained in copper minerals, including gold, silver and molybdenum. Of the US$16.5bn in Chilean mining exports recorded in 2004, copper accounted for US$14.4bn (87.2% of the total) and molybdenum (a by- product in the copper refining process) for US$1.4bn (8.4%). Foreign mining companies holding foreign investment contracts with the Chilean state through Decree Law 600—which includes a tax invariability clause—will be eligible to a royalty rate of 4% of operating profits if they renounce that clause and accept a new tax invariability contract for 12 years on the basis of the current tax code.

There will be no part- The state copper corporation, Codelco, has registered in its name most of the privatisation of Codelco richest unexploited mineral deposits in the country, and aims to increase its annual output to 3m tonnes of fine copper by 2020, from 1.84m tonnes in 2004, in response to rapidly growing global demand for copper. However, this requires investing around US$2bn per year, which is not possible under its present institutional arrangements. The company is statutorily required to transfer all its profits to the government through various mechanisms, and must finance its investments through borrowing. Having generated pre-tax profits of

Country Report July 2005 www.eiu.com © The Economist Intelligence Unit Limited 2005 Chile 23

US$3.3bn in 2004, Codelco is valued at over US$20bn and it does not find financing problematic because of its low debt stock. However, because it is a state company, any borrowing is counted as a public-sector deficit, which leads to an annual confrontation with the finance ministry over the size of its investment programme for the following year. Therefore, as the public policy debates prompted by the presidential and congressional election campaigns began to gather steam in mid-April, Codelco's executive president, Juan Villarzú, invited candidates to address the issue of how best to enable Codelco to develop. He mentioned the possibility of opening Codelco through a public share offer, involving a capital increase of no more than 20%, which would not affect the state’s control of the company or its operational flexibility. Another option would be to enact legislation enabling Codelco to retain and reinvest a significant proportion of the pre-tax income it generates. A third option that he mentioned would be to incorporate partners in its main projects. However, these suggestions were turned down by the government through the minister of mining, Alfonso Dulanto, as well as by Codelco’s labour unions. Both rejected any possibility of privatising Codelco, in part or otherwise.

A deal with Minmetals causes On May 30th, following seven months of negotiations, China’s leading state some controversy company specialising in metal trading and manufacturing, Minmetals, agreed to form a 50:50 joint venture with Codelco. The deal has been criticised for its lack of transparency and details have been released only gradually following intense pressure from the opposition and the media. What has emerged is that, in a first stage, Minmetals will make an advance payment of US$550m to Codelco in September 2005 in exchange for a 15-year contract guaranteeing the supply of 55,750 tonnes/year of fine copper annually. The advance will help to finance the construction of Codelco’s Gaby mine, which is scheduled to come on stream at the end of 2008. The deal grants Minmetals the option to acquire 25% of Gaby’s stock, probably in 2009, at the share price Codelco achieves for the sale of another 24% stake through a public auction. The Administradores de Fondos de Pensión (AFPs, private pension funds) are expected to be the leading bidders for that 24%. Codelco will maintain control of Gaby by retaining a 51% stake. Regarding the copper purchases, Codelco and Minmetals will form a 50:50 joint venture that will acquire the copper from Codelco at market prices, and sell it to Minmetals for the US$550m advance payment—which is estimated to be worth around 53 US cents/lb, plus an additional 50 cents/lb payable to the Codelco-Minmetals joint-venture on each copper delivery. The joint venture will have capital of US$220m, contributed 50:50 by the two parties, and will be further capitalised by retaining its profits in its first five years of operation. In subsequent years, it will distribute 100% of its profits or losses. This is meant to be followed by similar deals associated with other Codelco projects in subsequent years, in order to complete US$2bn in aggregate advance payments by Minmetals. Opposition senators criticised Codelco for contracting advisory services for this transaction from a Swiss bank, UBS and a local bank, Asset Chile, without an open tender. They were not pleased by the direct sale—without open bidding—

Country Report July 2005 www.eiu.com © The Economist Intelligence Unit Limited 2005 24 Chile

of a substantial stake in one of the most profitable projects in Codelco’s portfolio, and the fact that the price formula for the copper sales has an implicit financing cost of 8.3-8.7%. This doubles the financing cost currently available to Codelco through an international bond issue carrying a government guarantee. Codelco answered these criticisms, stating that it has had to look for more imaginative financing mechanisms to implement its ambitious US$12bn investment plans for 2005-12, because its debt is approaching the limits compatible with its high credit rating.

Pacific-4 is signed with Brunei, Following five formal rounds of negotiations that began in 2003, culminating New Zealand and Singapore with a final round held in Brunei in April 2005, on June 3rd Chile signed a Trans-Pacific Co-operation Accord with Brunei, New Zealand and Singapore, known as Pacific-4 or P-4. It includes a free-trade agreement (FTA) that initially grants tariff-free access to around 90% of merchandise trade between the parties. The most sensitive items of the remaining 10% of merchandise trade will reach zero-tariff trade within 12 years. The agreement also includes chapters on trade in services, crossborder investment and dispute settlement procedures, and it aims to encourage associative ventures between entities in P-4 member states, with a particular emphasis on technological co-operation and research and development. The accord will go to the four legislatures for ratification in the coming months, with a view to bringing it into operation at the start of 2006. The original agreement was negotiated between Chile, New Zealand and Singapore, but Brunei was welcomed when it expressed an interest in joining, and the agreement was left open for other members of the Asia-Pacific Economic Co- operation (APEC) forum to join.

Chile to adopt international In line with the global convergence towards international financial reporting financial reporting standards standards (IFRS) prepared by the International Accounting Standards Board (IASB), the Superintendencia de Valores y Seguros (SVS, the watchdog for securities and insurance) has called local accountants to prepare for the replacement of the local standards with the IFRS. The SVS is working with the Colegio de Contadores (the accountants’ guild) to determine the best way to effect this transition, which will require changes in the accountancy curriculum—of the 19 public and private universities currently training auditors and accountants, only two currently teach IFRS—and a re-training programme for professional accountants. The latter will receive the financial support of the Inter-American Development Bank (IDB).

Country Report July 2005 www.eiu.com © The Economist Intelligence Unit Limited 2005 Chile 25

The domestic economy

Output and demand

GDP growth slowed to 5.8% in Year-on-year GDP growth slowed to 5.8% in the first quarter of 2005, down the first quarter from 7.3% in the fourth quarter of 2004 and 7% in the third, despite a continued acceleration in domestic demand growth, to 10.8%. The strength of domestic demand growth was driven by 26.1% growth in gross fixed investment, which was a result of a remarkable 45.4% year-on-year growth in purchases of machinery and equipment and a 13.6% rise in construction and other works. Private consumption growth accelerated to 6.2%, up from 5.8% in both the third and fourth quarters of 2004, with consumption of durable goods up by 18%. Government consumption increased by 3.3%. Imports of goods and services rose by 21.6%, moderating slightly from the growth rate of 24.8% in the fourth quarter of 2004. Exports of goods and services slowed sharply, to 6.7%, down from double-digit growth in the second, third and final quarters of 2004.

Gross domestic product growth by demand (% real change, year on year, at 1996 prices) 2003 2004 2005 3 Qtr 4 Qtr 1 Qtr 2 Qtr 3 Qtr 4 Qtr 1 Qtr Domestic demand 2.4 6.7 6.1 5.6 9.5 10.4 10.8 Private consumption 3.3 4.5 5.2 5.7 5.8 5.8 6.2 Durable goods 9.9 9.7 10.6 14.4 14.0 14.1 18.0 Non-durable goods 4.2 4.9 7.4 6.7 7.5 7.0 6.9 Services 1.7 3.6 2.1 3.6 3.0 3.1 3.8 Government consumption 2.3 1.9 2.5 2.9 3.3 3.1 3.3 Gross investment in fixed capital 4.2 6.4 6.3 7.9 15.6 20.6 26.1 Machinery and equipment -3.0 5.1 12.7 11.7 27.7 39.2 44.7 Construction & other works 9.5 7.3 2.4 4.9 7.7 8.6 13.6 Other domestic demand 1.9 6.8 6.0 4.9 7.6 7.1 6.0 Exports of goods & services 11.7 3.4 8.8 11.4 15.7 15.5 6.7 Imports of goods & services 5.8 16.3 13.6 12.5 23.0 24.8 21.6 GDP growth 4.1 2.8 4.7 5.3 7.0 7.3 5.8

Source: Banco Central de Chile.

Construction was the most dynamic sector on the supply side in the first quarter, with output growth of 11.5% that was led by large investments in new industrial capacity, as well as by infrastructure investment, such as the expansion of Santiago’s underground railway system and the construction of urban highways. Retail and catering output expanded by 8.4%, helped by rising consumer confidence and double-digit growth in tourist arrivals. Transport sector activity increased by 6.4%, and financial services by 5.9%. The other sectors experienced below-average output growth, with mining output up by 5%, agriculture and forestry by 4.2%, and manufacturing by a surprisingly weak 3.4% (less than half the pace of the previous two quarters). Output from utilities was up by 3.9% and communications by just 1% as the dominant fixed-line communications company, Telefónica CTC Chile, continued its investment strike in protest at its regulated tariffs. Fishing output

Country Report July 2005 www.eiu.com © The Economist Intelligence Unit Limited 2005 26 Chile

contracted by 9.9% owing to a high base of comparison and the implementation of a temporary fishing ban to protect and allow for an increase in stocks. GDP at factor cost grew by 5.1% year on year in the first quarter, but growth at market prices reached 5.7%. This difference was owing to a 27.4% rise in import duties—a result of the continued boom in imports—and a 7.4% rise in the net value-added tax (VAT) collected, owing to strong consumption growth. Imacec, the monthly index of economic activity from the Banco Central de Chile (the Central Bank), rose by 6.3% year on year in April, the strongest performance for this month since 1998. This yielded an average year-on-year growth of 5.9% in the first four months of the year.

Gross domestic product growth by sector (% real change, year on year, at 1996 prices) 2003 2004 2005 3 Qtr 4 Qtr 1 Qtr 2 Qtr 3 Qtr 4 Qtr 1 Qtr Agriculture 2.1 2.9 8.0 5.5 6.9 7.8 4.2 Fishing -7.5 -20.5 28.1 22.8 14.1 17.7 -9.9 Mining 8.6 3.9 -0.3 6.5 9.4 11.4 5.0 Manufacturing 3.9 1.6 5.6 6.4 8.1 7.5 3.4 Electricity, gas & water 0.8 0.2 1.4 3.0 4.9 5.7 3.9 Construction 7.5 5.7 1.4 3.8 6.7 7.7 11.5 Retailing & catering 4.9 4.0 5.9 5.8 7.7 8.1 8.4 Transport 3.6 3.8 4.6 5.9 6.4 5.5 6.4 Communications 6.2 5.9 5.6 3.1 3.1 1.6 1.0 Financial services 3.4 1.9 3.9 5.2 7.0 7.7 5.9 House ownership 2.1 2.1 2.2 2.2 2.3 2.3 2.5 Personal servicesa 3.3 1.8 3.7 3.8 4.7 4.1 5.0 Public administration 1.9 1.9 2.0 2.0 2.1 2.0 2.2 Sub-total 4.1 2.4 4.3 5.1 6.4 6.7 5.1 Less: bank charges 4.6 2.5 5.3 5.9 7.0 8.3 5.8 GDP at factor costs 4.1 2.4 4.3 5.1 6.4 6.7 5.1 Plus: value-added tax 4.0 3.9 6.1 6.0 7.2 7.0 7.4 Plus: import duties 7.2 18.2 15.8 12.0 26.7 29.3 27.4 GDP at market prices 4.1 2.8 4.7 5.3 7.0 7.3 5.8 a Includes education, health and other services. Source: Banco Central de Chile.

Employment, wages and prices

Inflation approaches the Following a surprisingly high 0.9% rise in April—the highest monthly increase in centre of the target range nine years—and a 0.6% rise in March, annual consumer price inflation increased to 2.9%, close to the middle of the Central Bank’s target range of 2-4%. Inflation moderated slightly in the next two months, ending June at 2.7%. Underlying inflation, which ignores the prices of fuels, fruit and vegetables, reached 2.4% in the 12 months to June. Inflation in tradable products remained subdued in the 12 months to June, at 1.6%, but inflation in non-tradeables reached 3.5% in this period. The main factors explaining this rise were transport costs (up by 5.1% in the 12 months to June owing to record highs in

Country Report July 2005 www.eiu.com © The Economist Intelligence Unit Limited 2005 Chile 27

international fuel prices), education and recreation (3.4%), housing (3.5%) and healthcare (2.4%). These were partly offset by continued deflation in clothing (-1.3%) and household goods (-0.3%). Wholesale price inflation measured on a 12-month basis fell to 4.1% in June, from a peak of 9.7% in November 2004.

Price and wage trends (% change) Retail prices Wholesale prices Nominal Monthly Annual Monthly Annual Hourly wages 2004 May 0.5 0.6 3.3 4.2 3.0 Jun 0.4 1.1 1.8 5.2 3.2 Jul 0.2 1.4 0.3 4.8 3.2 Aug 0.4 1.6 1.4 5.0 3.2 Sep 0.1 1.5 -1.2 4.8 3.3 Oct 0.3 1.9 1.7 8.9 3.1 Nov 0.3 2.5 -0.8 9.7 3.2 Dec -0.4 2.4 -3.0 7.8 3.2 2005 Jan -0.3 2.3 -0.1 8.8 3.5 Feb -0.1 2.2 0.8 8.7 4.0 Mar 0.6 2.4 2.0 8.5 4.4 Apr 0.9 2.9 1.7 8.0 4.6 May 0.3 2.7 -0.1 4.5 5.0 Jun 0.4 2.7 1.4 4.1 -

Source: Instituto Nacional de Estadísticas (INE).

Real wages are rising at a The year-on-year rise in real hourly wages averaged 1.7% in the first five months moderate pace of 2005 according to the Instituto Nacional de Estadísticas (INE, National Institute of Statistics) following a 2.1% rise in 2004 and increases of 0.8% in both 2002 and 2003. The average monthly wage of the 1.5m workers at 32,885 companies affiliated to the Asociación Chilena de Seguridad (AChS, the largest insurance company for labour-related health risks) reached Ps353,797 (US$607) in April 2005, which represented a 1.9% rise year on year in inflation-adjusted terms. Mining and finance showed the highest average sectoral wages, with Ps648,950 and Ps524,118 respectively. The impact of mining was also reflected in average regional wages, which were headed by regions I and II in the extreme north, with Ps426,049 and Ps409,148 respectively. The Santiago metropolitan region recorded an average monthly wage of Ps382,399 among workers affiliated to AChS. On June 21st Congress ratified a government bill to raise the minimum monthly wage from Ps120,000 to Ps127,500 from July 1st. This is equivalent to a 3.5% rise in inflation-adjusted terms. This completed a real increase of 69% in the minimum wage since 1990. The bill also includes a provision to raise it to Ps135,000, or another 3% in real terms, from July 1st 2006.

Unemployment is trending The unemployment rate started to fall in year-on-year terms in the first quarter, lower owing to strong economic growth, increased investment and the government’s job-creation programmes. The number of people in employment increased by 3.6% year on year in the February-April running quarter, yielding an average rise of 3.4% in the first four months of 2005. Unemployment, as measured by

Country Report July 2005 www.eiu.com © The Economist Intelligence Unit Limited 2005 28 Chile

INE, reached 8.2% in the February-April running quarter, down from 8.7% in the same period of 2004 and the lowest unemployment rate for this quarter since 1998. Using a different methodology, the Universidad de Chile’s quarterly employment survey in the Santiago metropolitan area found an unemployment rate of 11.3% in March, 0.6 percentage points lower than in March 2004 and also the lowest in March since 1998.

Employment trends ('000 unless otherwise indicated) Labour force Unemployed Unemployment rate (%) 2003 2004 2005 2003 2004 2005 2003 2004 2005 Nov-Jan 6,003 6,132 6,353 459 453 479 7.6 7.4 7.5 Dec-Feb 6,025 6,121 6,328 474 455 483 7.9 7.4 7.6 Jan-Mar 6,054 6,139 6,335 495 500 501 8.2 8.1 7.9 Feb-Apr 6,072 6,161 6,346 518 538 519 8.5 8.7 8.2 Mar-May 6,094 6,159 - 534 581 - 8.8 9.4 - Apr-Jun 6,066 6140 - 549 590 - 9.1 9.6 - May-Jul 6,033 6,097 - 548 589 - 9.1 9.7 - Jun-Aug 6,021 6,136 - 564 605 - 9.4 9.9 - Jul-Sep 6,015 6,157 - 563 600 - 9.4 9.7 - Aug-Oct 6,036 6,239 - 533 589 - 8.8 9.4 - Sep-Nov 6,084 6,285 - 491 539 - 8.2 8.6 - Oct-Dec 6,128 6,358 - 453 495 - 7.4 7.8 -

Source: Instituto Nacional de Estadísticas (INE).

However, the unemployment rate remains about 2.3 percentage points higher than in 1997-98, at a comparably strong stage in the global business cycle. Critics blame the economy’s lower job creation on the labour reforms implemented since 1997, which increased rigidities in the labour market. This is reflected in a female unemployment rate of 10.7% in February-April, well above the 6.8% male unemployment, and high youth unemployment levels. Unemployment among those aged 15-19 stands at 23.1%, and at 18.6% in the 20-24 age group.

Financial indicators

Bank asset growth continues In May 2005 the banking system was managing the equivalent of US$69.9bn in to accelerate with rising profits financial assets following an acceleration in asset growth to 12.4% year on year in real peso terms, up from 10.4% in 2004, 4.6% in 2003 and 1.6% in 2002. Profits reached US$565m in the first five months of the year, an annualised return on equity of 18.9% (up from 16.7% in 2004) and a 1.94% annualised return on assets (1.76% in 2004). The average quality of bank assets has continued to improve, with the ratio between overdue loans and total bank assets down to 1.1%, from 1.2% in 2004, 1.6% in 2003 and 1.8% in 2002. The management of local banks remained prudent, with a strong capitalisation—capital and reserves totalled US$7.2bn by May 2005—and provisions totalling 1.82% of total bank assets, 61% higher than the aggregate overdue loans at the time. Factoring remains the fastest-growing category of bank assets, with year-on-year growth of 123% in May. Interbank loans increased by 29.1% to US$1.2bn, and leasing rose by 21.4% to US$3.1bn. Both housing and consumer loans increased by a strong 19.2% year on year, to US$13.8bn and US$8.1bn respectively. The

Country Report July 2005 www.eiu.com © The Economist Intelligence Unit Limited 2005 Chile 29

stock of commercial loans outstanding increased by 9.8% year on year to US$39.9bn, accounting for 57% of total bank assets, while foreign trade loans rose by 5.6% to US$6.9bn.

Bank results, May 2005a Market share Capital & Total assets Annual asset (% of total reserves Net earnings Return on (US$ m) growth (%) assets) (US$ m) (US$ m) capital (%) Banco Santander-Chile (Spain)b 16,067 10.8 23.0 1,437.2 158.5 26.5 Banco de Chilec 12,401 9.2 17.7 900.7 130.7 34.8 Banco del Estado 9,304 14.8 13.3 693.9 30.0 10.4 Banco de Crédito e Inversionesd 8,264 16.1 11.8 663.7 70.8 25.6 BBVA-Chile (Spain)e 5,338 15.2 7.6 435.1 23.8 13.1 Corpbanca 4,615 21.0 6.6 602.8 33.5 13.3 Banco del Desarrollo 2,635 16.1 3.8 237.6 11.7 11.8 Banco Securityf 2,192 25.7 3.1 218.7 15.0 16.4 Scotiabank Sud Americano (Canada) 2,091 0.3 3.0 228.0 9.1 9.6 Banco Bice 1,767 3.7 2.5 192.3 12.5 15.6 BankBoston (US) 1,594 19.4 2.3 182.5 10.7 14.1 Citibank N.A. (US) 1,476 -1.2 2.1 417.9 5.3 3.0 Banco Falabella 492 23.1 0.7 74.8 9.6 30.9 ABN Amro Bank-Chile (Netherlands) 366 14.1 0.5 161.4 1.3 1.9 HSBC Bank Chile (UK) 228 -16.0 0.3 154.0 2.1 3.3 Banco Ripley 216 79.0 0.3 24.7 1.2 12.1 Banco Paris 212 - 0.3 24.1 3.3 33.0 Banco Internacional 207 -4.3 0.3 25.9 1.4 13.4 Total banking system incl other 69,915 12.4 100.0 7,172.1 564.9 18.9 a All peso figures converted into US dollars at the end-May exchange rate of Ps583:$1. b A subsidiary of Banco Santander Central Hispano (BSCH); merged with Banco Santiago in August 2002. c Merged with Banco de A. Edwards at the start of 2002. d Merged with Banco Consosur at the start of 2004. e A subsidiary of Banco Bilbao Vizcaya Argentaria (BBVA); before March 2003 known as BBVA Banco Bhif; merged with Banco Sudameris in October 2003. f Acquired in September 2004 the local assets of Dresdner Bank. Source: Superintendencia de Bancos e Instituciones Financieras (SBIF).

The stockmarket trends The Índice General de Precios de Acciones (IGPA, the general share price index) upwards of the Bolsa de Comercio de Santiago (BCS, the Santiago Stock Exchange) trended hesitantly upwards in the first five months of 2005, achieving an overall rise of 2.6% since the end of 2004. The Indice Precio Selectivo Acciones (IPSA), which follows the 40 most-traded stocks, had a more robust performance, rising by 9.6% over the period. The volumes traded increased by 64% year on year in the first five months, totalling US$6.9bn according to the BCS.

Stockmarket performance (general share price index—IGPA; end-1995=100; end-period) Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec 1997 91.1 93.5 93.3 92.9 98.5 99.9 99.4 95.5 95.5 88.4 85.8 83.6 1998 75.3 78.6 85.1 80.0 75.2 70.8 71.7 56.7 56.9 59.2 69.0 62.6 1999 62.1 66.9 72.0 77.7 77.9 83.1 82.0 81.0 80.5 79.8 85.5 90.0 2000 94.6 90.4 89.6 86.4 87.0 85.7 84.1 86.3 84.5 82.8 84.3 84.8 2001 88.9 85.6 89.6 88.4 95.6 93.9 95.5 98.7 88.4 85.2 94.8 94.0 2002 91.8 92.1 93.0 91.0 89.5 87.2 86.3 86.3 81.8 83.1 83.9 87.4 2003 86.8 87.9 88.1 92.1 101.1 104.0 109.9 117.2 121.8 129.8 126.2 127.8

Country Report July 2005 www.eiu.com © The Economist Intelligence Unit Limited 2005 30 Chile

Stockmarket performance (general share price index—IGPA; end-1995=100; end-period) Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec 2004 123.3 132.9 130.2 127.9 125.6 131.0 137.3 143.5 149.2 153.4 156.8 156.0 2005 154.4 159.9 164.0 161.4 160.3 ------12-month % change 25.2 20.3 25.9 26.2 27.6 ------

Sources: Economist Intelligence Unit; Bolsa de Comercio de Santiago.

Codelco issues a local bond On May 10th Codelco tendered UF6.9m (around US$208m) in 20-year bullet bonds with a real coupon of 3.29%, implying a spread of 20 basis points in relation to the UF-denominated Chilean Treasury bonds (BTUs) with the same maturity. The issue, which does not have a government guarantee, was oversubscribed by US$94m and was sold at a price that exceeded the face value by 10.64%. Coldelco used the proceeds to help fund its purchase of the Ventanas copper refinery from the financially strapped Empresa Nacional de Minería (Enami).

Companies are opting for In the second week of June three companies—a telecommunications company, syndicated bank loans Entel; a retail company, Cencosud; and the state railway company, Ferrocarriles del Estado—raised a total of US$1.4bn through syndicated loans. The preference for these instruments over bond issues has been in evidence in recent months, and it is expected to continue in the remainder of the year, owing to the banks’ ample liquidity and their readiness to produce flexible and made-to-measure financing packages, without the rigid covenants that must be included in bond contracts.

Sectoral trends

Yields of agricultural crops INE's survey of annual crop results found that maize had a record season in continue to improve 2004/05, with the highest figures ever for the area sown (134,280 ha), total output (1.51m tonnes) and the average yield (11.24 tonnes/ha). There were also record yields for oats (4.66 tonnes/ha), beans (1.9 tonnes/ha) and sugarbeet (82.71 tonnes/ha). The total area sown to annual crops reached 834,314 ha in the 2004/05 season, of which 50.3% was allocated to wheat. The output of wheat (1.85m tonnes) represented a yield of 4.41 tonnes/ha, 3.5% lower than in 2003/04.

Results of the main annual crops in the 2004/05 season Harvest Area sown (ha) ('000 tonnes) Yield (tonnes/ha) Cereals Maize 134,280 1,510 11.24 Barley 21,500 100 4.76 Rice 25,030 120 4.67 Oats 76,680 360 4.66 Wheat 419,660 1,850 4.41 Vegetables Potatoes 55,620 1,120 20.06 Beans 23,510 46 1.90

Country Report July 2005 www.eiu.com © The Economist Intelligence Unit Limited 2005 Chile 31

Results of the main annual crops in the 2004/05 season Harvest Area sown (ha) ('000 tonnes) Yield (tonnes/ha) Industrial crops Sugarbeet 31,410 2,590 82.71 Rapeseed 12,130 41 3.40 Lupin 23,500 63 2.50

Source: Instituto Nacional de Estadísticas (INE).

Meat exports are booming Meat export earnings increased by 68.9% year on year in 2004, to US$386.2m, up from US$228.6m in 2003 and US$151.3m in 2002. They appear set to exceed US$550m this year: pork export earnings increased by 56% year on year in the first quarter, to US$95.8m, whereas poultry exports rose by 28.1% to US$43.8m and beef exports rose by 354% to US$21.2m. The industry appears on course to become as important for Chile as fruit, forestry, wine and salmon. The various segments of this industry are investing heavily in new capacity and state-of-the- art technology, encouraged by the opening of massive new markets through bilateral sanitary certification agreements.

Meat exports, 2004 (US$ m) Type Destination Pork 234.6 Japan 173.6 Poultry 93.6 Mexico 73.2 Beef 22.9 South Korea 53.6 Lamb 20.1 UK 18.1 Other 15.0 Other 67.7 Total 386.2 Total 386.2

Source: Odepa.

Following six years of negotiations, on May 10th the US Federal Register passed Chile’s inspection, certification and sanitary systems as being equivalent to those of the US, signalling its intent to authorise imports of beef, lamb and pork from Chile. Following exhaustive reviews—and considering Chile’s meat export plants have already been approved by markets as demanding as those of Japan, South Korea and the EU—this should not raise problems. In September the US's Food Safety and Inspection Service (FSIS) is expected to authorise meat imports from Chile, which will yield rapidly rising volumes of exports in the coming years. Chile is also negotiating sanitary certification agreements with China, India, Russia, South Africa, Algeria and the European Free-Trade Association (EFTA, which is formed by Iceland, Liechtenstein, Norway and Switzerland).

Wine exporters advance Export earnings of bottled wine increased by 15.5% year on year in the first slowly in raising prices quarter, to US$160m, as a result of a rise of 12% in volumes to 57.1m litres, and a 3.2% increase in the average price. Based on this trend, wine exports in 2005 are forecast to total in excess of US$950m, compared with earnings of US$835.2m in 2004 through sales of 467.5m litres (including 264.4m litres of bottled wine). The 3.2% increase in average prices for bottled wine shows the limited success

Country Report July 2005 www.eiu.com © The Economist Intelligence Unit Limited 2005 32 Chile

of the industry’s efforts to reposition Chilean wines into higher price brackets, despite the strengthening reputation of their quality.

Spence copper mine will An Anglo-Australian mining company, BHP Billiton, which owns the Cerro boost BHP Billiton Colorado copper mine in Chile and also controls La Escondida with a 37.5% stake, will overtake Phelps Dodge to become the world’s second-largest copper producer after Codelco in 2007 when its Spence copper mine comes on-stream. Spence has proven reserves of 310m tonnes, with ore grades in excess of 0.3% and an average ore grade of 1.14%. The new mine has been designed with a capacity of 200,000 tonnes/year of fine copper, a level it expects to achieve from September 2007. Spence is scheduled to start production tests in December 2006 and to reach normal output from August 2007. The mine is planned to have a productive life of 19 years.

Tourist arrivals are expected to Tourist arrivals exceeded 758,000 in the first quarter, a 14.4% year-on-year rise, reach 2m this year and tourism receipts rose by 14.1% to US$438m. The number of visitors from South America rose by 16% year on year in the first quarter, totalling 418,678, whereas tourists from Europe increased by 10.5% to 128,652, and those from North America by 13.8% to 99,825. This has kept the country on schedule to achieve its goal of 2m visitors and US$1.45bn in tourism revenue in 2005 set by the Servicio Nacional de Turismo (Sernatur, the government tourism office), and the Corporación de Promoción Turística de Chile (CPT, a private-sector tourism promotion organisation). The goal set for 2010 is 3.2m arrivals and US$2.3bn in revenue. This compares with 1.79m visitors and US$1.27bn in revenue achieved in 2004, and 1.61m with US$1.1bn in 2003. Chile’s tourism promotion campaigns are being focused on ecological tourism and business travel associated with conventions and conferences. The latter will yield direct revenue of around US$42m this year with 45 events and over 28,000 participants, up from 38 events with 23,500 participants that generated US$38m in 2004. The reservations for 2006 lead CPT to expect a rise of about 18% in the international conference business in 2006, and it has high hopes for subsequent years in view of the success encountered so far and the growing reputation of Chile’s internal security, natural beauty and modern infrastructure. This is prompting considerable investment in new high-end hotels and facilities for conferences and conventions around Santiago and in the regions, particularly in the south of the country.

Automotive sales will reach a Sales of cars and light commercial vehicles (LCVs) increased by 39.2% year on new record in 2005 year to 78,381 units in the first five months of 2005, according to the Servicio Nacional de Aduanas (the customs service). In value terms, they reached US$686.6m, 47.2% higher than in the first five months of 2004. Japan remains the main source of motor vehicles with imports worth US$205.6m (up by 29.8% year on year), but it lost market share to South Korea (whose automotive exports to Chile rose by 82.9% to US$140.3m), the US (up by 78.4% to US$41.8m) and Thailand (up 165.6% to US$28.1m). Imports from Brazil rose by 34.2% to US$82.3m; imports from Argentina by 33.9% to US$33.9m; and imports from Mexico rose by 43.1% to US$22.6m.

Country Report July 2005 www.eiu.com © The Economist Intelligence Unit Limited 2005 Chile 33

These figures suggest that the Asociación Nacional Automotriz de Chile (Asach, the motor-vehicle distributors’ association)—which recently revised its sales projection for the year up to a record 180,000 units—will have to revise its figures up once again. Truck sales are expected to reach 9,500 units in 2005, just below the record set in 1997.

Imports of cars and LCVs by origin, 2005 (Jan-May) Volume % change, Value % change, Units year on year US$m year on year Japan 23,138 37.0 205.6 29.8 South Korea 17,403 57.4 140.3 82.9 Brazil 11,782 23.7 82.3 34.2 Argentina 9,785 22.1 65.1 33.9 US 2,335 66.4 41.8 78.4 France 3,684 18.5 39.0 34.4 Thailand 2,803 234.8 28.1 165.6 Germany 788 56.0 25.7 60.6 Mexico 3,224 34.4 22.6 43.1 Total incl others 78,381 39.2 686.6 47.2

Source: Servicio Nacional de Aduanas.

Foreign trade and payments

The trade surplus is beginning After trending upwards at a strong pace for two years, reaching a peak of to narrow US$9.3bn in January 2005, the country’s 12-month trade surplus has started to fall, to US$8.6bn in May. Merchandise exports increased by 19.8% year on year in the first five months of 2005, reaching US$15.7bn, and a record US$34.6bn in the 12 months to May (a rise of 34.7% year on year). Merchandise imports, also measured on a fob basis, rose by 35.7% to US$11.7bn in the first five months of 2005, and by 35.4% in the 12 months to May, reaching an all-time high of US$26.1bn. Copper exports rose by 9.3% to US$6.3bn in the first five months of 2005, accounting for 40.3% of total merchandise export earnings, whereas non- copper exports increased by 28.1% to US$9.4bn. On a cif basis, imports of capital goods increased by 54.2% to US$2.7bn in the first five months, whereas imports of consumer goods rose by 27.9% to US$1.9bn and imports of intermediate goods by 36.3% to US$7.3bn. Asia absorbed 34.6% of Chilean exports in the first four months of 2005, Europe 26%, Latin America 20.1%, and the US and Canada 18.1%. Exports to the US increased by 16.5% year on year in the first four months, which kept it as Chile’s largest single market, absorbing 16.1% of its exports. It was followed by Japan (up by 29.5%, accounting for 11.7%), China (up 61.8% to 10.1%), the Netherlands— whose Rotterdam port serves as the main entry point into the EU—(up by 70.4% to 6.3%), and South Korea (up by 15.2% to 5.7%). Latin America remained the main source for merchandise imports in the first four months of 2005, accounting for 38.1% of the total. Asia accounted for 16.1%, the EU for 15.5%, and the US and Canada for 15.2%. Argentina was the leading supplier on an individual basis, with 17.9% of the total (supplying mostly oil and natural gas). It was followed by the US (13.5%), Brazil (11.2%) and China (6.8%).

Country Report July 2005 www.eiu.com © The Economist Intelligence Unit Limited 2005 34 Chile

Foreign trade (US$ m; fob) 12-month Exports Imports trade balance 2004 2005 2004 2005 2004 2005 Jan 2,195 2,968 1,683 2,200 3,772 9,276 Feb 2,233 2,584 1,436 2,015 4,282 9,048 Mar 3,056 3,651 1,870 2,544 4,968 8,969 Apr 2,759 3,440 1,748 2,373 5,706 9,024 May 2,866 3,065 1,849 2,522 6,455 8,550 Jun 2,302 - 1,724 - 6,790 - Jul 2,707 - 2,018 - 7,231 - Aug 2,779 - 1,997 - 7,830 - Sep 2,447 - 2,107 - 7,996 - Oct 2,764 - 2,237 - 8,269 - Nov 2,604 - 2,126 - 8,422 - Dec 3,313 - 2,211 - 9,019 -

Source: Banco Central de Chile.

The current-account surplus reached US$369m in the first quarter of 2005, down from US$688m in the same period of 2004. The country’s traditional surplus in net current transfers nearly doubled to US$287m, and the deficit in services increased only marginally, to US$83m, despite a 21.9% increase in debits, owing to a 22.6% rise in credits resulting from record tourist arrivals and strong performances by the merchant fleet and LAN Airlines. The trade surplus fell by US$50m year on year in the first quarter, to US$2.4bn; merchandise imports increased by 35.5% year on year and merchandise imports by 23%. Chile’s income deficit increased by US$402m (21.4%) to US$2.3bn in the quarter, owing to record profits by foreign investors in the country and a rise in interest payments.

Balance of payments (US$ m) 2004 2005 1 Qtr 2 Qtr 3 Qtr 4 Qtr Year 1 Qtr Merchandise exports 7,484.0 7,927.1 7,923.8 8,681.0 32,024.9 9,202.8 Merchandise imports -4,989.4 -5,320.8 -6,121.8 -6,573.7 -23,005.7 -6,759.9 Trade balance 2,494.7 2,606.3 1,811.0 2,107.2 9,019.2 2,444.8 Services credits 1,507.6 1,396.3 1,402.2 1,649.3 5,956.4 1,847.6 Services debits -1,584.2 -1,560.1 -1,688.5 -1,703.9 -6,536.7 -1,930.5 Services balance -76.6 -163.8 -285.3 -54.6 -580.3 -82.8 Income balance -1,878.4 -2,046.4 -2,027.0 -2,148.8 -8,100.6 -2,279.9 Net transfers 148.7 390.5 253.7 258.5 1,051.4 286.9 Current account balance 688.4 786.6 -247.6 162.3 1,389.7 369.0 Capital & financial account -414.4 -1,173.9 1,119.2 140.7 -328.3 51.4 Direct investment 1,835.0 570.5 3,173.3 1,081.1 6,659.8 697.9 Outflows -163.3 -189.6 -152.8 -437.2 -943.0 -475.7 Inflows 1,998.3 760.1 3,326.0 1,518.3 7,602.8 1,173.7 Portfolio investment -314.5 -1,447.8 -1,086.0 -585.5 -3,433.8 -114.2 Outflows -1,251.3 -1,053.0 -731.1 -1,521.6 -4,557.0 -227.0 Inflows 936.8 -394.8 -354.9 936.1 1,123.2 112.8

Country Report July 2005 www.eiu.com © The Economist Intelligence Unit Limited 2005 Chile 35

Balance of payments (US$ m) 2004 2005 1 Qtr 2 Qtr 3 Qtr 4 Qtr Year 1 Qtr Financial derivatives 140.7 -48.7 -109.7 -66.3 -84.0 93.3 Other investments -1,989.4 -223.3 -994.5 -459.0 -3,666.2 -1,000.8 Reserve assets -91.3 -24.5 136.2 170.4 190.8 375.2 Errors & omissions -274.0 387.3 -871.7 -303.0 -1,061.4 -420.5 Overall balance of payments 91.3 24.5 -136.2 -170.4 -190.8 -375.2

Source: Banco Central de Chile.

Net international reserves Net international reserves increased by US$386m or 2.27% in May to US$17.4bn, trend upwards completing an 8.4% rise since the end of 2004 and a 7.6% rise in year-on-year terms. However, rapidly rising imports have meant that import cover has fallen. Net international reserves in May were sufficient to provide 7.5 months of import cover, down from 8.4 months at end-2004.

Net international reserves (US$ m; end-period) 1997 17,841 1998 15,992 1999 14,710 2000 14,741 2001 14,400 2002 15,351 2003 15,851 2004 16,016 2005a 17,377 a End-May. Source: Banco Central de Chile.

Foreign debt rises by 3.3% in Following a rise of just 0.8% (US$165m) in the whole of 2004, foreign debt the first four months of 2005 increased by 3.3% (US$1.4bn) in the first four months of 2005, reaching US$45.2bn. Short-term debt increased by US$492m to US$8.2bn, whereas medium- and long-term debt rose by US$976m to US$37bn. Public-sector foreign debt rose by just US$70m in the first four months, to just under US$10bn, or 22% of the country’s total foreign debt. This includes US$993m in short-term debt. Private-sector foreign debt rose by US$1.4bn to US$35.3bn, of which 20.4% is short-term debt.

Country Report July 2005 www.eiu.com © The Economist Intelligence Unit Limited 2005 36 Chile

Foreign debt (US$ m; end-period, except 2005=end-Apr) 2001 2002 2003 2004 2005 Medium- & long-term 33,248 34,852 35,892 36,057 37,003 Public sector 5,346 6,255 7,881 9,131 8,958 Central Bank 2 1 1 1 1 Banco del Estado 54 50 15 227 82 Treasurya 2,959 3,620 4,586 4,732 4,685 Other 2,331 2,584 3,279 4,171 4,190 Private sector 27,902 28,597 28,011 26,926 28,045 Banks 1,382 2,481 2,981 3,740 4,678 Short-term 5,290 5,823 7,504 7,707 8,199 Public sector 778 938 1,436 750 993 Central Bank 13 11 9 16 13 Banco del Estado 1 99 313 64 18 Treasury 0 0 0 0 0 Other 764 828 1,114 670 962 Private sector 4,512 4,885 6,068 6,957 7,206 Banks 1,084 1,190 2,112 2,255 2,010 Total 38,538 40,675 43,396 43,764 45,202 a Includes private-sector debts with government guarantees. Source: Banco Central de Chile.

Country Report July 2005 www.eiu.com © The Economist Intelligence Unit Limited 2005