Hot spots: Chile.(international)

Chile has had to struggle against strong economic and financial headwinds during the past year, but conditions have held up better than most expected and the outlook is quite bright. The country has been battered by soaring world market prices for energy (Chile imports roughly two-thirds of what it needs) and for food. The pressures have been exacerbated by drought and a very tight energy situation caused by Argentina which, due to problems of its own, slashed shipments of natural gas to its neighbor as it diverted supplies to its own industries and residents.

To make matters worse, the third-driest winter in some 50 years has reduced power supplies from hydroelectric dams, which account for more than half the total on the country's central grid serving Santiago. Chile is building two liquefied natural gas terminals to ease the problem, of which one is to be completed, with some luck, by mid-2009, while the other, to serve the country's North in order to ease energy shortages in the main copper producing area, is being built with a targeted completion date in 2010. In the meantime, it appears that national power usage this year will be the same as in 2007 or even a bit lower, which would be the first time that a decline has been registered since 1982.

Finance Minister Andres Velasquez conceded not long ago that the energy shortage had acted as "the principal brake" on the economy this year and last. Moreover, the rocketing cost of energy has contributed to an inflation rate that rose to an annual 9.5% in both June and July in such convincing fashion that local economists recently raised their average forecasts for monetary erosion in all of 2008 to 8.0% from 7.5%. Core inflation in July was the fastest since the National Statistics

Institute started tracking it in 1997, as housing, health care and transportation became more expensive.

The Central Bank, though, has responded quite resolutely to the surge of prices. Arguing that "containing inflation isn't free, but postponing that containment is even more expensive," it yanked up its benchmark overnight lending rate on August 12 by half a percentage point for the second time in two months, to a 14-month high of 7.75%, warning that further increases would have to be reckoned with.

It also ended efforts to weaken the peso's exchange rate, which it had been pursuing with purchases of $50 million a day in the currency bazaar, both to build up international monetary reserves and to keep Chilean exporters of non-traditional goods internationally competitive. The peso dropped by as much as 16% after the CB announced the start of these purchases on April 10. It is still trading 3.25% lower than it did at the outset of this year, although the monetary authorities now have the view that a stronger peso will help dampen imported inflation.

What the Central Bank is really trying to do is anchor inflationary expectations, and in this it has a good chance of succeeding. The government, fortunately, is supporting its quest by constraining fiscal spending. President Michelle Bachelet will keep the 2009 budget as tight as possible, even though higher public spending has not been one of the principal causes of the acceleration of inflation. Much more of a problem is that marginal labor productivity has stopped rising. This means that the government needs to pay more attention to workforce training and to improving technical education, because experience shows that progress on these two fronts helps to boost productivity.