Hot spots: Chile; international insight. (International Affairs Section).

It is becoming increasingly clear that the economy's performance, in absolute terms, will be weaker this year than almost anyone anticipated at the outset, but relative to the rest of Latin America the country will still do remarkably well. In June, the so-called Imacec index, a close proxy of gross domestic product, was a mere 0.3 percent higher than a year earlier, the lowest monthly growth figure in 33 months. This was due in part to devastating rainstorms that flooded large sections of the country in that month, but also to softness in key industries such as mining and telecommunications owed to negative influences from abroad (in May, the Imacec was up 0.9 percent).

Retail sales in June rose by a meager 0.7 percent, year-on-year. Unemployment inched down to 9.4 percent of the labor force in the May-July period from 9.5 percent in April-June, but this decline still left it painfully high. Most Chileans seem to think that the economy is in much worse condition than it really is. In a recent survey conducted by the Public Studies Center, 52 percent of the respondents said that it is "bad" or "very bad." In fact, real GDP grew by 1.7 percent in the second quarter, year-on-year and by 1.6 percent in the first semester of 2002. While this was down sharply from the 3.5 percent gain clocked in the first six months of 2001, compared to the performance of most other economies in the region, it was quite good.

Basically, while Chile proved not to be totally immune to the repercussions emanating from neighboring countries in crisis, such as Argentina, Brazil and Uruguay, it showed remarkable resistance to contagion. The resilience, in turn, has been due largely to sensible policies that even the usually sharp-tongued IMF calls "objectives of promoting a recovery of domestic demand and moderate output growth this year" that are "broadly appropriate, particularly in light of the still high level of unemployment and associated output gap."

The Central Bank estimates that a 60 percent plunge this year of exports to Argentina (which, fortunately, even in normal times absorbs only about 3.2 percent of total Chilean sales abroad) coupled with a steep falloff of tourist arrivals from the neighboring country could cost Chile about half a percentage point of GDP growth. The IMF recently lowered its expectation for the 2002 expansion of gross domestic product to 2.6 percent from 3.0 percent, and the new projection looks decidedly more realistic than the government's 3.2 percent (which will probably soon be revised downward). It does not, however, even remotely resemble a recession. While global and regional factors and the still weak domestic demand and soft business confidence will probably continue to hamper the recovery, monetary policy has been compensating for much of this, as the Central Bank has been chipping away at interest rates all year to stimulate spending and growth.

Rates are now at historically low levels of around 3 percent, and even though the floating Chilean peso has been vulnerable in the exchange markets, trading below 700:USD 1 (down nearly 6 percent so far this year), the CB may loosen policy even further. In all probability, strong demand for dollars from foreign banks operating in Chile and fearing contagion from the country's financially troubled neighbors will persist and will continue to weigh on the peso's exchange rate. The CB, however, is no longer hemmed in by a policy ...