October 02, 2006	Monday	Ramazan 8, 1427

Argentine

THE Argentine economy has continued to deliver very positive outturns in the period following the 2002 crisis. After three years of around 9 per cent growth, real GDP has surpassed its 1998 peak by some 6 per cent, led by strong investment and consumption. The economy has benefited from a favourable terms of trade, significant reduction in the debt burden following the 2005 debt restructuring, and a competitive currency. However, inflation has risen steadily ending 2005 at 12.3 per cent.

According to the International Monetary Fund, the country’s external accounts have undergone a remarkable transformation in a relatively short period of time, allowing for the early repurchase of the entire stock of Fund credit in January 2006. Favourable global commodity prices and the emergence of Asia as a key export destination have increased earnings from primary and agro-industrial exports. At the same time, net private capital flows turned positive in 2005 for the first time since 1999.

Early indicators imply that current trends are set to continue this year. Public sector capital spending continues to rise rapidly, growing at a real rate of over 70 per cent in the 12 months to May. Substantial increases in subsidies and discretionary transfers to provinces continue. The strong balance of payments has allowed the central bank to accumulate around US$1 billion of international reserves per month so far this year, and reserves now stand at US$26 billion according to the IMF latest assessment.

Inflation: Measured inflation fell to 11 per cent at end-June, a result of the government’s efforts to dampen price pressures through price agreements with industry and retail groups and a temporary ban on meat exports. Underlying inflation, however, remains high—core inflation is running at 12¼ per cent—and end-2007 inflation expectations are around 12 per cent. While real wages in the informal sector remain depressed, formal private sector real wages are rising rapidly, and labour markets are tightening.

Argentina is Latin America’s third-largest economy. According to private economists, it has expanded by about nine per cent in each of the last three years, recovering from a deep crisis in 2001-2002. But growth has begun to slow. The Argentine government’s draft budget bill foresees 2007 economic growth at four per cent and inflation between eight per cent and 11 per cent. It also targets the federal government’s primary budget surplus at three per cent of gross domestic product — in line with its goal for 2006.Economists and analysts surveyed by the central bank last month forecast 2007 economic growth at six per cent, compared with a median outlook for 7.8 per cent for this year.

Chile

THE Chilean economy expanded by 5.1 per cent year-over-year in the first quarter. This seems reasonable, but was below expectations and represented the weakest growth in two years. While industrial output and commercial activity propelled the economy forward, flat mining output and a drop in agricultural activity combined to slow it down.

On the positive side, industrial output rose by 6.3 per cent year-over-year, notably outpacing its performance in the first quarter of 2005 when it expanded by 3.7 per cent. This strong expansion reflected the growth of consumption and of external demand, with sectors such as food, beverages, tobacco, chemicals and fuels performing especially strongly.

Commercial activity also rose by 6.3 per cent, outpacing the GDP growth, led by the retail trade. Sales of durable goods and, particularly, automobiles were especially strong, reflecting the robust rise in formal employment and credit availability.

Less positively, mining activity rose by a mere 0.8 per cent, with production of metals other than copper (especially gold and molybdenum) compensating for contracting copper output due to capacity constraints, lower ore grades, and technical failures.

Output: Agricultural output declined by 2.4 per cent, reflecting a drop in production of fruit (a major export) attributed to a late spring and an especially long, rainy winter season. In addition, this drop reflected a statistically high base of comparison in the first quarter of last year. Other sectors continued to grow, albeit at a slower pace. The output of the electricity, gas and water sector rose by seven per cent year-over-year, driven by higher hydroelectric generation, given favourable weather conditions in the first quarter.

Despite the positive impact of external trade on maritime and air transportation, the transport sector expanded by only 4.7 per cent. However, the communications sector recorded growth of 12.8 per cent year-over-year, led by continued strong growth in mobile telephony and private courier services. A reduction — as compared to the first quarter of last year — in the restrictions imposed by Argentina on its exports of natural gas to Chile also meant higher natural gas sales.

Construction activity growth, at 4.8 per cent, has continued to decelerate since peaking in the first quarter of 2005. Although propelled by investment in mining and energy infrastructure, it continues to reflect the completion of public infrastructure and urban railway projects. This gradual slowdown, whilst it may be coming a little earlier than forecast, was to be expected, and still represents robust growth by any objective standard. Economists are forecasting the GDP growth of 5.4 per cent for 2006 and 5.1 per cent for 2007, down from 6.3 per cent in 2005.

Consensus: This is not far away from local consensus expectations for 2006, which have fallen from a recent high of 5.7 per cent growth to current levels of 5.5 per cent. This gradual slowdown is expected to continue as global growth looks set to moderate and local export and investment trends weaken, and tighter domestic monetary policy does its job

Although the Chilean economy is approaching its maturation phase and signs of a slowdown are visible, the below-expectations growth seen in the first quarter of this year is not a ceiling for the remainder of the year, and our forecasts for GDP growth, which already pointed to a gradual convergence toward medium-term trend expansion levels, remain unchanged.

On the back of 38 per cent year-to-date export growth — a function of higher copper volumes and prices, as well as strong industrial exports — aggregate exports in 2006 are expected to total US$54.8 billion, an increase of 35 per cent over 2005. For 2007, slightly lower exports (US$53.1 billion) are anticipated in line with the UBS’s expectation that copper prices will remain high (US¢265/lb), but also incorporating slower world growth.

Venezuela

Venezuela is the Latin America’s fourth-largest economy. It has attracted $1.2 billion in foreign direct investment last year, a 4.9 per cent increase from 2004. The investment bank forecasts a further 25 per cent increase this year to $1.5 billion. Despite high oil prices and high economic growth, private investment continues to grow at sub-par rates because of uncertainty related to the future treatment of private property. However, the country suffers from FDI volatility and except for oil is losing attraction among many foreign investors concerned about growing state control over the economy.

Revenues: In an oil-dependent economy, such as the Venezuelan, the windfall created by soaring oil prices since 2004 has allowed public expenditure to increase steadily injecting the abundant export revenues into the economy. This increased money supply sharply, making interest rates to fall, and internal demand — particularly private consumption — to steadily increase. As a consequence, internal productive activities expand, allowing the GDP to grow by more than 10 per cent on the average in the past two years.

Although inflation is still above 10 per cent, one of the highest in Latin America, it is steadily declining despite of the intense money supply growth. Mainly, this is a consequence of a highly overvalued currency, massive government subsidies, strict price controls and efforts of the central bank (BCV) to reabsorb part of the sweeping liquidity. Abundant dollars coming from oil exports have allowed the government to anchor the exchange rates despite higher local inflation than abroad, which in turn overvalues local currency. Inexpensive and abundant dollars, in defiance of the existing exchange controls, have allowed imports to soar.

Growth of the money supply (M2) has accelerated over the course of the year, to 62 per cent year on year in July. In its latest move to sterilise excess domestic liquidity, the Banco Central de Venezuela (BCV, the Central Bank) has raised the bank reserve requirement from 15 per cent to 30 per cent, but inflation is set to remain high. Based on strong second-quarter GDP data, we have revised upwards our forecast for GDP growth in 2006, from 8.9 per cent to 9.2 per cent. Amid signs of overheating, we have also revised upwards our forecast for inflation, to 15.5 per cent at end-2006. Monetary authorities are making big efforts to reabsorb part of the fast growing money supply in order to avoid additional pressures on prices.

In fact, a large proportion of overall liquidity has been subtracted by BCV through the sale of certificates of deposits to banks. Despite these expensive efforts, the central bank’s capacity to stabilize prices is very limited as its autonomy is almost inexistent. Thus, a recent legal amendment forced BCV to transfer $10 billion — about a third of the international reserves — to the executive branch for public expenditure financing.