Earthquake to drag on Chile recession recovery

The 8.8-magnitude quake tore up highways and bridges, knocked out power that feeds mines and factories, and shook apart scores of buildings, killing more than 700 people.

With details of the extent of the destruction still emerging, economists said it was hard to estimate the degree to which Latin America's most advanced economy would be set back.

The damage could cost Chile up to $30bn, equivalent to roughly 15 percent of GDP, said Eqecat, a firm that helps insurers model catastrophe risks.

The quake has also shaken president-elect Sebastian Pinera's pledge to boost economic growth just before his centre-right government is sworn in, ending 20 years of leftist rule.

“There will be a widespread and deep impact on Chile's economy,” said Nick Chamie, who heads research on emerging markets at RBC Capital Markets in Toronto.

Chamie and other analysts said Chile's peso could weaken, perhaps sharply, on the news. “We would play the Chilean peso short,” IDEAglobal said.

At the same time, the country's biggest copper mines, which are important economic drivers, were mostly spared by the disaster and officials said copper exports would not be affected. Chile produces a third of the world's copper.

The country's relatively good construction standards also helped it resist the quake, which was one of the world's strongest in the last 100 years.

“The direct economic impact of the earthquake (could) be limited,” said PIMCO portfolio manager Curtis Mewbourne, based in Newport Beach.

Further helping Chile, the country's fiscal position is widely considered to be the most solid in Latin America, which will make it easier for the government to rebuild hospitals and highway overpasses.

But with damaged and destroyed buildings now littering central Chile, the earthquake nevertheless knocks some of the wind out of a recovery from last year's recession, which was its first in a decade.

Rethinking rate hikes
Chile's economy was set to grow as much as 5.5 percent this year after shrinking an estimated 1.9 percent in 2009, according to forecasts by the central bank, which has hinted it could raise rates although not until at least the second quarter.

Policymakers might now hold rates steady for longer to give the economy a lifeline.

“This will create serious disruptions for a few weeks,” said Goldman Sachs economist Alberto Ramos, who said GDP would take a hit in the current quarter and probably in the April-June period as well.

“It's likely the central bank will keep liquidity and monetary conditions extremely loose in the near future in order to support the government's efforts to stabilise the economy,” Ramos said.

Despite the immediate hardships, Chile is probably Latin America's best-prepared nation for disasters.

Chile privatised its pension system in 1981, years ahead of similar policy shifts in other Latin American countries. The change helped build a deeper domestic capital market that reduced dependence on borrowing from foreigners. Strict regulation also helped Chile's fend off the global financial crisis.

And while Latin American governments like Mexico freely spend their natural resource bounties, Chile has a track record of prudent saving and has amassed a huge warchest of funds from copper exports.

This makes Chile less dependent on borrowed money, and Chile has one of Latin America's lowest government debt-to-GDP ratios, helping it borrow at cheaper rates than can Mexico or Brazil.

“As the priority shifts from the urgent humanitarian needs to reconstruction, the strong state of government finances in Chile will facilitate these efforts,” said PIMCO's Mewbourne.

The reconstruction will likely benefit construction and materials sectors in the medium-term, Ramos said.

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