Copper and Chile, for Better or for Worse - November 1, 2006
By Stephen S. Poloz, Senior Vice-President, Financing Products Group, Export Development CanadaCopper and Chile go together like Jack and Jill. They both have gone up the hill together, but it is legitimate to ask how things will turn out for Jill when Jack tumbles down the hill.
The facts are straightforward enough. Chile exports fine wines, fresh fruits, farmed salmon and lots of other mining output, but copper makes up around half of all its exports. This has quite an impact on GDP – during 2005, copper exports contributed 16% of Chilean GDP, and lately that figure has been around 23%.
The steep rise in the contribution of copper to Chile’s GDP is related to copper’s meteoric price rise in the past two years. After rising by about 50% during 2005, the price of copper rose by a further 60% during March-May earlier this year. A big top was traced in May, giving way to a major correction in June, coincident with a significant global sell-off in emerging market equities and bonds that appeared to be related to growing concerns that global economic growth was slowing. Since that time, copper has been fluctuating in a range between $7,000 and $8,000 per tonne, with a very slight downward trend as markets have embraced a soft landing scenario for the U.S. economy. Nevertheless, copper is still about double the price of two years ago.
This has boosted Chile’s economic performance significantly, with growth exceeding 6% in 2005 and likely to be over 5% this year and next. Inflation has remained under control despite this, at around 3%, in part because the rise in copper prices has also pushed up the value of the Chilean peso, which has appreciated by about 15% in the past two years. It is also because the government is running a counter-cyclical fiscal policy that prevents overheating.
What will happen to Chile when slower global economic growth leads to a significant correction in copper prices? There will be some big increases in global copper capacity in the next 12-18 months, timed to arrive almost precisely as global economic growth gears back. The fact that U.S. housing has already slowed dramatically – and housing is a big user of copper for wire and pipes – has led to a steady rise in global copper inventories already. If these conditions lead speculators to abandon the copper market, the price decline could be sizeable.
Fortunately, the same features that have prevented Chile from overheating during copper’s run-up will prevent a chill during its decline. The government is running a huge fiscal surplus, setting aside funds for public pensions and accumulating enough assets that it is no longer a net debtor. The government wishes to maintain a government debt market, so it will carry financial assets, too, and have those handled by professional fund managers. But tax revenues will automatically decrease with copper prices, stabilizing economic growth. Chile’s currency will depreciate with lower copper prices, too, another shock absorber. This suggests that Chile’s economic growth will remain above 5% in 2007, despite the prospect of lower copper prices and slower global growth.
The bottom line? Unlike Jack and Jill, Chile is positioned very well for copper’s likely tumble. This stems from a steady strengthening in domestic fundamentals, and smart, far-sighted policies.
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