Why you should care
The economic slowdown in China and the U.S.-led trade war is pulling down copper prices, hurting a country far from both Washington and Beijing.
Concerns are growing in Chile that it could be the first country in resource-rich South America to feel the impact of the slowdown in China and the U.S.’s escalating trade war with Beijing, with a fall in copper prices already putting pressure on the economic agenda of President Sebastián Piñera.
As the world’s leading copper producer, and one of South America’s most open economies, Chile is particularly vulnerable to a drop in copper prices, which last week touched its lowest level of the year on worries over China’s economic growth. The metal accounts for more than 43 percent of Chile’s exports. The challenges faced by Chile are a warning sign for other commodity exporters in the region, economists say, especially given the metal’s reputation for predicting turning points in the global economy.
“[Copper] could be something of a canary in the coal mine,” says Carlos Végh, World Bank chief economist for Latin America and the Caribbean. “If there are fundamentals in the world economy that cause commodity prices to fall in the near future, then it may well be that copper is proving to be the first victim.”
The government was counting on a higher copper price during its mandate.
Jorge Bande, mining expert in Santiago
China’s long economic boom was an important motor of growth for Latin America for many years. Now a Chinese slowdown and the knock-on effects from U.S. tariffs on China’s growth could further dampen the Asian giant’s demand for South American exports.
The International Monetary Fund recently lowered its growth forecasts for Latin America, now forecasting that the region will grow 1.6 percent this year, 0.4 points lower than its previous projections in April. Moody’s, the rating agency, has also downgraded Chile’s rating by one notch to A1 from Aa3, citing a “broad-based deterioration” in the country’s credit profile.
Certainly, Chile is already feeling the pinch from lower copper prices, currently around $2.80 per pound. Officials have recently underlined the importance of copper prices staying above $3 per pound for the government’s proposed economic agenda to be viable. Some fear that a sustained fall in copper prices could jeopardize Piñera’s ambitious reform program, including changes to the country’s pensions system and much-needed infrastructure plans.
“The government was counting on a higher copper price during its mandate,” says Jorge Bande, a mining expert in Santiago, who argues that lower revenues from mining taxes could thwart Piñera’s efforts at fiscal consolidation, given that the situation was “already quite stretched” before the recent fall in copper prices.
Nevertheless, Felipe Larraín, Chile’s finance minister, points out that a more competitive exchange rate, which is closely correlated to the copper price, is good for most other areas of the economy. Although the mining sector dominates exports, it accounts for just 10 percent of overall economic output.
“Manufacturing and agricultural exporters are quite happy right now, because their returns have increased quite substantially,” says Larraín, arguing that a freely floating exchange rate is a key tool to cushion the blow. Certainly, this helped Chile to weather the most recent drop in copper prices in 2015-16.
In addition, Chile may gain from some second-round effects of the trade war, he says. For example, if China imposes additional levies on wine or fruit imported from the U.S., they could be replaced by imports from Chile — just as Brazilian soybeans have benefited from China imposing a 25 percent tariff on U.S. exports.
“I would very much like not to have a trade war. Given that we [do] have a trade war, we are not immune, but we are well prepared,” says Larraín, adding that a reduction of the fiscal deficit from 2.8 percent in 2017 to 1.7 percent this year will also help given lower financing needs.
He also highlights a tax modernization bill that will provide incentives for saving and investment, as well as efforts to cut red tape for large investment projects and plans for public private partnerships in public works projects.
Axel Christensen, chief investment strategist for Latin America and Iberia at BlackRock Investment Institute, points out that despite its trade vulnerabilities, Chile is less exposed to financial volatility than many other emerging markets that have been badly hit in recent months, especially neighboring Argentina.
“However, the net effect [of a trade war] for the Chilean economy should be negative, as its major exports are related to copper, which continues to be dominated by the pace of growth of China,” he says, cautioning that all will depend on how serious a U.S.-China trade conflict might be.
For many observers, the outlook is uncertain. U.S. trade policy remains enigmatic, while the extent to which the global economy could decelerate is unclear. Unfortunately, though, the dangers loom just as the region is emerging from a protracted economic slowdown.
OZY partners with the U.K.'s Financial Times to bring you premium analysis and features. © The Financial Times Limited 2020.