Itaú BBA - A turning point?

Scenario Review - Chile

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A turning point?

March 10, 2015

We have revised our GDP growth-rate and inflation forecasts for 2015 to 2.8% and 3.0%, respectively.

• Following recent strong activity data, we have revised our GDP growth-rate forecast for 2015 to 2.8% from 2.5% previously. We continue to see growth of 3.5% in 2016.

• With the recent recovery of copper prices since the beginning of February, the Chilean peso has outperformed most EM currencies. Because we expect the U.S. dollar to continue to strengthen globally both this year and next, we see the peso weakening to 665 to the dollar by the end of 2016 (650 in our previous scenario), from 645 in 2015. Even so, we continue to see the current-account deficit widening in 2015, to 1.9% of GDP (from -1.5% in 2014) and to 2.2% in 2016.

• Inflation surprised on the upside again in February, with headline inflation and its underlying measures remaining high. We now expect inflation to reach 3.0% by the end of 2015 (2.8% previously) and 2.9% in 2016 (from 2.7%).

• Considering the evolution of inflation, the fact that real interest rates are already very low and the pressure for exchange-rate depreciation coming from the Fed, we continue to see no rate cuts throughout our forecast horizon. 

• Finally, with lower government approval ratings, the debate over labor reform starts in Congress, with complaints coming both from the unions and the business community.


Revising our 2015 growth forecast

Activity indicators for January reaffirmed that a gradual economic recovery is underway. Adjusted for calendar effects, the Imacec gained 2.9% from the previous year (3.1% in December). Sequentially, a 0.4% gain from December to January was recorded, down from the 1.1% monthly gain recorded in December. This results in a quarter-over-quarter annualized rate of 5.5%, up from the 3.8% as of December and the highest mark since the third quarter of 2013 (6.6%). Growth momentum in the Manufacturing sector is improving: although output fell 0.4% from December, that still resulted in a strong 5.7% qoq/saar (after 5.4% in 4Q14). On the other hand, retail sales contracted 2.3% from December to January (which still resulted in a 9.6% qoq/saar gain, due to the favorable comparison base created by September’s very weak reading).  

Meanwhile, the labor market remained robust. The unemployment rate stood at 6.2% in January (versus 6.1% in the same period last year and 6.3% in 2014), inching up from 6.0% in the quarter ending in December. Total employment grew 1.1% year over year, led by waged employment (+2% in the year), while self-employment slowed to 0.1% year over year after growing 3.1% in the quarter ending in December. That combined with strong nominal wage growth led to a 4.6% year-over-year gain in the real wage bill, which will provide some support for consumption.

Confidence is also gradually improving, but it is still in pessimistic territory (below 50%). The business confidence index produced by Icare fell to 41.9% from 45.1% in January (51.1% in the same period last year). However, this was due to a sharp decline in mining confidence, which is traditionally very volatile. All the other business sectors recorded varying levels of improvement in confidence. Construction confidence picked up to 34.5% from 26.3% in January, and retail confidence is on the brink of returning to optimistic territory after climbing to 49.9% from 48.7% previously. Industrial confidence improved marginally, reaching 43.4% from 43.0% in January. Consumer confidence also improved in February, but still stood below 50%. The largest recovery came from expectations for the country’s situation in five years, which had seen a significant loss in January, and perception about purchases of durable goods.

Considering the recent economic data, we now expect GDP to grow 2.8% in 2015, up from the estimated 1.8% in 2014 and our previous forecast of 2.5%. Even so, the economic performance for this year would be considerably weaker than the average seen over the past decade. Expansionary policies (fiscal and monetary) and the exchange-rate depreciation are only partly offsetting the negative effects of lower copper prices.  

Weaker peso down the road as the dollar gains traction

The trade balance remained strong in February. The 12-month rolling surplus fell slightly, to USD 10.3 billion, from USD 10.5 billion in January (USD 8.6 billion in 2014). We estimate that on a seasonally-adjusted and annualized basis, the trade balance is running even slightly higher than the 12-month measure.

As copper prices recovered, the Chilean peso outperformed most EM currencies since the beginning of February and stood broadly stable against the U.S. dollar. However, considering that we expect the U.S. dollar to continue to strengthen globally, we see the peso reaching 645 to the dollar by the end of this year. For 2016, we now see the exchange rate reaching 665 (versus 650 in our previous scenario), as we anticipate the strong dollar movement will extend into next year.

We continue to see the current account deficit widening in 2015, to 1.9% of GDP and to 2.2% in 2016, up from the 1.5% estimated for 2014. The recovery of oil prices and the gradual recovery of the economy would lead the deficit to grow. Still, compared with many other emerging markets, Chile’s current account deficit would remain low.

Inflation surprises to the upside once again

Consumer prices grew 0.4% month over month in February, somewhat above expectations. Underlying inflation is still high, with core measures recording monthly gains of between 0.3% and 0.6%.

Price increases were led by housing and basic services, with a 2.4% gain from January, reflecting hikes to electricity tariffs. As expected, fuel prices continued to decline, down 1.7% in the month (-8.7% in January) while fresh fruits and vegetables were also down, by 4.4% in the month (flat in the previous month). Inflation excluding food and energy gained 0.3% month over month, decelerating from the 0.7% recorded in the previous month. Tradable good prices grew 0.5% in the month, after the 0.3% contraction previously. Non-tradable inflation came in at 0.2% (from 0.5% previously).

On an annual basis, inflation is falling, but very slowly. It reached 4.4% from 4.5% in January. The 18.7% year-over-year drop in fuel prices is being partly offset by high non-tradable inflation (5.1%). Alcoholic beverages and tobacco continue to record double-digit growth rates. The core measure (excluding food and energy prices) grew 4.7% from one year ago, slightly down from 4.8% in January, but it is still well above the 4% upper bound of the central bank’s target range. Non-tradable inflation is running at 5.1% (from 5.4% in January).

Additionally, nominal wages are still growing strongly, up 7.1% year over year in January (only slightly down from 7.2% in December). Wages gained 0.8% from December (1.3% in the previous month). According to our own estimations, wages gained a still-strong 0.6% from December on a seasonally adjusted basis, following a 0.7% gain in December. The high growth of nominal wages can be partly attributed to the indexation mechanisms that exist in Chile’s economy.

Due to the recent inflation numbers, we have raised our year-end forecast to 3.0% from 2.8% previously. For 2016, we now see inflation reaching 2.9% in December (up from 2.7% last month).

Rate cuts are even less likely

In its February Monetary Policy Meeting, the Central Bank of Chile left its reference interest rate unchanged, at 3.0%, as widely expected. The press statement announcing the decision maintained a neutral tone.

The minutes of the meeting revealed that the decision was unanimous, and that the option of leaving the rate unchanged at 3.0% was the only “relevant” one. The research staff believed that rate cuts would be inconsistent with the higher-than-expected inflation in January and with activity that continued to evolve in line with the latest Inflation Report (IPoM) scenario. On the other hand, the observed inflation was not viewed as a threat to target convergence, and the medium-term risks to growth remained largely downward-biased. In that sense, raising the policy rate was not deemed appropriate either.

One board member indicated that if the inflation rate remains above the target for a longer period than anticipated, a tighter monetary policy could be required. However, other members sounded much more “neutral”.

In our expected scenario for activity and inflation, we see the central bank keeping the policy rate at 3.0% throughout this year and next. In our view, the central bank is clearly comfortable with the current amount of monetary stimulus already in place, and it will likely avoid adding liquidity amid interest rate increases in the U.S., especially considering the high levels of underlying inflation measures. We expect our view to be confirmed in the forthcoming monetary policy report to be released on March 30.

The debate on labor reform begins

February was a quiet month in the legislative arena, as politicians went away on summer holiday recess. The discussion resumed in March, with the labor law reform leading the discussion. The bill, which the authorities submitted last December, seeks to strengthen the collective bargaining institutional framework. Already, the leader of the workers’ confederation has described the project as a lukewarm attempt to improve workers’ bargaining power, and she expects the discussion in parliament to modify it in order to gain the support of labor movements. Meanwhile, the manufacturing confederation, which believes the current project wrongly focuses on low unionization rates as the main threat to labor rights, met the Labor Commission of the lower chamber of congress to present its views.

Poor government approval ratings might weaken the executive branch’s bargaining power in congress. Nevertheless, we expect the reform agenda to advance broadly in line with the administration’s plan. Besides labor reform, other projects already in congress include the new framework for investment promotion and the abortion legalization law. During the year, the administration plans to submit the second part of its educational reform bill and a reform of electoral and political funding.


 


 

João Pedro Bumachar
Miguel Ricaurte

Vittorio Peretti



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