Itaú BBA - An Easing Bias Amid Higher Volatility

Scenario Review - Chile

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An Easing Bias Amid Higher Volatility

February 10, 2014

Chile’s economy slowed substantially during the last quarter of 2013, bringing growth for the full year to 4.0%.

•           Chile’s economy grew weakly during the last quarter of 2013, as investment continues to slow. Consumption remains strong, supported by a tight labor market. We expect a 4.2% GDP expansion in 2014 and 4.5% in 2015.

•           The Chilean peso depreciated due to weaker than expected activity numbers in China and in the U.S. We see most of the weakness as transitory. Our year-end forecasts remain at 540 pesos to the dollar in 2014 and 550 in 2015.

•           The central bank left the policy rate unchanged in January, but reinforced the easing bias. We expect a 25-bp rate decrease this month (to 4.25%), but the cut is not a done deal in our view. Further weakening of the peso before the decision could lead the central bank to wait a bit more before reducing rates. We expect the easing cycle to end with the policy rate at 4.0%.

•           President-elect Michelle Bachelet announced her cabinet, naming Alberto Arenas as her finance minister. Arenas helped write Bachelet’s program, which includes plans to raise the corporate tax rate to finance education reform.

Investment Reduces GDP Growth

Chile’s economy slowed substantially during the last quarter of 2013, bringing growth for the full year to 4.0% (from 5.6% in 2012). The IMACEC (monthly proxy for GDP) increased by 2.6% year over year in December, bringing growth for 4Q13 to 2.7% (from 4.7% the previous quarter). However, on a sequential basis, the IMACEC gained a robust 0.8% between November and December, after a 0.5% increase the previous month. Even so, the quarter-over-quarter growth rate was weak (0.8% annualized). But the carry-over for the first quarter of the year is now favorable.

Investment continues to be the key drag on growth. Gross fixed investment, which led aggregate demand over the past few years, slowed to 3.2% year over year in 3Q13. During the last quarter of 2014, imports of capital goods fell by a remarkable 32% year over year, hinting at a further weakness of investment. 

In spite of the weakening economy, the labor market remains tight, lifting consumption. The unemployment rate stood at 5.7% in 4Q13, down from 6.1% one year before. Employment grew by 2.7% year over year, faster than in 3Q13, while waged employment expanded by 2.3% (2.1% in 3Q13). Retail sales increased 9.4% year over year and 12% qoq/saar in 4Q13. However, unemployment will likely rise as a result of below-potential growth. In fact, the labor-vacancy index produced by the central bank – a leading indicator of the labor market – declined 13% year over year in December.

We expect growth of 4.2% this year and 4.5% in 2014. Higher global growth will likely support Chile’s economy. Monetary stimulus will help as well.

Most of the Exchange-Rate Depreciation Is Temporary

In spite of weaker internal demand growth, the trade surplus is narrowing. Exports contracted faster than imports in 4Q13 (-8.5% and -7.1% year over year, respectively). As a result, the trade surplus fell to USD 0.6 billion in the last quarter of 2013, bringing the full-year surplus to USD 2.4 billion (from USD 3.4 billion in 2012).

The Chilean peso depreciated as a result of weaker-than-expected activity numbers in the U.S. and China. Our scenario for the global economy suggests that most of the weakening is transitory. Thus, our year-end forecasts for the exchange-rate are unchanged. We expect the peso to end this year at 540 to the dollar and to be 550 by the end of 2015.  

Inflation Remains Below the Target Center

Inflation in Chile continues to be tamed in spite of rising non-tradable inflation. Inflation fell to 2.8% in January, from 3.0% in December. The fall was attributable to a reduction in tradable inflation, dropping to 1.9% from 2.4% in December. On the other hand, non-tradable inflation increased to 4.1% (from 3.8%), reflecting a tight labor market. Excluding food and energy, inflation increased to 2.4% (from 2.1% previously), remaining below the target center.     

We expect inflation to end the year at 2.8%. Below-potential growth will likely ease some of the pressure on non-tradable prices, while the weaker exchange rate could offset this. In 2015, we see inflation at the 3.0% target.  

Rate Cuts Are Likely, but Global Market Volatility Is a Risk

As expected, the central bank left the policy rate unchanged in January. The press statement announcing the decision contained a far-more-determined easing bias than the central bank had been showing up to that time. This highlights the concerns within the board over economic growth. In the statement’s concluding remarks, the board explicitly said that greater monetary stimulus will likely be necessary within the next few months to ensure that inflation remains at 3% in the relevant monetary-policy horizon. The minutes of the meeting later revealed that the decision to hold rates was unanimous. They also showed that the board unanimously agreed to signal the stronger easing bias. From the debate over the policy options, it becomes clear that the key reason for waiting a bit more to resume the easing cycle was the unwillingness to surprise markets, which would potentially trigger an undesired drop in the interest-rate curve.

The decision to place the easing bias took place before the deterioration in global markets. However, Enrique Marshall, who is a board member, recently said in an interview with a local newspaper that he is comfortable with the exchange-rate weakening. According to him, the depreciation should be seen more as a solution than a problem.  

We expect the central bank to lower rates by 25-bps in February. A second 25-bp rate cut before the end of 2Q14 is also likely as volatility retreats. Most market participants are now expecting a cut in the next policy decision. Considering the unwillingness of the central bank to surprise the markets, a rate cut in February seems very likely, but it is not a done deal. A further increase of volatility before the February decision may convince the board to wait a bit more to reduce the interest rate.

The New Government Takes Shape

Michelle Bachelet announced her cabinet in January. Alberto Arenas will be her finance minister. He is a member of the Socialist Party and was the budget director in the previous Bachelet government. Arenas helped write Bachelet’s program, which includes plans to raise the corporate tax rate to finance education reform. The deputy finance minister is Alejandro Micco and the minister of economy, development and tourism (which shares responsibility over economic affairs with the finance minister) is Luis Felipe Cespedes (both were advisors to the finance minister in Bachelet’s first term.) The appointments were well received by the market. Meanwhile Bachelet has reaffirmed the intention to reach a zero structural balance in 2018 (it is currently -0.7% of GDP), hinting that social policies will not lead to fiscal deterioration.

Sebastian Piñera’s approval rating continues to be on the rise, reaching 49% in January (45% in December), for five months of consecutive improvement and the highest rate since November 2010’s 50%. In January, disapproval fell to 39% (from 41%). Piñera’s better-performing categories continue to be international relations, job creation and the running of the economy.

The International Court of Justice (ICJ) in The Hague, the Netherlands, ruled that Chile and Peru should split control over an area of sea off their cost. As a result of the ruling, Chile lost control over part of that maritime territory. Politicians from both countries have agreed to implement the ruling, avoiding any potential conflict.

João Pedro Bumachar
Rodrigo Aravena

Forecasts: Chile

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