Itaú BBA - Clarifying the appetite for easing

Scenario Review - Chile

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Clarifying the appetite for easing

May 11, 2017

The central bank would implement another 25bps rate cut before the end of 2Q17.

Please see the attached file for all graphs.

• The mining strike in 1Q17 led to the weakest activity performance since the global financial crisis. Although we expect mining to recover in the remaining quarters of the year, consumption will likely continue to be weak. We see downside risk to our 1.8% growth forecast for this year (1.6% in 2016).

• The central bank implemented the additional 25-bp rate cut that it had signaled in its recent Inflation Report, but it added that some further easing is possible. The recent deterioration of the labor market was likely the trigger behind this stance. We continue to expect a further cut, to 2.5%, before the end of 2Q17.  

A weak 1Q17, but recession averted

According to the Imacec (monthly proxy for GDP), activity in 1Q17 slowed to the lowest growth rate since the global financial crisis, but a technical recession was averted. The quarter was negatively affected by the extensive labor strike at the country’s largest copper mine, making this the weakest start to a year since 2009. In 1Q17, activity slowed down to +0.2% year over year (0.8% in 4Q16), with mining activity falling 13.3% (-3.3% in 4Q16), while non-mining activity grew 1.4% (0.8% in 4Q16).

Front-loading of fiscal expenditure and a real-estate pickup likely contributed positively to growth, but we see these factors as transitory. The Chilean budget office revealed that fiscal spending rose 7.8% year over year in 1Q17 in real terms. Fiscal spending growth will likely slow during the remainder of the year, given that the target deficit for 2017 includes expenditure growth of just 2.7%. Meanwhile, real estate sales gained steam in 1Q17, likely due to the extension of the VAT tax break until the end of the quarter, and it will probably mean improved construction activity in the quarter (as shown by the positive job growth in the sector). As this incentive is no longer present, we will likely see slowing construction and real estate activity during the rest of the year. In turn, the central bank’s May business perception report highlighted that commercial activity has been boosted by sales to tourists (particularly Argentinians), while car sales have seen a pickup, in part due to the need for replacement after several years of postponing that decision. So, there are no signs that domestic private consumption is on an improving trend.

At the margin, activity grew, thanks to the non-mining sector. In 1Q17, the seasonally adjusted Imacec rose by a weak annualized rate of 0.6% from 4Q16, so the economy avoided a technical recession following the 1.3% qoq/saar drop in the final quarter of 2016. Given the impact of the labor strike, mining contracted 23.9% qoq/saar (vs. -7.7% in 4Q16), while non-mining activity expanded 3.0% qoq/saar, from a weak-0.7% qoq/saar in 4Q16. Mining is expected to rebound in 2Q17.

The continued loosening of the labor market hints at less support for private consumption ahead. Compared with the final quarter of 2016, employment growth has picked up, but this is mainly due to creation of low-quality jobs. Meanwhile, the unemployment rate came in at 6.6% in the quarter, up 0.3 percentage points from one year before.

We do not expect a significant activity recovery this year. Furthermore, our 1.8% growth forecast has a downward bias. Activity will be aided by higher copper prices this year (relative to 2016), low inflation and the loose monetary policy. Meanwhile, the continued weakening of the labor market and depressed private sentiment will limit growth. For 2018, we expect 2.5% growth.

Lower trade balance as mining strike bites

The impact of the extensive labor strike at the largest copper mine is reflected in the lower trade balance at the start of the year. A USD 1.2 billion surplus was recorded in 1Q17, down for the USD 2.2 billion in 1Q16. As a result, the rolling 12-month trade surplus narrowed to USD 4.3 billion, compared with the USD 5.3 billion in 2016, but it is still consistent with a low current account deficit. Our seasonally adjusted series shows that, at the margin, the trade balance dropped to USD 1.0 billion (annualized) in 1Q17, from the USD 6.9 billion recorded in 4Q16.

We expect mining exports to recover ahead as copper export volumes rebound. We also believe internal demand will remain weak this year, and so Chile’s current account deficit is set to remain low. We estimate a current-account deficit broadly stable from the 1.4% of GDP recorded last year. With internal demand likely to show some recovery, a widening to 1.7% is expected for next year.

The peso has weakened recently as copper prices fall on concern over the strength of Chinese manufacturing and as a global risk-off mood sweeps the markets. Nevertheless, we still see the exchange rate at 675 pesos per dollar by the end of the year, with further weakening to 695 pesos per dollar by the end of 2018.

Inflation stable at low levels

Inflation remains below the 3% target, while weak growth and a stable currency hint at low inflation ahead. In April, annual inflation was stable, at 2.7%, completing seven months below the 3% target. Inflation excluding food and energy prices stayed low, at 2.1%. Meanwhile, core services inflation ticked up, to 3.5%. Our diffusion index continues to show more consumer items are posting inflation below the 3% target than above it, reflecting constrained inflationary pressures going forward.

We expect inflation to stay low for the remainder of the year. We continue to see inflation ending the year at 2.8% (2.7% in 2016) and to be at the 3% target by year-end 2018.

Clarifying the appetite for easing

The central bank board unanimously decided in April to cut the monetary policy rate by 25 bps, to 2.75%. The central bank embarked on a 50-bp easing cycle in 1Q17, following the guidance included in the 4Q16 Inflation Report (IPoM). Lowering the policy rate or leaving it unchanged in April were both deemed consistent with the scenario presented in the 1Q17 IPoM, according to the minutes of the decision, but the discussion within the board surrounding the inclusion of an easing bias in the communication was more intense.

The board viewed domestic activity as being in line with the recent IPoM, but it acknowledged a sharper-than-expected deterioration in the labor market. The discussion about the outlook for employment and its impact on consumption ahead indicates that the worsening labor market was likely the trigger for the rate cut last month. Moreover, the labor market would play a similar role going forward. Meanwhile, the evolution of inflation was less of a concern.

The central bank clarified that more easing ahead is possible. The 1Q17 IPoM hinted at only one 25-bp cut, to 2.75% (as was reflected by asset prices at the time of publication), a message that was repeated by President Marcel during his presentation of the report. Hence, cutting the rate at the April meeting would, strictly speaking, have required a neutral bias in the communication. However, the staff argued during the meeting that the IPoM guidance did not represent an unwavering commitment. The board agreed with this position by signaling further loosening ahead.

Overall, we believe the central bank has a clear, but certainly limited, appetite for additional easing. We expect the policy rate to reach 2.5% before the end of the quarter and remain there until the end of the year. In addition, if activity, particularly through the labor market, disappoints further, additional easing may be warranted.

No longer a net creditor

Last year, Chile became a net debtor for the first time since 2004. The end of the envied position follows from the continued decline of copper revenue into the public purse, increasing public expenditure and low growth. Copper revenue totaled 1.7% of total public revenue last year (0.4% of GDP), far below the 34.2% in 2006 (8.4% of GDP). As a result, total government revenue dropped from 24.5% of GDP in 2006 to 21% last year. Meanwhile, in that same period, government expenditure rose from 17.1% of GDP to 23.7% last year, with the bulk of the gain linked to current expenditure. The tax reform introduced during President Bachelet’s second administration has contributed to lower the fiscal deficit. Overall, gross debt increased to 21.3% of GDP (17.4% in 2015), a continued deterioration since the 3.9% minimum was recorded in 2007. This rapid widening has drawn the attention of rating agencies. Chile’s credit rating includes a negative outlook from both S&P (“AA-”) and Fitch (“A+”). When the sovereign wealth fund and other short-term assets are accounted for, net debt came in at 1.0% of GDP (-3.5% in 2015), a far cry from the net creditor position of -19.3% of GDP registered less than a decade ago in 2008.

Governing coalition splinters

The center-left Christian Democratic (DC) party decided to participate directly in the November presidential election rather than compete in July’s primaries. The move confirms the unease within the Nueva Mayoria coalition regarding current policymaking and the upcoming election. In the most likely scenario, the left will not hold primaries, something that could diminish the governing capability of an eventual Guillier administration.

Meanwhile, the presidential elections are now becoming a three-horse race with the recent rise of leftist Beatriz Sanchez. According to Adimark’s April public opinion survey, leading candidates Sebastián Piñera and Alejandro Guillier lost support from the previous month. Meanwhile, the hard-left Beatriz Sanchez (a journalist with no public office record) made ground and is now the clear leader of the chasing pack. In April, Piñera’s lead over Guillier edged up to five percentage points (from four points in March), despite shedding three points, to 24% (as Guillier dropped four points, to 19%). Carolina Goic only garnered 2%. The surprising emergence of Beatriz Sanchez (from 2% to 11%) following the official launch of her candidacy at the start of April does create another element of political uncertainty. The emergence of a noteworthy alternative (>10% support) with a more populist political ideology is in line with the break from political establishments witnessed globally in recent years. Important to note is the stability of undecided voters, at a high 29%, meaning that a significant part of the public needs convincing and the presidential race could swing substantially as the election draws near.

Turning to the expected runoff vote, the latest Cerc-Mori public opinion survey points at a dead heat between Sebastian Piñera and Alejandro Guillier. The latter’s five-point advantage over Piñera from the December survey has all but vanished. Guillier holds 33% in the polls (35% previously), while Piñera is up to 32% (from 30% previously).


 

João Pedro Bumachar

Vittorio Peretti

Miguel Ricaurte



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