Itaú BBA - Details of constitutional reform unveiled

Scenario Review - Chile

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Details of constitutional reform unveiled

November 10, 2015

The entire process will extend into the next administration, easing political tensions.

Please see the attached file for all graphs.  

• The economy improved somewhat between 2Q15 and 3Q15. We expect Chile’s economy to expand by 2.0% this year, broadly stable from the 1.9% recorded for 2014. The monetary stimulus, albeit shrinking, together with an improvement in confidence will likely support a modest recovery of 2.5% in 2016. 

• The perception of lower risk in the global economy led to a stabilization of the exchange rate recently in spite of the growing probability of a rate hike in December in the U.S. We expect the exchange rate to end the year at 700 pesos to the dollar. For next year, some additional weakening is likely as the U.S. dollar continues to appreciate globally. Our 2016 year-end forecast is 715.

• Inflation came in slightly above expectations in October, but its peak seems to be behind. We still expect year-end inflation at 4.8% this year. A sluggish economy and less intense currency depreciation will likely help inflation to fall to 3.5% by the end of 2016. 

• The central bank’s decision last month to increase the policy rate to 3.25% was unanimous. However, the board is emphasizing that the tightening cycle will be small, so the policy rate will remain expansionary after the cycle is over. We still expect only one additional rate hike of 25 bps (to 3.5%) in November. The sluggish economy and a gradual decline in inflation will likely prevent the board from raising interest rates further.

• President Bachelet announced the long-awaited details of the constitutional reform, one of her key campaign promises. The entire process will extend into the next administration, easing political tensions.

Activity growth is stabilizing at a low level 

The small improvement of the economy in 3Q15 eased concern over the possibility of a further slowdown. The September monthly GDP proxy (Imacec) surprised to the upside. Activity expanded 2.6% year over year, taking annual growth in 3Q15 to 2.1%, up from the 1.9% recorded in 2Q15. Corrected for seasonal factors, activity gained 1.1% from August (the largest monthly increase since January 2013), following a 1.0% decrease in August. Consequently, the quarter-over-quarter annualized growth rate rose to 1.3%, from -0.3% in 2Q15.

The economy improved in 3Q15 despite slower consumption growth. Although retail sales rose 3.1% year over year, they slowed to 2.6% in 3Q15, down from 3.4% in 2Q15. Supermarket sales followed a similar pattern. Sequentially, retail sales contracted by 1.6% qoq/saar after a strong 4.9% gain the previous quarter.

Although business confidence improved in October (versus one year before), it remains in pessimistic territory. Business confidence was once again below neutral (50), extending 19 consecutive months in pessimistic territory, according to think-tank Adimark. All sub-indexes but mining are below the neutral level of 50.

The labor market continues to show notable resistance in the face of lower growth, suggesting that a large portion of the economic slowdown is structural. The national unemployment rate in 3Q15 came in at 6.4%, compared with 6.6% in the corresponding period in 2014. Employment growth accelerated to 2.3% year over year, from 1.5% in 2Q15, while the labor force expanded 2.0% (1.6% in 2Q15). The solid waged employment growth is likely a result of the positive impact of the fiscal stimulus and the pickup in residential construction activity ahead of the VAT increase on new housing.

We expect GDP growth of 2.0% this year and 2.5% in 2016, after the 1.9% registered in 2014. Our scenario for growth considers that there will be some recovery in confidence, due to less uncertainty over reforms, which, together with a still-expansionary monetary policy, will allow for a modest recovery next year.

Weak mining exports erode the trade balance

Mostly due to weak mining exports, the trade balance recent upward trend has been reversed. The rolling twelve-month trade balance came in at USD 6.6 billion in October, down from USD 7.1 billion as of September. Our own seasonal adjustment shows a larger deterioration in the trade balance at the margin, to USD 3.2 billion (annualized) over the past three months, down from USD 4.5 billion in 3Q15.

The perception of lower risk in the global economy led to a stabilization of the exchange rate recently in spite of the growing probability of a rate hike in December in the U.S. We see the exchange rate at 700 pesos to the dollar, broadly stable from current levels. For next year, as the Fed raises rates by more than the market is pricing in, some additional exchange-rate weakening is likely. Our forecast for 2016 is 715 pesos to the dollar.

A bumpy road toward the target range

Inflation came in slightly above expectations in October, although it moderated due to a favorable base effect created by the drop in oil prices last year. Annual headline inflation fell to 4.0%, down from 4.6% in September. Inflation has now been at or above 4% for the last 19 months. Excluding food and energy, inflation was stable at 4.8%, while non-tradable inflation came down only slightly (to 4.8%, from 4.9%).

Meanwhile, wage growth remains at high levels. Nominal wages grew 5.9% year over year in September (5.8% in August). The slow adjustment of nominal earnings amid low growth is in part due to indexation mechanisms amid high inflation. However, the fact that the labor market is not loosening much also helps keep pressure on wages.

We continue to expect year-end inflation to reach 4.8% by the end of this year (after the 4.6% recorded at the end of 2014). We anticipate that prices will remain above the 2%-4% target range well into 2016 and end the year at 3.5%. A less intense depreciation next year would bring some relief to tradable prices, which, along with the sluggish economy, would help to bring inflation down.

A short tightening cycle began

The central bank of Chile raised its policy rate by 25 bps, to 3.25%, in its October meeting, as expected. The decision ends the 11-month spell during which the rate was held at 3.0%, and it received the full backing from the board of the central bank.

The tightening cycle will likely be modest. In the minutes of the meeting, the central bank continued to signal hikes totaling 50 or 75 bps, so monetary policy would remain expansionary after the cycle ends.

The timing of the next hike is less than certain. On the one hand, a board member mentioned in the minutes that, by hiking now, it was not clear how immediate an additional hike would be. On the other hand, another member suggested that the board could have also considered hiking the rate by 50 bps in October and removing the tightening bias at the same time.

We expect only one additional rate hike of 25 bps. In addition, we expect this extra hike to come this month, as inflation kept surprising on the upside in October. The sluggish economy and the gradual decline in inflation will likely prevent the board from raising interest rates further.

Kick-starting the constitutional reform process

President Bachelet announced the long-awaited details of the constitutional reform, one of her key campaign promises. The process of approving a new constitution will extend into the next administration. The initiative comprises two independent reforms. The first one will seek to amend the current constitution to allow for a constitutional reform (this bill will be sent to congress by the end of 2016). The mechanism to approve a new constitution would only be set in motion by the next congress (members are scheduled to take office in March 2018). The new constitution will have to be approved by the population in a binding public consultation vote.

The three stages required to draft a new constitution were set forth. First, there will be a civic education process to last until March 2016. During this stage, the government will seek to educate the public on the rights and duties implied in a constitution. Then, there will be public discussion, to last until October 2016. During this time, the government will collect citizens’ concerns and suggestions, some of which could be included in the new constitution. Finally, there will be the writing of the new constitution. This phase will culminate with the presentation of the draft to congress in the second half of 2017.

The next congress would have four alternatives to choose from to advance the constitutional reform project. First, congress might opt for a joint commission of senators and representatives to analyze the bill. Alternatively, it could convene a mixed commission of lawmakers and citizens for the task. Also, congress could require the formation of a constitutional assembly. A final option would be to hold a referendum and let voters decide on which of the three alternatives to pursue.

Ultimately, we view an extended constitutional discussion as positive for the overall economic environment, as it reduces the likelihood that constitutional changes will be made that respond only to the specific agenda of the current administration.

Bachelet’s approval ratings improve somewhat

According to Adimark’s October survey, the approval rating for President Bachelet rose to 29% from 25% the previous month. This is the second consecutive month of gains. Meanwhile, the disapproval rating dropped three percentage points, to 67%. There was an improvement in the evaluation of all the president’s attributes versus the previous month. The same trend was seen in the ratings for the government.

Meanwhile, the discussion of next year’s budget is advancing. The key issue of provisional funding for free higher education gained the support of the public finance commission in congress. But not everything is working in the administration’s favor. A thorny wage negotiation with public sector employees is threatening to keep key public services paralyzed. Moreover, the investigation into the businesses of the president’s son continues.

Codelco will cut its five-year investment plan by as much as USD 4 billion. The state-owned mining company originally intended to invest USD 25 billion to revamp its aging mines and avoid a significant drop in its copper production. The downward revision in the investment plans comes amid the slump in copper prices, which is slashing profits for producers. The government announced a fresh injection of USD 600 million in capital to improve the company’s balance sheet so that it can obtain financing at attractive rates. The equity injection would be in addition to Codelco’s recent issuance of USD 2 billion in 10-year bonds.


João Pedro Bumachar
Miguel Ricaurte

Vittorio Peretti


Please see the attached file for all graphs.  


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