Itaú BBA - Downside Risk for Growth

Scenario Review - Chile

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Downside Risk for Growth

July 2, 2013

We maintain our growth forecasts (4.5% and 4.7% for 2013 and 2014, respectively), but downside risks for activity are increasing.

•           Activity indicators for May and some leading indicators still do not point to a rebound in the economy, in an environment of lower copper prices. Although we maintain our growth forecast of 4.5% and 4.7% for 2013 and 2014, respectively, we acknowledge that the risk to these numbers is tilted to the downside.

          Due to a tighter monetary policy stance in the U.S. and to downward revisions in our forecast for copper prices, we now expect the Chilean peso to end this year at 510 to the dollar and at 525 by the end of 2014.

          Inflation once again surprised on the downside in May and fell to 0.9% year over year. Still, due to a weaker exchange rate, we maintain our 2.2% forecast for this year and 2.8% in 2014.

          The central bank left the policy rate unchanged in June. We expect a 25-bp rate cut in August, and we still see room for a 75-bp easing cycle. However, we now anticipate a less front-loaded cycle, so we expect the policy rate to end this year at 4.5% and at 4.25% in 2014.

          The combination of lower copper prices and moderation in economic growth led us to lower our forecast for the fiscal surplus to 0.2% of GDP (previously: 0.7%).

          Finally, Bachelet won in the primaries leading up to November’s presidential elections   

Recovery at Risk 

Activity indicators for May came in weak, and we expect a modest 3.3% year-over-year increase in May’s IMACEC. Manufacturing production fell by 4.2%, more than offsetting the 3.4% gain in the previous month. Building permits fell 13.8% in the same period, while mining production gained a modest 3.0% year over year. On the other hand, the vigor of consumption was notable: retail sales surged 13.2% year over year, helped by a solid labor market. Employment growth gained 2.0% year over year in May, which coupled with low inflation and high nominal wage growth continues boosting workers’ purchasing power. 

We maintain our growth forecasts (4.5% and 4.7% for 2013 and 2014, respectively), but downside risks for activity are increasing. In fact,some leading indicators and lower copper prices suggest that a recovery of the economy will not occur in the near term. According to Adimark (a local market research firm), consumer confidence fell to 55.3 in May (59.2 in April), driven by a drop in the “perception of the current situation” component. Meanwhile data on imports of capital goods and construction are consistent with weak investment growth, which is the demand component leading the slowdown. Finally, according to a survey published by the central bank, credit conditions are increasingly tighter.

Weaker Currency, Wide Current Account Deficit

We now see the peso trading at 510 to the dollar by the end of this year and at 525 by the end of the next. Lower terms of trade and a tighter monetary stance in the U.S. will lead to a weaker peso. We were previously expecting the exchange rate at 485 by the end of this year and 475 by the end of the next.

A wide current account deficit this year and next (5.0% and 5.3%, respectively) is likely. In our scenario, lower copper prices offset the weaker peso. However, we note that the high current account deficits in Chile have been investment-driven. Because we see downside risk for our investment outlook, current account deficits may not widen as much as we are currently expecting.  

Inflation to Remain Below Target, Despite Exchange-Rate Depreciation

Inflation in May once again came in lower than expected, at 0% month over month. As in April, inflation was mostly due to lower energy prices (-1.7%). Year-over-year inflation fell to 0.9%, from 1.0% in April. For June, we expect the CPI at 0.5%, mostly due to higher food and fuel prices. 

Our inflation forecasts are unchanged, at 2.2% for the end of this year and 2.8% by the end of next. Low inflation for Chile’s main trading partners, below-trend growth and low short-term inflation expectations are consistent with inflation running below the target’s center. The weaker exchange rate only removes downside risk to our forecasts. 

Monetary Policy: The Question Is When to Loosen

Chile’s central bank kept its policy rate unchanged, at 5.0% in June. The decision was in line with market expectations, but contrary to our forecast of a 25-bp cut. Still, a rate cut in the near term is likely. The minutes of the meeting revealed that the board members, for the second consecutive month, considered lowering rates by 25 bps. Also, in its most recent monetary policy report, the central bank reduced both its growth and inflation forecasts and said that, in its baseline scenario, the monetary policy rate follows a path similar to that expected by the market. Thus, the central bank is signaling a 50-bp easing cycle that is likely to start in 3Q13.

We now expect the central bank to make the cycle’s first cut in August. Furthermore, we see the policy rate ending this year at 4.5% (from 4.25% in our previous scenario). Our year-end 2014 forecast for the policy rate remains unchanged, at 4.25%. However, we note that the labor market in Chile is still tight, consumption continues to grow rapidly and the current account deficit is wide. These factors are clearly making the central bank uncomfortable with providing monetary stimulus to the economy. So, in our view, there is a risk that the easing cycle may be postponed if the upcoming data fails to show a reversal in the trend of these indicators.

Lower Cyclical Fiscal Balances

We expect a public nominal surplus of 0.2% of GDP this year (0.7% in our previous scenario). The year-to-date surplus is 51.1% down from one year before. Cyclical factors – lower growth and lower copper prices – are responsible for a lower fiscal surplus versus 2012, meaning that the structural fiscal balance will likely remain unchanged from last year’s. 

Bachelet Wins in the Primaries Leading Up to November’s Presidential Elections

The primary presidential elections were held in Chile on June 30. People voted for a political coalition and picked a candidate from the chosen coalition to run in the presidential election. As expected, the Nueva Mayoria Coalition (formerly known as Concertacion and now the opposition party) won in the primaries (with 74.2% of the vote), and Michelle Bachelet, a former president, was chosen as the coalition’s candidate. For the government’s coalition, Pablo Longueira received the most votes (51%). The presidential elections will take place on November 17.

Meeting the demand for higher social spending amid structurally lower public sector revenues (due to lower long-term copper prices) will be one of the main challenges for the next administration. In addition, Michelle Bachelet’s economic advisors aim to reduce the structural public deficit (currently around 1% of GDP) to zero. At first, higher social spending and lower public deficits would be achieved by raising corporate taxes to 25% from 20%, but that would come at a time when investment is already at risk due to lower copper prices.

João Pedro Bumachar

Rodrigo Aravena

Forecasts: Chile

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