Itaú BBA - Expectations weigh on activity

Scenario Review - Chile

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Expectations weigh on activity

June 16, 2015

We have reduced our growth forecasts to 2.5% from 2.8% for this year and to 3.4% from 3.5% in 2016.

• The year began on a positive note as activity growth accelerated in 1Q15. However, the economy is losing momentum in the second quarter. While part of the deceleration is due to temporary factors, confidence remains low. We have reduced our growth forecasts to 2.5% from 2.8% for this year and to 3.4% from 3.5% in 2016. 

• On an annual basis, inflation decelerated to 3.97% from 4.1%, re-entering the target range after remaining above 4% for 13 months. We continue to expect inflation to reach 3.3% year over year in December, and 3.0% in 2016.

• The central bank’s June IPoM (Monetary Policy Report) retains the tightening bias, but the tone has softened slightly. The bank now indicates that rate hikes would come only in the first half of 2016. However, considering our scenario for growth and inflation, we do not expect rate moves this year or the next.

• The current-account balance continues to improve, driven by large trade surpluses. We now see a narrower current-account deficit than in our previous scenario (1.1% of GDP this year, versus 1.9% previously, and 1.8% in 2016, versus a 2.2% of GDP deficit before).

• In a strong U.S.-dollar environment, we expect the peso to continue to depreciate, reaching 645 to the dollar by the end of this year. For 2016, we see the currency at 650, somewhat stronger than we were previously forecasting (665).   

• The new cabinet members, led by Minister of Finance Rodrigo Valdes, have been verbal about the need to focus on economic growth and investment. In spite of the cabinet change, approval for the Chilean government and the President continued to fall in May.

A weaker second quarter

The year began on a positive note as activity growth accelerated 4.2% qoq/saar (the highest growth pace since 3Q13), from the 3.4% increase in 4Q14. Domestic demand excluding inventories grew by 3.6% from the previous quarter. Notably, government consumption (9.6% qoq/saar) continued growing well above GDP, reflecting in part the counter-cyclical fiscal plan in place. Private consumption grew by a modest 2.4%, negatively affected by spending on durable goods. Gross fixed investment grew by 3.5% qoq/saar, but it is still down from one year ago (-1.7% year over year). Meanwhile, exports in real terms expanded by 4.7% qoq/saar.  

However, activity is losing momentum in the second quarter. The monthly GDP proxy (IMACEC) stood flat from March to April after two consecutive contractions. So, the quarter-over-quarter annualized rate decelerated sharply to 0.2%. Furthermore, high-frequency indicators for May continue to point downward. Trade showed contraction in all categories, car sales have yet to stabilize and electricity generation is down as well.

Confidence remains subdued in spite of the recent cabinet reshuffle, which was viewed favorably by the private sector. Following the faltering government approval numbers, business confidence showed a retreat in May and is now 14 consecutive months in pessimistic territory. The sub-indexes of Construction and Manufacturing saw the largest retreats, with Commerce stable just below the neutral threshold of 50. As confidence levels remain low, credit-backed consumption decisions might be affected, as has been noted in the most recent central bank credit-conditions survey. Without a significant improvement in overall sentiment ahead, the expected recovery for 2H15 is facing downward risks, something central bank Governor Vergara noted in the context of the most recent inflation report (IPoM).

The dissonant note in activity comes from the labor market, with the unemployment rate still at a low 6.1% in the quarter ending in April. Total employment growth was pushed by job creation in public administration (mostly waged employment), while the commercial activities, domestic workers and mining sectors keep shedding jobs.

With growth momentum failing to pick up as we had previously anticipated, we have reduced our growth forecast to 2.5% this year (2.8% previously), with a weaker carry-over resulting in a more gradual recovery to 3.4% in 2016 (3.5% previously).

Creeping into the target range

Consumer inflation in May was in line with market expectations after numerous upside price surprises over the past 12 months. On an annual basis, inflation decelerated to 3.97% from 4.1%, re-entering the target range after 13 months above 4%. Core measures remain above the target range, but are also falling. Our diffusion index also suggests that inflation is moderating, but slowly. Finally, nominal wages – a source of concern for the central bank – have decelerated recently, to a still-high 6.4% year over year (from 7.1% in 1Q15).  

We continue to expect a gradual decline of inflation to 3.3% year over year in December and 3.0% in 2016.

Tightening bias, but softer tone

The central bank’s June IPoM retains the tightening bias, but the tone has softened slightly. Unlike the previous IPoM, in which the central bank was signaling that the monetary stimulus would likely start to be removed between the end of this year and the beginning of 2016, the June report assumes that the first hikes would likely come in 1H16. The rate guidance, which is in line with market expectations for the next year, is consistent with the revised growth and inflation forecasts.

The central bank lowered its 2015 GDP growth forecast range for this year by 25 bps to 2.25%-3.25%. The revision follows lower mining production (partly due to the floods that recently affected the northern part of Chile) and weaker private spending. Also, short-term indicators for 2Q15 hint at a lower dynamism and the expected contribution from net exports diminished.

The IPoM also revisited the labor market’s performance and analyzed the reasons behind the recent drop in confidence and investment. On the topic of labor, the IPoM concludes that in spite of the low unemployment rate, the labor market has behaved according to its fundamentals. In particular, had it not been for the strong public job growth, employment would have deteriorated, as its private component contracted in the recent cycle. Moreover, wage growth, which has been significantly above inflation since 2011, reflects a combination of indexation mechanisms and past inflation. So the high wage-growth rates are not a sign of tightness in the labor market. Still, the central bank acknowledges the risk of less slackness in the economy than it currently estimates. When analyzing expectations and investment, the central bank first concludes that the recent slump in confidence was in response to non-economic conditions and, then, that the lower confidence is partly responsible for the drop in investment.

With a slower growth recovery expected, the central bank now sees inflation at 3.4% by the end of this year and at 3.1% by the end of 2016 (from 3.6% and 3.2%, respectively). Prices excluding food and energy (IPCSAE) are the principal reason behind the inflation revision.

In this context of soft economic growth and gradual convergence of inflation to the target, we do not expect rate moves this year or the next. Still, we acknowledge that if inflation fails to show a clear downward trend, then the central bank may remove monetary stimulus even earlier than it currently considers.

Improving external accounts

The current-account balance continues to improve driven by large trade surpluses. A USD 1.2 billion deficit in 1Q15 brought the four-quarter rolling balance to -0.5% of GDP, an improvement from the 1.2% of GDP deficit for 2014. The improvement mainly came from the goods-and-services trade surplus and the narrowing in factor income payments, most likely due to the impact of lower copper prices on profits of mining companies. The financial account registered the first net outflow of direct investment since 2Q11, as foreign investment fell and Chilean investment abroad rose sharply. The four-quarter rolling foreign direct investment into Chile declined to 8.1% of GDP from 8.5% in 2014.

Data available for 2Q15 suggest the current account will stay low. A USD 982 million trade surplus was recorded in May, taking the twelve-month rolling trade balance to USD 8.2 billion, only slightly down from USD 8.4 billion in 1Q15. Lower copper prices are being offset by the benefits of the weaker currency and internal demand deceleration.

With the positive surprises in the external accounts, we now see a narrower current-account deficit than we were previously forecasting. For 2015, we expect a 1.1% of GDP deficit (1.9%, previously) and for 2016 our forecast is 1.8% (from a 2.2% of GDP deficit before).

In a strong U.S.-dollar environment, we expect the peso to continue to depreciate, reaching 645 to the dollar by the end of this year and 650 by the end of the next. Previously we were expecting a slightly sharper depreciation in 2016 (to 665). The faster-than-expected narrowing of the current-account deficit is behind the revision.

A tough political landscape

In a further setback for President Michelle Bachelet, the newly appointed secretary general of the presidency resigned after widespread criticism over past advisory work for mining companies while head of the mining committee in the House of Representatives. Jorge Insunza was in the position for less than a month, following an extensive cabinet reshuffle that included changes to the finance and labor ministries. Although holding the dual roles was not illegal, Mr. Insunza’s actions could have led to a possible conflict of interest. In resigning, Jorge Insunza stated that the move was aimed at helping to restore faith in public institutions and the administration.

The new cabinet members, led by Minister of Finance Rodrigo Valdes, have been vocal about the need to focus on economic growth and investment. Among the goals set by Mr. Valdes are that of a fiscal policy aimed at preserving credibility of the fiscal rule (hence hinting at a less expansionary budget next year), moderating the labor reform discussed in Congress, working to restore expectations, and preserving private property as defined in the current constitution. In the meantime, education-related projects are advancing in congress amid criticism from all parts of the political spectrum.

In spite of the cabinet reshuffle, approval for the Chilean government and the president continued to fall in May, according to think-tank Adimark. President Bachelet’s approval rating is now at 29% (from 31% in April). 


 

João Pedro Bumachar
Miguel Ricaurte

Vittorio Peretti



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