Itaú BBA - Gaining momentum

Scenario Review - Chile

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Gaining momentum

March 8, 2018

We now expect GDP growth of 3.6% this year, with risks tilted to the upside

Please see the attached file for all graphs.
 

• Confidence and expectations are high that Chile will rebound strongly this year, as tailwinds gain momentum. Data at the start of the year puts the recovery on a firm footing. We now expect GDP growth of 3.6% this year (from 1.6% last year), with risks tilted to the upside. The consolidation of investment and an export-driven recovery are likely to lead to 3.5% growth in 2019.

• We see the exchange rate at CLP 620/USD by YE18 and CLP 625 by YE19, with some depreciation from spot levels due to the normalization of U.S. monetary policy. The firm performance of the currency will help offset recovering internal demand growth and keep inflation below the 3% target throughout the year.

• Low inflation means that the central bank will remain comfortable with keeping the policy rate steady at an expansionary 2.5% this year. The normalization process would likely start next year, as the output gap narrows, taking the rate to 3.5% before year-end.

High expectations

Activity started 2018 on a high note. The monthly GDP proxy (Imacec) increased 3.9% from one year ago (2.6% in December and 1.6% in 2017), boosted by mining, manufacturing and commerce. Mining will remain a clear driver in the coming months, as copper prices remain high and production encounters a very low comparison base due to the extended labor strike at a principal mine early last year. Meanwhile, recovering internal demand and strengthening global growth will aid a manufacturing improvement. Retail sales grew 3.8% in the month, led by double-digit vehicle sales. Wholesale sales also improved, led by machinery, equipment and materials – an encouraging sign for the expected recovery in investment this year.

At the margin, activity gained 0.8% from December, building on the 0.3% rise in the previous month. Activity accelerated to 4.3% QoQ/SAAR in the quarter, from 2.1% in 4Q17. The improved performance was primarily driven by non-mining production (5.2% QoQ/SAAR, from 3.0% in 4Q17). Mining activity, however, continued to fall (5.3% QoQ/SAAR) as production continued to normalize following the post-strike boost (+44.6% in 3Q17).

Looking ahead, there are some positive signs for consumption from the improvement in private employment. Employment in the quarter ending in January grew 2.5% YoY – the fastest pace since the quarter ending in February 2014. The 16.9% increase in public salaried posts boosted overall employment growth, while private salaried jobs grew by a modest 0.5%, interrupting a five-month job-loss period. 

Private sentiment keeps improving. The central bank’s 1Q18 business perception report noted that several respondents expect a pickup in dynamics in 2H18, while some expect an improvement by as early as 2Q18. Fundamentals that justify this bullish outlook include a favorable external scenario (higher copper prices) and expectations that the incoming administration (taking office on March 11) will pursue business-friendly policies. Further indication of a bright growth outlook can be inferred from the February business confidence indicator. Both the total business confidence indicator (57.4) and the ex-mining measure (55.6) moved further into optimistic territory in February (from 46.0 and 40.5 one year before, respectively), reaching levels unseen since early 2013. Only the construction sub-index remains in pessimistic territory (48.6) but is substantially higher than one year ago (24.0).

We now expect GDP growth of 3.6% this year (from 3.3% previously), an improvement from the 1.6% expected for last year. With a stronger-than-expected start to the year, risks are tilted to an even stronger rebound. High copper prices, strong external demand, low interest rates and low inflation amid increased confidence will support the recovery. For 2019, we see growth at 3.5%.

Low external imbalances

Chile’s current account deficit remains low, as the trade balance started the year on a strong note. The 12-month rolling trade surplus increased to USD 8.5 billion as of February, from USD 6.9 billion in 2017 and USD 5.3 billion in 2016. Our seasonally-adjusted series shows that, at the margin, the trade balance surplus ticked up to a sizable USD 10.2 billion (annualized) in the rolling quarter (USD 10.1 billion in 4Q17). Import growth is broadly stable and high, still boosted by consumption goods. Recovering imports of machinery is an encouraging sign for the expected investment recovery. Recent data shows a widespread improvement in the export divisions, particularly mining.

With copper prices expected to remain high, robust global growth and only a gradual improvement in internal demand, we expect the current account deficit to remain low. We expect the current account deficit to narrow to 1.2% of GDP, from the 1.5% estimated for 2017. As internal demand recovers through 2019, we see some widening of the deficit to a still-low 1.8% next year.

We see the exchange rate at CLP 620/USD by YE17, weakening to CLP 625/USD in 2018. The expected weakening from current levels can be attributed to the normalization of monetary policy in the U.S. and some moderation of copper prices. 

Low inflation

Inflation is back at the bottom end of the 2%-4% inflation target range. The dip to 2% in February (from 2.2% in January) was partly explained by food and non-alcoholic inflation slowing to 2.8% (from 3.8%), while housing and basic service inflation moderated to 3.3% (4.2% previously). The lower inflation could also reflect diminished pressures following the sustained period of a stronger exchange rate. Core inflation (excluding food and energy prices) was stable at 1.6%, below the central bank’s target range, which we expect to continue throughout the year, as the output gap remains wide. Tradable inflation dipped to 1.3% (1.5% in January), while non-tradable inflation moderated to 2.9%, a historically low level. Our diffusion index has remained broadly stable over the last three months at levels that are low and reflect limited price pressure. 

We see inflation remaining below the 3.0% target during the year, with a yearend forecast of 2.5%. A gradual acceleration to 2.8% by the end of 2019 is anticipated once the output gap is narrowing.

Back to a full board

The Chilean central bank did not hold a monetary policy meeting in February. Starting this year, the central bank reduced the frequency of its monetary policy meetings from every month to eight times per year. The next meeting is scheduled for March 20, and the quarterly Inflation Report will be published the following day. Nevertheless, according to the minutes for the January meeting, the decision to keep the policy rate at 2.5% had the full support of the board and confirmed a consolidation of the rates-on-hold baseline scenario. Several board members agreed that recent data reduce the downside risks to both activity and inflation outlined in the 4Q17 Inflation Report. However, on retaining the easing bias, all board members stated that attention must be paid to how potential short-term downward deviations in inflation could risk the convergence to the 3% target over the policy horizon.  

We expect the policy rate to remain stable at 2.5% in 2018, as inflation remains low and the activity recovery unfolds. The normalization process is likely to start next year as the growth recovery consolidates and the output gap narrows. 

President Michelle Bachelet nominated Alberto Naudon for the vacant central bank director post following the end of Sebastian Claro’s term late last year. The announcement came right at the close of the Bachelet government, following extensive discussions between the left and right-leaning political representatives. The vacant post is aligned with the political right, under the board-member-composition agreement. The nomination of Alberto Naudon requires congressional approval. Naudon (42) became head of research at the central bank in September 2014. In 2013 he was chief economist at a private local bank. Before his stint in the private sector, Naudon was head of the macroeconomic forecasts and modelling department and an economist in the central bank’s research department. Naudon is an economist from the Catholic University in Chile and holds a PhD in economics from the University of California, Los Angeles.

Easing fiscal concerns

We expect the fiscal deficit to narrow to 1.9% of GDP this year (from 2.8% last year), as the incoming government moves toward fiscal consolidation. Risk-rating agency, Fitch, recently maintained Chile’s rating at A with a stable outlook amid better expectations for copper prices and economic growth. Public debt remains low in Chile, compared with its peers. However, the rapid rise in recent years was a source of concern for rating agencies, leading to one-notch downgrades by Fitch and S&P last year. Recovery in copper prices and growth will likely result in a more gradual public debt increase and keep rating agencies at bay. 


 

João Pedro Bumachar
Vittorio Peretti
Miguel Ricaurte


 

Please see the attached file for all graphs.



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