Itaú BBA - Lower copper prices weigh on the economy

Scenario Review - Chile

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Lower copper prices weigh on the economy

August 7, 2015

We have reduced our 2016 forecast to 3.0% (from 3.2%).

 We continue to expect GDP growth of 2.2% this year, but have reduced our 2016 forecast to 3.0% (from 3.2%) due to the deteriorating copper price outlook.

• A worsening external environment for emerging market currencies (including lower commodity prices) led to continued depreciation of the Chilean peso in July. We now see the exchange-rate at 665 pesos to the dollar by year-end 2015 (from 645 previously) and at 675 in 2016 (from 650).

• Despite the drop in copper prices, we now estimate a current account deficit of 0.8% of GDP for 2015 (1.1% previously), compared with the 1.2% deficit registered in 2014, and at 1.5% in 2016 (from 1.8% previously). The exchange rate depreciation and lower oil prices are behind the revision.

• In light of the weaker Chilean peso and the supply-shocks that have affected food prices, we now anticipate inflation of 4.0% by year-end (3.7% previously), decelerating to 3.0% in 2016.

• The minutes of the Central Bank’s July monetary policy meeting revealed increased concerns about inflation. However, we continue to expect no rate movements this year or the next.

• Amid a challenging scenario for the Chilean economy, the government has been trying to implement measures to boost confidence.


The weakest quarter of the year?

Activity was strong in June, but the economy remained weak during 2Q15 as a whole. Manufacturing production increased 1.8% from May to June, which resulted in a still-weak 0.5% qoq/saar expansion in 2Q15, although up from -4.7% in 1Q15. Mining posted a gain of 0.5% month over month, but fell 1.2% qoq/saar after a strong 17.3% expansion in 1Q15. Meanwhile, the consumption data was mixed: retail sales increased 0.4% relative to May and 4.9% qoq/saar (0.4% in 1Q15), but supermarket sales slowed from 10% qoq/saar in 1Q15 to 2.4% in the second quarter (-2.5% from May to June). As a result, the Imacec (monthly GDP proxy) expanded 2.7% year over year (3.1% adjusting for calendar effects). Corrected for seasonal factors, activity rose 1.1% from May, but resulted in a quarter-over-quarter annualized contraction of 0.3% in 2Q15 (+4.1% in 1Q15).

Despite the weak economy, the labor market is loosening gradually. The unemployment rate for 2Q15 was 6.5% – the same rate recorded in the corresponding period of last year (6.1% in 1Q15) – taking the average for the first half of the year to 6.3%. The labor force increased by 1.6% year over year (0.7% in 1Q15) and employment grew by 1.5% (1.0% previously), led by a 9.0% growth in public sector jobs (11.6% in 1Q15). Private employment advanced at a much slower rate of 1.1%, but exceeded the 0.4% recorded in 1Q15.

Consumer and business confidence remain in pessimistic territory. The consumer expectations index (IPEC) slipped in 2Q15, to 38.2% – below the 42.1% recorded in 1Q15 and the 50.7% registered in 2Q14. While none of the sub-indicators posted monthly gains, consumption of household goods remained in positive territory. The perception of the current economic situation and the five-year prospect components showed the largest monthly deteriorations. Entering the third quarter, business confidence is showing no signs of recovery. Overall business sentiment dropped to 42.6% in July, led by the deterioration in the construction component, while mining continues to be the only sector in optimistic territory (62.4%).

Our growth forecast for 2015 remains at 2.2%, but we have lowered our call for 2016 to 3.0% (from 3.2%). The continued drop in copper prices is likely to weigh negatively on income, confidence, and investment going forward.

A weaker exchange-rate and a narrow current-account deficit

Alongside other emerging market currencies (particularly of commodity exporters), the Chilean peso has continued to depreciate in the last month. Although we anticipate some recovery of copper prices from the current levels, we now expect the Chilean peso to end the year at 665 to the dollar (from 645 in our previous scenario) and at 675 in 2016 (from 650 previously).

Despite the lower copper prices, we now expect a current account deficit of 0.8% of GDP for 2015 (1.1% in our previous scenario), from the 1.2% registered in 2014, and at 1.5% in 2016 (1.8% in our previous forecast). The drop in oil prices and the weaker Chilean peso are the factors behind our revisions.

Depreciation to keep inflation above the target

Annual inflation moved further beyond the central bank’s target range, to 4.6% in July, after the 4.4% recorded in June. Excluding the volatile food and energy components, inflation also accelerated to 4.9%, after a 4.7% gain in June. Tradable goods prices grew 4.4%, significantly above the 4.0% recorded in June, while inflation for non-tradable goods was 4.9% (from 5.0%). Our diffusion index picked up from previous months, driven by its tradable component.

The further weakening of the Chilean peso is likely to put additional pressure on inflation going forward. We now expect a more gradual convergence of inflation toward the target range. Our year-end forecast for inflation is now 4.0% (from 3.7% in our previous scenario). Higher food prices also played a role in our revision. For 2016, we expect the lower exchange-rate depreciation and a negative output gap to bring inflation to the center of the target.

Central Bank concerned about persistent inflation

According to the minutes of the July monetary policy meeting, the decision to keep the rate at 3% was unanimous and was the only relevant option considered. The central bank did not signal rate movements in the near term.

Rate cuts are clearly off the table, as neither the staff nor the board link the economic slowdown to a lack of stimulus. The central bank believes that the high inflation is a result of transitory factors (i.e., the weakening exchange rate and its spillover to other prices through indexation mechanisms), so inflation expectations for the relevant horizon remain anchored, making rate hikes also unsuitable.

However, the central bank seems more concerned about the inflation outlook. The technical staff mentioned the risks for inflation expectations stemming from persistently high inflation. The prevalence of high price growth cannot be ruled out in light of the recent weakening of the peso and the risk of further depreciation ahead; we note that the exchange rate has weakened further since the meeting. In addition to the pressures from the currency depreciation, there is an ongoing debate within the central bank on how disinflationary the output gap actually is. We expect the next Monetary Policy Report (IPoM) to address this issue alongside a revision of the forecast scenario.

Our scenario continues to assume that the policy rate will remain at 3%, at least until the beginning of 2017.

Working to improve sentiment

The government continues to work to boost confidence. Finance Minister Rodrigo Valdes reiterated the administration’s intent to make technical improvements to last year’s tax reform in order to help simplify its implementation. Regarding the labor reform currently under discussion by the Senate, Mr. Valdes and Labor Minister Rincon have indicated that the discussion must consider worker’s demands together with the needs and challenges of businesses, particularly SMEs. Overall, the increase in productivity required for long-term growth is gaining space in the economic policy discussion. President Bachelet has summoned a specialized commission to propose recommendations in this regard.

Positive news flow surrounded the announcement that the public teachers’ union ended a 57-day long strike opposing the teachers’ career bill. This followed a bumpy debate on the bill in Congress. The teachers’ union, which is opposed to the linking of salaries with performance reviews and exams throughout a teacher's career, will continue to negotiate with the Ministry of Education to perfect the bill in parliament. This is one of the key pillars in President Michelle Bachelet’s campaign promise to overhaul Chile’s education system.

However, not everything is improving for the government, particularly on the labor front. As wage renegotiations in the public sector approach, state-owned Codelco’s operations at several mines – including iconic Chuquicamata – were temporarily halted due to contractor protests, which resulted in the death of one worker. Other public servants are also considering work stoppages to demand improved labor conditions.

The president and government’s approval ratings continue to drop. According to the July Adimark survey, the approval ratings of the president and the administration reached a new historical low, while disapproval exceeded 70% for both. Insecurity and corruption were the areas that led the negative marks. On the upside, support for the educational reform registered an uptick, while approval of the labor reform remained stable from the last reading (both currently in the low-to-mid-30s).


João Pedro Bumachar
Miguel Ricaurte

Vittorio Peretti


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