Itaú BBA - Nearing a neutral stance

Scenario Review - Chile

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Nearing a neutral stance

August 10, 2016

A bleak outlook for growth and disinflation could lead to a looser monetary stance next year.

Please see the attached file for all graphs.

 Mining remained the biggest drag on Chile’s economic activity in 2Q16, but other sectors have been slowing down as well. The labor market continues to weaken gradually. We expect GDP growth of 1.5% for this year, down from 2.1% in 2015, followed by a modest recovery to 2.0% growth in 2017, but we acknowledge that there are downside risks to our forecasts.

• We expect a current-account deficit of 1.7% of GDP for this year (2.0% in 2015), with low mining company profits improving the income balance, partly offsetting the lower trade surplus. For 2017, we expect a deficit of 2.2% of GDP.

• We still expect a year-end exchange rate of 685 pesos per dollar, as we foresee one hike by the Fed before the end of this year. By the end of 2017, we expect the rate to have weakened to 695 pesos per dollar as the Fed continues to normalize monetary policy, narrowing the interest rate differential with Chile.

• We expect the inflation rate to end this year at 3.5% and to hit the 3% target in 2017. A wider output gap and a more favorable evolution of the exchange rate relative to the previous two years will likely drive disinflation.

• The central bank has kept the policy rate unchanged at 3.5% since the beginning of the year. We do not expect rate hikes until at least the end of 2017 and we cannot rule out some monetary loosening next year given the bleak outlook for growth and the fact that inflation is approaching the target.

• Political woes continue to dampen the government’s approval ratings. Social protests are putting pressure on the government to advance its reform agenda more swiftly, ahead of the debate over the 2017 budget.

Anemic activity

Chile’s economic activity weakened in 2Q16 as the mining sector contracted while growth in other sectors slowed down. GDP grew by 1.1% in 2Q16 (2.0% in 1Q16), with mining output falling by 5.8% year over year (-1.9% in 1Q16), while the non-mining component (more influenced by cyclical conditions) moderated to 1.9% (2.4% in 1Q16). The National Account data for 2Q16 will be released on August 18, when the central bank will revise its GDP figures from 2015 onward to incorporate previously unrecorded information on hotel, restaurant and commerce activity. The central bank expects its revised estimate for GDP growth in 2015 to be 0.2 percentage points above the current estimate of 2.1%.

Business confidence remains low, with no signs of a recovery. The index has been in pessimistic territory (below 50) for 28 consecutive months, hovering near the lows of the subprime crisis. Consistent with this, the central bank’s quarterly business perception survey, which summarizes the views of managers at medium and large enterprises nationwide, shows that most interviewees expect stability in business results through the remainder of this year and 2017. This differs from the previous survey, in which some respondents expected an improvement next year. Overall, most respondents reaffirmed that their investment plans remain restricted.

The labor market continued to weaken gradually in the second quarter. The national unemployment rate increased to 6.9% (6.5% in 2Q15), a level last seen in 2011. The breakdown of employment data indicates that the labor market is looser than is being implied by the level of the unemployment rate, as paid employment expanded by a modest 0.4%, while self-employment grew by 6.0%. Additionally, there was a 4.0% increase in unpaid employment in family businesses.

We still expect the economy to expand by 1.5% this year and by 2.0% in 2017. However, we see downside risks to our growth forecasts. Activity remains anemic, with confidence levels and expectations showing no signs of recovery.

Trade surplus gradually narrowing

In spite of weak internal demand and low oil prices, the trade surplus is narrowing due to poor mining exports. The 12-month rolling surplus dropped to USD 2.7 billion in July (from USD 3.5 billion in 2015). In the quarter ending in July, exports fell by 7.2% year over year (as mining external sales were down 12.8%).

Nevertheless, we expect the current account deficit to narrow to 1.7% of GDP this year (-2.0% in 2015). The shrinking trade balance will likely be offset by the impact of low copper prices on the profits of foreign mining companies operating in Chile, leading to a smaller income balance deficit. For 2017 we expect a larger current account deficit of 2.3% of GDP, as internal demand and oil prices recover somewhat.

The Chilean peso has been supported by high copper prices and the loose monetary policy stance prevailing in the core economies. Given our forecasts for copper prices and interest rates in the U.S., we expect some weakening in the exchange rate from current levels, to 685 pesos to the dollar by the end of this year and 695 pesos to the dollar by the end of 2017.

Gradual disinflation continues

Despite an upside surprise in July, annual inflation fell enough to reach the upper bound of the 2% - 4% target range. Consumer prices gained 0.24% from June to July, so annual inflation moderated to 4.0%, from 4.2% previously. Core inflation – which excludes food and energy prices – remained broadly stable at 4.2%, the lowest reading since October 2014. Tradable inflation moderated to 3.7% (3.9% in June), while non-tradable inflation slowed to 4.5% from 4.6% the previous month. Our diffusion index still indicates that inflationary pressures are disseminated.

We expect the negative output gap, a more favorable evolution of the exchange rate (compared with the previous two years) and well-anchored inflation expectations to yield a disinflation to 3.5% by year-end (4.4% in 2015). For next year, we expect inflation to stabilize at the 3% target.

Ready to drop the tightening bias

The minutes of the central bank’s July monetary policy meeting confirm that the policy rate will likely remain unchanged in the near term. For the seventh time this year, the board voted unanimously to leave the policy rate at 3.50% (the only option considered), following two rate hikes in 4Q15.

The board retained the tightening bias because inflation remains high and the external scenario is volatile. However, one board member noted that the time was approaching for the bias to be removed, and another member went as far as saying that in the current conditions, a rate cut had more appeal than a hike.

We believe that the central bank will probably remain on hold for at least the remainder of this year and the next. Additionally, we anticipate that in the 3Q16 inflation report, the central bank will remove the tightening bias from its monetary policy guidance. However, we cannot rule out some monetary loosening next year given the bleak outlook for growth and the fact that inflation is approaching the center of the target range.

Political discord on the rise

Political woes continue to hurt President Bachelet’s approval ratings. Throughout July, the presidential approval rating stayed at 22%, its lowest level since the inception of Adimark’s public opinion survey in 2006. Meanwhile, the disapproval rating rose by one percentage point, to 73%. Overall, the government has an approval rating of 17% (19% in the previous month). The government’s reform agenda is still viewed negatively, with spikes in disapproval ratings for both the education and labor reforms.

In this context, social protests are regaining momentum. Most recently, calls by politicians in the government and the opposition, as well as social movements, have effectively prioritized the discussion on a pension law amendment. This increases the chances a reform is approved before the end of this administration. Overall, pressure for a cabinet reshuffle is increasing, barely a month after the government made a leadership change at the key Ministry of Interior.


 

João Pedro Bumachar
Vittorio Peretti
Miguel Ricaurte


 

Please see the attached file for all graphs. 


 

 



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