Itaú BBA - Neck-and-neck in the presidential race

Scenario Review - Chile

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Neck-and-neck in the presidential race

December 7, 2017

Activity recovery for 2018 requires a private sentiment improvement.

Please see the attached file for all graphs.

• The general election will reshape the political landscape. On the presidential side, two candidates moved on to a December 17 runoff vote. Former president Sebastian Piñera and Alejandro Guillier (supported by the majority of the ruling coalition) are canvassing support, with available polls predicting the election is currently too close to call. Meanwhile, in the parliamentary arena, the election produced a fragmented congress that would make the passage of legislation a challenging task for the candidate who emerges as the winner in the runoff vote.

• Activity showed some improvement in 3Q17, but the recovery is uneven across sectors and labor dynamics are worrisome. We now see growth of 1.5% this year (1.7% previously; 1.6% in 2016) and a pickup to 2.7% next year. Higher global growth and expansionary monetary policy will likely boost growth, although uncertainty over reforms could limit the improvement. 

• We expect a stable policy rate for most of 2018. Nevertheless, low inflation and inflation expectations along with some concern over the robustness of the activity recovery mean that further easing cannot be ruled out.

Presidential outcome too close to call

The results of the November 19 presidential election produced two surprises. At one end of the political spectrum, former president and candidate of the center-right coalition, Sebastian Piñera, secured 37% of the votes, below the 43% average from the polls (for those published between September and early November). Meanwhile, Beatriz Sanchez, from the leftist Frente Amplio (a coalition close to the movement advocating the elimination of the private pension system), received 20% of the vote in the election, above the 14% upper bound outlined in the polls prior to the election. Therefore, as has been the case in so many other events around the world in the last year and a half, polls failed to accurately anticipate voters’ preferences.

Nevertheless, with no candidate achieving a simple majority, the election moves to an expected runoff vote on December 17. Piñera will face Alejandro Guillier (22% of the vote), who represents the majority of parties in the current governing coalition. The election results show a polarized country, as candidates on the extremes of the political spectrum obtained significant support. Both Piñera and Guillier are scrambling to gather support from like-minded politicians and parties. Piñera has already been endorsed by former presidential candidate José Antonio Kast (8% of the vote in the first round of the election) and former Puente Alto Mayor Manuel José Ossandon (whom Mr. Piñera defeated in the primary of the center-right coalition back in July). Meanwhile, the center Christian Democrats (whose candidate, Carolina Goic, got 5.9% of the vote) have thrown their support behind Guillier, as has Marco Enriquez-Ominami (5.7% of the first-round vote). The parties that make up Frente Amplio have fallen short of fully supporting Guillier; they expect the candidate to earn the allegiance of voters by committing to some of the policies it champions. Still, Beatriz Sánchez personally endorsed Guillier, a move that may benefit the candidate's bid.

Voter turnout in the runoff election is likely to be the key factor. Guiller needs most of Sanchez’s supporters if he is to win the vote. Hence, if a large portion of the electorate chooses to abstain from voting (as a form of protest against the political establishment), the resulting fall in participation could favor Piñera. Poll simulations for the runoff vote reveal that Piñera has a small lead, but statistically this race is tied. 

Regardless of who is elected, the composition of congress means that policy will likely be balanced. The right-leaning parties fared well, with the center-right coalition holding 47% of the lower chamber and 44% of the senate for the 2018 to 2022 governing period. This is one of the highest representations since the return to democracy in 1989 (with the exception of the 2009 election). Hence, a potential Piñera government would have a chance to negotiate with moderate opposition members in order to get some legislation approved. 

Investment remains a drag

Activity showed some improvement in the third quarter of the year. GDP grew 2.2% year over year, increasing from 1.0% in 2Q17 (revised from 0.9%). This is the highest growth rate since 1Q16 and is likely the beginning of a gradual recovery. Durable consumption (11.5%) continued to be a firm driver of activity in the quarter, boosted by vehicle sales, while public consumption growth moderated to 2.2% (3.0% in 2Q17) after the government front-loaded some of its budget expenditure. Overall, total consumption grew 2.7%, stable from the previous quarter. An export recovery, partly led by higher copper exports, partly offset the drag on activity from net exports. Net exports pulled growth down by 0.4 percentage points in 3Q17, far less than the 2.7 percentage point drag in the previous quarter. Meanwhile, gross fixed investment posted its fifth consecutive annual contraction (-2.3%; -4.6% in 2Q17). 

Activity improved sequentially, boosted by the mining recovery but also by manufacturing exports, durable consumption and the machinery and equipment component of investment. GDP expanded by 6.0% qoq/saar, following a 3.5% expansion in the previous quarter.

Nevertheless, data at the start of 4Q17 was mixed, indicating that the expected recovery could be bumpy. The GDP proxy expanded 2.9% year over year in October, led by mining (+11.1%), while non-mining activity grew 2.2%. Growth slowed sequentially, to 3.6% qoq/saar from 5.8% in 3Q17. Notably, the destruction of private salaried jobs could limit consumption growth. The contribution to total employment from the formal private sector is at historically low levels, outlining the low quality of jobs being created regardless of a still-low unemployment rate (6.7%).

While higher global growth (supporting copper prices) and expansionary monetary policy will likely aid an activity recovery going forward, the year is set to end on a weaker note than we were expecting. We now forecast growth of 1.5% this year (1.7%, previously), slightly lower than the 1.6% in 2016, but we still see a recovery to 2.7% for 2018. The outcome of the December presidential runoff and the debate over the reform agenda next year would influence confidence and, consequently, investment and growth.

Low current account deficit not fully financed by direct investment

The current account deficit narrowed in 3Q17 as copper exports bounced back. The current account deficit came in at USD 1.5 billion in the third quarter of the year, down from the USD 2.2 billion deficit recorded in 3Q16. A recovery in mining exports led the improvement from last year, but a growing income deficit was an offsetting factor. The resulting rolling-4Q current account deficit of USD 4.6 billion (1.7% of GDP) was still higher than the USD 3.6 billion in 2016 (1.4% of GDP). But our own seasonal adjustment shows the trade recovery resulting in a current account surplus of 0.1% of GDP, from a 2.6% deficit in 2Q17. 

However, net direct investment has not been enough to finance the deficit. Over the last four quarters, foreign direct investment into Chile fell to USD 7.4 billion, from USD 12.2 billion in 2016 and USD 20.5 billion in 2015. Hence net direct investment declined to USD 0.2 billion (USD 5.1 billion in 2016). Meanwhile, foreign portfolio investment in Chile rose to USD 6.6 billion for the year concluded in 3Q17 (USD 3.0 billion last year).

As internal demand is still weak, the effects of the mining strike continue to fade, and copper prices stay high, the current-account deficit will likely continue low. However, the slower-than-expected deficit narrowing in 3Q17 has led us to revise our forecast for this year to 1.5% from 1.4% previously (still broadly in line with last year). A narrowing to 1.2% is still expected next year as copper exports remain robust. 

We still see the exchange rate ending the year at 650 pesos per dollar and ending 2018 at 660 pesos per dollar. The weakening from current levels is based on the likelihood of continued monetary-policy normalization in the United States. Nevertheless, the sustained performance of copper prices would help to ease depreciation pressures. In the short run, developments on the political front could have an impact on the exchange rate. But we note that Chile’s fiscal and balance-of-payment fundamentals are solid enough to prevent excessive volatility. 

Inflation stays at low levels

Inflation in November was stable at 1.9%. The breakdown shows that tradable inflation continues to be less of a drag (1.0% vs. 0.8% in October), whereas non-tradable inflation moderated to 3.1%, after being sticky at 3.3% for the previous three months. Core inflation (excluding food and energy prices) is 1.8%, low but in line with the outlook that only sees convergence to the 3% target in 2H19. Our diffusion index reflects that price pressure remains restricted.

Low inflation is here to stay, at least for some time. Inflation has been below the lower bound of the central bank’s 2%-4% target range for six consecutive months, the longest period since the seven-month run in early 2013. Going forward, the lagged effect of the prolonged strong performance of the Chilean peso and inertia will help keep inflation low. Our 2018 inflation forecast is for a pickup to 2.8%, from 2.2% this year, and assumes a narrowing of the output gap, some depreciation of the Chilean peso and the gradual normalization of fresh food prices.

Staying on hold

The Chilean central bank opted to leave the monetary policy rate unchanged, at 2.5% in November. The move was widely anticipated by the market after inflation surprised to the upside in October. In our view, the easing bias retained in the press release is signaling that the board remains attentive to volatile inflation prints and low year-over-year readings rather than being ready to commit to an increase in monetary stimulus. 

The central bank’s last inflation report (IPoM) for 2017 reiterated the view of stable rates. The board’s baseline scenario for monetary policy continues to assume that rates will be unchanged, at 2.5%, until the output gap begins to close (2H18). According to the central bank, the main explanation for lower-than-expected inflation over the past three months comes from the performance of some volatile prices (specifically, food). However, core prices have been evolving in line with forecasts presented in the previous IPoM. Overall, the central bank has noted that the recent surprise, along with the strong currency and low activity growth, could lead to a slower convergence of inflation to the target than was expected in 3Q17. The new baseline scenario of the central bank shows inflation staying near the lower bound of the central bank’s 2%-4% tolerance range during 1H18, and thereafter reaching the 3% target in 1H19, while core inflation will converge during 2H19. Overall, the risks for these inflation forecasts are deemed to be balanced.

The central bank’s inflation report is broadly in line with our own forecast. We see an export and investment-driven recovery in activity next year, along with a pickup in inflation. Accordingly, the policy rate would remain stable, at 2.5%, for most of 2018. Still, we note that, in the short term, risks lean towards more easing.


João Pedro Bumachar
Vittorio Peretti
Miguel Ricaurte


Please see the attached file for all graphs.

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