Itaú BBA - Not So Sluggish After All

Scenario Review - Chile

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Not So Sluggish After All

August 30, 2013

Chile’s economy posted weak growth in 2Q13, but the number’s breakdown shows strong final demand growth.

·         Chile’s economy posted weak growth in 2Q13, but the number’s breakdown shows strong final demand growth. In addition, the first indicators available for 3Q13 came in strong. We expect Chile’s economy to grow by 4.2% this year and by 4.4% in 2014. 

·          In spite of methodological changes, headline inflation continues below the center of the target, while core measures are running below the lower bound of the range. Our inflation forecasts stand at 2.2% in 2013 and 2.6% in 2014. 

·         The current account stopped widening in 2Q13 while both direct and portfolio investment were strong. We revised our forecast for the current-account deficit to 3.7% of GDP this year and to 4.1% in 2014. Our exchange-rate forecasts are unchanged at 510 pesos to the dollar by year-end 2013 and at 525 by year-end 2014. 

·         The central bank left the policy rate unchanged in August, but maintained an easing bias. Additionally, it reduced its estimates for GDP and CPI in the monetary policy report of 3Q13, and considered rate cuts in its baseline scenario. We expect rates to remain unchanged in September, as board members look for more convincing signs that the economy needs monetary stimulus. Still, our scenario for growth and inflation is consistent with lower rates ahead. We see the reference rate at 4.5% before the end of this year and at 4.0% before the end of 2014.

 ·        The government announced the long-term parameters to be used in the fiscal budget of 2014. The potential GDP rate declined to 4.8% (from 5.0%) and the long-term copper price was adjusted from USD 3.06 to USD 3.04, leaving less room to increase fiscal spending next year. Therefore, we think that fiscal policy will be less expansionary, leaving room to lower interest rates ahead.

·          According to a poll conducted by CEP (Centro de Estudios Publicos), a local think tank, Michelle Bachelet would receive 44% of the vote in the next presidential election, while Evelyn Matthei (from the government coalition) would get 12%. If there were no candidates with more than 50% of the votes, the next president would be elected in a runoff (to be held on December 15).

Not So Sluggish After All

The GDP was weak during 2Q13, but the number’s breakdown brought some positive news. Chile’s economy grew by 1.9% qoq/saar during 2Q13, following an also below-trend (but upwardly revised) 3.2% increase in the previous quarter. However, the number’s breakdown shows that private consumption expanded by 6.4% (4.8% in 1Q13) and gross fixed investment gained 13.4% (-18.5% in 1Q13). As a result, while inventory changes led to a 1.9% contraction in internal demand, excluding inventories, internal demand grew a strong 8.3% (previously -4.5%). In addition, the IMACEC (monthly proxy for GDP) showed better growth momentum in May and June. The index grew 0.9% month over month in May and 0.8% in June, creating a favorable carry-over effect for 3Q13. In July, the activity grew 5.3% year over year (0.0% month over month).

The first activity indicators available for the third quarter came in strong. Manufacturing production gained 4.7% year over year in July, while retail sales jumped 10.3%. Imports of capital goods – a proxy for investment in machines and equipment – were up by 18.2% and car sales increased 20%.

We expect Chile’s economy to grow by 4.2% this year and by 4.4% in 2014. While growth would remain below trend in our scenario, GDP would pick up from the second half of this year on, while consumption and investment would slow. Consumer and business confidence and the recent slowdown in real wages point to lower consumption growth ahead. 

Inflation Is Not a Concern

Inflation increased to 2.2% year over year in July (from 1.9% in June), remaining below the center of the target (3.0%). Annual inflation has been running below 3.0% since June 2012. The core measures continue below the lower bound of the target. The CPIX (which excludes fresh food and fuel) came in at 1.3%, while the CPI excluding food and energy was up by 0.9% year over year. Non-tradable inflation fell further and is now at the center of the target, while tradable inflation increased to 1.5% year over year (0.9% in July).

The July CPI already incorporates a new methodology for tracking clothing and footwear prices. The weight of these items in the price index is 5.2%. The changes in methodology aim to address the puzzling persistent decline of these prices (-11.31% in 2011 and -7.0% in 2012). Now, the INE (official statistics institute) will calculate the clothing and footwear price changes of products with the same brand, quality and country of origin. By doing so, INE ignores price declines related to changes in fashion preferences. In addition, the new methodology will not consider price declines due to “out of season” discounts. On a year-over-year basis, clothing and footwear prices fell by 11.2% in July (versus a 12.7% deflation in June). We estimate that the changes add 50 bps to headline inflation over a 12-month horizon.

We expect inflation at 2.2% by the end of this year and at 2.6% by the end of 2014. In our view, a looser output gap will likely keep non-tradable inflation in check, while tradable prices will rise further due to a weaker exchange rate and higher oil prices.

The Current-Account Deficit Trend Improves 

The current account stopped widening and we now expect a current-account deficit of 3.7% of GDP this year and at 4.1% in 2014. Previously we expected a current-account deficit of 4.7% and 4.9% for 2013 and 2014, respectively. During 2Q13, the current account posted a USD 1.6 billion deficit, almost flat from the 2Q12 result. As a consequence, the 4-quarter rolling deficit stood at 4.0% of GDP. Lower internal demand growth is smoothing the pace of deterioration of the trade account. Meanwhile, the income deficit is shrinking, possibly influenced by lower mining sector profits.

Capital flows were strong during 2Q13. Net direct investment came in at USD 2.1 billion, bringing the 4-quarter rolling result to USD 11.4 billion (4.1% of GDP) – enough to fully finance the current-account deficit. In spite of the volatility in global markets, the portfolio account saw net inflows of USD 5.4 billion, as both foreigners and residents brought capital to Chile.

Our exchange-rate forecasts are unchanged, at 510 pesos to the dollar by the end of this year and at 525 by the end of 2014.Higher U.S. yields and lower copper prices are weighing on the currency, but Chile’s strong fundamentals are containing the depreciation of the peso without exchange-rate intervention.

Postponing the Easing Cycle

The central bank kept the policy rate at 5.0% in August. The tone of the statement that accompanied the decision was broadly in line with the previous meeting’s. The central bank kept an easing bias, alluding to possible rate cuts if the incoming data confirms the deceleration outlined in the official forecasts. The minutes of the meeting revealed that the board, for the fourth consecutive month, also considered cutting the policy rate by 25 bps.

Central Bank´ new scenario: Downward revision in GDP and CPI. Chile’s central bank published its 3Q13 Monetary Policy Report. As we expected, it changed its GDP forecast to 4.0%-4.5% in 2013 (from the previous 4.0%-5.0% range), in line with our estimate of 4.2%. For 2014, it expects an increase between 4.0%-5.0%, confirming the expansion at a slower pace than potential GDP (which is around 4.8%, according to the Finance Ministry’s external advisory committee). However, the central bank increased its estimate of final sales (domestic demand ex-inventories) for 2013, to 5.7% (from 5.1%), due to higher-than-expected dynamism in consumption. For 2014, it said investment maturity in the Mining sector, slowing employment growth, the downward trend in real wages and the recent worsening in consumer confidence are all pointing to lower growth in all components of GDP. Furthermore, the report cited a downward bias in GDP forecasts. On inflation, the central bank reduced the CPI forecast for 2014 to 2.8% (from 3.0%), although it left its forecast for 2013 unchanged, at 2.6%.

Confirming the easing bias. In this scenario, the central bank reaffirmed an easing bias, mentioning that the monetary policy rate would move in accordance with current economic expectation surveys. According to the August Economic Expectation survey (published by the central bank), analysts expect rate cuts of 50 bps within the next five months.

We expect rates unchanged in September. The central bank is clearly waiting for more convincing signs that the economy and internal demand are actually slowing before delivering rate cuts. In our view, the recent set of activity numbers still casts doubts on the economic deceleration.

Our policy-rate forecasts for year-end 2013 and year-end 2014 are unchanged. In our scenario, Chile’s economy grows below trend in both 2013 and 2014, and inflation continues below the target-center throughout our forecast horizon. This scenario is consistent with lower rates ahead. We expect two 25-bp cuts this year and another two 25-bp cuts in 2014, bringing the reference rate to 4.5% this year and to 4.0% in 2014. The timing of the easing cycle is clearly dependent on activity data.

Lower Contribution to GDP from Fiscal Policy in 2014

The finance minister announced the long-term copper price and potential GDP to be considered in the fiscal budget for 2014, which has to be sent to the congress by September 30.According to the external advisory committee, the long-term copper price declined to USD 3.04 (from USD 3.06 last year), while the potential GDP rate was reduced to 4.8% from 5.0%. These estimations are consistent with lower growth of structural revenues, leaving less room to increase fiscal spending, especially considering the intention to reduce the structural deficit to 1.0% of GDP in 2014 and the rising costs of Codelco. The government estimates a deficit of 1.2% in 2013. In our view, these parameters are pointing to fiscal expenditure growth between 4.5% and 4.7% in 2014, lower than the 5.9% estimated by the government for this year (according to the forecasts made in July). Therefore, we think that the fiscal policy will be less expansionary in 2014, leaving room for lower interest rates ahead.  

Bachelet Leads the Presidential Race

Michele Bachelet (socialist and former president of Chile) is the presidential candidate receiving the highest support, according to a poll taken by the CEP (Centro de Estudios Publicos).She received 44% of vote intentions, while Evelyn Matthei (from the government coalition) received 12%. In third place, both Marcos Enriquez Ominami (independent, from the left) and Franco Parisi (independent, from the center-right) got 4.0%. These results confirm that Bachelet has a high probability of becoming the new president of Chile.

The same poll hints that the next president would be elected in the runoff. There are no candidates with more than 50% of total votes, which means that the next president would be elected in the runoff (to be held on December 15). Additionally, it is relevant to consider that the poll was taken between July 13 and August 18, so it wasn’t totally representative of Matthei’s support (she assumed the candidacy on July 20.) Finally, 20% of potential voters hadn’t decided their vote, so there is still room for changes in the coming polls.

João Pedro Bumachar
Rodrigo Aravena

Forecasts: Chile

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