Itaú BBA - Oil prices speed up the external adjustment

Scenario Review - Chile

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Oil prices speed up the external adjustment

December 10, 2014

Chile’s 3Q14 GDP grew 0.8% from the previous year

• Activity was weak in 3Q14, the October IMACEC (monthly GDP proxy) indicates no meaningful recovery, and the drop in copper prices will add to the slowdown. We maintain our growth forecast for the year at 1.7%, but now expect a 2.5% expansion in 2015 (from 3.1% in our previous scenario). 

• Weak internal demand and the exchange-rate depreciation continue to yield more favorable external accounts. We reduced our current account deficit forecasts to 1.7% of GDP for 2014 and 1.4% of GDP for 2015 (vs. 1.7% in our previous scenario), due to the decline in oil prices, which more than offset the drop in copper prices). 

• The Chilean peso weakened further, in a strong global dollar environment, and we expect it to continue to depreciate next year, to 635 pesos per dollar (from 610 in December 2014).

• Based on our new oil-price and growth forecasts, we reduced our inflation estimate to 2.5% for 2015 (from 3.0% in our previous scenario) and 5.0% for 2014 (from 5.2% in our previous scenario). 

• The Chilean Central Bank remained on hold in November, also maintaining its neutral bias. Although we expect no rate moves for the remainder of 2014 or 2015, our new growth and inflation forecasts suggest that the probability of rate cuts next year is not small.

• The 2015 budget, which is pending final presidential approval, calls for a 9.8% increase from the original 2014 budget – marking the highest annual growth in public expenditure since 2009.

Activity remains disappointing

Chile’s 3Q14 GDP grew 0.8% from the previous year (in line with the IMACEC data for the period), following a 1.9% increase in the previous quarter.

Investment continued to be the main drag on 3Q14 growth. After falling an 8.4% year-over-year in 2Q14, it contracted 9.9% in 3Q14. Machinery and equipment purchases declined 24.6% from the previous year, while investment in construction fell 0.7%. Private and public consumption slowed, to 2.0% and 1.8% year over year, respectively (from 2.1% and 2.5% in the previous quarter). Weak domestic demand had a negative impact on imports, which fell 7.2% from last year, while exports accelerated to a modest 1.0% year over year (from 0% in 2Q14) so there was a positive contribution from the external sector.

GDP growth accelerated to a still-weak 1.5% qoq/saar on a sequential basis, following a 0.3% contraction in 2Q14. Gross fixed investment fell 2.8% qoq/saar, while private consumption accelerated to 1.9% qoq/saar and exports increased 4.0%.

The available 4Q14 indicators are not promising. The October IMACEC showed a 0.4% expansion from September, but the trend remains modest (1.8% qoq/saar). Capital goods imports declined 15.5% year over year in the quarter ending in November. More importantly, business confidence deteriorated further in November, to 40.56% (from 41.5% in October and 49.3% in November 2013). Confidence has been particularly weak in the Construction sector.

We maintain our growth forecast for 2014 at 1.7%, but reduced our growth estimate for 2015 to 2.5% (from 3.1% previously). Although we continue to expect a recovery, driven by monetary and fiscal stimuli, the drop in copper prices (and its impact on income, confidence and investment) as well as the recent disappointing growth figures make us more cautious about the strength of the recovery.   

A still-narrow current-account deficit

The combination of weak internal demand and the depreciation of the peso has fostered an improvement in Chile’s external accounts. The current account showed a USD 1.7 billion deficit in 3Q14, from a USD 3.4 billion deficit in 3Q13. This takes the four-quarter rolling deficit to 1.9% of GDP, from 2.5% in 2Q14, supported by better trade-balance numbers. In the capital account, a notably strong foreign direct investment of USD 7.6 billion in 3Q14 led to a net direct investment (i.e., foreign direct investment minus direct Chilean investment abroad) of USD 9.1 billion in the past four quarters – more than enough to finance the current-account deficit. Foreign portfolio investment reached a record high of USD 5.7 billion in the quarter, while Chilean investment abroad stood at USD 3.5 billion, resulting in a net inflow of USD 0.3 billion to the portfolio account over the past four quarters.

The downward revision of our copper-price estimates is more than offset by our lower oil-price forecasts, so Chile’s terms of trade will likely be somewhat better than previously expected. We see the deficit reaching 1.4% of GDP in 2015 (vs. 1.7% previously), from an estimated 1.7% in 2014 (vs. 1.9% in our previous scenario).

While the recent exchange-rate depreciation has exceeded our expectation, our forecast for year-end 2015 remains unchanged at 635 pesos per dollar, which implies an additional weakening from the current levels (we now see the peso at 610 to the dollar by the end of this year), driven by a rise in the U.S. treasury yields faster than the one expected by the market.  

A sharp decline in inflation starts 

Chile’s CPI came in at 0% month over month in November, after a 1.0% increase the previous month. The significant decline in inflation is attributable to the revision of the price-stabilization mechanism for fuel prices (MEPCO) that followed the drop in international oil prices. Fuel inflation was -3.8% month over month in November, while fruit and vegetable prices fell 0.7% (following a 10.5% increase in October), also contributing to the lower inflation.

As a result, annual inflation fell to 5.5% in November (from 5.7% in October). Notwithstanding the weak economy, inflation excluding food and energy rose to 4.3% (from 4.1% in October), while non-tradable inflation reached 5.3% (from 5.0% in October). The indexation mechanisms and high recent inflation numbers are the likely culprits behind these increases. On the other hand, inflation expectations remain well-behaved. The surveyed monetary-policy expectations for the relevant horizon are at 3.0%, while the breakeven inflation for the same period is currently below the center of the target.   

Due to the recent fuel-price movement, we now expect 0.2% deflation month over month in December, which would take annual inflation to 5.0% by year-end (vs. 5.2% in our previous scenario). 

Based on the downward revision of our growth and oil-price forecasts for next year, we now see inflation at 2.5% by year-end 2015. Our previous scenario called for 3.0% inflation. Compared with 2014, inflation would fall not only due to lower energy inflation and a wider output gap, but also because exchange-rate is expected to depreciate much less than it did this year. 

Neutral bias remains

The Chilean Central Bank maintained its reference interest rate (at 3.0%) and the neutral bias unchanged in November, as was widely expected.

According to the minutes, remaining on hold was the only relevant option, given the high inflation readings in recent months (which favor an interest-rate hike), offset by an economy that has yet to recover (which favors a rate cut).

Although board members agreed that the recent inflation numbers are mostly attributable to transitory factors, the persistently high inflation generated debate about the uncertainty regarding the size of the current output gap. Some board members seem to doubt that the gap is as wide as currently believed. One member said that an analysis of the labor market, wages and the pass-through of the exchange-rate depreciation to prices is crucial when evaluating the output gap. All members agreed that the next monetary policy report is the appropriate occasion to analyze the economy’s spare capacity in order to recalibrate its forecasts and strategy for future monetary-policy evolution.

Although we continue to expect no further rate moves this year or in 2015, our new growth and inflation scenario suggests that the probability of additional cuts next year is not small.

Strong expected growth in public expenditure

The 2015 budget was approved by both chambers of congress, setting the government’s expenditures 9.8% above the original 2014 budget. The approval, which is pending the President’s signature, includes an authorization to contract 500 million dollars in debt. In line with the original plan, public investment will increase 27.5% relative to the previous year’s budget. According to authorities, 68% of the budget constitutes social spending.

President Michelle Bachelet’s approval rating registered a fourth consecutive decline in November, according to polling company Adimark. President Bachelet’s 42% approval rating is the lowest of her second term. Likewise, the survey shows that the disapproval numbers exceeded 50% in November. On a similar note, a separate survey by CEP indicated growing rejection rates from July to October, although still below 50%. The current administration continues to face political, economic and, more recently, safety issues.


João Pedro Bumachar
Miguel Ricaurte

Vittorio Peretti

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