Itaú BBA - Recovery consolidates

Scenario Review - Chile

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Recovery consolidates

May 10, 2018

With a broad-based activity recovery and still-low inflation, there is no rush for rate hikes

Please see the attached file for all graphs.

The activity recovery advanced in the first quarter of the year, driven by mining as well as an improvement in other sectors and upbeat confidence levels. We continue to expect growth of 3.6% this year, from 1.5% last year. Recovering investment and stronger exports are likely to lead to 3.5% growth in 2019.

Our base case is a stable policy rate of 2.5% for this year, given the very low inflationary pressures despite solid growth. We expect four 25-bp hikes next year, as the output gap closes, taking the policy rate to 3.5%.

Widespread recovery in 1Q18

Activity in the first quarter of the year was driven by mining. A low comparison base boosted mining growth, implying some growth moderation for the remainder of the year. However, the improvement in manufacturing, utilities and commerce bodes well for expectations of an overall growth recovery. 

In the first quarter of the year, manufacturing increased 2.2% year over year, up from 0% in the  final quarter of 2017. Adjusted for calendar effects, manufacturing posted even higher growth of 3.1% – the highest reading since 1Q13 (+0.8% in 4Q17). Mining production increased 16.0% in the quarter (from 4.9% in 4Q17), due to the 13.7% drop a year earlier following the extensive labor strike. Utilities recovered with growth of 2.0% in the quarter, compared with -1.1% in 4Q17. Overall, industrial production grew 7.6% in the first quarter of the year (from 2.1% in 4Q17), securing a solid base for growth this year (vs. -6.7% in 1Q17). Commercial activity also improved, with growth of 5.5% (from 5.1% in 4Q17). Robust domestic demand was also reflected in supermarket sales, which accelerated to 5.3% from 2.8% in 4Q17 – the highest growth rate since 1Q13. 

The GDP proxy Imacec increased 4.0% in the quarter, up from 3.3% in 4Q17. Sequentially, the index grew a strong 4.7% QoQ/SAAR, driven by the 4.6% growth of the ex-mining component. Encouraging signs from the labor market bode well for the recovery consolidation ahead. A rising unemployment rate (up 0.3 pp over the last twelve months, to 6.9% in 1Q18) can be partly attributed to a higher participation rate (the highest since 1Q14), as the improvement in activity likely supports job seekers. Public job growth remains a key driver, but the creation of private salaried posts in the quarter is encouraging, adding 40 thousand posts after shedding 36 thousand in 4Q17.

We expect strong external demand, high copper prices, low interest rates and low inflation amid increased confidence to support an activity recovery this year. We see GDP growth of 3.6% this year, a notable pick-up from the 1.5% posted last year. For 2019, we expect a 3.5% expansion.

Large trade surplus in 1Q18

Chile recorded the largest trade surplus for the first quarter of a year since 2011, suggesting that the current account deficit will remain low. The country registered a trade surplus of USD 3.2 billion in 1Q18, exceeding the USD 1.1 billion reported in 1Q17 and the largest since the USD 4.2 billion posted in 1Q11. Increased mining exports, mainly aided by higher copper prices, was the principal driver for the trade improvement. The 12-month rolling trade surplus increased to USD 10.1 billion, from USD 7.9 billion in 2017 and USD 5.4 billion in 2016. According to our seasonally-adjusted series, the trade balance surplus remained high at the margin, at USD 9.8 billion (annualized), in the quarter (vs. USD 12.1 billion in 4Q17).

Mining drove exports in the first quarter of 2018. Total exports gained 24.3% year over year in 1Q18 (from 17.2% in 4Q17), with mining exports gaining 32.1% (30.8% in 4Q17). Meanwhile, import growth was a positive sign for internal demand. Total imports rose 11.5% in 1Q18, from 11.7% in 4Q17. Consumer imports continued to perform well, up 13% in 1Q18 (from 14.1% in 4Q17). Energy imports increased 11.7%, due to still-high international fuel prices, but decelerated from the 25.6% in registered in 4Q17. Capital goods imports increased 2.1% (from 4.5% in 4Q17), in line with a gradual recovery in investment.

We expect the current account deficit to remain contained this year. A gradual recovery of internal demand and robust copper exports support our forecast of a low current account deficit. Nevertheless, on the back of our upwardly revised oil scenario, we now see a deficit of of 1.3% of GDP this year (1.2% previously; 1.5% last year). As internal demand improves, oil prices stay elevated, some widening to 2.0% of GDP is expected for 2019 (1.7% previously). 

We still see the exchange rate at 620 CLP/USD by the end of the year, weakening to 625 CLP/USD in 2018. The recent strengthening of the USD is in line with our view that the market had previously not fully priced in the likelihood of a faster normalization process in the U.S.

Still-low inflation

Inflation in April remained below the bottom of the 2%-4% inflation target range. The 1.9% reading for the month was marginally above the 1.8% registered in March. The still-low inflation reflects easing pressures following a sustained period of a stronger exchange rate. Core inflation (excluding food and energy prices) was stable at 1.6%. Tradable inflation ticked to 1.1% (from 0.9% in March), while non-tradable inflation was stable at 2.9%, a historical low. Our diffusion index stayed low and stable, continuing to show low inflationary pressures.

We see inflation remaining below the 3.0% target in 2018, with a year-end forecast of 2.7% (revised from 2.5% following the upside April surprise). A gradual acceleration to 2.9% by the end of 2019 is anticipated (2.8% previously), given the gradual narrowing of the output gap.  

No monetary policy news

The Central Bank of Chile held the policy rate at 2.5% in May, as expected. The press release – which confirmed the unanimity of the decision – bore a neutral stance. With activity consolidating and the inflation outlook unchanged, the central bank is comfortable with its baseline scenario of steady rates, at least until the start of 4Q18. 

In a context of a broad-based activity recovery this year and still-low inflation, there is no rush for rate hikes. We therefore do not expect a tightening cycle to start before 1Q19. We see the policy rate ending 2019 at 3.5%. Nevertheless, the recent weakening of the exchange rate mitigates the downside risks for inflation, reducing the likelihood of rate cuts. 

Education takes center stage once again

President Sebastián Piñera presented a key initiative from his presidential campaign, but could not deter student unrest. The bill extends free higher education from universities to technical and professional institutes. The president noted that 70% of the most vulnerable (low-income) families in Chile would benefit from the bill, possibly increasing to 90% of families if public finances allow. The initiative would give 167 thousand students access to tuition benefits. Students nevertheless held their first demonstration against the government, voicing opposition to profits in private higher education and against private financing of student loans. President Piñera’s popularity during his first term in office (2010-14) was undermined by student protests that led to a drop in his approval rating to 27% by late 2011, according to Adimark.

Since the 2011 uprisings, many reforms have been approved to increase the access of the lower income population to university education and to improve working conditions of teachers and increase government control of primary and secondary education. It remains to be seen how active the student protests will be this time around and how the government will manage the situation. 

Regarding public finances, Finance Minister Felipe Larraín has indicated that Chile “will work to get its rating back to where…it should be” following last year's downgrades by S&P and Fitch. Minister Larraín noted that “most of the work has to be done internally," adding that Chile "can’t just sit and wait for the international markets to pick the country up." The administration is targeting growth of 3.5%-4%, which will “significantly cut the structural and overall deficit," according to the Finance Minister. The administration's goal is to “stabilize the debt-to-GDP ratio in the next three to four years”. Mr. Larraín has also spoken on the much anticipated tax reform, saying that “we have to be realistic in Chile, and all countries, and acknowledge [that] the U.S. tax reform has put tremendous tax competition on us.” According to Larraín, the administration will put a responsible tax reform before Congress that is tax neutral before the end of the year.

João Pedro Bumachar
Vittorio Peretti
Miguel Ricaurte


Please see the attached file for all graphs.

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