Itaú BBA - Slower Growth

Scenario Review - Chile

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Slower Growth

August 6, 2013

The economy posted a below-expectation growth during the first half of the year.

•      The economy posted a below-expectation growth during the first half of the year, while some leading indicators also declined recently. We now expect the Chilean economy to grow 4.2% this year and 4.4% in 2014. 

•     The consumer price index rose 0.6% month over month in June, but annual inflation remains below the lower bound of the target range. Moreover, core measures show no demand-side inflationary pressure despite the tight labor market. Consistent with the revision in our growth forecast, we now expect inflation to end 2014 at 2.6%; our 2.2% forecast for 2013 remains unchanged.

•      The monetary policy rate was maintained at 5.0% in July, but an easing bias was introduced in the press statement following the decision. We expect the central bank to cut the interest rate by 25 bps in August and by another 25 bps before the end of 2013. We also expect the reference rate to reach 4.00% in 2014.  

•     Higher costs are reducing CODELCO’s profit margin. As a result, we reduced our fiscal-balance forecast to -0.8% of GDP in 2013. For 2014, we reduced our forecast to -0.3%, also taking into account the revision in our growth forecast. 

•      Evelyn Matthei is the government coalition’s presidential candidate, following Pablo Longueira’s decision not to run. Given that the election will be held on November 17, the details of her economic proposals are likely to come out soon. 

Below-Trend Growth

Activity remains weak. Despite a 1.0% month-over-month gain in June’s IMACEC (monthly GDP proxy), the index rose by a modest 2.6% (annualized) during 2Q13 (vs. 2.1% the previous quarter). Year-to-date, activity posted a 4.1% increase from a year earlier. Once again the sector performances were mixed in June: retail sales gained 7.7% year over year, while manufacturing fell 2.7%.

The main leading investment indicators indicate further weakness ahead, while consumer confidence and tighter credit standards suggest that consumption will also lose momentum.Building permits decreased 11.9% year over year in June, while the IMACON index (a monthly proxy for construction activity) rose 4.6% (down from 11.5% in 2012) and construction material sales contracted 11.7% in May. Capital goods imports (a proxy for machinery investment) also moderated, to 6.1% year over year in June, down from 22.0% in the first five months of the year.

We now expect the Chilean economy to grow 4.2% this year and 4.4% in 2014. In our previous scenario, our growth forecast stood at 4.5% and 4.7% for 2013 and 2014, respectively. The below-trend growth will likely cause a rise in the unemployment rate; we now expect 6.4% in 2013 and 7.2% in 2014. 

Our growth forecasts are below market consensus. According to the central bank’s July Economic Expectation Survey, market analysts revised their GDP forecasts, from 4.6% to 4.4% for 2013 and from 4.7% to 4.5% for 2014. We believe there is room for further reductions in GDP expectations in the coming surveys.

Inflation Remains Low

Although the consumer price index increased 0.6% month over month in June, annual inflation remains below the target range, while inflation excluding food and energy fell to 0.8% year over year. Thehigher sequential inflation in June was mostly attributable to the 4.6% increase in energy prices from May. As a result, tradable inflation reached 0.9% year over year (vs. -1.0% in May). Non-tradable inflation fell to 3.1%, close to the target’s center, underscoring the lack of demand-side inflationary pressure.

Lower growth is likely to offset the impact of a weaker peso. Our year-end inflation forecast for 2013 remains unchanged at 2.2%. For 2014, we see inflation at 2.6% (vs. 2.8% in our previous scenario), still below the target’s center. 

The Easing Cycle is About to Start

The central bank’s latest monetary policy report introduced rate cuts to its baseline scenario. The central bank revised its GDP forecast for this year, to 4.0%-5.0% (from 4.5%-5.5% in the previous report), mostly due to weaker investment growth. The official inflation forecast for this year was also revised, to 2.6% (vs. 2.8% previously). According to the central bank, in this scenario the policy rate would follow a path similar to market expectations (at that point), implying interest rate cuts of 25 to 50 bps before the end of the year.    

Although the central bank maintained the policy rate unchanged in July, it introduced an easing bias in the press statement that accompanied the decision. According tothe minutes of the meeting, board members considered lowering the reference rate by 25 bps for the third consecutive month. However, the board decided to keep the rate unchanged to avoid surprising the market (which was expecting unchanged rates), and to wait for further evidence that consumption is actually weakening. 

We expect the easing cycle to start in August, and see room for a 100-bp easing cycle. In our view, the recent numbers confirm that all demand components are weakening, while the easing bias introduced in the press statement following the July decision should avoid a surprise if the board decides to lower rates in August. In our scenario, the reference rate will end the year at 4.5%, which is consistent with the central bank’s baseline scenario. However, we see room for another 50-bp cut in 2014, as the economy grows below trend and inflation runs below 3%. Our previous scenario called for a reference rate of 4.25% at the end of 2014.  

Lower Public-Sector Revenue Led to Higher Fiscal Deficit 

Chile’s government ran a fiscal deficit of USD 494.3 million in the second quarter of 2013, equivalent to 0.2% of annual GDP. This number reflects the government’s higher fiscal spending (+9.5% year over year in real terms) and lower revenue (-8.5%), which was hurt by both lower copper prices (copper tax revenue declined 40%) and lower economic growth. Thus, after reaching a surplus of 0.8% in the first quarter, the government has now recorded a surplus of 0.6% of GDP (USD 1.8 billion) in the first half of the year (down 65.1% from a year earlier). In our view, the government will continue to increase its fiscal spending (according to the budget), despite further reductions in revenue. Considering this scenario, and the weaker earnings from CODELCO (the state-owned copper company), we lowered our fiscal-balance forecast to -0.8% and -0.3% of GDP for 2013 and 2014, respectively (from 0.2% and 0% in our previous scenario).

A New Government Coalition Candidate

The UDI (one of the political parties of the ruling alliance) confirmed that Evelyn Matthei will be its presidential candidate. The announcement came after Pablo Longueira dropped out of the race. Longueira had won the primaries against Andres Allamand (of Renovación Nacional, the other party of the government’s coalition), but decided not to run for personal reasons. Ms. Matthei has served as Labor Minister under President Piñera and, before that, occupied key positions in both the lower house and the senate.

The Renovación Nacional party (RN) supported Matthei’s candidacy, making her the sole candidate for the government coalition.The coalition’s main challenge is to provide a sense of unity to the people, especially considering the weak voter support for the governing alliance (only 26% in the latest primaries) and the previous candidates’ failures (Matthei is the third presidential candidate in only four months). Given that Bachelet comes from the center left and Matthei from the center right, we believe the presidential campaign will be marked by the battle to win more votes from the center. We must pay close attention to any potential changes in proposals that indicate significant differences between the candidates, such as education, pension funds, tax reform and energy.

João Pedro Bumachar

Rodrigo Aravena

Forecasts: Chile

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