Itaú BBA - Starting the year on the back foot

Scenario Review - Chile

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Starting the year on the back foot

February 3, 2016

We reduced our 2016 growth forecast to 2.0%.

Please see the attached file for all graphs.  

• We reduced our 2016 growth forecast to 2.0% (from 2.3%), but we left unchanged our estimate for 2015, for which we still forecast 2.0% growth. While a weak end to 2015 was not enough to trigger a reduction of our 2015 forecast, it did result in a negative carryover for this year. Amid weak confidence, we now foresee a 2017 growth rate of 2.5% (down from 2.7% in our previous report).

• We expect the exchange rate to stand at 730 pesos per dollar at the end of 2016, and then to remain broadly stable throughout 2017. We estimate that the 2016 current-account deficit will be flat with last year’s, at 1.7% of GDP, before increasing to 2.2% in 2017 as internal demand recovers somewhat and oil prices rebound.

• In our baseline scenario, the inflation rate ends 2016 at 3.5% and falls to 3.0% by the end of 2017. As we expect oil prices to rebound in the second half of this year, the relief for inflation caused by the recent oil-price decline is likely to be transitory.

• We still expect the central bank to increase interest rates gradually, taking the policy rate to 4.0% this year and leaving it there throughout 2017. But the risks are tilted in the direction of no hikes at all if the economic weakness persists and inflation continues to converge toward the target. 

• The fiscal balance for 2015 was significantly lower than expected due to extraordinary revenues that came in at the end of the year.

Lower growth expected for 2016

Economic activity in Chile remained suppressed in 2015, so the economy is starting 2016 on the back foot. Manufacturing production fell by 0.6% in 2015, which represents an improvement from the -1.2% posted in 2014, while mining production deteriorated (dropping by 0.6% for the year, after a 1.0% increase in 2014). Retail sales growth was in line with the 2014 figure, at 2.5%. In 4Q15, manufacturing and mining production declined from one year before, while sectors linked to private consumption showed slow growth. Specifically, manufacturing production declined by 2.0% year over year in 4Q15 (vs. a 0.5% gain in 3Q15). Meanwhile, mining production declined by 0.7% in 4Q15 (vs. a 4.1% drop in 3Q15). Retail sales grew by 2.8% in the quarter, a weak figure but still higher than the 2.3% gain of the previous quarter.

The unemployment rate for the final quarter of 2015 came in at 5.8%, below the 6.0% recorded one year before. This is the lowest unemployment rate for a fourth quarter since 2013. Employment growth was 1.5% year over year (vs. 2.3% in 3Q15), with wage employment decelerating to 1.4% (vs. 2.7% in the previous quarter). Growth in self-employment (arguably jobs of lower quality) also decelerated (to 3.5%, from 5.0% previously). Construction continued to be one of the largest contributors to job creation, as companies are fast-tracking housing projects in order to avoid a sales tax hike that will apply to projects completed after 2016. Employment in public administration slowed in the quarter, after strong growth earlier in the year, possibly signaling that the impact of the fiscal stimulus is fading.

We now expect a growth rate of 2.0% year over year in 2016 (down from our previous estimate of 2.3%), stable from the 2.0% growth we estimate for 2015. The weak end to 2015 will have an unfavorable carryover effect into 2016. Confidence is likely to be affected by a weaker performance of the economy this year. Hence, we now expect the recovery in 2017 to be less robust, with a growth rate of only 2.5% (down from our previous forecast of 2.7%).

Externally driven volatility

In our baseline scenario, we expect a current account deficit of 1.7% of GDP this year, stable with 2015. However, we expect a larger 2.2% deficit in 2017. As oil prices recover later this year and internal demand becomes more favorable in 2017, some deterioration in the external accounts is likely. However, we would note that Chile’s energy import bill is significant, so if oil prices remain close to their current spot prices, our estimates indicate that the current-account deficit will be 0.4% of GDP lower in 2016.

Consistent with the uncertainty over the global economy, the Chilean peso has been volatile, but ended January broadly stable with its year-end 2015 level of 709 pesos to the dollar. We continue to expect a year-end exchange rate of 730 pesos to the dollar, as some additional appreciation of the dollar globally is likely this year. For 2017, we expect the exchange rate to remain broadly stable.

Inflation’s slow retreat

We expect inflation to remain above the 3%-4% target range for most of 1H16. In the short run, the upward pressure on consumer prices will mainly come from inertia (electricity tariffs will be raised in January and February, while education prices will increase in March, with the adjustment in both cases being at least the 2015 inflation rate) and from higher taxes (particularly on tobacco and financial services), factors that will likely be only partly offset by a decline in oil prices. In this context, we expect the inflation rate to remain near 5% in 1Q16.

Our forecast for the inflation rate at the end of this year stands at 3.5%. In the second half of 2016, we expect a recovery of oil prices to push up gasoline prices while the stabilization of the exchange rate and the weak economy put downward pressure on CPI growth. We note that if oil prices remain at their current levels, inflation would end the year around the midpoint of the target range (assuming that all the other variables evolve in line with our baseline scenario). For 2017, we expect an inflation rate of 3.0%.

Gradually withdrawing stimulus

The Central Bank of Chile’s decision to leave the policy rate unchanged at 3.50% in January was unanimous, according to the minutes of the meeting. The decision followed a rate increase of 25 bps in December (the second hike in a tightening cycle that started in October).

Both of the available options – hiking the policy rate or leaving it unchanged – were considered at the meeting. According to the minutes, a hike could have been justified by the still-high inflation and dynamic labor market, and the current policy rate is expansionary. Also, a weakening currency would continue to push up tradable prices ahead. On the other hand, holding the rate steady was deemed consistent with the scenario laid out in the inflation report (IPoM) published in December, because the board still sees inflation unfolding accordingly, and possibly even falling faster because of low oil prices. Furthermore, the central bank now sees a higher probability of the downside risks to growth materializing. 

We continue to expect two 25-bp hikes this year (between 2Q16 and 3Q16), taking the rate to 4% and ending the cycle. The central bank will likely continue to raise rates amid a slow deceleration of inflation. However, considering the weak domestic activity, slow growth abroad and our expectation that inflation will enter the target range in 2Q16, the risk is that the central bank aborts the tightening cycle before, leaving the policy rate at the current level.

A positive fiscal surprise

The central government reported a better-than-expected 2015 fiscal balance on the back of improved collections at the end of the year. While the most recent estimates had hinted at a deficit of 3.3% of GDP in 2015, the final deficit figure was 2.2%. The key surprise was in non-mining income taxes, which grew by a staggering 26.9% compared with 2014, fueled by an amnesty that allowed taxpayers to declare capital holdings abroad. Revenues from VAT rose by 4.8%, well above the economic growth rate. On the other hand, mining revenues shrank as both tax payments from private companies (down 13.2% in real terms) and transfers to the treasury from the state-owned company Codelco (down 50.2%) fell from their 2014 levels. The overall contribution of mining to total revenue was only 6%, the lowest level since 2003 (3%) and well below the historical peak of 34% in 2006. All in all, revenues grew by 5.2% in real terms between 2014 and 2015.

Expenditures grew by 7.4% in real terms, the highest real growth rate since a 16.5% increase in 2009, when fiscal policy helped Chile navigate the global financial crisis. Even so, expenditure growth was somewhat lower than had been projected in October, when the budget was updated. At that time, the government was projecting 8.4% expenditure growth, meaning that the evolution of expenditures by the end of the year also helps to explain the lower-than-expected deficit.

As a result, Chile’s 2015 structural deficit came in at 0.6%. The structural deficit was significantly smaller than the expected 1.6% of GDP and broadly unchanged from the 0.6% reported for 2014.

We still estimate nominal deficits of 3.5% for this year and 3.2% in 2017 as low growth and still-weak copper prices continue to constrain fiscal revenue and the government receives less support from one-off revenues.

Congress goes into recess

Chile’s congress has approved adjustments to the recent tax reform legislation (which became law in 2014), with the aim of simplifying parts of the tax code. The adjustments do not alter the tax burden but rather address specific measures that had been deemed too complex by affected parties. The changes also institute new mechanisms to discourage tax evasion. One of the key changes is the removal of the option for small companies – with individual shareholders – to choose between the two different tax systems. These companies will now be compelled to use the system in which shareholders cannot take the corporate income tax levied on dividends (at a 25% rate) as a credit toward individual income tax. Other companies still have a choice between the abovementioned system and the one where the 27% corporate tax rate levied is eligible to be claimed as tax credit by shareholders.

But the reform process remains complex. The labor reform proposal – for which the government had self-imposed a January deadline – has been delayed to March, after the legislative summer recess. Disputes within the governing Nueva Mayoria coalition are behind the delay. The internal replacement of workers during strikes and extending union-negotiated benefits to non-unionized workers are some of the main sticking points between some factions in the coalition. The finance ministry continues to pursue a bill that seeks an interim balance between equality and efficiency. Meanwhile, the teaching profession bill, which seeks to improve the monitoring of teacher performance and is part of the larger project to improve the education system in Chile, has passed in Congress.


João Pedro Bumachar
Miguel Ricaurte

Vittorio Peretti


Please see the attached file for all graphs.  


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