Itaú BBA - The Easing Cycle Ends

Scenario Review - Chile

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The Easing Cycle Ends

November 7, 2014

Chile’s IMACEC (monthly proxy for GDP) fell 0.2% between August and September,

• Activity in 3Q14 remained weak. We further reduced our growth forecasts for this year to 1.7%, and now expect a 3.1% expansion in 2015 (down from 3.5% in our previous scenario). 

• Weak internal demand and the exchange-rate depreciation have led to an improvement in external accounts. We maintained our current account deficit forecast for 2014 at 1.9% of GDP and continue to expect a drop in 2015, to 1.7% of GDP. 

• After months of underperformance, the Chilean peso gained more than 3% against the dollar in October, amid a strong global dollar environment. We now see the Chilean peso reaching 600 to the dollar by year-end 2014 (from 615 in our previous scenario), but we maintain our 635 forecast for the end of 2015.

• Inflation came in very high in October, lifted by taxes and supply shortages of non-processed food. We now expect inflation to end this year at 5.2%. In spite of the recent drop in oil prices and our new forecasts for the exchange-rate and activity, we slightly increased our projection for 2015 to 3.0% (from 2.9%). 

• The Chilean Central Bank announced another 25-bp interest-rate cut in October, taking the reference rate to 3.0%. The easing bias was removed, indicating that the central bank is satisfied with the amount of stimulus already in place. We expect no rate moves during the remainder of 2014 or 2015. 

• While the central bank signals that enough monetary easing is in place, the 2015 budget was also announced, proposing an expansion of 9.8% from the original 2014 budget – which would be the highest annual growth in public expenditure since 2009.

A Weak 3Q14

Chile’s IMACEC (monthly proxy for GDP) fell 0.2% between August and September, after two consecutive monthly expansions. On a quarter-over-quarter basis, the economy posted a weak 1.2% (annualized) growth, but improved from the 0.4% expansion recorded in 2Q14. Adjusting for calendar effects, the IMACEC increased only 1.0% year over year in September and 0.8% in 3Q14.    

The 3Q14 weakness was broad-based. Although manufacturing improved from the previous quarter (when it contracted 3.8% qoq/saar), it was up by only 0.4% qoq/saar. Mining output declined 9.7%. As a result, the industrial production indicator (which comprises mining, manufacturing and utilities) declined 1.4% year over year in 3Q14. Retail sales fell 2.4% qoq/saar, surpassing the 1.5% drop recorded in 2Q14.  

Business and consumer confidence remains glum. Consumer expectations in particular have reached the lowest level since August 2011, coming in at 42.5% in September (50% is the threshold between optimism from pessimism). Business confidence fell again in October, to 41.5%, down from 43.16% in September and 51.5% in October 2013. According to the reported data, pessimism in the Construction sector has been the main drag on business confidence.

We reduced our growth forecast for this year to 1.7% of GDP, and now see growth at 3.1% in 2015. Higher global growth amid loose fiscal and monetary policies is expected to drive the recovery next year. Still, the low confidence levels pose a significant constraint to the recovery. Our previous scenario anticipated a 1.9% growth this year and 3.5% next year.  

The Trade Surplus Continues to Widen

Chile’s external accounts continue to improve as internal demand wanes and the Chilean peso weakens. The 12-month rolling trade balance reached USD 7.5 billion in October (the highest level since April 2012). Exports remain weak, down by 9.9% year over year (-3.8% for the three-month period ending in October), as mining exports contracted by 16.2% (-10.4% for the quarter ending in October). Soft domestic demand continues to weaken imports, which fell 13.4% year over year (-11.6 in the quarter). Capital goods imports in particular – which closely match investment in machines and equipment – declined 24.8% year over year in October.

As we revised downwards our forecasts for both copper and oil prices, our view of Chile’s terms of trade remains unchanged. We expect a current account deficit of 1.9% of GDP for this year (down from a 3.4% deficit in 2013). For 2015, we see the deficit reaching 1.7% of GDP.

After months of underperformance, the Chilean peso gained around 3.4% against the U.S. dollar in October, amid a strong global dollar environment, lower domestic yields (e.g., the one-year swap rate narrowed 17 bps in October) and unchanged copper prices. Considering that Chile is a net energy importer (almost 6% of GDP), lower oil prices may have contributed to the move.

We now see the Chilean peso reaching 600 to the dollar by yearend of 2014 (from 615 in our previous scenario). However, our forecast for 2015 is unchanged, at 635 pesos to the dollar. The additional depreciation next year would come from higher U.S. treasury yields.

A Strong Upside Surprise in Inflation

Chile’s inflation came in very high and significantly above expectations in October, at 1.0% month-over-month. Inflation was led by an impressive 10.5% increase in prices for “fruits and vegetables”, as a result of reduced supply of these items, but higher taxes on tobacco and beverages (both alcoholic and non-alcoholic) also played an important role in explaining the October’s CPI. In fact, food, beverages and tobacco together contributed 80 bps to the monthly inflation. On a year-over-year basis, inflation is now at 5.7%, significantly above the upper bound of the target (4.0%).

All in all, the October’s inflation increase is largely attributable to transitory shocks, but inflation is still far from being comfortable even when these shocks are removed. Excluding food, non-alcoholic beverages and energy, inflation came in at 0.5% and, according to our calculations, if alcoholic beverages and tobacco are also excluded from the basket, inflation was 0.4%.

We now see inflation at 5.2% next year and at 3.0% in 2015 (2.9% in our previous scenario). The drop in inflation next year would come from lower oil prices, lower exchange-rate depreciation and a negative output gap. However, the high inflation level and indexation mechanisms will curb somewhat the size of the drop in inflation.

Interest-Rate Cut, But Easing Bias Removed

As expected, the Chilean Central Bank cut the policy rate by 25 bps, to 3.0%, in October, and removed the easing bias in the press statement announcing the decision. The interest rate has now reached the level suggested in the baseline scenario of the latest monetary policy report. The decision was unanimous, according to the minutes.

The minutes also noted that the board considered two “relevant” options: i) a 25-bp cut, to 3.0%, and the removal of the easing bias; or ii) maintaining the policy rate at 3.25%. The decision to lower the interest rate by 25 bps was, in the board’s view, consistent with the policy of gradual adjustments already underway, while dropping the bias was in line with the view that monetary policy is providing sufficient aid to activity while still supporting the convergence of inflation towards the target.

One board member argued during the monetary policy decision that the inclusion (or not) of an easing bias in conjunction with a 25-bp rate cut would not restrict the monetary policy if faced with a substantial deterioration in the international scenario. The other board members disagreed, emphasizing the need to communicate that the cycle was complete and that – using the words of one member – substantial deviations from the baseline scenario would be needed to change the interest rate from 3.0%. 

We continue to expect no further rate moves this year or in 2015. Although there is no sign that Chile’s economy is recovering, we think that the persistence of inflation will likely turn the central bank more cautious in easing the monetary policy further.

Strong Growth in Public Expenditure

The 2015 budget sent to Congress for approval proposes a 9.8% increase in government expenditure from the original 2014 budget. This would be the highest annual growth in public expenditure since 2009, likely led by a 27.5% growth in investment and a 10.2% increase in education spending. The recently implemented tax reform (which is expected to contribute USD 2.3 billion to government revenue in 2015) will provide part of the financing for the additional expenditure. The government has also launched a plan to cut the red tape and speed up private investment projects totaling USD 6.0 billion, approximately 2% of GDP.

President Michelle Bachelet’s approval rating posted the fourth consecutive decline in October, according to polling company Adimark. The President’s approval rating dropped 2 percentage points from September, to 45% – Bachelet's lowest result since returning to power in March. This is the first time that the level of disapproval (47%) has surpassed the level of approval. The poll also showed that the peoples’ opinion regarding the tax and education reform has not changed significantly, with both reforms receiving approval ratings of below 50%.


João Pedro Bumachar
Vittorio Peretti

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