Itaú BBA - Turning the page

Scenario Review - Chile

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Turning the page

January 11, 2018

We have improved our growth outlook on more favorable external and domestic conditions.

Please see the attached file for all graphs.

• Former president Sebastian Piñera will return to La Moneda in March following a convincing runoff victory against Alejandro Guillier. His main campaign promise is to return Chile to a path of sustainable growth, while fine-tuning some of Michelle Bachelet’s key reforms.

• Activity likely closed 2017 on a strong footing, with the non-mining component showing improvement. The improved carry-over effect and upwardly revised copper prices, combined with the expectation that confidence will continue to rise, have led us to expect growth of 3.0% this year (from 2.7% in our previous scenario and an estimated 1.5% last year). The consolidation of the investment- and export-driven recovery will see growth rise to 3.5% next year.

• The recent strengthening of the Chilean peso can be mostly explained by the performance of copper. The persistence of current exchange-rate levels in the short run will lead to less tradable inflation, and we now see inflation for 2018 at 2.5% (2.8% previously). Nevertheless, we expect some weakening of the exchange rate before year-end as the Federal Reserve continues its monetary-policy normalization while copper prices retreat. So, we forecast 635 pesos per dollar by the end of this year (660 previously).

• With low inflation and a still-negative output gap, we expect the central bank to keep its policy steady at 2.5% this year. A normalization process would start next year, taking the rate to 3.5% before year-end.

President Piñera 2.0

Former president Sebastián Piñera (2010-2014) emerged victorious in Chile’s presidential runoff vote on Sunday, December 17. Leading up to the vote, the few polls published after the first-round result indicated that the race was too close to call.

However, Piñera (center-right) obtained a wide margin in his favor. Former-President Piñera (37% of the first-round vote) triumphed with 54.6%, a 9.2 pp lead over Alejandro Guillier (whose candidacy was supported by the parties in the current governing coalition and who received 22% of the first-round vote). Unexpectedly, participation increased to close to 49%, from 46.7% in the first round.

Guillier fell short of fully capturing a fragmented center-left that included Frente Amplio (whose candidate Beatriz Sanchez received 20% of the first-round vote), the Christian Democrats’ Carolina Goic (5.9% of the first-round vote) and Marco Enríquez-Ominami (5.7%). Meanwhile, Piñera appears to have successfully seized some centrist voters in addition to voters in favor of José Antonio Kast (independent, right; 7.9% in the first round).

Piñera will take office on March 11. The center-right coalition (supporting him) does not have a majority in Congress (44% of the senate and 47% of the lower house), so the advancement of policy will require negotiation. He campaigned on fine-tuning Michelle Bachelet’s reform agenda, rather than a more aggressive reversal of the changes implemented during the current administration. While Piñera would like to see a decreased tax burden, the fiscal deficit limits the space to lower taxes, so a milder simplification of the tax law is more likely. The incoming government will also have to tackle the hot topic of pension reform. Piñera is in favor of establishing an additional employer contribution rate of 4% (compared with the 5% proposed by Bachelet’s government) directed to private accounts, while in Bachelet’s proposal, the added contribution would have been split between individual savings accounts and a collective savings system. Additionally, Piñera’s government will attempt to address some ambiguities and add flexibility to the implementation of the labor reform. 

Piñera will take the reins of the economy aided by improving global factors (higher copper prices and increasing global demand). Still, the former president must be mindful to not alienate too many political players (especially from the so-called social movements) given the importance of negotiation in Congress. Since winning the election, Piñera has shown a conciliatory tone, meeting with various officials of the current administration and praising some policy proposals from other parties. He has also noted that he would work to form a broad cabinet that includes some continuity, but allows for change. Regarding economic policy, some members of president-elect Piñera’s economic team (and potential candidates for key posts within the administration) include former central bank governor Rodrigo Vergara, Felipe Larraín (the Finance Minister in his first governing term), Juan Andrés Fontaine (former Economics Minister) and Rodrigo Cerda (macroeconomic coordinator in his first government).

Recovery firms up

Available data suggests that activity in the final quarter of 2017 likely ended on a high note. Activity for the quarter ending in November came in at 2.6% year  over year, up from 2.2% in 3Q17 and 1.0% in 2Q17. The non-mining component grew 2.2%, the highest rolling-quarter annual growth rate since July 2016. Mining activity continues to moderate at the margin, but higher copper prices will likely support mining production in 2018. 

The strong end to 2017 boosts the carry-over effect which – alongside elevated copper prices, higher global growth, expansionary monetary policy, low inflation and improved private sentiment – led us to increase our 2018 growth forecast to 3.0% (2.7% previously). This would follow estimated growth of 1.5% for 2017 (1.6% in 2016). We have revised our average copper price forecast for 2018 up by 8%, as well as our medium-term outlook, which transmits into a consolidation of the expected investment recovery this year (following four years of contraction). 

A risk to the activity scenario comes from the weakness of the labor market. The unemployment rate came in at 6.5% in the quarter ending in November, 0.3 percentage points above that recorded one year ago. However, public salaried posts continue to prop up employment growth, while the formal private sector lacks strength. Going forward, the boost from the public sector (134 thousand jobs created year-to-date) is unlikely to persist given the expected fiscal consolidation. We forecast the unemployment rate to average 6.7% this year, remaining broadly stable from last. The expected activity recovery will likely lead to a recomposition of jobs rather than a large-scale increase in employment.

Large trade surplus in 2017

Mining exports remain robust, but industrial goods are also performing well. Overall, the trade surplus is sizable and Chile’s external vulnerabilities are limited. The trade balance recorded a USD 1.1 billion surplus in December, taking the trade surplus for the year to USD 6.9 billion (USD 5.3 billion in 2016), the highest since 2011. Our seasonally adjusted series shows that, at the margin, the trade balance surplus is running even higher, but dipped to USD 9.6 billion (annualized) in the final quarter of the year (USD 12.8 billion in 3Q17), partly due to a widening of the energy deficit.

With copper prices set to remain high for most of 2018 (11% on average higher than in 2017), we expect the current account deficit to stay at low levels. We expect a narrowing to 1.3% of GDP, from the 1.5% expected for 2017. As internal demand recovers through 2019, we see some widening of the deficit to a still-low 1.8% next year. 

The Chilean peso ended 2017 at a stronger-than-expected level, boosted by elevated copper prices alongside improving business sentiment ahead of a change in the political cycle. The recent performance of copper explains the bulk of the peso’s strengthening since early December. We expect the recent rally to persist for some time, but do see some weakening before year-end as the Federal Reserve continues with its monetary policy normalization, while copper prices retreat to fair value. Nevertheless, we see a more appreciated currency vs. our previous scenario (635 pesos per dollar, compared with 660 previously).

Temporary inflation pick-up

Inflation for 2017 came in at 2.3%, down from 2.7% in 2017. The December print was the highest in 2H17, but is likely due to an unfavorable base effect. The breakdown shows that tradable inflation continues to be less of a drag (1.9% vs. 1.0% in November), whereas non-tradable inflation moderated further to 3.0% (3.1% previously). Core inflation (excluding food and energy prices) is at a low 1.8%. Our expectation is that core inflation will stay near the lower bound of the central bank’s 2%-4% target range throughout 2018.  

The recent strengthening of the Chilean peso, still-mild inflationary pressures and inertia mean inflation will run below 2% in the first half of this year. We now expect inflation to end 2018 at 2.5% (2.8% previously) as the pick-up from tradable inflation is slower than we were previously anticipating. Moreover, as indexation mechanisms operate, we see only a gradual acceleration to 2.8% by the end of 2019.

Steady course for rates 

The central bank’s latest inflation report (IPoM) for 2017 changed little from the preceding quarter’s edition. Following the implementation of a 100-bp easing cycle (to 2.5%) in the first five months of the year, the baseline outlook sees inflation staying near the lower bound of the central bank’s 2%-4% target range during 1H18. Thereafter, inflation would reach the 3% target only in 1H19, while core inflation converges during 2H19. Overall, the risks for these inflation forecasts are deemed to be balanced.

The board remains vigilant on the behavior of short-term inflation. In the current scenario of still-low growth (in spite of the recovery), limited inflationary pressures and some measures of inflation expectations below the 3% target, deviations to the downside of inflation in the short term could still result in more interest-rate cuts. In fact, the central bank still maintains an easing bias.

We expect the policy rate to remain unchanged at 2.5% throughout this year. A normalization process would start only next year, as the output gap narrows. Yet in an environment of low inflation, if the incipient recovery does not gain momentum, additional easing is likely. 


João Pedro Bumachar
Vittorio Peretti
Miguel Ricaurte


Please see the attached file for all graphs.

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