Itaú BBA - Waiting for a glimmer of hope

Scenario Review - Chile

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Waiting for a glimmer of hope

June 30, 2017

Weak activity will likely show some improvement through this year as the mining drag subsides.

Please see the attached file for all graphs.

• Activity is weak but will likely show some improvement through the remainder of the year as the mining drag subsides. The modest but continual improvement in confidence also bodes well for some investment and consumption recovery ahead. However, in our view, more clarity on the political agenda after the presidential elections is key for a meaningful and sustained rebound of confidence and investment.  

• Lower oil prices will contribute to tame the current account deficit and inflation. In turn, the central bank will likely maintain a loose monetary policy for some time ahead.

• As anticipated, fiscal expenditure growth slowed at the start of 2Q17 after the front-loading efforts in 1Q17 helped to avert a recession. Nevertheless, the expected continuance of rising debt levels will keep the rating agencies watchful.

A slight recovery in confidence

Activity remained weak at the start of the second quarter of the year. The Imacec (monthly proxy for GDP) grew 0.1% year over year in April (0.3% in March). Once adjusted for calendar effects, economic growth was better, but still weak. At the margin, activity contracted 1.5% qoq/saar (+0.6% qoq/saar in 1Q17, -1.5% in 4Q16) as effects from the mining strike are still being felt (mining activity was down by 39.5% qoq/saar). As a result, growth in the first four months of the year was only 0.1% year over year and 0.5% once adjusted for calendar effects.

Still, business and consumer confidence are showing flickering signs of improvement. Although think-tank Icare’s May business confidence index remained in pessimistic territory (< 50) for the 38th consecutive month, it picked up over 3 percentage points from May 2016 to reach 44.9 points (44.1 in the previous month). This was the third consecutive month business sentiment has been above the level recorded one year prior. There was widespread improvement in all the sub-indexes. Meanwhile, consumer confidence is also improving in spite of completing three years below the neutral level. Adimark’s May consumer confidence came in at 40.3 points, up from 33.9 points in the 2016 corresponding period (40.1 in April 2017). The short-term (12-months ahead) expectation indicator increased by 9.6 points.

We expect activity to pick up ahead. Given the importance of mining activity in Chile, the strike likely had an impact on non-mining activity as well. The benefits of low inflation, loose monetary policy and higher average copper prices so far this year (vs. 2016) will also aid activity. These factors would more than offset a less-supportive fiscal policy. However, a meaningful recovery will need consumers and business communities to leave pessimism behind, which in our view will only happen as uncertainty over the post-election fate of the reform agenda fades. We expect growth of 1.6% this year, stable from 2016. A recovery to 2.5% next year is expected.

External imbalances to stay limited

Following the conclusion of the mining strike, mining exports are recovering and maintaining a comfortable trade surplus. The rolling 12-month trade surplus came in at USD 4.2 billion as of May, broadly stable from 1Q17 (USD 5.3 billion in 2016). Our seasonally adjusted series shows that, at the margin, the trade balance surplus picked up to USD 3.7billion (annualized) in May, from the USD 1.1 billion annualized surplus recorded in 1Q17. A further improvement of the trade balance in the months ahead is expected. Lower oil prices will contribute to keep external vulnerabilities low. We expect the current-account deficit to stay broadly stable from last year, at 1.2% of GDP, widening slightly to 1.4% next year (1.7% in our previous scenario). As has been the case in recent years, we expect the bulk of the deficit to be financed by net FDI inflows.

The peso continues to perform well together with copper prices. Going forward, the expected hikes from the Fed will result in some weakening of the Chilean peso. We see the exchange rate at 675 pesos per dollar by the end of the year, with further weakening to 695 pesos per dollar by the end of 2018.

Limited inflationary pressure

Consumer price inflation stayed low in May, as expected. Inflation was below the center of the 2%-4% range around the target for the eighth consecutive month, with tradable inflation falling further on a stable currency, while non-tradable inflation picked up slightly (to a still moderate level).

Annual inflation came in at 2.6%, slightly down from the 2.7% recorded in the previous month. Tradable inflation slowed to 1.7% from 2.0%, supported by the further decline of clothing and apparel. Meanwhile, non-tradable inflation ticked up to 3.6% (3.5% previously). Once food and energy prices are excluded, inflation picked up to 2.5% (from 2.1% previously). Other core inflation measures also rose, in all cases mainly due to the increase in tourism package costs. Core services inflation inched up to 3.6% (from 3.5%). Inflation would continue to inch closer towards 2.0% as tradable price pressures abate towards mid-year.

We continue to see inflation ending the year at 2.8% (2.7% in 2016) and to be at the 3% target by year-end 2018. We acknowledge downside risks, given the weakness of the economy and well-behaved currency and low oil prices.

Wait and see

In the June monetary policy meeting, the Central Bank of Chile opted to keep the policy rate at 2.5%, as unanimously expected by market participants. The press release announcing the decision retained the same neutral bias adopted in the previous meeting. This is in line with a board that is content to wait and observe how the economy unfolds, given the monetary stimulus already implemented (cuts by 100 bps since January).

The central bank sees the economy evolving in line with its forecast for 2Q17 inflation. The press release noted that inflation expectations remain anchored and that available activity indicators for 2Q17 are in line with the central bank baseline scenario.

While we do not expect the central bank to implement further rate cuts this year and only see the start of a normalization process towards the end of next year, additional rate cuts before the end of 2017 are a possibility, given the weakness of activity and low inflation. 

Less supportive fiscal expenditure

As anticipated, fiscal expenditure growth slowed at the start of 2Q17 after the front-loading efforts in 1Q17 helped to avert a recession. Fiscal spending rose 7.8% year over year in 1Q17 in real terms (11.9% specifically in March). Considering that the target deficit for 2017 includes expenditure growth of just 2.7%, it was expected that fiscal expenditure would slow throughout the remainder of the year. The data for April supports this outlook, with fiscal expenditure growth slowing to 1.5% year over year. As support from public expenditure moderates, the support  so far witnessed in the labor market and overall activity will diminish.

Rising debt levels place Chile on the downgrade watch list. The rating agency Moody's noted that the weak growth outlook for Chile (Aa3, stable) will offer restricted support for most economic sectors. In this scenario, combined with the need to recapitalize state-owned enterprises and increase educational spending, debt levels are likely to rise. Moody’s sees government gross debt increasing from 21% of GDP to 25% by the end of this year, with a further increase to 28% next year. Nevertheless, Moody's noted that although high, the expected gross debt levels for next year will only be around two-thirds of Chile’s Aa peers. We note that the level of public debt is not the main concern but rather the rapid widening from the 3.9% minimum recorded in 2007. Chile’s credit rating includes a negative outlook from both S&P (AA-) and Fitch (A+).

Electioneering in full swing

The presidential candidate pool is set to shrink as coalitions from the left and right of the political spectrum hold their primaries on the first weekend of July. One notable absence will be the ruling Nueva Mayoría that decided to go directly to the November 19 first round presidential vote with Alejandro Guillier (representing the majority of the coalition’s parties) and Carolina Goic (from the Christian Democratic Party) as candidates. The center right coalition will elect either former president Sebastian Piñera, Felipe Kast (planning minister in Piñera’s first administration) or Senator Manuel José Ossandón, with the former having a clear lead according to the latest polls. Nevertheless, the margin of victory and turnout will give an indication of the winning candidate’s strength ahead of the general election.  Likewise, the Frente Amplio (a political movement arising from disenchantment with the current administration) will also choose its candidate, likely to be Beatriz Sanchez. The journalist, with no public office experience, has made strides in recent polls cementing herself in third spot with 11% of voting intentions, according to Adimark’s May public opinion survey. Alejandro Guillier and Sebastian Piñera are the election frontrunners with 21% and 25%, respectively. However, the few available second round simulations show Guillier and Piñera statistically tied, suggesting political uncertainty will remain elevated right until the end of the year.


 

João Pedro Bumachar

Vittorio Peretti

Miguel Ricaurte


 

Please see the attached file for all graphs.



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