Itaú BBA - Waiting for the Run-Off

Scenario Review - Chile

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Waiting for the Run-Off

December 3, 2013

Chile’s GDP was up 4.7% year over year during 3Q13, following 4.0% growth the previous quarter.

•    Chile’s GDP grew by 5.4% qoq/saar in 3Q13, which is a rebound from the very weak first half. However, the IMACEC (monthly proxy for GDP) fell by 0.8% month over month in September, so carry-over effects will likely lead to a below-trend GDP growth in 4Q13.  We have reduced our GDP forecasts for 2014 to 4.0% (from 4.4%). 

•    Headline inflation fell to 1.5% year over year, helped by base effects. Still most core measures are running below the lower bound of the target range. We expect inflation to reach 2.2% by year-end 2013 and 2.5% in 2014 (2.6% in our previous scenario). 

•    The central bank reduced the monetary policy rate by 25 bps for the second consecutive time in November. Although we believe the central bank will maintain the policy rate unchanged in December, we see two 25-bp cuts in 1Q14, so the interest rate would end next year at 4.0%. 

•    As U.S. yields rise and the central bank reduces rates, the exchange rate has weakened over the last few weeks. We still expect the peso at 525 to the dollar by the end of 2014. For the end of this year, we adjusted our forecast to 515 (from 500 previously). 

•    Michelle Bachelet and Evelyn Matthei will compete in the presidential run-off scheduled for December 15. Following the parliamentary elections, the Nueva Mayoria coalition (Bachelet’s coalition) has 58% of the seats in the lower house and 55% in the Senate. Hence, the Nueva Mayoria didn’t reach the minimum quorum needed to introduce constitutional changes in Bachelet’s program.

Lower Investment Growth Is Causing the Slowdown

Chile’s GDP was up 4.7% year over year during 3Q13, following 4.0% growth the previous quarter. The GDP breakdown reveals that growth was driven by a 13.1% jump in exports (mining exports were up by 19.5%). Consumption slowed to 5.2% (down from 6.1% the previous quarter), while gross fixed investments rose only 3.2% (8.6% the previous quarter). As a result, final internal demand slowed to 4.7%, down from 6.7% in 2Q13. Inventories contributed negatively to growth, so internal demand grew by a weak 1.3% from one year before.

On a sequential basis, GDP was up by 5.4% qoq/saar, following a 1.3% expansion during the previous quarter that was significantly below potential (and downwardly revised). Consumption declined to 3.8% qoq/saar (from 5.7% the previous quarter), while gross fixed investment expanded 1.3%. External demand led sequential growth, as exports increased 8.6% after a notable 21.9% gain in the previous quarter. Within exports, mining sales gained 15%, while manufacturing sales were almost flat (0.3% qoq/saar).

Although GDP numbers showed a rebound in 3Q13, activity in Chile is clearly losing the dynamism of previous years. From January to September, activity increased by a below-trend 4.5% yoy, down from 5.6% in 2012 and 5.9% in 2011. Moreover, the GDP breakdown confirms that slower investment growth, due to the maturing of the mining investment cycle, is leading the weakening of activity. Consumption is now also slowing, as labor market conditions become less supportive (that is, slower real wage bill growth). Rapidly growing exports have partly offset the weakness of internal demand. This is a direct consequence of the mining capacity expansion of the previous few years (in fact, mining output increased 8.5% year over year during 3Q13, leading to a 7.5% increase in natural resource GDP, according to our estimate). Thus, while lower mining investment growth curbs GDP growth, higher Mining sector production limits the slowdown.

We left our GDP forecast for this year unchanged (at 4.2%), but we reduced our GDP forecast for 2014 from 4.4% to 4.0%. Although GDP growth was strong during 3Q13, the IMACEC (monthly proxy for GDP) fell by 0.8% from August to September. Hence, carry-over effects will likely bring quarter-over-quarter growth back to a below-trend pace in 4Q13, even taking into account the very strong retail sales growth in October (13.4% year over year).  In addition, the economy would now need to grow very strongly on a sequential basis in 2014 to reach our previous forecast of 4.4%.

A Temporary Fall in Headline Inflation

Annual headline inflation fell below the lower bound of the target. Inflation came in at 1.5% year over year in October (from 2.0% in September), marking the lowest annual inflation since May. The drop was largely due to a decrease in energy inflation (from 3.0% in September to -1.6% in October) and in food inflation (from 3.2% to 2.8%), which brought tradable inflation down to 0% (from 0.7% in September).

Most core measures are still below the central bank target range. Specifically, excluding food and energy, inflation edged up to 1.6% (from 1.4% in September) but remained below the lower bound of the range. Non-tradable inflation was flat, at 3.5% (above the center of the target but within the target range).

In our view, the fall in annual inflation is temporary. Unfavorable base effects will likely contribute to an increase in inflation in November. In addition, we note that the recent frost damage may soon lift food inflation. We still expect inflation to end this year at 2.2%. In 2014, the below-trend economy will likely keep non-tradable inflation in check, while tradable inflation will increase, influenced by the weakening of the Chilean peso. However, due to our GDP forecast revision, we now see inflation ending 2014 at 2.5% (2.6% in our previous scenario), still below the center of the target.

We note that the persistent below-target inflation readings in Chile are influencing inflation expectations for the relevant monetary policy horizon. According to the most recent surveys conducted by the central bank, traders see inflation at 2.8% two years from now. While analysts expect inflation at the center of the target (3%) during the same horizon (median expectation), the proportion of them that expect inflation below 3% is on the rise (27%, up from 12.7% in the previous survey). Breakeven inflation 24 months from now is also running below 3%.

Another 25-bp Rate Cut in November

The central bank lowered the monetary policy rate by 25 bps for the second consecutive month in November. The policy rate is now at 4.5%. Although this decision was in line with our estimate, we note that many market participants were expecting the central bank to deliver the next interest rate cut only in December (according to Bloomberg consensus, analysts expected a 25-bp cut in November, while analysts surveyed by the central bank expected the second cut only in December). In the press statement accompanying the decision, the board cited the gradual recovery in advanced economies (led by the United States) and more moderate growth in emerging economies. The central bank also highlighted that central banks of core economies reiterated their intention to continue expansionary monetary policies (that is, the ECB cut its policy rate and the Fed maintained its asset-purchase program unchanged). On the domestic front, board members said that activity has continued to develop at a moderate pace, as 3Q13 data shows that all final internal demand components are slowing. The board noted that inflation expectations are consistent with a gradual normalization of inflation to 3% within the relevant monetary policy horizon (24 months).

The central bank is limiting the expectation of further interest rate cuts. In a recent interview with a local newspaper, the governor of the central bank (Rodrigo Vergara) said that the current stance of the monetary policy is now “neutral”. In the most recent monetary policy report, published after this interview, the central bank assumes that in its baseline scenario the interest rate follows a path similar to the one expected by analysts , which implies that the easing cycle would end when the interest rate reaches 4.25%. We continue to expect the central bank to maintain the interest rate in December before resuming the easing cycle. In our scenario, growth and inflation allow for two 25-bp rate cuts during 1Q14.

Lower Current Account Deficit as Internal Demand Slows          

The slowing demand for investment in Chile is curbing GDP growth, but it is also contributing to a narrower current account deficit. In addition, deficit financing continues to be comfortable, as net direct investment is more than sufficient to fully finance the deficit. During 3Q13, the current account deficit was USD 3.5 billion, down from a deficit of USD 4.9 billion one year before. As a result, the rolling four-quarter current account deficit improved to USD 9.5 billion, or 3.4% of GDP (from USD 11 billion, or 3.9% of GDP, in 2Q13). As for the capital account, net direct investment amounted to a strong USD 4.5 billion during 3Q13 and USD 12.3 billion in the four-quarter period ending in September. In spite of tighter financial conditions abroad, foreign portfolio inflows stayed in positive territory (USD 2.6 billion in 3Q13) but fell from the previous quarter (USD 3.4 billion). Still, as Chilean portfolio investment abroad reached USD 3.0 billion in 3Q13, the portfolio account saw net outflows of USD 0.4 billion during 3Q13, bringing net portfolio investment to USD 2.0 billion for the last four quarters. We now see the current-account deficit at 3.5% of GDP in 2013 (3.7% in our previous scenario). For 2014, lower terms of trade will likely lead to a 3.8% of GDP deficit (4.1% in our previous scenario).

The Chilean peso has depreciated over the last few weeks. Higher interest rates abroad and lower interest rates at home are leading to a weaker peso. Lower copper prices next year will also weigh on the exchange rate. We still expect the peso to end 2014 at 525 to the dollar. However, we revised our forecast for the year-end 2013 exchange rate to 515 pesos to the dollar.

A Presidential Run-Off

No candidate received more than 50% of the vote in the presidential elections held in November. Michelle Bachelet and Evelyn Matthei will now participate in a run-off after receiving 47% and 25% of the total votes, respectively. Support for Michelle Bachelet was in line with predictions made by numerous polls, but the support received by Evelyn Matthei was better than expected. According to several polls, Michelle Bachelet will likely win the run-off. The new president will take office on March 11, 2014.

The Nueva Mayoria coalition received the most votes in the parliamentary elections. The opposition coalition (Nueva Mayoria, composed of the former Concertacion coalition plus the communist party) received 48% of the vote in the Chamber of Deputies, while Alianza (the government coalition) received 36%. In the Senate elections, the Nueva Mayoria received 51% and Alianza 38%. As a result, the Nueva Mayoria now has 58% and 55% of the seats in the lower house and Senate, respectively. Therefore, although the opposition won the parliamentary elections and will likely win the presidential election, it will not have enough representation to change the constitution alone (the required quorum is at least 60%).

João Pedro Bumachar
Rodrigo Aravena

Forecasts: Chile

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