Itaú BBA - A Sharper Deceleration and Further Rate Cuts

Scenario Review - Chile

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A Sharper Deceleration and Further Rate Cuts

Março 10, 2014

Chile’s economic activity has continued to slow, led by investments.

• Chile’s economic activity has continued to slow, led by investments. Additionally, private consumption is also losing momentum. We reduced our GDP growth estimate for 2014 and 2015 to 3.6% and 4.2% respectively, (from 4.2% and 4.5%).

• Annual inflation increased to 3.2% in February, mostly due to a weaker currency. All the core measures remain below the central bank target, while non-tradable inflation is still above the upper limit of the range. We still expect inflation to be at 2.8% at year-end of 2014 and 3.0% in 2015.

• The central bank reduced the interest rate and maintained its easing bias in February, signaling that a rate cut is highly likely this month. We now expect a deeper easing cycle, so we see the policy rate at 3.5% before the end of this year. A looser monetary policy will likely lead to an additional depreciation of the peso. We now see the peso at 575 to the dollar by the end of this year and next.

• The structural fiscal deficit was reduced to 0.7% of GDP in 2013, surpassing the original commitment made by the government in 2010 (1.0% of GDP).

• President Bachelet confirmed that several reforms will be announced within the first 100 days of the new government term. The tax reform will likely be the first project that the new administration submits to Congress. The contents and timing of this reform will be closely watched by the market.

Dwindling Investment Continues to Lead the Slowdown

The economy disappointed again in January. The IMACEC (monthly proxy for GDP) grew by 1.4% year over year, while on a sequential basis it increased by only 1.9% qoq/saar. Most activity indicators released by the INE (National Institute of Statistics) also slowed. So in our view, the recent port strikes do not explain the bulk of the activity weakening in January.

Several indicators suggest that private investment is still leading the slowdown. Capital goods imports contracted by 20.4% and 26.7% year over year in January and February, respectively, after declining by 32.1% year over year in 4Q13. Furthermore, sales of construction materials increased by a weak 0.9% in 4Q13, after growing by 2.0% in the previous quarter, pointing to a slowdown in housing investment. According to our estimates, there was a negative growth of gross fixed investment in 4Q13.

Consumption is also losing momentum, and the less supportive labor market will likely reduce its growth rate further. On a sequential basis, consumption-related indicators slowed substantially in January: retail sales grew 4.7% qoq/saar (from 11.7% last month), while supermarket sales decreased by 0.5% qoq/saar. The unemployment rate increased to 6.1% in January (from 5.7% in the previous month and 6.0% one year ago). Although the unemployment rate is still low, employment is growing much slower than it was until recently. Specifically, waged employment growth fell to a weak 1.2% year over year in January. Lower employment growth together with the “normalization” of inflation is reducing the real wage bill growth.

Leading indicators continue to worsen. According to Adimark (a local survey company), overall consumer confidence declined to 54.6 points in January (from 56.6 last month), led by a sharp reduction in expectations for finding a job over the next 12 months (this fell to 49.2 points, the pessimistic zone). Additionally, the IMCE (a business confidence index) declined to 50.44 points (from 50.88 last month), led by worse expectations in the Mining sector.

We have cut our GDP estimate for 2014 and 2015, respectively, to 3.6% and 4.2% (from 4.2% and 4.5%). In our scenario, the slowdown this year will be led by lower dynamism in internal demand, while the weaker currency and higher mining output (as investments made in previous years mature) will likely improve the contribution of net exports to growth. A looser monetary policy this year will likely help the economic recovery expected for 2015.

Higher Inflation Led by a Weaker Currency

Inflation rose in February, led by tradable prices. The CPI increased by 0.5% month over month in February, mainly due to higher gasoline prices. Consequently, annual inflation rose to 3.2% (from 2.8% last month), slightly above the center of the central bank´s target range (between 2.0% and 4.0%). In addition, all core measures increased in February: CPIX rose to 2.7% (vs 2.4% in February) and CPI excluding food and energy was 2.5% (from 2.4% last month). Tradable inflation rose from 1.9% last month to 2.4%, mostly because of the weaker peso, but non-tradable inflation also rose (to 4.3%), likely a result of the still-tight labor market.

Our inflation forecasts are unchanged. We expect the CPI to be at 2.8% at year-end 2014. In our scenario, the looser output gap will likely reduce non-tradable inflation, more than offsetting the impact of a weaker peso. For 2015, our estimate remains at 3.0%.

More Rate Cuts Will Come, Leading to a Weaker Exchange Rate

The central bank reduced the interest rate by 25 bps (to 4.25%) in February. This decision came after the central bank introduced a strong easing bias in the previous meeting, so it wasn’t surprising for the market. In the press release, the central bank emphasized the lower-than-expected growth in both domestic demand and GDP. The central bank maintained the easing bias by repeating in the last paragraph of the statement that “the Board estimates that in the coming months it might be necessary to increase the monetary stimulus to ensure that projected inflation will stand at 3% in the policy horizon.”

The informal communication also signals further reductions of the policy rate. According Board members Joaquin Vial and Pablo Garcia stated recently to the press that more rate cuts could come. In an interview with El Pulso newspaper, Mr. Vial said that the next change in the monetary policy rate would be a reduction, although “it wouldn’t necessarily be in the next meeting,” and he also hinted that a negative revision in the GDP forecast would come at the next IPoM (to be released in March). Relative to the exchange rate, he mentioned that the current level is within a consistent range of long-term fundamentals, signaling that the recent depreciation wouldn’t be a problem in continuing with the easing cycle. Meanwhile, Pablo Garcia told the local press that a weaker exchange rate and lower interest rates were “healthy” for the economy.

We now expect a deeper easing cycle. The central bank will likely reduce the policy rate in March with an additional 25-bp cut, to 4.0%. Going forward, our new scenario for activity leaves room for additional rate cuts. Therefore, we now expect the easing cycle to end (this year) once the rate reaches 3.5% (4.0% in our previous scenario). We still expect the central bank to raise rates in 2015, by increasing the interest rate by 50 bps, to 4.0% (4.5% in our previous scenario).

We now project an exchange rate of 575 pesos to the dollar by year-end 2014. The looser monetary policy is consistent with a weaker exchange rate than we were previously forecasting (540 to the dollar). For 2015, we also expect the peso at 575.

A Higher-Than-Expected Reduction in the Structural Deficit

The government reduced the structural fiscal deficit to 0.7% of GDP in 2013, surpassing the original commitment made in 2010. President Sebastian Piñera set a goal of reducing the structural deficit from the 3.1% of GDP registered in 2009 (due to the counter-cyclical measures applied during the financial crisis) to 1.0% of GDP at the end of his administration.

There was also a reduction in the effective fiscal balance during the past few years. The fiscal balance (including cyclical effects) improved from -4.4% of GDP in 2009 to -0.6% of GDP in 2013. However, from 2012 (when there was a 0.6% of GDP surplus) to 2013, the fiscal accounts deteriorated, as lower copper prices and higher mining costs reduced fiscal revenues in 2013 (mining revenue fell by 29% year over year), more than offsetting the lower-than-budgeted growth of public expenditures.

Tax Reform in the Spotlight

According to the press, the tax reform would be the first proposal from the new Bachelet administration to be sent to congress. Although the market is aware of the tax reform’s main points (aiming to increase fiscal revenue by 3.0% of GDP, mainly by raising the corporate tax to 25% from the current 20%), there is room for surprise, especially in the timing of the reform.

João Pedro Bumachar

Rodrigo Aravena

Forecasts: Chile


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