Itaú BBA - Consumption Continues to Post Rapid Growth

Scenario Review - Chile

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Consumption Continues to Post Rapid Growth

Outubro 2, 2013

We expect Chile’s GDP to grow 4.2% in 2013 and 4.4% in 2014.

•    Although the activity indicators for August suggest weak GDP growth during the month, consumption growth has sustained a rapid pace, supported by the tight labor market. We expect Chile’s GDP to grow 4.2% in 2013 and 4.4% in 2014. 

   Despite the strong consumption growth, both headline and core inflation remain below the midpoint of the Central Bank target. We maintain our CPI forecasts for 2013 and 2014, at 2.2% and 2.6%, respectively. 

•    The Central Bank maintained the interest rate unchanged, at 5.0%, in September, but reaffirmed its easing bias. We expect board members to maintain the interest rate again in October, waiting for further evidence of slowing internal demand. In our scenario, consumption recouples with GDP, so we continue to expect a 100-bp easing cycle. However the latest strong consumption numbers pose a risk that the Central Bank will take longer than we expect to lower interest rates.   

    According to the 2014 budget, fiscal spending growth will fall to 3.9% (in real terms), while the structural deficit would be reduced to 1.0% of GDP. These numbers confirm that the fiscal policy will also contribute to a looser monetary policy. 

    Evelyn Matthei (the presidential candidate for the government coalition) is not considering changes in the tax system in her economic proposals. However, her program emphasizes the need for a lower structural fiscal deficit, thereby limiting the room for social spending growth. 

Strong Consumption Amid a Tight Labor Market

The IMACEC (monthly GDP proxy) rose 5.3% year over year in July, reaching the highest annual rate since January. According to the Chilean Central Bank, the growth was led by Retail (10.3% year over year) and Mining (14.2% year over year). On a seasonally-adjusted basis, activity stood flat from June to July, after increasing 0.7% in May and 0.9% in June. The statistical carry-over therefore helped boost the annualized quarter over quarter growth rate to 5.3% from May to July, from 1.7% in the second quarter.

The available activity numbers for August indicate weak GDP growth and strong consumption. Electricity generation decelerated to 3.7% year over year (from 6.9% in July), while manufacturing production fell 2.0% (vs. +4.7% year over year in July). Consumption, however, rose sharply retail and supermarket sales grew 12.0% and 9.3%, respectively. We expect the IMACEC to grow 3.7% year over year in August.

A tight labor market continues to drive consumption. The unemployment rate fell to 5.7% in August (from 6.4% a year ago), as employment grew 2.7% year over year and the labor force increased 1.9%. The employment breakdown also suggests that the labor market remains tight. Waged employment rose 2.7% year over year (from 2.4% in July and 2.2% in June), while the self-employment growth rate fell to 3.4% (from 4.2% the previous month). We now expect the unemployment rate to average 6.2% this year and 7.0% in 2014 (from our previous scenario of 6.4% and 7.2%, respectively).

Leading indicators suggest that the decoupling between consumption and GDP will not last long. According to Adimark (a local think-tank), consumer confidence fell to 50.4 in August, marking the lowest figure since July 2012. Confidence has been on a downtrend since April, when the index reached 59.2 points. Real wage growth declined to 2.9% year over year in July (from 5.0% in June), while the real wage bill growth fell to 5.3% (from 6.1% in June).

We expect the Chilean economy to grow 4.2% in 2013 and 4.4% in 2014. Thus, according to our below-consensus scenario, the economy will grow below trend at least until next year.

Inflation Remains Subdued

Annual inflation stood at 2.2% year over year in August, close to the lower bound of the target range. The core measures remain below the lower bound of the Central Bank’s target, confirming the lack of demand-side inflationary pressure. The CPIX (which excludes fresh food and gasoline prices) rose 1.6% year over year, while the CPI (excluding food and energy) increased 1.2%. Tradable inflation (1.2%) continues to run below non-tradable inflation (3.4%) on a year-over-year basis. However, the gap between tradable and non-tradable inflation has been narrowing over the last few months, mostly due to a weaker exchange rate.   

In our view, inflation will remain below the target’s center throughout our forecast horizon. We expect the inflationary pressures from a weaker currency to be offset by a looser output gap. Our CPI forecasts remain at 2.2% for 2013 and 2.6% for 2014.

Postponing the Easing Cycle 

The Central Bank maintained the policy rate at 5.0% in September, and maintained the easing bias for the coming decisions. The tone of the statement that accompanied the decision was similar to that of the previous statement. The Central Bank explicitly mentions the possibility of lower interest rates if the incoming data confirms the scenario outlined in the last monetary policy report.

In the statement, board members also highlighted the moderate activity growth and strong private consumption. The Central Bank is clearly uncomfortable with providing stimulus to an economy in which consumption is growing so rapidly and the labor market remains tight. 

Our scenario for growth and inflation in Chile is consistent with lower rates ahead. We currently expect the easing cycle to start in November, with a 25-bp rate cut. According to our scenario, the Central Bank would also cut the policy rate in December, bringing it to 4.5%.; we expect the policy rate to reach 4.0% by the end of 2014. As consumption growth and the labor market continue to play against rate cuts, we acknowledge that the risk of a later-than-expected start to the Central Bank’s easing cycle is not negligible. 

Stronger Currency, for Now  

The Chilean peso has strengthened since mid-August. We believe that a wider interest-rate differential (as the Chilean Central Bank postpones the beginning of the easing cycle and the Fed delays the withdrawal of monetary stimulus) is driving the current appreciation.

We now expect the Chilean peso to end the year at 500 to the dollar (from 510 in our previous scenario). Our 2014 forecast remains unchanged at 525 pesos to the dollar. A tighter monetary policy stance in the U.S., lower interest rates at home, and lower copper prices are likely to lead the currency to weaken in 2014.

A Less Expansionary Fiscal Policy in 2014

The government will lower fiscal spending growth in 2014. President Piñera’s announced fiscal budget for next year will be discussed in congress over the next two months. According to the government’s proposal, fiscal spending would grow 3.9% (in real terms) in 2014, marking the lowest growth rate since 2011. For this year, the Finance Ministry estimates a fiscal spending growth of 5.9%.

The structural fiscal deficit would fall to 1.0% of GDP in 2014. This is consistent with the previously announced goal of reducing the structural deficit, from 3.1% of GDP in 2009 to 1.0% by the end of the current government’s term.

Lower growth in structural public revenues is the reason behind public expenditure deceleration. The drop in the potential GDP growth rate (from 5.0% to 4.8%, according to estimates by the external advisory committee), lower long-term copper prices and the higher costs in the Mining sector (attributable to the increase in energy and labor costs) are dragging the public sector income growth down in 2014. 

Evelyn Matthei Announced Economic Program

Evelyn Matthei will not seek changes in the tax system. According to the head of Ms. Matthei’s economic team, she would avoid “changing rules for investors”. Evelyn Matthei’s economic proposal would consider a reduction in the structural fiscal deficit, to zero, but only very gradually (“four to eight years”). In any case, it seems there would be no room for a significant increase in social spending under this proposal.  

On the other hand, Michele Bachelet has reaffirmed her intention to increase fiscal revenue by 3% of GDP. This would be primarily achieved through an increase in the corporate tax rate, from 20% to 25%, in the next four years. According to Mrs. Bachelet, there are two main objectives behind increasing tax revenues: i) to reduce the structural fiscal deficit to 0% over the next four years and ii) to finance an educational reform.

The presidential elections in Chile will be held on November 17. If no candidate is able to get more than 50% of the vote, there will be a runoff election on December 15. According to CEP’s (Centro de Estudios Públicos, Chile’s main think tank) latest political poll, published in August, Michele Bachelet has 44% of the vote, while Evelyn Matthei has only 12%. Voting in Chile has been non-mandatory since 2012, which has led to a decline in voter participation in the last two elections (40% turnout in municipal elections and 20% turnout in the primaries, held in October 2012 and June 2013, respectively). The low turnout has been a major source of uncertainty for this election.

João Pedro Bumachar
Rodrigo Aravena

Forecasts: Chile

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