Itaú BBA - Investment-Led Slowdown

Scenario Review - Chile

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Investment-Led Slowdown

Janeiro 14, 2014

We maintain our GDP estimate at 4.2% for 2013, but we increased our 2014 forecast to 4.2% (from 4.0%).

•    Chile’s economy will likely continue to grow below potential this year and next, although we expect that the improved outlook for the global economy will ease the slowdown. Still, inflation will not be as low as before, but it will be comfortable enough to allow for additional rate cuts. In an environment of lower copper prices and a narrower interest rate differential, the Chilean peso will likely continue to depreciate. 

•    We maintain our GDP estimate at 4.2% for 2013, but we increased our 2014 forecast to 4.2% (from 4.0%), because of the revisions in our scenario for the global economy and copper prices. We expect GDP to increase by 4.5% in 2015.

•   Annual inflation increased to 3.0%, reaching the center of the central bank´s target range. The INE (official statistics institute) announced a new CPI basket with increased weighting for non-tradable goods, which will likely contribute to higher inflation and less volatility then we previously expected. We now see annual inflation at 2.8% at year-end 2014 (2.5% previously) and 3.0% in 2015.

•   The central bank maintained the interest rate at 4.5% in December, following two consecutive 25-bp cuts. Although we expect the central bank to maintain the interest rate in January, we believe it will resume the easing cycle by 1Q14. Our year-end forecast for the policy rate remains at 4.0%, but we now expect a less front-loaded easing cycle. Rate hikes are likely in 2015. 

•    We expect the Chilean peso to continue to depreciate against the dollar in 2014, as the interest rate differential with the U.S. narrows and copper prices fall further. Our year-end forecast is now at 540 to the dollar. For 2015, we also expect some depreciation, to 550. 

•   Michelle Bachelet was elected president on December 15, receiving 62% of the vote, well ahead of opponent Evelyn Matthei´s 38%. Bachelet will announce her cabinet in late January. Meanwhile, President Piñera’s popularity reached the highest level since 2010.

Activity in 4Q13 Was Weak

Chile’s IMACEC (monthly proxy for GDP) increased 2.8% year over year in November. According to the central bank, the growth was led by mining (increasing 6.7%, according to INE data) but partially offset by the fall in manufacturing production (-1.1% year over year). From January to November, activity was up 4.2%, down from a 5.6% expansion in 2012 and below the potential growth rate of the economy.

Sequentially, the economy is growing well below potential. On a quarter-over-quarter basis, activity fell 0.6% (annualized) in November, down from a 2.4% expansion in the previous month. Although the central bank does not provide a breakdown for the IMACEC data, the contraction in capital goods imports (by 32.1%in 4Q13) and the weakening in some housing indicators (such as building permits and cement sales) suggests that private investment is leading the slowdown.

The labor market continues to be tight, but it is not as supportive of consumption as before. In spite of the economic slowdown, the unemployment rate stood at 5.7% in November (the lowest level reached by the time series), as employment grew faster than the labor force (2.0% and 1.5%, respectively). Still the real wage bill growth slowed to 5.2% in November (from 6.5% in October), mostly due to higher inflation. As a result, in November retail sales grew 4.7% qoq/saar. While this is still a robust growth rate, it is much lower than the ones recently witnessed.

We still expect Chile’s economy to expand 4.2% in 2013, but we revised our 2014 forecast to 4.2%, because of the revisions in our scenario for the global economy and copper prices. For 2015, we expect that monetary stimulus (some of it already in place) will lead to a 4.5% expansion.

Inflation Ends 2013 at the 3% Target

On a year-over-year basis, inflation rose to 3.0% in December, from 2.4% in November, reaching the central bank’s target. The increase was largely attributable to a rise in tradable inflation, from 1.3% in November to 2.4% in December, mainly a result of the weakening Chilean peso. Non-tradable inflation increased slightly, to 3.8%, and stood close to the upper bound of the central bank’s target range, as labor market conditions continue to be tight. However, inflation excluding food and energy – the core measure closely tracked by the central bank – rose from 1.8% to 2.1%, close to the lower limit of the target. 

The INE announced a new CPI basket for 2014, together with a few methodological changes. The main changes include a reduction in the number of goods (from 368 to 321), an increase in the weight of non-tradable goods (to 46.1% from 41.9%) and the introduction of a new hedonic pricing methodology for some electronic devices (photo cameras, TVs and cell phones). We estimate that under the new methodology, inflation would have been somewhat higher over the past few years.

We raised our CPI forecast for 2014, to 2.8% from 2.5%. Apart from the new methodology, a weaker exchange-rate explains the revision. Still, we continue to believe that, because of a looser output gap, inflation will end 2014 below the center of the target (even though we note that unfavorable base effects will likely drive inflation above the target range in 2Q14). For 2015, we expect inflation at 3.0%.

Monetary Policy: Only a Pause

The central bank maintained the monetary policy rate at 4.5% in December, following two consecutive 25-bp cuts. This decision was in line with both our expectation and the market consensus. The minutes of the meeting showed that board members considered cutting the policy rate as a “relevant option”, suggesting that an easing bias remains. In the document, board members listed the reasons to justify leaving the interest rate unchanged. First, although all board members agreed that October’s activity was weaker than the market expected, members viewed the economic slowdown as smooth. Second, given the previous two rate cuts, the monetary policy was already looser than before, at a moment when credit continues to flow to households and corporates. Third, the real exchange rate has weakened, which will likely help to rebalance economic growth. Finally, the board pointed out that a third consecutive cut could signal to markets that there is “greater urgency regarding the fragility of the national economy and lead to an additional correction of the expected path for the policy rate, which would not be in line with the monetary policy report.” 

We expect Chile’s central bank to resume the easing cycle in the next few months. Although we expect board members to maintain the interest rate in January, we see a 25-bp rate cut in 1Q14 and a further 25 bps in 2Q14, finishing the easing cycle at a policy rate of 4.0%. Previously, we were expecting both rate cuts in 1Q14. In 2015, we expect that the central bank will start to normalize monetary policy, so we expect a 50-bp tightening cycle.

A Weaker Peso

We expect the peso to continue to depreciate against the dollar, reaching 540 at year-end 2014, after ending last year at 526. A lower interest rate differential with the U.S. and declining copper prices will weigh on the currency. In 2015, we expect the currency to reach 550 to the dollar.

The trade balance recorded a USD 2.4 billion surplus in 2013, down from USD 3.4 billion last year. Exports declined 8.5% yoy in 4Q13, driven by a 15.2% contraction in mining sales, resulting in a 1.2% contraction in overall exports during the year. Imports contracted 7.1% in 4Q13 (driven by lower imports of capital goods), so growth in 2013 was only 0.2% (significantly below the 5.6% growth recorded in 2012).

We adjusted our current account deficit estimate to 3.4% of GDP for 2014 (from 3.8% in our previous scenario), due to an upward revision in our forecast for copper prices. So the current account deficit would stay close to the level that we estimate for 2013 (3.5% of GDP). In 2015, we expect a reduction of the deficit to 2.8% of GDP. Our expectation for this lower deficit is due to a recovery in export volumes (as mining investment matures) and a weaker Chilean peso.

Politics: Bachelet’s Cabinet to Be Announced Soon

Michelle Bachelet was elected president in the runoff held on December 15, receiving 62% of the vote, well ahead of opponent Evelyn Matthei’s 38%. Bachelet will announce her cabinet during the second half of January and will take office on March 11, 2014.The president-elect has held meetings with the leaders of the seven Nueva Mayoría coalition parties, where all have agreed to support Bachelet’s nominees. We note that the Nueva Mayoria failed to obtain sufficient representation to change the constitution on its own.

The December approval rating for president Piñera, according to Adimark, rose 2 points from November to 45%, reaching the highest rating since December 2010. His approval rose mostly due to a better perception of his economic management. The disapproval rating fell below the approval rating for the first time since December 2010, reaching 41% (47% in November).

João Pedro Bumachar

Rodrigo Aravena

Forecasts: Chile

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