Itaú BBA - Losing Momentum

Scenario Review - Chile

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Losing Momentum

Março 31, 2016

Weak growth, a stronger currency and falling inflation confirm our view of no rate hikes.

Please see the attached file for all graphs.  

• The economy expanded 2.1% last year, but lost momentum in the last quarter. We see 2016 growth at 1.8%, while weak confidence and low copper prices weigh down activity. Next year, growth would pick up mildly, to 2.3%.

• The external environment turned more supportive for emerging-market currencies and we now expect the exchange rate to be 700 pesos to the dollar by the end of 2016 and to remain stable throughout 2017. We still see a current-account deficit of 1.7% of GDP this year and some widening to 2.2% in 2017.

• Our new exchange-rate forecast removes upside risks for inflation. We expect that inflation will decelerate to 3.5% by year-end 2016, and reach 3.0% in 2017, helped by a widening output gap and well-anchored inflation expectations as well as the stabilization of the exchange rate.

• Amid weaker growth, the central bank moderated the monetary tightening guidance in its recent monetary-policy report. We expect no additional rate hikes this year or next.

• The government has found a second wind and was able to move forward the discussion of key economic and social reform bills in the month.

Growth Weakness

Chile’s economic growth lost momentum in the last quarter of 2015. The economy only expanded 1.3% year over year, below the 2.2% recorded in 3Q15.

Domestic demand saw a broad-based slowdown, led by the contraction of gross fixed investment. Fixed investment fell 1.3% year over year after expanding 4.3% in 3Q15, as expenditure in machinery and equipment went back to contraction and the construction component slowed down. Meanwhile, government and private consumption continued to expand, albeit slower than in 3Q15. On the external front, exports of goods and services fell for the third consecutive quarter and imports also shrank.

Sequentially, growth slowed down to 0.3% qoq/saar, from 1.2% in 3Q15. Domestic demand contracted for the first time since 2Q14, pulled down by government consumption and gross fixed investment, while private consumption still expanded. Net exports favored growth in the quarter as real imports fell by 9.0% qoq/saar, while exports grew by 9.3%.

The full-year growth rate was 2.1% in 2015, after recording a 1.9% expansion in 2014. Domestic demand led growth in the year, in spite of the slowdown in consumption (pulled down by the private component, which recorded the lowest expansion since 2009). Gross fixed investment showed a second year of contraction. Net exports favored growth in the year, but less so than the year before.

We continue to expect growth of 1.8% in 2016, a further slowdown from last year. Low copper prices and uncertainties regarding the reform agenda will likely continue to stand in the way of a recovery. In fact, the risk for our forecast for this year is tilted to the downside. For next year, we expect a modest recovery, to 2.3%.

A wider but moderate current-account deficit

The current-account deficit widened in 2015. As the 4Q15 deficit came in at USD 2.1 billion, the full-year result reached USD 4.7 billion (2.0% of GDP), a deterioration from the USD 3.3 billion (1.3% of GDP) deficit in 2014.

The trade balance of goods and services ended the year on deficit (USD 0.3 billion versus a USD 2.5 billion surplus in 2014). Nominal exports contracted more than imports. Meanwhile, the service trade balance remained broadly unchanged from the previous year. The income-balance deficit was also narrower in 2015 than the year before, supported by lower profits from mining companies, a weaker currency and low growth.

In 2015, the foreign appetite for Chilean assets moderated. Foreign direct investment fell to a still-high USD 20.5 billion (USD 22.3 billion in 2014). However, net direct investment was USD 4.7 billion (2.0% of GDP), so it was only just enough to fully finance the current-account deficit. Foreign portfolio investment last year was the lowest since 2008, with a USD 3.0 billion inflow (USD 12.8 billion in 2014).

We continue to expect a current-account deficit of 1.7% of GDP this year. Weaker internal demand and the lagged impact of exchange-rate depreciation will likely reduce the deficit this year. In 2017, some recovery of domestic demand would result in a mild widening of the current-account deficit to 2.2% in 2017.

Alongside other emerging market currencies, the Chilean peso strengthened in a more supportive external environment. The peso is currently at a 6-month high against the U.S. dollar. We now expect the currency to reach 700 pesos to the dollar by year-end and to remain broadly stable throughout 2017 (in our previous scenario we saw the currency at 730 by the end of both years).

A gradual convergence

Inflation in February remained elevated at 4.7%, while core prices accelerated to 5.0%. Pass-through of past depreciation of the currency, indexation mechanisms in the economy and the effect of the tax reform continue to put pressure on prices. However, our diffusion index remains broadly stable, indicating that the increase in prices is not becoming more widespread.

The slow loosening of the labor market means that inflation will only gradually moderate this year. Nominal wage growth accelerated to 5.8% year over year in January (5.2% in December) in spite of weak growth, reflecting inertia and a still-low unemployment rate.

While inflation will remain above the target range until mid-year, we continue to see it at 3.5% by the end of the year, and reaching the 3.0% target by the end of 2017. The widening output gap, well-anchored inflation expectations and the stabilization of the exchange rate will help to bring inflation down. Our view of a stronger currency this year (relatively to our previous scenario) means diminishing upside risks to our call.  

Loosening the monetary policy stance

In March, the central bank of Chile left the policy rate unchanged at 3.50% and retained a tightening bias. The monetary authority has been on hold for a full quarter, following what has so far been a short and discontinuous tightening cycle that started in 4Q15.

In the 1Q16 Monetary Policy Report (IPoM), published after the March meeting, the central bank signaled less monetary tightening on the policy horizon relative to the previous report. The guidance is now that only one additional 25-basis-point hike would occur this year (previously, up to two hikes were in the cards), with one additional rate hike between one and two years (previously, the rate was expected to be between 4.0% and 4.25%). A flatter trajectory for the policy rate comes amid lower growth expectations. The central bank now sees a 1.25%-2.25% growth rate this year, from 2%-3% in the December report. As a result, the central bank lowered its inflation forecast for 2016 from 3.8% in December, to 3.6% in the current report.

We do not expect further rate hikes this year or in 2017. In our view, the central bank will continue to gradually abandon its monetary-tightening bias amid weak growth and falling inflation.

Uncertainty over reforms help to keep confidence low

The labor reform is advancing in congress. However, the bill in the Senate was substantially different from the one approved earlier in the lower chamber of congress, so there will be a bi-cameral discussion to reconcile the two versions of the bill.

The abortion bill also moved forward this month. As progressive center-right parties joined the government, the bill that de-penalizes abortion in the cases of rape, unviability of the child, and life-threatening situations was approved by the lower chamber. The bill will now move to the senate for discussion. The government does not want to rush the debate, as it needs to secure the support of its conservative allies, the Christian Democrats.

The political environment is not helping private sentiment. Consumer confidence in February remained in pessimistic territory, where it has been for 21 months. Meanwhile, business sentiment has now been in pessimistic territory for 23 consecutive months. Expectations on employment deteriorated in all economic sectors, hinting at a loosening of the labor market going forward.


João Pedro Bumachar
Vittorio Peretti
Miguel Ricaurte


Please see the attached file for all graphs.  


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