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Scenario Review - Chile

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No recovery yet

Junho 9, 2016

Low copper prices, less fiscal support and pessimistic private-sector sentiment are weightening on activity.

• Our expectation of fewer rate hikes by the Fed this year offset the downward revisions in our forecast for copper prices. We continue to see the exchange rate at 685 pesos to the dollar at the end of this year and at 695 pesos to the dollar at year-end 2017.

• We forecast a year-end inflation rate of 3.5% (4.4% in 2015), as the negative output gap, lower currency depreciation and well-anchored inflation expectations all favor disinflation. For 2017, we expect inflation to return to the central bank’s 3% target.

• Considering the outlook for growth and inflation, it is unlikely that the central bank will resume the tightening cycle. We expect no rate moves from 3.5% over our forecast horizon.

Scrambling to finalize labor reform

After the constitutional court blocked the labor reform bill late last month, the government is analyzing its options for moving forward with the legislation. The court ruled that the bill’s attempt to grant unions exclusive rights in collective negotiations between workers and firms was unconstitutional. In the court’s view, bargaining rights reside with workers, not organizations, so barring other forms of worker associations from negotiating with employers would violate the constitution. The delay in the final approval of the bill is causing some concern within the governing coalition, especially as the national workers union (CUT) has indicated that they will not accept any bill that does not give unions a key role in collective bargaining.

Hurt by recent developments, approval ratings for President Bachelet fell to 24% in May, down five percentage points from April. In addition to the labor reform complications, demonstrations by groups ranging from fishermen to students have added to the government’s woes. The survey also yielded low approval ratings for the opposition, showing the population’s overall discontent with the political class. Most recently, the minister of interior resigned his post, showing friction within the governing coalition.

Chile’s public debt continues to increase. According to the Budget Office, the country’s gross public debt reached 17.7% of GDP in 1Q16, showing a consistent rise from the past (8.6% in 2010). Net debt is around 0% of GDP, but has also risen significantly over the past few years. The rising debt levels have been flagged by various rating agencies. However, in a positive development for Chile, S&P recently reaffirmed its sovereign rating for Chile and kept its outlook at Stable based on the country’s reputation for fiscal responsibility. In fact, the government is trying to balance the reform agenda (which will mean higher expenditures, at least in the case of the education reform) against the need to reduce the structural deficit in the current adverse scenario for fiscal revenues (due to the deterioration of copper prices and potential growth).

Stuck in a low-growth rut

Economic activity remained weak in the first quarter of 2016. GDP growth was 2.0% year over year in the first quarter of 2016, a pick-up from the 1.3% recorded in 4Q15. Activity in the quarter was favored by the extra working day created by the leap year, as annual growth in the seasonally adjusted series (which corrects for calendar effects) was 1.7% (up from 1.4% in 4Q15). Sequentially, activity accelerated to 5.3% qoq/saar, but only after weak results for the previous three quarters. 

Internal demand remains weak. Final domestic demand grew by 1.9% year over year (1.1% in 4Q15). Total consumption growth of 2.2% (1.8% in 4Q15) was led by a 5.4% increase in public consumption (4.9% in 4Q15), while the private component grew by only 1.6% year over year (1.1% in 4Q15). Gross fixed investment improved, growing by 1.2% (-1.3% in 4Q15 and -1.5% in 2015). On the external front, exports of goods and services recorded an increase after three consecutive quarters of declines, rising by 2.4% from one year ago. Meanwhile, imports continued to decline (-3.0% year over year).

2Q16 has started off on the wrong foot. The monthly GDP proxy (Imacec) rose by 0.7% year over year in April (2.2% in March), well below market expectations. Mining and manufacturing output dragged activity down during the month, while retail sales and other services activity boosted growth.

Pessimistic private-sector sentiment continues to play a role in the weak evolution of economic activity. Business confidence worsened in May and is now at lows last seen in 2014. Excluding the more volatile sentiment in the Mining sector, business confidence is lingering around the lows recorded during the subprime crisis.

We continue to expect 1.8% growth this year, which would mark a further slowdown from the 2.1% recorded in 2015. Activity is being weighed down by low copper prices, less fiscal support and pessimistic private-sector sentiment. For 2017, we expect a recovery to 2.3% growth: as uncertainty over domestic reforms diminishes, with still-expansionary monetary policy, growth is likely to improve somewhat.

The labor market continued to loosen over the quarter ending in April. The unemployment rate increased compared with last year’s corresponding period (to 6.4% from 6.1%). Moreover, self-employment once again led employment growth. We expect a further increase in the unemployment rate as the economy continues to grow at below-potential rates and as construction-related labor demand drops (with the end of the VAT tax credit on new property approaching). We forecast that the average unemployment rate will reach 7.1% for 2016, above the 6.3% recorded last year.

A comfortable current account deficit

Chile’s current account deficit remains low. With the current account balance registering a USD 0.5 billion surplus for 1Q16, the four-quarter deficit was relatively stable compared with 2015 (USD 4.7 billion, or 2.0% of GDP). The weak currency and low internal demand growth are leading to lower imports of goods and services, at the same time that the impact of low copper prices on exports is being partly offset by lower profits for foreign mining companies operating in Chile. So even though the income deficit widened slightly, it remained at historically low levels.

Net direct investment is still sufficient to fully finance the current account deficit. Foreign direct investment of USD 21.4 billion in the rolling-four-quarter period (compared with USD 20.5 billion in 2015) benefited the mining, financial and service sectors. Net direct investment in 1Q16 stood at USD 8.4 billion (1.2% of GDP), up from USD 4.7 billion in 2015. Meanwhile, foreign portfolio investment (USD 3.4 billion over the last four quarters) remains far below its peak levels (a high of USD 15.4 billion in 2013).

We expect a current account deficit of 1.7% of GDP this year. The lagging impact of the weaker currency and low internal demand growth will likely lead to some narrowing of the deficit compared with last year. As internal demand recovers next year, the current account deficit will likely widen to 2.2% of GDP.

Our expectation of fewer rate hikes by the Fed this year offset the downward revisions in our forecast for copper prices. We continue to see the exchange rate at 685 pesos to the dollar at the end of this year and at 695 pesos to the dollar at year-end 2017.

Core inflation continues to slow

Inflation is likely to drop into the range in the second half of this year. Consumer prices gained 0.2% from April to May, below expectations, but the annual rate was still above the 2%-4% target range, at 4.2%. Core inflation – which excludes food and energy prices – fell to 4.3% (4.6% previously), the third consecutive month of deceleration, while tradable inflation was broadly stable at 3.9%. Non-tradable prices once again increased by 4.7%. Our diffusion index shows inflationary pressures are diminishing, supported by a smaller tradable component.

We expect a 2016 inflation rate of 3.5% by year-end (4.4% in 2015), as the negative output gap, a more favorable evolution of the currency (relatively to last year) and well-anchored inflation expectations all favor disinflation. For 2017, we expect inflation to return to the central bank’s 3% target.

Loosening the tightening bias

At its most recent meeting the central bank unanimously voted to hold the policy rate at 3.5%, consistent with a still-expansionary monetary policy. The minutes showed board members pondering whether to remove the tightening bias from the communication. The technical staff proposed leaving the rate unchanged as the only valid option.

In its 2Q16 inflation report, the central bank indicated that the monetary policy normalization would occur at a slower pace than previously anticipated. In this context, the policy guidance is that the reference interest rate will be raised through one additional 25-bp hike between the end of this year and the start of 2017, with a second hike (to 4%) coming within a one- to two-year period. Previously, the central bank had hinted at the same overall number of rate hikes, but with the additional tightening coming a quarter earlier than in the updated scenario.

We expect the central bank to take a prolonged pause, holding the policy rate at 3.5% throughout this year and 2017. In our view, with declining inflation, low growth and well-anchored inflation expectations, it is unlikely that the central bank will resume the tightening cycle.


João Pedro Bumachar
Vittorio Peretti
Miguel Ricaurte


Please see the attached file for all graphs. 



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