Itaú BBA - Tailwinds begin to help

Scenario Review - Chile

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Tailwinds begin to help

Fevereiro 8, 2018

Stronger global growth, high copper prices, recovering private sentiment and expansionary monetary policy will boost a recovery in activity

Please see the attached file for all graphs.

• In 2017, GDP growth remained below potential for the fourth year, at 1.6%, joining 2016 as the weakest year since the global financial crisis. Nevertheless, there was evidence of improvement towards the end of the year. With higher copper prices, improving confidence and stronger global growth, we now expect growth of 3.3% this year (revised upward from 3.0% in our previous scenario). The consolidation of investment and an export-driven recovery will see growth rise to 3.5% next year.

• Due to higher copper prices, we revised our exchange rate forecast to CLP 620 per USD by the end of the year (previously CLP 635) and CLP 625 by the end of 2019 (previously CLP 640). Some depreciation from current levels is likely, as copper prices moderate and monetary policy normalization in the U.S. continues. In this context, inflation will likely remain below the 3% target throughout this year.

• We see the central bank comfortable with steady rates at 2.5% this year, as the output gap remains negative and inflationary pressures muted. The normalization process would likely start next year, as the output gap narrows, taking the rate to 3.5% before year-end.

• President-elect Sebastian Piñera presented his cabinet. The economic team will focus on prudence following the sovereign credit rating downgrades last year and will benefit from the recovery in commodity prices.

Leaving behind a difficult year

The monthly GDP proxy IMACEC indicates activity grew only 1.6% in 2017, in line with the growth rate in 2016. While activity accelerated throughout the year, 2017 growth was the lowest since 2009 (when the economy fell 1.6%). Mining production was less of a drag in the year (-0.9% vs -2.9% in 2016), while non-mining activity moderated to 1.8% (2.0% in 2016). Mining was hampered by a major labor strike in 1H17. Data from 2H17 shows production recovering, aided by higher copper prices and firmer global demand. Mining grew 6.6% in 2H17 and will be a key driver to activity in 1H18, as it encounters favorable base effects. Improved confidence levels, low interest rates and increasing real wage growth also suggest that non-mining activity will pick up.

Activity in the final quarter of the year increased 2.9% YoY (2.2% in 3Q17). Some indicators of optimism for growth include the central bank’s credit conditions survey, showing household credit demand continued to strengthen in 4Q17. This is in line with new home sales in greater Santiago, expanding 2.7% YoY in the final quarter of 2017 (+16% in the year, up from a -38% drop in 2016), according to the Chilean Construction Chamber, following an 8.2% gain in 3Q17. Meanwhile, credit demand from  real estate companies is no longer deteriorating for the  first time since 1Q15. In turn, at the close of 2017, consumer confidence left pessimistic territory for the first time since May 2014. Adimark’s consumer confidence index reached 53.1 points in December 2017 (50 = neutral), a 13.1-point gain in the 12-month period (the largest since December 2012). Driving the improvement were gains made in the economic outlook. More significant for investment, business confidence for January of this year jumped into optimistic ground for the first time since early 2014, while the central bank Business Perception Report revealed an upbeat private sector.

Stronger global growth outlook, high copper prices, recovering private sentiment and expansionary monetary policy will all boost recovery in activity this year. We now forecast a pick-up to 3.3% in 2018 (3.0% last month). As investment projects consolidate, further acceleration to 3.5% is anticipated for next year. 

Stronger peso

Mostly due to high copper prices, the peso has performed strongly over the past two months. We now see the exchange rate at CLP 620 per USD by yearend (revised from CLP 635), with some weakening to CLP 625 next year (revised from CLP 640). Some depreciation from current levels is likely, as copper prices moderate and monetary policy normalization in the U.S. continues.

We expect the current account deficit to remain low. We forecast the current account deficit to narrow to 1.2% of GDP, from the 1.5% expected for 2017. Together with terms of trade, an expected recovery in mining production is key. As internal demand recovers through 2019, we see some widening of the deficit to a still-low 1.8% next year.

Modest inflationary pressures

Inflation in January came in at 2.2%, broadly stable from the 2.3% at the close of 2017, but surprising the market to the upside. The unexpected acceleration in fruit and vegetable inflation to 10.7% (from 2.9% in December) offset a drop in goods and energy inflation. As a result, core inflation (excluding food and energy prices) dropped to 1.6%, from the 1.9% close at 2017, dipping further below the lower bound of the central bank’s 2%-4% target range. Our expectation is that core inflation will stay below the lower bound of the central bank’s 2-4% target range throughout 2018, and will likely only show notable pickups by yearend and through 2019 as the output narrowing gap advances.

January’s surprise puts an upside bias to our 2.5% yearend inflation forecast. However, the strengthening of the Chilean peso and a still-negative output gap will likely contain inflationary pressures. A gradual acceleration to 2.8% by the end of 2019 is expected as the output gap narrows.

Less conviction for easing bias

In line with market consensus, the central bank of Chile held the policy rate at 2.5% at the first meeting of the year. Revamped communication, which now allows the board to further explain its assessment of the economy, shows the decision was unanimous. Still only four members took part in the meeting, as a replacement for former board member Sebastian Claro has yet to be finalized. Overall, the decision is in line with the central bank’s baseline scenario (outlined in the December Inflation Report, IPoM) for rates on hold for most of this year.

While more easing is still a possibility, the central bank’s messaging appears to be gradually moving away from an easing bias on the back of firmer activity. The press release retained its easing bias, but the board sees that some risks to activity have become more moderate since the 4Q17 IPoM. In this scenario, the central bank would maintain the current level of rates (deemed to be expansionary) until the output gap begins to close (2H18). Nonetheless, the board indicated it remains vigilant to signs of delayed inflation convergence to the target, something that would warrant increasing the monetary stimulus.

We expect the policy rate to remain stable at 2.5% during 2018, as inflation stays low and the activity recovery unfolds. The normalization process will start next year, as the output gap narrows (year-end rate of 3.5%). 

Large fiscal deficit despite recovering mining revenue

In 2017, Chile registered its fifth consecutive fiscal deficit. The fiscal deficit reached 2.8% of GDP, up from 2.7% of GDP in 2016, slightly above the government’s own 2.7% forecast. Revenue increased 4.7% in real terms from 2017 (1.1% in 2016), boosted by a recovery in mining operation revenue. Private mining operation revenues posted a notable increase, while income from public operations rose 47%. VAT revenue rose by 4.8% (2.1% in 2016). Revenue growth is expected to surpass 7% this year, as mining income continues to recover.

Expenditures grew by 4.7% in real terms, up from 3.8% in 2016 and above the initial 2.7% approved in October 2016. This was mainly the result of lower-than-forecasted inflation in the year, and less so by government outlays exceeding the budget by 0.5%. The 6.5% expansion in current expenditures was led by health and education, while capital spending fell 3.1%.

As a result, Chile’s 2017 structural deficit came in at 1.7%, from the 1.1% recorded in the previous year. The government estimated a smaller, 1.5% structural deficit this year in its 2018 budget, in line with the commitment to narrow the structural imbalance by a quarter point each year. We estimate a nominal deficit of 1.9% for this year and 1.5% in 2019. Higher copper prices, larger tax revenue amid stronger growth and fiscal prudence following the sovereign rating downgrades will support the narrowing.

A market-friendly cabinet

President-elect Sebastian Piñera’s incoming cabinet (March 11) is comprised of numerous former ministers and parliamentarians. There were no major surprises and overall the cabinet is technically sound. The center-right coalition supporting Piñera does not have a majority in Congress (holding only 44% of the senate and 47% of the lower house), so the advancement of policy will require negotiation. Piñera campaigned on fine-tuning Michelle Bachelet’s reform agenda, rather than a more aggressive reversal of the changes implemented during the outgoing administration.

Felipe Larraín repeats his stint as Finance Minister. Larraín has a PhD in Economics from Harvard and vast experience as an international consultant and academic. Larraín will have to address Piñera’s desire for a decreased tax burden, amid the limitations from fiscal deficits. Hence, a milder simplification of the tax law is more likely at first. In charge of the Economics, Development and Tourism Ministry is José Ramón Valente, a well-known private sector economist and consultant.

Familiar faces reside in posts within the “political wing” of the cabinet. Campaign Advisor Gonzalo Blumel is the Secretary of the Presidency (Chief of Staff), while Cecilia Peréz retakes the Government Secretary Post. Andrés Chadwick also returned to the Interior Ministry.

One unexpected choice is that of Gerardo Varela to lead the Education Ministry. A lawyer, who has served in the board of a handful of private organizations with interests in the educational sector, will raise interest in how he steers a portfolio that faced student protests in Piñera’s first term. Piñera has committed to preserve the free education plan established under Bachelet, and include technical scholarships. Since then, Congress approved the bill, with widespread support, legally providing free education for 60% of the most vulnerable students. Free education may eventually extend beyond the 60%, depending on economic performance (for example, once structural fiscal income meets certain targets). Meanwhile, Piñera’s former Foreign Relations Minister Alfredo Moreno will lead the Social Development Ministry and tackle some of Chile’s thorniest social issues, including a comprehensive reform of child protection services.

Piñera will take the reins of the economy aided by improving global factors. Even so, the former president will probably move cautiously, mindful not to alienate too many political players given the importance of negotiations in Congress. 


João Pedro Bumachar
Vittorio Peretti
Miguel Ricaurte


Please see the attached file for all graphs.

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