Itaú BBA - The debate on labor reform goes to the justice

Scenario Review - Chile

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The debate on labor reform goes to the justice

Maio 5, 2016

Low commodity prices, less fiscal support and low confidence will continue to limit a recovery.

Please see the attached file for all graphs.  

• We expect the economy to grow 1.8% this year, as the economy is affected by poor confidence and low copper prices. Next year, we anticipate a modest pickup, to 2.3%.

• The external environment for emerging market improved. We now expect the exchange rate to reach 685 pesos to the dollar by the end of 2016 (700 previously), depreciating to 695 by the end of 2017 (700 previously). The current account deficit would reach 1.7% of GDP this year and 2.2% in 2017.

• The strengthening of the peso helps disinflation. The below-potential growth amid well-anchored inflation expectations will also help to bring inflation down. We see inflation reaching 3.5% by year-end 2016 and slowing to 3.0% in 2017. 

• With low growth and declining inflation, we expect no additional rate hikes this year or the next, so the policy rate would end both years at 3.50%.

• The labor reform bill was finalized, but parts of it were deemed unconstitutional by the highest court in the country. Government support remains at low levels.

Labor market loosens

Growth likely reached 1.8% year-over-year in 1Q16, according to Imacec (the monthly GDP proxy), up from 1.3% in 4Q15. Activity in the quarter was favored by the leap-year effect. The seasonally-adjusted indicator - which also corrects for working-days – grew by a more modest 1.5%, around the same rate recorded in 4Q15. At the margin, activity improved (4.7% qoq/saar) following a very weak 4Q15 (0.3%). 

The main drag on growth is coming from the Mining sector, but Manufacturing is also weak. Mining activity contracted 2.0% year over year in 1Q16 (-0.7% in 4Q15). The decline in mining production is spilling over to manufacturing, as indicated by the poor performance of manufacturing of metal products. Industrial production fell by 0.8% in 1Q16 from last year (-1.0% in 4Q15).

Meanwhile, momentum for private consumption came in mixed, as retail sales picked up from 4Q15, while supermarket sales slowed. Still, both indicators exhibited stronger growth than headline Imacec. Retail sales expanded by 4.0% year over year in 1Q16, while supermarket sales were up by 3.2%.   

The labor market is now loosening more visibly. The national unemployment rate picked up to 6.3% in 1Q16 (6.1% in 1Q15) as employment growth decelerated. Furthermore, waged jobs were virtually unchanged from last year, while self-employment was the main force behind the 1.3% annual gain in employment. Although the labor market is deteriorating, we note that the rise in unemployment rate is significantly smaller than the one registered in the Santiago metropolitan area (9.4% in 1Q16 versus 6.8% one year ago). As the economy continues to grow below potential, we anticipate a 7.1% average unemployment rate for 2016, above the 6.3% recorded last year.

Low private sentiment continues to play a role in the weak economic activity evolution. Business confidence in April was once again below neutral (50), adding 25 months in pessimistic territory, according to think-tank Icare. Meanwhile, Adimark’s consumer confidence sits at 35.5 points in March, below the 39.7 points recorded in the equivalent period of 2015.

We expect GDP growth of 1.8% this year, below the 2.1% recorded in 2015. Low commodity prices, less fiscal support and low confidence will likely limit a recovery. We expect a 2.3% expansion next year. Less uncertainty over reforms (as many of them are approved) could help the economy somewhat.

Lower trade surplus ahead

With a USD 1.9 billion trade balance in 1Q16, the resulting 12-month rolling trade balance surplus fell to USD 3.1 billion (from USD 3.5 billion in 2015). Exports continue to contract sharply (10.9% year over year, compared with the 19.3% fall in 4Q15), mostly due to weak mining exports. Imports (FOB) also declined by double digits (10.2% year over year in 1Q16, versus a contraction of 14.5% in 4Q15), reflecting a weaker currency and low internal demand.

We anticipate the trade surplus will continue to narrow this year as mining exports are negatively affected by the low copper prices. We expect a trade surplus of USD 1.6 billion (USD 3.5 billion in 2015). However, we see the current account deficit stable from last year, at 1.7% of GDP this year. As economic activity recovers modestly next year, we expect the current account deficit to widen to 2.2% of GDP.

With the better environment for emerging market currencies, the Chilean peso strengthened further in April. We now expect the exchange rate at 685 pesos to the dollar by the end of 2016 (700 previously) and at 695 pesos by year-end 2017 (700 previously).  

Less pressure on inflation

Inflation is still above the target range, but it is retreating. Inflation in March moderated to 4.5%, from the 4.7% registered in the previous month. A strengthening peso from the beginning of the year is likely helping to reduce inflation: tradable inflation decelerated to 4.0% (from 4.5% in February). Meanwhile, non-tradable inflation was stable, at a high 5.0%, reflecting the indexation mechanisms in place. In any case, our diffusion index is moderating, also supporting the view that domestic prices are losing momentum.

We continue to expect inflation at 3.5% by year-end (4.4% in 2015), as the exchange rate and the negative output gap continue to favor disinflation. For 2017, we expect inflation to return to the central bank’s 3% target.

No further hikes this year

In April, the central bank of Chile left its policy rate unchanged, at 3.50%, as was widely expected. This was the fourth consecutive stay-on-hold decision. In the minutes board members highlighted the importance of being explicit that the pace of monetary policy normalization will likely be more gradual than previously indicated. Consistent with this, the latest monetary policy report assumes only one additional 25-bp hike this year.

We expect no further hikes this year or the next. With growth still low and inflation entering a downward trend, it is unlikely that the central bank will resume the tightening cycle. However, given that inflation is still high and a tightening bias is still in place, the risk for our forecast is tilted to higher interest rates.

A weakened labor reform bill

The Senate gave its final approval to the labor reform bill following an almost 16-month discussion that produced two different versions of the legislation and required a bicameral commission to reconcile them. The bill strengthens collective bargaining rights in Chile, and it was criticized by some as a departure from business-friendly regulation in the country. Unions will now be the exclusive representative of workers in negotiations with management. Previously, non-unionized workers could form “negotiation groups” regardless of the presence of a union in a firm. Moreover, benefits negotiated with the unions cannot be automatically extended to non-unionized workers.

Internal and external worker replacement is forbidden during strikes. However, unions must supply “minimum services” – a concept to be defined by management and unions prior to the start of negotiations – “to avoid significant and irreversible damage to the firm, the environment or interested parties.”

Constitutional Court rejected part of the bill. The signing of the bill into law by President Bachelet will be delayed as the center-right opposition searched for clarity on the legality of some aspects of the bill. The Constitutional Tribunal ruled that the provision that unions will be the exclusive representative of workers in negotiations is unconstitutional.  Additionally, it ruled as unconstitutional the measure to allow for automatic extension of previously negotiated benefits to newly unionized members.

In light of all this, President Bachelet continues to face declining popularity. The approval rating for Ms. Bachelet came in at 29% in April (26% in the previous month), according to Adimark. The disapproval rate is at 65%. Governance areas that are hindering the president’s evaluation include the manner in which state corruption is addressed and the so far ineffective fight against crime. Labor reform received a 41% approval rating from respondents (the same as in March), which is still below the overall disapproval rating (46%).


João Pedro Bumachar
Vittorio Peretti
Miguel Ricaurte


Please see the attached file for all graphs.  


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