Lower commodity prices and slowdown in China: a dangerous duo for Chile
Like most commodity-exporting countries, Chile has suffered and continues to suffer from simultaneous macroeconomic and financial woes for two reasons:
• Standing at 29% and 57% respectively, exports of agricultural and fuel & mining products account for nearly 90% of Chile’s total exports.
Chilean exports fell 2% in the first three quarters of 2015, which had a negative impact on GDP (-0.6%) (See Graph 1). However, because of a technical recovery and gains in competitiveness linked to lower nominal wages, Chile’s exports are expected to return to positive growth rates. However, since we are predicting a continuing slowdown in China and have just revised our US growth projections downward, it is best to remain cautious and avoid overestimating the Q4 2015 and 2016 rebound.
Furthermore, plunging commodity prices – particularly copper in Chile’s case – have resulted in a decrease of export earnings and a fall in private investment. Since early 2014, falling investment has been the main stumbling block for the Chilean economy. Foreign direct and indirect investment have also been volatile and have done little to help stabilise the Chilean economy (See Graph 2). Ultimately, investment fell by more than 6% in 2014. Under the influence of a positive third quarter (+7%), investment rose 0.6% on average in the first three quarters of 2015. In our view this rebound, which clearly indicates that the worst is over, bodes well.
In this sense, the trend data for the month of November point to a sharp increase in economic activity, positive industrial output growth and higher retail sales.
However, should today’s low commodity prices sink further or persist, this could delay the recovery in investment and force us to downgrade our growth forecasts. Moreover, some economic indicators proved to be disappointing in December. For instance, retail sales grew only 1.9% year-on-year compared to 3.1% the previous month. Meanwhile, manufacturing output fell 2.8%, far more than in November (-0.2%), not to mention the sharp contraction in the mining sector (-4.6% year-on-year). In fact, signals pointing to a deceleration of the real economy coupled with a slight pick-up in inflation prompted the Central Bank of Chile to keep its key rates unchanged during its recent Monetary Policy Meeting despite the fact that December’s monthly CPI inflation, at 4.38%, was slightly above the upper bound of its target (4%).
We think that Chilean monetary policy will remain accommodative (see the paragraph below) so that in 2016, investment is expected to continue rising and make a positive contribution to GDP growth.
The Central Bank of Chile was relatively accommodative given the depreciation of the peso and rising inflation
The peso did not escape the wave of deprecation that hit all emerging currencies, in particular the currencies of commodity-exporting countries. As a result, the peso depreciated by more than 25% against the dollar in the space of two years. This depreciation accelerated the inflationary trend that began taking hold in 2013. Consequently, in March 2014 inflation exceeded the upper bound of the target (4%) established by the Central Bank. However, notwithstanding creeping inflation, monetary policy remained accommodative. It was not until October 2015 that the Central Bank decided to raise its key interest rate (50bp in three months).
However, we think that this tightening of monetary policy had more to do with the anticipation of tighter US monetary policy than with inflation, as the objective was to curb capital outflows and put further pressure on the peso. In fact, the decision was made even though inflation had fallen back below its upper bound. Moreover, as we previously pointed out, this cycle had already been interrupted during January’s Monetary Policy Meeting.
We note that the inflationary impacts linked to the depreciation of the peso were limited by the sharp drop in imports. In fact, as early as the last quarter of 2013, we began to notice a sharp drop in imports, which helped to contain the effects of exchange-rate pass-through to inflation. Imports fell by nearly 7% in 2014 and a little more than 1.5% in the first three quarters of 2015. Furthermore, this drop in imports made a positive contribution to GDP growth. Looking ahead, we think the prospect of weak imports will last throughout 2016 and will not hurt growth.
Furthermore, assuming, as we did above, that the pass-through effects of the depreciation in the value of the peso on inflation will continue to be limited, then Chilean monetary policy may not turn out to be as restrictive as expected by the market, especially as China continues to export its deflation and since we just scaled back the number of our projected Fed funds rate hikes (to just one rate hike of limited size by the end of 2016).
We also think that Chilean monetary policy was and will remain relatively accommodative so that investment and consumption will not be heavily penalised.
Sufficient budgetary room to manoeuvre to offset an additional negative shock
Public and private consumption are the two main drivers of Chilean economic growth, contributing 0.5% and 1.5%, respectively, to GDP growth in 2014 and during the first three quarters of 2015.
However, due to the downward adjustment of real wages induced by a nominal wage adjustment, the growth of private consumption slowed in 2015. This real wage adjustment is expected to continue in 2016, especially since the labour market has started to deteriorate (slight uptick in the unemployment rate). By contrast, households will continue to benefit from lower commodity prices and consumer-friendly budget initiatives.
With public debt standing at less than 20% of GDP, notwithstanding the fact that the government deficit grew in 2015 and could exceed 3% according to the IMF, budgetary policy has sufficient room to manoeuvre to adopt countercyclical measures to absorb a prolonged or additional negative shock to commodity prices.
As we state in our title, Chile should hold up well again this year with our projected 2016 growth estimate of 2.5%. At the same time, we do not deny that the downside risks are becoming increasingly serious. In this regard, we point out that both the Central Bank of Chile and the IMF have recently revised their 2016 growth forecasts downward by nearly 0.5 percentage points, i.e. an estimated rate of growth of between 2% and 3% for the former institution and 2.1% for the latest.
Faced with falling commodity
The Central Bank was
The authorities have the