One Swallow Does Not A Summer Make
We have revised our forecasts: (i) We now expect GDP to grow 2% in 2016, down from 2.5% previously; (ii) The current account deficit will be around 2% of GDP in 2016 and will increase another percentage point of GDP in 2017; (iii) The fiscal deficit will be close to 4.0% of GDP both in 2015 and 2016; (iv) Our December 2015 forecast for inflation is 4.3%, and for December 2016 it is 3.5%. Inflation will remain above 4% for the first half of 2016. After that, disinflationary pressures will take over and inflation will slowly trend down, falling below the 3% target in 2017; (v) Our current scenario is that the Central Bank will implement a rise of 25bps in December and another hike after the December Monetary Policy Report (possibly February), and then keep the rate fixed for a long time.
The latest GDP data, corresponding to the third quarter of 2015, show that although activity remains weak, a mild recovery seems to have taken place. However, the positive news should be taken with caution: The government continues to play an important role in the expansion of the economy (at least in accounting terms), there are elements that could well be transient, and international macro conditions have deteriorated. Nor do other recent data suggest that the country is on a path to recovery.
In the third quarter imports recovered while exports continued to fall. The trade balance surplus fell and the current account deficit increased. Most of the deterioration in the current account can be attributed to an additional drop in the terms of trade. It is important to notice that FDI is still the main source of external financing.
In response to the terms of trade deterioration, the peso has experienced a strong depreciation. Throughout 2015 the peso has been one of the emerging market currencies that depreciated the most. Nevertheless, in multilateral terms the peso has been more stable relative to the US dollar, so the country has not gained as much in competitiveness as it may appear by looking just at the peso/USD exchange rate.
The budget for 2016 was recently approved by Congress. The Central Government’s total expenditure will increase by 4.4% in real terms. Even though this implies a substantial fall in the rate of growth of government spending, we have to consider that expenditure will continue to grow more than GDP. The budget also contemplates increases in specific taxes, as part of the tax reform. With the increase in expenditure, the increase in non-copper tax collection and the fall in income coming from the mining sector, the fiscal deficit will be similar to this year’s.
Down the road, the combination of sluggish growth, continued current account and fiscal deficits and the deterioration of the net asset position of the government may well result in a downgrade of Chilean sovereign debt.
Inflation continues to run above 4%. The four elements that have kept inflation high are the depreciation of the peso vis-á-vis the US dollar, the mechanical effect of the tax increases on some specific goods in the final months of 2014, low unemployment plus high increases in labor costs, and inflationary inertia and persistence. On the other hand, medium-to-long term inflationary pressures continue to moderate.
After keeping the Monetary Policy Rate (TPM) steady at 3% for a year, the Central Bank decided to raise it to 3.25% in October. The Central Bank is launching a preemptive war against the potential de-anchoring of expectations. Another reason for raising the TPM is what one might call the “Vergara effect”. Since the current President of the Central Bank Rodrigo Vergara took office, the Bank has only cut the TPM, never raised it. The exchange rate is not mentioned in the minutes, a fact that supports the idea that we are far from an intervention in the FX market.
The 2015 will be sadly remembered among Chilean financial actors. It has been a year full of financial scandals: Penta, Banco de Chile, Soquimich, CMPC and now one involving the former Chairman of Consorcio Financiero.
A recent scandal in the Chilean soccer federation has underlined the crisis of confidence that all the country's major institutions are facing. Although for years public opinion polls have provided evidence of this phenomenon, there are few signs that the institutions – or those running them – are willing to change. This may be explained in Acemoglu and Robinson's Why Nations Fail, which teaches us that while inclusive institutions lead to long term growth and stability, elite-dominated extractive institutions are much harder to change.
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