Recovery or Wishful-thinking?
Executive Summary
The economy continues on a slow recovery path. GDP data released this month shows that the second half of 2014 was better than the first. Consumption decelerated, but overall it has been more stable than investment. Consumption has been helped by low interest rates, low unemployment and rapid wage growth.
Investment is showing a modest pickup, mostly driven by public investment. We know that part of the story is the end of the investment boom in the mining sector, but another part is the domestic confidence shock provoked by uncertainty around the recent round of reforms.
Fiscal spending is playing an important role in boosting both consumption and public investment. This was announced by the government as part of its plan to reactivate the economy.
Inflation has systematically surprised markets on the upside over the last few months. The devaluation, the reversion of the international price of fuels, the robust labor market, and tax increases have all contributed to contain deflationary pressures coming from slow growth.
In spite of increasing inflation, during 2014 the Central Bank reacted to the deceleration of the economy cutting its reference interest rate. Recently the President of the Bank said that he does not see the need for further cuts in the near future, and the just-released Inflation Report expressed a greater concern with inflation dynamics than earlier reports.
In our base scenario the economy will grow around 2.7% in 2015. The main question mark pertains to private investment. We continue to expect both investment and consumption to recover slowly.
Our inflation forecast for December 2015 has increased again. This is the consequence of a series of unexpected shocks, related to the pass-through of tax increases, the devaluation of the peso, the rebound in the international price of gasolines, among other.
Our new base scenario is that the Central Bank will not engage in a new cutting cycle. We expect the Central Bank to keep the Monetary Policy Rate at the current 3% for several months.
On the political front, the most recent polls show that President Michelle Bachelet’s popularity continues to plummet. The Chilean public has been exposed to months of scandal, ranging from a tax fraud investigation to revelations that the president’s son may have used his official government position to secure business deals for his wife’s company.
But there is a more troubling problem. The tax fraud investigation has shed light on how different private sector companies finance politicians from across the political spectrum.
The problem is not exclusively Chilean. As society becomes more complex, political parties find it difficult adequately to represent its demands. Yet one thing is not knowing how to respond. It is quite another to continue functioning as if nothing is wrong.
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