Rodrigo Vergara: The Monetary Policy Report and the Financial Stability
Report
Presentation by Mr Rodrigo Vergara, Governor of the Central Bank of Chile, before the
Finance Commission of the Honorable Senate of the Republic, Santiago de Chile,
18 December 2012.
The Monetary Policy Report of December 2012 and the Financial Stability Report of the second half of 2012 can
be found at http://www.bcentral.cl.
* * *
Introduction
Mr. President of the Senate's Finance Commission, Senator Jose García, senators members
of this Commission, ladies and gentlemen,
I appreciate your invitation to present our Board's vision on recent macroeconomic and
financial developments, their prospects and implications for monetary and financial policy.
This vision is contained in detail in our Monetary Policy Report of December 2012 and our
Financial Stability Report
of the second half of 2012.
The year that is ending has brought good news to our economy. The inflationary fears we
expressed early in the year have abated. This year our economy will grow 5.5 percent.
Unemployment is low, labor income is growing steadily and consumer and business
expectations are optimistic. Investment is high by historic standards.
A year ago, when we presented our reports to this Commission, we foresaw that the
deepening of the Eurozone crisis at the time could have significant effects on our economy,
including a major slowdown during 2012. It did not. Although the world economy froze
significantly in the last year, other important dimensions of the external scenario, such as the
terms of trade and international financial conditions, took a course that is favorable to us.
Actually, Chile's economic performance has been quite different from that of many other
countries. The main advanced economies are still struggling with the consequences of the
financial crisis that resulted in the world recession of 2009. They have a long road ahead to
resolve the imbalances and weaknesses associated with this situation before they can
resume sustained growth. The Eurozone countries have made progress in resolving their
fiscal and financial problems, as well as strengthening the institutional pillars of the monetary
union. These steps have been welcome by the markets, but the efforts must continue.
Achieving a solution is a slow, costly and complex process, considering the great number of
players involved. There is also the ongoing deterioration of the economic situation, which
only makes things worse and complicates the required adjustments. Countries suffering
negative growth rates and high unemployment for too long already cannot easily implement
new austerity measures. Furthermore, the core European economies, which until recently
had been relatively spared of the recession of the peripheral countries, have begun showing
signs of weakness. Accordingly, the risks in the Eurozone remain.
In the United States, the recovery of output and demand is weak, insufficient to quickly
absorb its high unemployment. The Federal Reserve has undertaken to keep an
ultraexpansionary monetary policy in place for as long as this situation persists and does not
jeopardize inflation, which has important implications for the global financial scenario that the
Chilean economy will continue to face in the coming years. Plus, the U.S. has a high fiscal
deficit that reflects in an excessive increase of its public debt. If a political agreement is not
achieved, early next year a number of automatic adjustments of taxes and expenses (the
socalled fiscal cliff) will be forced into the economy. Given the sluggish growth in this country, if
they have to apply such major adjustments, the economy will relapse into a new recession.
Unfortunately, when the deadline is only days away, there are no signs of agreement in sight.
The emerging world continues to outperform the developed economies, although with greater
diversity within the group. In China, indicators suggest that growth is picking up after the
deceleration of most of 2012. Latin America, meanwhile, has shown reduced growth during
the year and the outlook for the next two years has also been revised downward. The
slowdown has been sharper in Brazil and it is not clear what the velocity of its recovery will
be. Mexico and Colombia have also begun giving signs of a slowdown. Peru continues to
grow strongly, while Argentina is dealing with major adjustments.
The Chilean economy has remained on an upward slope, driven by strong domestic demand
and, particularly, fixed investment. Also, private consumption has increased in line with the
significant increase in personal income. Still, we face significant risks, which I will look in
more detail in a moment. Those coming from abroad have to do with the world economic
situation I just described; domestically, they relate to the possibility of an exacerbation of
output and expenditure.
Beyond these risks, in the baseline scenario that today we believe to be the most likely, the
Chilean economy will resume growth in line with the trend, while inflation will gradually return
to levels that are consistent with the target. Let me now describe this scenario and the risks
we have identified.
Macroeconomic scenario
The macroeconomic scenario facing the Chilean economy has not changed significantly in
the past several months. As I just said, Chile's output, and especially domestic demand, has
grown above expectations. Some progress has been made abroad, but the risks derived
from the Eurozone crisis are still present. In this context, headline inflation has fluctuated
substantially in recent months, due to one-time events associated with supply shocks. Core
inflation - discounting foodstuffs and energy - has declined slightly to near 2 percent y-o-y.
The Board, continuing with what has been the tone throughout the year, held the monetary
policy interest rate at 5 percent.
Domestic situation
As of November, y-o-y CPI inflation was 2.1 percent, after rising to almost 3 percent in
October (figure 1). Y-o-y growth in nominal wages has remained roughly constant in the 6%
to 7% range, although with differences across sectors.
Output, meanwhile, grew 5.7 percent y-o-y in the third quarter of 2012, flat from the previous
quarter, but more than expected. The Economic Expectations Survey (EES) of August -
available at the closing of the previous Monetary Policy Report - forecast 4.6 percent growth
for said quarter. The greater increase was due to better performance in general. However,
output's velocity of expansion dropped from 8.3 to 5.7 percent annualized.
In the baseline scenario, the Board estimates that GDP will grow 5.5 percent this year. This
projection is higher than the ceiling we estimated in September, with a similar revision as has
been made in private forecasts. Still, both our forecasts and private ones have experienced
sustained upward revisions in the past year (figure 2).
On the domestic spending side, third quarter growth (i.e. 8.0 percent y-o-y) largely surpassed
second-quarter figures, however swollen by some specific factors. While every component of
expenditure posted higher increases, the large increase in machinery and equipment
investment is worth noting: 19.9 percent y-o-y. The acceleration of domestic spending
amplified the negative current account balance, which in the third quarter went to 2.9 percent
of the GDP accumulated in the last year. The baseline scenario assumes that the deficit will
end the year 2012 at 3.8 percent of GDP, exceeding September's forecast of 3.2 percent.
Meanwhile, the national financial system has operated normally in a context of strong
investment and favorable external credit conditions. Household credit has continued to grow
in tandem with disposable income, although the increase in loans by non-bank suppliers -
with a higher penetration in lower-income households - has been smaller than in previous
periods. Corporate debt has grown somewhat above GDP, driven by strong local banking
credit and external financing via bonds, in a context of favorable financing conditions in
international markets. In turn, the banking system keeps robust indicators, with capital
significantly above regulatory levels, a more diversified external funding base, and a stable
liquidity position.
Toward 2013, the Board estimates that GDP growth will be within the range of 4.25 to
5.25 percent. This range is above the one foreseen in September. In this scenario, domestic
demand will increase 5.7 percent y-o-y, further amplifying the current account deficit to
4.6 percent of GDP. This projection supposes that macroeconomic conditions facing the
Chilean economy will remain fairly unchanged in the near future, and that the economy will
grow in line with trend rates, which the Board continues to estimate around 5 percent
(table 1).
Internationally, the baseline scenario foresees that in 2013 and 2014 the world economy and
Chile's trading partners will grow by averages of 3.6% and 3.8%, respectively, not far from
those of 2011-2012. Important differences remain between the performances of the
developed world and the emerging world. The recession in the Eurozone has settled and is
expected to last some more time. Expectations regarding the United States are that it will
continue to recover at a slow pace, and that moderate adjustments to the fiscal policy will
take place. The downgraded outlook for Japan needs mention, due to both its relation with
the Eurozone and some fiscal adjustment measures foreseen for 2014. In the emerging
world, incoming data from China suggest that the slowdown of most of 2012 may be
reverting. Thus, again y-o-y growth rates around 8 percent are forecast for the Chinese
economy for 2013 and 2014. Growth prospects for Latin America are revised downward for
this and the next two years.
In this scenario, commodity prices will not change much from forecasts a few months back.
In the two-year period 2013-2014, the baseline scenario foresees average prices of
US$3.45 per pound of copper and US$102 per Brent oil barrel. Accordingly, terms of trade
estimates for Chile continue to be high, but lower than they were this year (table 2).
External financial markets have shown some calm these months. However, as I noted at the
beginning, there is still a long way ahead before the Eurozone crisis can be resolved. The
commitment of various organizations to work out a solution seems to be bearing fruit in the
market's evaluation. Anyway, the baseline scenario again considers the possibility of new
stress episodes in the world markets. Such greater calm has also reflected in stock markets
and currency parities. In recent months, the U.S. dollar has depreciated slightly against the
main currencies. The peso/dollar parity, with ups and downs, is somewhat lower than in the
previous Monetary Policy Report, while the real exchange rate (RER) has shown no
significant variation. The Board continues to estimate that, with the prevailing nominal
exchange rate and currency parities, the RER is in the lower part of the range of values
consistent with its long-term fundamentals (figure 3).
In the baseline scenario, y-o-y CPI inflation will stand below the tolerance range in the
coming months, to start rising later and approach 3% by the end of 2013 and over the
projection horizon, this time the last quarter of 2014. There are several factors explaining the
lower figures foreseen for the near future, including the high basis for comparison of late
2011 and the turn of 2012. Core inflation will post y-o-y variations below 2% over most of
2013, then it will rise gradually to near 3% over the course of 2014 (figure 4).
This path assumes that wages will grow in line with productivity and target inflation. In
addition, it relies on the methodological assumption that, over the projection horizon, the
RER will be fairly unchanged from its recent values. Finally, the baseline scenario uses as a
working assumption that the MPR trajectory will be stable, as suggested by the latest
surveys available at the statistical closing of this Monetary Policy Report (figure 5).
The baseline scenario reflects those events that are believed to be the most likely with the
information at hand at the closing of this Report. There are risk scenarios, however, which if
materialized, may reshape the macroeconomic environment - in some cases, significantly -
and therefore, may alter the course of monetary policy. On this opportunity, having evaluated
the alternative scenarios, the Board estimates that the risk balance is unbiased for both
output and inflation.
In the world economy, the main risk continues to be the situation in the Eurozone. On
one hand are the difficulties in implementing agreements. On the other, like I said, as
time has passed, the economic situation of the most affected countries has complicated
further, while core European economies seem to be taking a turn for the worse. A
sharper deceleration in Germany or France could aggravate the problems in the region
and amplify pass-through channels to other economies. Neither can this analysis rule out
episodes of volatility in the financial markets that could be more severe than the ones
considered in the baseline scenario.
However, the potential effects on Chilean banks of a deepening of the crisis in the Eurozone
are still bounded. While banks' profitability and solvency indicators have dropped most
recently, stress tests show that the banking system's level of capital is appropriate to absorb
the losses caused by a risk scenario of this kind.
Another risk is the ongoing discussion in the United States to ward off a sharp fiscal
adjustment in 2013. Failure to reach an agreement could significantly hamper growth and
increase market volatility.
And central banks of developed economies have continued to boost, and even intensify, very
expansionary monetary policies, which can bring consequences on capital flows, asset
prices, currency parities, commodity prices and credit growth in the other economies,
including Chile. So far the domestic effects of these policies have been limited, but they are
certainly a source of concern.
Finally, in the emerging world, the biggest risk continues to be the pace of economic activity.
Incoming data indicate that China has resumed strong growth, but the weakening of Europe
and pending discussions in the United States could affect the Chinese economy, and through
it the emerging world. Chile would be especially affected because of its incidence in the
determination of the copper price. In addition, the recent drop in world trade growth figures is
cause for concern.
In Chile, despite particularly low inflation, medium-term inflationary risks remain present. The
sustained dynamism of Chile's economic activity has intensified the use of installed capacity,
and a strengthening of domestic demand could trigger inflationary pressures incompatible
with the inflation target. So far, inflation has remained bounded and has even decreased. Our
evaluation is that the recent drop is a transitory event that will be gradually reversed within
the next few quarters to return to levels around the Central Bank's target. Behind its recent
performance there may have been factors such as compressed trade margins, increased
mean labor productivity and lower prices of imported goods. However, these are typically
procyclical factors, so it is quite possible that their effects are transitory. With this uncertainty,
one must not overlook the medium-term inflationary risks of a more dynamic trajectory of the
economy.
A more dynamic domestic demand could also amplify the deficit of the current account of the
balance of payments and increase the economy's external vulnerability, eventually
confronting it with costly potential adjustments. The Board pays close attention to the
evolution of the current account deficit. Its level, persistence, composition and funding
sources are all aspects that may affect the vulnerability of the Chilean economy, particularly
if confronted with adverse external scenarios.
However, the current deficit has several peculiarities that mitigate the associated risks. First,
a significant part is explained by higher investment in a number of projects aimed at the
production of exportable goods and services. Second, a major part of the deficit is being
financed via foreign direct investment rather than external debt. Finally, the evolution of
domestic and external credit is showing no signs of overborrowing by either households or
firms. Accordingly, the evolution of private consumption does not divert far from the increase
in labor income, the low rate of unemployment and financial conditions. Similarly, from a
longer perspective, in nominal terms, the ratio between private consumption and private
national disposable income is close to its historic average.
Overall, an increase in the current account deficit could entail unwanted risks, which is
particularly important in a context where sudden changes may occur in macroeconomic
conditions, which could precipitate difficult adjustments to the national economy. In the past,
most of the crises that the country endured were preceded by high and persistent current
account deficits, an excessive increase in borrowing, and important currency mismatches.
However, today's economic policy framework is more advanced, including a rule that
governs fiscal policy and cushions the impact on public expenditure of both copper price
fluctuations around its long-term trend and the ups and downs of the business cycle. It also
includes a floating exchange rate regime that puts currency risks under the light allowing an
early response to sudden changes in external conditions. And it contemplates proper
financial regulation and supervision to prevent the incubation of excessive risk. Accordingly,
the Board estimates that it is paramount to closely monitor those factors that are behind the
current account deficit, in order to avoid the incubation of imbalances that may affect the
future performance of the economy.
Another risk factor we have identified is the dynamic of the real estate sector. In mid year, we
called the attention to the evolution of real estate prices, with a focus on some districts.
Today, seeing that some of those trends have deepened and widened, we need to return to
this topic. As we have noted and is now part of public debate, during the last few quarters
real estate prices have been steadily increasing in some districts and for some types of
construction (table 3). Aggregate prices of office space also continued to grow, but less than
did residential prices.
In the residential sector, the sales of houses and apartments have risen substantially,
especially in blueprint or catalog stage, indicating some shortage in the short-term supply
(figure 6). In the commercial sector, although the available vacancy indicators are still low,
private real estate firms continue to forecast significant growth in the supply of office space
for this purpose.
Although such price increase can find justification in its macro and microeconomic
fundamentals, it must be monitored closely. These price increases have occurred in a
context of high growth in housing demand and a significant expansion in output in the sector,
accompanied with higher leverage among real estate firms. Meanwhile, and because of the
stage of the supply-demand cycle the residential real estate sector is in now, an acceleration
of mortgage credit in the medium term cannot be ruled out. It must also be kept in mind that
the lending standards for these credits have eased somewhat, which reflects in an increase
in the fraction of the property price that is lent (figure 7).
This type of developments could create vulnerabilities in the real estate and construction
industry, or in those households searching for a new home. It is also worth noting that the
current combination of higher property prices, low long-term interest rates, favorable lending
standards and higher volatility of other financial asset categories, configure a scenario that
could motivate an increase in financial investment in the sector, potentially exacerbating
these risks.
Therefore, we have stressed how important it is that agents consider these risk factors when
evaluating their investment and lending decisions in the sector. In particular, these decisions
need to bear in mind that past price increases are no guarantee of further increases in the
future. We believe that raising this type of alert, thus increasing the amount of information
available for risk assessment, is part of our role of promoting the normal functioning of the
financial system. We believe that the extended discussion that has taken place on the topics
of the real estate sector is extremely valuable.
Another risk factor requiring close attention is the evolution of medium-sized banks.
Recently, credits granted by these banks have increased faster than those of other banks
(figure 8). There is certainly a positive side to it, as it implies lower concentration of risks in
the system. However, its growth dynamic could become a source of vulnerabilities. On one
hand, because of higher exposure both to those sectors more closely linked to the business
cycle and to individual debtors who, faced with a deterioration of macroeconomic conditions
could be severely affected. On the other hand, because of the higher relative growth of
rollover consumer credit (i.e., credit cards and credit lines). This, because of the possible
underestimation of the risk that these products may cause, as they allow for sharp increases
in borrowing that may affect repayment ability without a timely reflection in the borrower's
payment behavior. Finally, and as has been noted before, the greater reliance of some
midsized banks to wholesale funding makes them more vulnerable to episodes of greater
difficulties in bank lending.
As already noted, the present scenario depicts significant risks that call for policy responses
in different directions. The MPR is within the range of values considered neutral. However,
from the policy makers' perspective, the task of dealing with the challenges posed by this
type of risks goes beyond the scope of monetary policy, and requires the concurrence and
coordination of a broader set of macroeconomic and financial policies. Actually, some of
these risks (e.g., those relating to the current account deficit and the just mentioned real
estate sector) can be observed even in a situation where inflation remains bounded and in
line with the target.
At the international level, we have seen growing interest in the use of macroprudential
measures. This concept covers a significant number of possibilities, some of which are the
direct decision of the central banks while others rely on other authorities. For example, the
potential risks that could be generated in the real estate sector have driven some regulators
and supervisors elsewhere to use a series of prudential instruments to safeguard the
financial system and reduce the sector's volatility. Worth mentioning are the limits to the loan
to value ratio, the limits to the ratio between debt and income, changes in the credit risk
weighting, and capital requirements. The particulars of these measures vary from country to
country, but normally more than one of them applies and entails coordination of several
authorities. Because of its short history, a full evaluation of the results is yet to be done. The
Financial Stability Board, created one year ago in Chile, is a proper instance of coordination
to analyze these issues.
In any case, the Board follows closely the evolution of the external and domestic
macroeconomic scenarios and their implications on inflation, and reiterates its commitment to
conduct monetary policy in such a way that projected inflation stands at 3% over the policy
horizon, as well as to continue to closely monitor any risk factors that could affect the
financial stability of the country.
Let me finish with some reflections.
Final reflections
The Chilean economy is in a good standing. The results we have obtained in the last year
have been quite better than the world's average and much better than we projected a year
ago. But there is still a long road ahead before we achieve the stage of development we all
wish for. Besides, the present situation poses significant risks. Coordination with every
organization in charge of policies is critical to succeed in meeting this challenge.
If the economy continues to grow above trend, or spending exceeds our true possibilities,
especially in some sectors, some imbalances may be incubated that may generate
significant vulnerabilities and require costly adjustments going forward. Our history has
taught us how difficult these adjustments can be, and we must do everything in our power to
avoid revisiting these situations. More so considering that these events hit the most
vulnerable population hardest.
As I have said on previous opportunities, Chile enjoys a high international reputation in many
circles. The laudatory words about our economy recently uttered by the IMF's Managing
Director attest to that. Our country stands out for its soundness, its good macroeconomic
management and the functioning of its institutions. This is an important asset, especially in a
small country geographically distant from economic centers, so that should be valued and
nurtured.
Our duty is to protect this reputation and conduct policies that allow maintaining sustainable
development of the economy economic aiming to achieve greater welfare of our country. Our
contribution as the Central Bank is to keep inflation low and stable. Also to help, within the
scope of our powers, to identify and deal with any risks that may jeopardize the normal
functioning of our financial system.
Thank you.
Figure 1
Inflation indicators
(annual change, percentage)
10 10
8 8
6 6
4 4
2 2
0 0
-2 -2
-4 -4
-6 -6
-8 -8
06 07 08 09 10 11 12
CPI CPIEFE CPIEFE goods CPIEFE services
Sources: Central Bank of Chile and National Statistics Institute (INE).
Figure 2
Gross Domestic Product
(annual change, percentage)
5.5 5.5
5.0 5.0
4.5 4.5
4.0 4.0
3.5 3.5
Dec. 11 Mar. 12 Jun. 12 Sep. 12 Dec. 12
EES GDP 2012 Range MP Report Dec. MP Report forecast
Table 1
Economic growth and current account
(annual change, percentage)
2011 2012 (f) 2013 (f)
MP Report MP Report MP Report MP Report
Sep. 12 Dec. 12 Sep. 12 Dec. 12
GDP 6.0 4.75-5.25 5.5 4.0-5.0 4.25-5.25
Domestic demand 9.4 5.6 6.6 5.5 5.7
Domestic demand (w/o inventory change) 10.2 5.5 6.8 5.8 6.0
Gross fixed capital formation 17.6 7.0 11.3 7.1 7.6
Total consumption 7.9 5.1 5.3 5.4 5.5
Exports of goods and services 4.6 3.5 2.7 3.6 3.0
Imports of goods and services 14.4 4.0 5.5 5.8 5.9
Current account (% of GDP) -1.3 -3.2 -3.8 -4.4 -4.6
(f) Forecast.
Source: Central Bank of Chile.
Table 2
International baseline scenario assumptions
2011 2012 (f) 2013 (f) 2014 (f)
MP MP MP MP MP MP
Report Report Report Report Report Report
Sep. 12 Dec. 12 Sep. 12 Dec. 12 Sep. 12 Dec. 12
Growth (annual change, percentage)
Trading partners 4.2 3.5 3.3 3.8 3.5 4.3 4.0
World at PPP 3.8 3.1 3.0 3.6 3.3 4.1 3.8
United States 1.8 2.2 2.3 2.0 1.9 2.4 2.3
Eurozone 1.5 -0.4 -0.5 0.3 -0.3 1.7 1.2
Japan -0.7 2.7 1.6 1.3 0.5 1.4 0.9
China 9.3 7.8 7.7 8.1 8.0 8.3 8.2
India 6.5 5.8 5.6 7.1 6.6 7.3 6.4
Rest of Asia (excl. Japan, China & India) 4.2 3.5 3.5 4.5 4.3 4.8 4.7
Latin America (excl. Chile) 4.4 3.0 2.8 3.4 3.3 3.9 3.7
(levels)
External prices (in US$) 10.1
LME copper price (US$cent/lb) 400 355 361 340 340 350 350
WTI oil price (US$/barrel) 95
Brent oil price (US$/barrel) 111 113 112 109 105 103 100
(annual change, percentage)
Terms of trade 0.5 -7.4 -5.0 -2.6 -0.8 1.3 1.3
(f) Forecast.
Sources: Central Bank of Chile based on a sample of investment banks, Consensus Forecasts, the IMF and statistics bureaus of
Figure 3
Real exchange rate (*)
(index, 1986=100)
120 120
110 110
100 100
90 90
80 80
70 70
88 90 92 94 96 98 00 02 04 06 08 10 12
RER 1997-2011 average 1992-2011 average
(*) December figure includes information up to 13 December 2012.
Source: Central Bank of Chile.
Figure 4
CPI inflation (1)(2) CPIEFE inflation (2)
(annual change, percentage) (annual change, percentage)
10 10
10 10
8 8
8 8
6 6
6 6
4 4
4 4
2 2 2 2
0 0
0 0
-2 -2
-2 -2
-4 -4
-4 -4
07 08 09 10 11 12 13 14 07 08 09 10 11 12 13 14
MP Report Sep.2012 MP Report Dec.2012
(1) December 2012 figure uses median of monthly inflation forecast in the EES. (2) Gray area, as from the
fourth quarter of 2012, shows forecast.
Figure 5
MPR and expectations
(percentage)
9 9
8 8
7 7
6 6
5 5
4 4
3 3
2 2
1 1
0 0
07 08 09 10 11 12 13 14
FBS first half December 2012 EES December 2012 MPR
Source: Central Bank of Chile.
Table 3
Growth in housing prices (1)
(real annual growth, percentage)
2002-2007 2009-2T2012
Nation-wide total (2) 3.1 5.7
Average of districts with significant increases (3) 1.6 8.3
(1) Averaged y-o-y growth between first quarter of initial year and last quarter of final year in each case.
(2) Obtained using stratified method.
(3) Average of districts with structural growth breakdown, according to methodology of Ferreira and Gyourko (2011).
Source: Central Bank of Chile based on Internal Revenue Service (SII) data.
Figure 6
Housing sales by building phase
(percentage of total)
100 100
80 80
60 60
40 40
20 20
0 0
08 09 10 11 12
Completed Finishes Structural work Other unfinished
Source: Cámara Chilena de la Construcción.
Figure 7
Mortgage debt to collateral ratio (*)
(percentage)
90 90
85 85
80 80
75 75
70 70
65 65
07 08 09 10 11 12
(*) Preliminary figures of new operations approved in respective quarter.
Source: Superintendence of Banks & Financial Institutions (SBIF).
Figure 8
Total loans
(real annual change, percentage)
30 30
20 20
10 10
0 0
-10 -10
07 08 09 10 11 12
System Medium-sized multibanks
Large multibanks Retail banks
Source: Central Bank of Chile based on SBIF data.
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