Rodrigo Vergara: Chile's latest Monetary Policy Report
Presentation by Mr Rodrigo Vergara, Governor of the Central Bank of Chile, of the Monetary
Policy Report before the Honorable Senate of the Republic, Santiago de Chile, 4 September
2013.
* * *
The Monetary Policy Report of September 2013 can be found at http://www.bcentral.cl.
Accompanying figures and tables can be found at the end of the speech.
Mister President of the Senate, Senator Jorge Pizarro, honorable senators, ladies,
gentlemen,
Thank you for inviting the Board of the Central Bank of Chile to present our Monetary Policy
Report. Each September, this presentation coincides with the annual report of the Central
Bank to the Senate, where we share our vision on the recent macroeconomic and financial
developments in Chile and the world, together with the economic-financial outlook and its
implications on monetary policy.
When I presented our Monetary Policy Report to the Senate's Finance Committee in early
July, I said that the world economy had begun to move towards a more normal configuration,
with a more balanced growth outlook between developed and emerging countries, and where
the terms of trade and financial conditions would not be as favorable to Chile as they had
been for some years. This scenario would imply a lower external stimulus to our economy
and increased volatility in international financial markets in the short term, but at the same
time it contained some positive elements such as recovering growth in developed economies
and more normal international interest rates, which would help achieve a more sustainable
global economy in the medium term.
In recent months, the world has continued to advance towards a more balanced situation, but
it has also unveiled some of the risks we pointed out last July. Some countries have been
more volatile in this transition, as reflected in strong devaluations of their currencies, higher
interest rates, downward adjustments in growth expectations and capital outflows (figure 1).
The list includes some of the biggest emerging economies like Brazil, India, Indonesia,
Turkey and South Africa. This reflects a combination of a lower monetary stimulus expected
in the U.S. with the vulnerabilities that were created in previous years in some emerging
economies. The latter include greater reliance on external funding, currency mismatches,
fiscal imbalances, rapid growth in domestic credit and relatively high inflation rates. These
shortcomings mean less room to maneuver economic policies to compensate for the
deterioration in the external scenario. Several economies that had intervened very actively to
prevent exchange rate appreciations have begun to act now to curb the depreciation of their
currencies. Brazil, for example, announced an intervention amounting to 60 billion dollars by
the end of the year, while India has introduced capital controls to grapple with the sharp fall
in the rupee. An important risk we highlight in this Report is an intensification of financial
volatility and the slowdown in the growth of emerging economies. In Chile, the effects of this
greater international volatility have so far been limited and have manifested mainly in the
depreciation of the peso and a stock market downturn.
Another important source of risk that we consider in this Report is related to China. As we
have mentioned time and again, the evolution of this economy concerns us not only for its
importance as driver of global growth, but also for its impact on exports from Chile and, in
particular, the price of copper, since China is the largest copper consumer in the world. In
recent times there have been doubts about the situation of their financial system, especially
after the strong growth in bank credit and non-bank intermediation from 2009 onwards.
Another source of risk is the behavior of oil prices because of the geopolitical situation in the
Middle East. Moreover, although there are encouraging signs from the Eurozone, risks
remain associated with its complex political, fiscal and financial outlook.
These external risks are important enough for us to evaluate that Chile's economic growth
risks are biased downward. The challenges from abroad are diverse, but as we have
mentioned several times, the Chilean economy is well prepared to face them. As a country
we have worked for years in strengthening a solid institutional framework with an economic
policy scheme based on inflation targeting and a floating exchange rate, with a fiscal rule, a
well regulated and supervised financial system, and trade and financial openness.
As we have said on other occasions, our scheme of inflation targeting and floating exchange
rate allows us to better cope with fluctuations in international markets. The float facilitates
early and flexible adjustment of relative prices to changes in the external environment and
prevents distortions in the decisions on external financing and exchange-rate hedging of
companies and financial institutions in Chile. The recent depreciation of the peso is going in
the right direction to help the economy to adjust. Furthermore, the credibility of the inflation
targeting framework grants flexibility to the central bank to make changes to the monetary
policy and the cost of credit if so required by the macroeconomic scenario, along with
allowing adjustments to the nominal and real exchange rate.
In order for us to grasp these benefits in times of shortage, we need to act consistently in
times of abundance. We have often been confronted with social pressures to intervene the
exchange rate market or lower the interest rate to prevent an appreciation of the peso,
following the example of countries that are more active in this field. While recognizing that
overreactions can occur in the short term in either direction that could warrant such an
intervention, we need to be aware that it entails carry costs for the Central Bank and affects
the overall economy.
Focusing on keeping inflation near the target and preserving the flexibility of the exchange
rate in times of bonanza allows the peso to accommodate conditions like the present ones
and adjust more efficiently to the new situation. We also know that exchange rate flexibility
plays a critical role in preventing currency mismatches, which have taken such a great toll
elsewhere in the region and in Chile in the past. Overall, the appreciation of the peso that we
saw a few months back was milder than that of other currencies, so now the depreciation has
not been as sharp either.
Domestically, monetary policy has continued to face many short-term challenges. The sound
economic slowdown we were expecting has been gradually occurring. On the expenditure
side, however, consumption continues to be very strong, boosted by labor market conditions.
Actually, the latest indicators confirm the strength of the labor market.
The information we have reviewed for this Report suggests that this component of domestic
demand will moderate in the coming quarters, but we must not overlook the risk of a slower
than expected adjustment of consumption, affecting the use of domestic resources and the
deficit of the current account of the balance of payments.
In this context, the Board has held the MPR at 5%, but noting that if these trends consolidate
adjustments to the policy rate may be required.
Let me now describe for you our baseline scenario for the Chilean economy and the main
risks examined in our Report.
Macroeconomic scenario
International trends depicted in June have settled. News coming from the developed
economies, particularly the United States, confirms a gradual recovery. The revision of U.S.
economic figures lowered the growth forecast for the whole year, but showed that the U.S.
economy picked up sooner than expected. In the second quarter it accelerated thanks to
increased investments in fixed assets, a steady improvement in the labor market and more
optimistic expectations of consumers and enterprises. In addition, the markets foresee that
the Fed will anticipate the withdrawal of the monetary stimulus in place. The recovery of the
Japanese economy continues, but questions remain regarding its sustainability. After
six quarters of contraction, the Eurozone recorded positive growth in the second quarter,
driven by Germany and France, and also favored by the economies of the periphery that
moderated their contractions. However, it is still premature to conclude a change in trend.
The emerging world, on the other hand, has continued to show widespread deceleration.
China settled in lower growth figures, despite some signs of stabilizing output and messages
from the authorities that they will sustain an economic expansion of 7% annually.
Accordingly, our baseline scenario has revised the growth outlook for the world and our
trading partners for 2013 and 2014 slightly downward (table 1).
The portfolio realignment originating in the transition to a more balanced configuration of the
external scenario has not been without volatility, which again was evident in the weeks
before the close of this Report. Although the authorities of the U.S. Federal Reserve (Fed)
have pointed out that the unconventional stimulus program will be withdrawn gradually
- helping to tone down the reaction of the markets - most recently volatility has been on the
rise. Capital flows to emerging economies have retreated and become costlier, especially in
the most vulnerable economies. The U.S. dollar depreciated against the currencies of
developed economies, but appreciated in the emerging world. As I said at the beginning of
this presentation, the latter has complicated macroeconomic management in some countries
because of its inflationary and financial effects, and has led to reverse previously adopted
exchange rate interventions. In the developed markets, long-term interest rates have risen
again, internalizing that the Fed will soon begin reducing its asset purchases.
In Chile, since our June Report, domestic output and demand have continued with the
gradual normalization process that began this year, growing less than in 2012 for the second
consecutive quarter. In the second quarter, GDP expanded 4.1%, confirming the slowdown
(figure 2). The natural resources sector reduced its annual growth rate by more than two
points compared with the previous quarter, primarily related to lower mine production early in
the quarter, but also to the significant drop in fishery. Sectors other than natural resources
performed below trend in the second quarter. Growth was mainly driven by trade and
construction, while other areas linked to investment slowed. Installed capacity utilization has
declined accordingly.
Domestic demand slowed down further in the second quarter. Final demand, however, which
excludes inventories, continued to grow at the same pace of the first quarter. Gross fixed
capital formation posted y-o-y expansion flat from the first quarter of this year, but below the
figures of the second half of 2012. As has been noted before, this slowdown owes mainly to
the maturing of mining investments after three years largely outperforming GDP. Also in an
external context where the copper price has dropped and moderating expectations for growth
around the world but especially in China, which call for more caution when evaluating
investment decisions. On the other hand, private consumption was more dynamic, especially
in its non-durable component, while durables remained high. Labor market conditions have
continued to tighten, but are still the main driver of this component. Nominal and real wages
have moderated their annual variation, while the unemployment rate remains near all-time
lows. Again, unlike previous cycles, credit growth has accompanied private income, but has
not been the main determinant of household spending. This last quarter saw a significant
depletion of inventories, reversing the opposite trend seen in the first quarter of the year, due
to, among other factors, the effects of the port strike.
As forecast, CPI inflation has returned to the tolerance range, as the temporary factors that
affected it have eased (figure 3). In particular, the prices of electricity and gasoline rose, the
former due to the end of price recalculations, the latter because of world prices and, to a
lesser extent, the exchange rate depreciation. Yet the core measure - CPIEFE, which
excludes foods and energy - has remained near 1% annually, affected by the persistent
negative incidence of the goods component. Inflation expectations two years ahead remain
close to 3% annually.
Although the Board has held the MPR constant, there have been variations in domestic
interest rates and the real exchange rate that smooth the economy's adjustment to a
scenario of lower external impulse and less pressures on internal resources. Market interest
rates have dropped in the year so far. The real exchange rate (RER) has depreciated,
approaching its average of the past 15 to 20 years, and is believed to be within the range
consistent with its long-term fundamentals (figure 4).
The baseline scenario assumes that Chile's GDP will grow between 4.0 and 4.5% this year.
This range is consistent with assumptions in last June's Report. In 2014, growth should be in
the 4.0 to 5.0% range. The baseline scenario reflects the slowdown in output that has been
occurring during the year. It also assumes that investment will moderate further as the
investment cycle is completed, consistently with adjustments seen in business surveys and
investment plans. Consumption is expected to slow gradually because of the still strong labor
market and the relative stability of household saving during the expansionary phase of the
cycle. Consumer expectations are less optimistic these past few months and are
approaching neutrality, which will help moderate this component of expenditure. So will the
slower pace of marginal job creation, particularly salaried work, and the slowdown of real
wages. Coupled with this is the depreciation of the real exchange rate which will affect
durable consumption. Also, moderating investment will help to take pressure off the labor
market. Finally, there is the foreseen reduction in the impulse from abroad (table 2).
Inflation is expected to continue to grow steadily to reach 3% during the first half of 2014 and
and be stable until the end of the projection horizon, this time the third quarter of 2015. The
CPIEFE will take somewhat longer to hit 3%. The underlying assumption is that nominal
wages will rise in line with productivity and the inflation target. There is also the
methodological assumption that the RER will remain near its recent values. Finally, the
baseline scenario uses as a working assumption that the MPR will follow a path similar to the
one implicit in expectations surveys available at the closing of this Report (figure 5).
The baseline scenario reflects the developments that the Board believes to be the most likely
to occur with the information at hand at the statistical closing of the Report. However, there
are risk scenarios that, if materialized, might change the macroeconomic outlook and,
therefore, the course of monetary policy. On this occasion, after evaluating the alternative
scenarios, the Board estimates that the risk balance is downward biased for output and
unbiased for inflation.
On the global front, a first risk comes from China, namely the fragility of its financial system,
among other factors. As I said at the beginning, the banks' off-balance-sheet financial
intermediation has been increasing and credit has accumulated enormous growth in the past
few years, with a substantial portion going to local governments. In other economies,
episodes of rapid credit growth have resulted a few years down the line in a deterioration of
the quality of banking assets and financial intermediaries' balance sheets, and in a slowdown
in domestic demand. Although the Chinese financial system has some features that
differentiate it from others, there is no denying that any difficulties in this field could have
negative effects on China's growth for a longer period. If so, it would hurt world growth and
commodity prices, particularly for copper.
A second risk coming from abroad has to do with the way emerging economies will
accommodate the withdrawal of monetary stimulus packages in developed countries. The
credit conditions facing emerging economies have tightened, which is causing financial,
exchange-rate and inflationary difficulties in those where vulnerabilities built up during the
boom. Special attention deserve the economies with high external financing needs, including
not only emerging ones but also some in peripheral Europe. Finally, there is still the risk
associated with the complex fiscal and financial situation of the Eurozone. Add to this the
intensifying geopolitical tensions in the Middle East, which could significantly affect the oil
price, causing negative effects on world growth and higher pressures on fuel inflation.
In Chile, although the economic slowdown is underway, it is possible that final demand,
particularly private consumption, continues to adjust at a slower-than-desired pace,
increasing the risk of higher inflation and a constant or growing current-account deficit. The
risk of a wider current-account deficit would increase in a scenario of further deteriorated
terms of trade. However, as we have pointed out before, this deficit comes largely from
investment flows into the tradable sector - especially mining - financed by foreign direct
investment. The recent slowdown of investment and the exchange rate depreciation are
some of the adjustments needed. Moreover, the evidence shown in a box in this Report
suggests that the mining investment cycle is maturing. This will moderate domestic demand
and pressures over internal resources, the labor market and imports of capital goods.
Meanwhile, the startup of mining projects has driven volume exports up. All of this points at
more favorable current-account balances in the medium term. Anyway, for the purposes of
assessing this risk we also need to review the evolution of the deficit measured at trend
prices. In this sense, news is pointing in the right direction, because the estimate for this year
went from 5.7% of GDP last March, to 4.9% in this Report. We estimate that in 2014 it will
continue to recede to 4.6% of GDP.
The international economy is undergoing a normalization process that influences the Chilean
economy. This means a lower external impulse, with more balanced world growth between
developed and emerging economies, terms of trade approaching their long-term level and
global financial conditions more in line with historic patterns. A smaller boost from foreign
investment is also to be expected - especially in mining -, which will take pressure off the
current-account deficit and the use of internal resources. Monetary policy is well equipped, if
so required, to back this adjustment process. The Board follows closely the evolution of the
external and domestic macroeconomic scenario and its implications on inflation, and
reaffirms its commitment to conduct monetary policy so that projected inflation stands at
3% over the policy horizon.
I would like to end by sharing with you some final thoughts.
Final thoughts
We have been 19 months with the same monetary policy interest rate. And as with the
exchange rate, during this time we have received the most diverse recommendations and
suggestions from the market. From taking prompt action to prevent the economy from
overheating to acting just as promptly to avoid deterioration. In this dilemma, we have always
opted for a medium- to long-run look over the short-term ups and downs, and therefore
considered all the risks involved. So far this has allowed us to properly anticipate events and
stick to what we believe has been the right monetary policy.
The international conjuncture puts us to the test; we have identified many risks in this area.
Over the months they have increased in both variety and origins. We know that we are
prepared to face them in the best way possible. It is impossible to be immune. In fact, a small
open economy like Chile is always subject to the vagaries of the international economy: it
could not be otherwise. However, policy makers should be able to overcome them without
major setbacks.
There are also challenges within our borders, especially doubts about the evolution of a
number of variables, such as employment and consumption, among others. It is precisely
this medium- to long-term vision what helps us not to make hasty decisions. We have said
that we are ready to take action if necessary, but overreacting to one particular event would
be tantamount to throwing away the well-earned credibility of the Central Bank, which is a
fundamental anchor to achieve our goal of safeguarding the stability of the price level and the
financial system.
In short, the country is prepared to face a somewhat less favorable external scenario next
year, which undoubtedly will have effects on the domestic economy. For years we have built
solid macroeconomic balances, which yield their fruit when adverse situations hit. We are
confident that, in such a scenario, this will be no exception. Our institutions, solid but flexible
at the same time, distinguish us in the world. This allows us to look at the country's future
with calm and optimism. We as central bank will continue to contribute our own efforts to the
stability of the currency and the normal functioning of the internal and external payment
system, the development and welfare of the Chilean population.
Thank you.
Figure 1
Nominal exchange rate variation in 2013 (*)
(percent)
South Africa
India
Indonesia
Australia
Brazil
Turkey
Peru
Colombia
Malaysia
Philippines
Russia
Chile Emerging Asia
New Zealand
Latin America
Thailand
South Korea
Other
Poland
Emerging Europe
Mexico
Hungary
Czech Rep.
Bulgaria
Slovakia
China
-5 0 5 10 15 20 25
(*) An increase denotes a depreciation.
Sources: Central Bank of Chile and Bloomberg.
Figure 2
GDP and final demand
(annual change, percent)
20 20
15 15
10 10
5 5
0 0
-5 -5
-10 -10
-15 -15
04 05 06 07 08 09 10 11 12 13
GDP Domestic demand Final demand
Source: Central Bank of Chile.
Figure 3
Inflation indicators
(annual change, percent)
10 10
8 8
6 6
4 4
2 2
0 0
-2 -2
-4 -4
-6 -6
06 07 08 09 10 11 12 13
CPI CPIEFE
Source: National Statistics Institute (INE).
Figure 4
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
( ) g y
RER 1998-2012 average 1993-2012 average
Figure 5
MPR and expectations
(percent)
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 15
FBS, second half August 2013 EES, August 2013
Forward, September Report MPR
Source: Central Bank of Chile.
Table 1
International baseline scenario assumptions
2012 2013 (f) 2014 (f) 2015 (f)
Mar. 13 Jun. 13 Sep. 13 Mar. 13 Jun. 13 Sep. 13 Sep. 13
Report Report Report Report Report Report Report
GDP growth (annual change, percent)
Trading partners' GDP 3.4 3.6 3.4 3.3 4.2 3.7 3.6 4.0
World GDP at PPP 3.1 3.3 3.1 3.0 3.9 3.6 3.5 3.9
United States 2.8 1.9 1.9 1.5 2.5 2.7 2.6 2.7
Eurozone -0.5 -0.4 -0.6 -0.5 1.3 1.0 1.0 2.1
Japan 2.0 1.1 1.8 1.7 1.3 1.0 1.0 0.8
China 7.8 8.1 7.6 7.5 8.2 7.5 7.4 7.5
India 5.1 6.3 5.4 5.4 6.4 5.9 5.8 6.3
Rest of Asia (excl. Japan, China and India) 3.8 4.3 3.8 3.8 4.7 4.1 3.9 4.1
Latin America (excl. Chile) 2.7 3.3 2.8 2.7 3.7 3.1 2.9 3.7
(levels)
LME copper price (US$cent/lb) 361 350 325 330 340 305 305 290
Brent oil price (US$/barrel) 112 108 105 108 101 98 108 97
(annual change, percent)
Terms of trade -4.1 -0.4 -3.5 -5.2 -1.6 0.4 0.1 -1.2
(f) Forecast.
Sources: Central Bank of Chile based on a sample of investment banks Consensus Forecasts IMF and respective statistics bureaus
Table 2
Domestic scenario
(annual change, percent)
2012 2013 (f) 2014 (f)
Mar. 13 Jun. 13 Sep. 13 Sep. 13
Report Report Report Report
GDP 5.6 4,5-5,5 4,0-5,0 4-4,5 4,0-5,0
Domestic demand 7.1 6.1 4.9 4.9 4.9
Domestic demand (w/o inventory change) 7.3 6.1 5.1 5.7 4.8
Gross fixed capital formation 12.3 7.2 5.5 5.6 4.5
Total consumption 5.8 5.7 5.0 5.6 5.0
Goods and services exports 1.0 3.1 3.8 4.0 3.3
Goods and services imports 4.9 5.9 5.0 5.6 4.5
Current account (% of GDP) -3.5 -4.4 -4.7 -4.5 -4.8
December CPI 1.5 2.8 2.6 2.6 2.8
December CPIEFE 1.5 2.5 2.0 1.7 2.8
(f) Forecast.
Source: Central Bank of Chile.