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,
3 December 2013.
* * *
The Monetary Policy Report of December 2013 and the Financial Stability Report of the second half of 2013 can
be found at http://www.bcentral.cl.
Introduction
Mr. President of the Senate's Finance Commission, Senator Andrés Zaldívar, senators
members of this Commission, ladies and gentlemen.
I am grateful for your invitation to present the vision of the Central Bank's Board on the
recent macroeconomic and financial developments, its Outlook and implications on monetary
and financial policy. This vision is contained in detail in our December Monetary Policy
Report Financial Stability Report
and our second-half we are presenting now.
The macroeconomic scenario has evolved along the trends described in the latest Monetary
Policy Reports. In the external scenario, growth is more balanced between developed and
emerging economies than it was before the subprime crisis hit. International financial
conditions are steadily normalizing, while the terms of trade are declining and approaching
their trend values.
In this scenario, the Chilean economy will receive a milder boost from abroad than we saw in
recent years. The less expansionary monetary policies in the developed world will be
coupled with a rebound in developed economies that will favor not only these countries but
the world economy at large. Certainly, some countries have more reasons to worry than
others about these adjustments in the world economy, because of their external and
domestic vulnerabilities. Meanwhile, the past and present volatility of the world will continue
to affect our economy, but, while we are certainly not immune to what happens outside our
borders, we feel we are on a good stand to deal with this transition.
At home, output and demand are gradually decelerating and inflation is still low. Our
projections, which I will be reviewing shortly, indicate that in the short term the Chilean
economy will continue to expand somewhat below trend, affected by the normalization of the
mining investment cycle and labor market conditions. We thus estimate a 4.2 percent growth
for this year and a 3.75 to 4.75 percent range for next. This 2014 forecast range is slightly
less than what we were expecting in September. Although these growth rates represent a
slowdown from previous years, we see no obstacles ahead that could prevent our economy
from resuming growth at closer to trend rates, which we continue to estimate at 5 percent
annually.
In this context, the Board decided to lower the monetary policy rate from 5 to 4.5 percent in
its meetings of October and November, in order to accommodate the monetary stimulus to
our slower economy and not jeopardize the convergence of inflation to the target. The recent
reduction of the MPR is part of a necessary adjustment to deal with recent changes in our
macroeconomy and, as I said, ensure compliance with our inflation objective. Going forward,
further changes to the MPR will depend on incoming information and its implications on the
economy's evolution. Actually, the baseline scenario does not foresee the need for any
significant changes in the MPR but, should such need arise, monetary policy has room and is
prepared for further adjustments.
Over the period, both the real and the nominal exchange rates have depreciated, which is
part of the process of restructuring the sources of growth after some time when domestic
demand has been the primary driver of such growth.
Let me now describe for you our baseline scenario and the main risks we have identified in
our reports.
Macroeconomic scenario
Chile's third-quarter growth was 4.7 percent y-o-y. Mining grew strongly, boosted by the
startup of major investment projects of recent years. Thus, mining exports have increased,
helping to reduce the current account deficit. Sectors other than natural resources,
meanwhile, continued to post lower growth rates than in 2012 (figure 1). This, together with
the revision to growth rates of earlier quarters, confirmed that the Chilean economy has lost
some strength compared with last year.
On the expenditure side, the slowdown extended to each and every component, including
private consumption, which was accompanied with significant inventory depletion (figure 2).
In this trajectory, the maturation of the mining investment cycle discussed in previous
Reports has played a major role. In addition, the extraordinary imports of transport materials
of the last quarter of 2012 did not continue into this year, and imports of other capital goods
were weak in the past few months. Consumption has also slowed down, although its
adjustment has proceeded gradually, because of still tight labor market conditions, real
wages growing strongly and consumer expectations still optimistic, although less so than in
the first half of the year. The deceleration of private consumption is expected to continue
over the coming months coupled with a not so strong labor market, a vision that is grounded
Informe de Percepciones de
on our business perception report Negocios.
CPI inflation has been below expectations, mainly reflecting the drop in international fuel
prices, which more than offset the seasonal price increases of some perishable foods and
the peso depreciation. Thus, in October the CPI rose 1.5% y-o-y, which again placed it
temporarily below the tolerance range. In contrast, the core measure CPIEFE brought no
major surprises and continued to increase up to 1.6% annually in the same month. Two
years ahead inflation expectations remain around 3% (figure 3).
In the international financial markets, movements in the last few months have been largely
determined by news about the future course of monetary and fiscal policies in the United
States. Recall that, after the signs delivered by the Federal Reserve last May, the withdrawal
of the monetary stimulus was expected to begin in September. This drove up long-term
interest rates by more than 100 basis points in the U.S., the currencies depreciated against
the dollar and volatility increased, with particularly harsh effects on emerging economies.
Later on, as such withdrawal did not occur in September, interest rates receded some and
calm returned to the markets. Although this resulted in some improvement of the external
lending standards to emerging economies, our baseline scenario considers the possibility of
recurrent episodes of volatility during the transition towards more normal financial conditions.
For one thing, the temporary nature of the U.S. fiscal agreements could bring new tensions in
early 2014, although this seems less likely.
At any rate, external lending conditions are less favorable than they were early in the year.
Compared with September, long-term interest rates dropped as the Federal Reserve kept the
asset purchase plan unchanged, and at the same time international stock markets improved.
Several emerging market currencies depreciated against the dollar - the Chilean peso
included - which was trading at more than $520 per dollar in November and has recently
surpassed $530. The real exchange rate, as I said, has risen to near its 15 to 20 years'
average.
In terms of the outlook for global growth, developed economies are still in a process of
gradual recovery. In the third quarter, the U.S. exceeded market consensus expectations
and, although inventory accumulation played a part, the improved performance of the
housing and labor markets, combined with better entrepreneurial and consumer
expectations, the behavior of stock and other asset prices and, in particular, the lower
intensity of the fiscal adjustment suggest that next year the country will outperform its 2013
figures. The recovery of the Japanese economy is still ongoing, but the tax increases
announced for 2014 will taper economic growth. The Eurozone posted positive growth for the
second consecutive quarter, although less than expected by the consensus. Worth noting
were the slower growth of Germany and the contraction of the French economy and, on a
positive note, that some of the peripheral economies grew again.
Emerging economies have slowed down further and consensus forecasts have seen new
downward revisions. In China, after a substantial correction to its growth projections in the
first half of the year, recent data show growth stabilizing around 7.5 percent, quite less than
in recent years, however. The baseline scenario assumes that the Chinese economy will
slow further to reach 7.2 percent annually in 2015, which points to the need to continue to
restructure its sources of growth and resolve some of the vulnerabilities of its financial
system.
In the rest of the emerging world, economic activity continues to moderate, leading some
economies to lower their benchmark rates. Others, however, have restricted their monetary
policies responding to higher inflationary and exchange rate pressures related to fiscal,
monetary or external vulnerabilities. Anyway, the slower growth expected in China, lower
commodity prices, less expansionary international financial conditions, the contractionary
adjustments in some large emerging economies and the need to progress in the
strengthening of the Chinese financial system plus its growth re-composition are behind the
vision that emerging economies will expand at a slower pace than during the last three years.
The baseline scenario of our Monetary Policy Report foresees that, after expanding at
3.4 percent in 2013, our trading partners will grow by 3.6 and 3.8 percent in 2014 and 2015,
respectively, somewhat less than we thought in September. In this context, inflation has been
below expectations in both emerging and developed economies. Commodity prices have
dropped. Geopolitical tensions in the Middle East have eased with respect to a few months
ago, as have some refinery problems in the United States, which led to lower actual and
expected fuel prices compared with September. The copper price, after remaining fairly
stable for some months, posted a decline in recent weeks, so the price outlook for the metal
remains unchanged from the previous Report. Accordingly, the baseline scenario assumes
that the terms of trade will not divert from those in the last Report (table 1).
As I have already mentioned, our baseline scenario estimates that the Chilean economy will
expand 4.2 percent in 2013, and between 3.75 and 4.75 percent in 2014, slightly less than
forecast in September. In 2014, gross fixed capital formation will grow near the rate of this
year. As for consumption, the baseline scenario foresees a slight deceleration from 2013.
This forecast combines, on one hand, a moderation in private income growth, inflation
converging to 3 percent and an exchange rate depreciation that will affect durable
consumption. On the other, still optimistic consumer expectations and a strong labor market
- although not as tight as this year - that will continue to underpin consumption. This
scenario assumes an external impulse similar to September's. Furthermore, it considers that
part of the inventory depletion of recent quarters is an unwanted development, so it will be
reversed in the coming months. Taking into account the weaker imports and stronger
exports, this scenario also foresees a narrowing of the current account deficit compared with
the September estimate: 3.2 percent of GDP this year and 3.7 percent in 2014. The surprise
here - a positive one indeed - is that some of the trends that were anticipated in previous
reports, have come sooner and stronger. In particular, the maturation of the mining
investment cycle, which has been one of the main sources of the higher deficit due to its
import component, has allowed copper exports to grow beyond expectations, while capital
imports have begun to decline. The estimate of the current account deficit measured at trend
prices is also adjusted downward, so the risk associated with the evolution of the current
account that had been identified in the last Monetary Policy Report is reduced (table 2).
In the baseline scenario, CPI inflation will converge to 3 percent towards the end of the
projection horizon, this time the last quarter of 2015. Thus, reaching the target will take
longer than expected in September. The CPIEFE will continue to gradually approach
3 percent, without major changes from the September forecast (figure 4). This projection
implies that nominal wages will be adjusted in line with productivity and the inflation target. It
also includes as a methodological assumption that the RER will remain virtually unchanged.
Finally, the baseline scenario uses as a working methodological assumption that the policy
rate will follow a path similar to the one shown in the latest Economic Expectations Survey
(figure 5).
The baseline scenario reflects those events that are estimated to be the most likely to occur
with the information at hand at the closing of this Report. There are risk scenarios, however,
which if materialized, may reshape the macroeconomic environment and, therefore, may
modify 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.
On the external front, one risk relates to growth in emerging economies, particularly China.
Concerns persist about the fragility of the Chinese financial system, which together with
doubts about the evolution of real-estate prices could limit its future growth prospects. As has
been noted before, China's evolution is cause for unrest because of its weight in world GDP
and its impact on the pricing of commodities, copper included.
The volatility that financial markets have shown in recent months implies that ending the
quantitative easing in the U.S. will not be stress-free, especially because of the difficulty to
calibrate the policy actions of this unprecedented process. In this regard, a major risk has to
do with its effects on some of the larger emerging economies that have accumulated
macroeconomic imbalances and are more dependent on external financing. The risk
associated with the complex interaction between weak growth, a frail fiscal situation and
financial problems in Europe is still present.
At home, headline inflation of recent quarters has been lower than forecast, and the moment
when it will expectedly reach the target has been postponed time and again. While the recent
cuts to the MPR will help inflation converge to 3 percent, if the widespread slowdown in all
the demand components is confirmed, along with longer-lasting low inflation in the rest of the
world and maybe a sharper fall in international fuel prices could further postpone such
convergence to 3 percent. However, the depreciation of the peso and the still tight labor
market could work in the opposite direction.
Projections indicate that in the short term the Chilean economy will continue to expand
somewhat below trend for still some quarters. However, labor market conditions and a faster
recovery in inventories, among other factors, could result in a faster recovery of the economy
that would bring it closer to its trend.
In the Financial Stability Report we are presenting today, the same risk scenarios coming
from abroad that I have just identified are examined, this time from the perspective of their
impact on our domestic economy's financial stability. We conclude that of the three risk
scenarios described, the episode of volatility originating in the monetary stimulus withdrawal
is the most likely to occur. However, a deepening of the Eurozone crisis or a sharp
deceleration of a systemic emerging economy would have stronger effects on the Chilean
financial system. Especially because, as I have noted, the withdrawal of the monetary
stimulus in the United States will come about when the U.S. economy's improved growth is
already confirmed.
The banking industry's capital levels are adequate to remain solvent before a significant
deterioration of economic growth and financial conditions. Stress tests show that the banks'
current capital levels allow them to absorb potential losses generated by a macroeconomic
risk scenario that combines a GDP contraction - like that of the subprime crisis - higher
financial costs for the short and long term, and a sharp depreciation of the exchange rate.
One such test - motivated by the risk scenarios identified in the process of monetary
tapering in the U.S. - shows little exposure of the banking system to a sharp increase in the
interest rates of long-term securities.
Meanwhile, households' aggregate borrowing and financial burden indicators show a
marginal decline, although with some changes in the composition of the debt. The share of
bank debt has increased compared with other credit providers, while total corporate debt is
stable as a ratio to GDP and the financial indicators of companies reporting to the
Superintendence of Securities and Insurance (SVS) are also fairly stable. Capital inflows to
Chile continue to be dominated by FDI while aggregate solvency and liquidity figures are also
stable.
In this way, our general analysis of the domestic financial system yields that it is on a good
standing to deal with the risk scenarios described, and we see no incubation of systemic
risks at the local level. This explains, in part, why the recent volatility episode in foreign
financial markets had lesser effects on the Chilean financial system than in other emerging
economies, where risks did incubate over the past few years.
However, to maintain this resilience the different players making up the financial system must
take the necessary decisions and safeguards, especially considering the dynamism of the
financial sector. One first firewall, perhaps the most important one, is the one related to
corporate stockholders, who should establish and implement clear policies aimed at
restricting their operating risks via corporate governance, boards and management. A
second firewall is related to public institutions such as the Superintendences and the Central
Bank, which have complementary roles in the monitoring, supervision and regulation of the
financial system. The continual improvement of regulations and laws, as well as the search
for best practices at the global level is one objective that must always be present in our
actions. Within this monitoring role, our Financial Stability Report plays a key role. In it we
identify developments which, if intensified, might create risks, or where we believe there is
room to reduce residual risks.
I would like now to describe some of these developments as well as the main regulatory
amendments that have been implemented during the last six months.
In our Financial Stability Reports a couple of issues ago we warned about some
developments in the real estate sector which, if intensified, could become a source of risk.
We were particularly concerned about the combination of dynamic prices with a credit
acceleration originating in this sector. In this context, one good element is that mortgage
credit growth has remained stable, with no relaxation of lending standards for mortgage
loans or credit to construction and real estate firms. However, housing price indexes are as
dynamic as in previous periods, in a scenario of high demand and low inventories.
Meanwhile, the expected supply of office space continues to rise and is in historically high
levels. In this context, it is important that all players involved consider in their investment and
funding decisions that the current price and demand trends of the sector might not continue,
especially considering the external risks described, the expected increase in supply and the
economic slowdown.
While total household debt over income has dropped, the available evidence suggests that
bank debt remains dynamic, particularly in the middle to upper income homes. To the extent
that banks properly evaluate and analyze the credit risks inherent in this segment, it should
not be a source of vulnerability. However, there are factors that could contribute to an
underestimation of these risks. First, rolling credits have been pretty dynamic in recent years.
Second, the absence of a consolidated debtor data base hinders any household credit risk
assessment for supervisors and suppliers - a concern we brought up before this Senate last
time we presented our Financial Stability Report. Finally, those banks that have recently
expanded a lot their consumer loan portfolios have seen a sharper deterioration of their
NPLs indicators, consistent with greater risk taking in this segment. So far, this has been
accompanied by increased provisions.
While in recent years the overall Chilean banking system has tended to reduce its
dependence on short-term wholesale funding, some small and midsize banks remain highly
dependent on this source. Although wholesale funding plays an important role in market
discipline, it is particularly sensitive to changes in perceptions about the risk of issuers and to
the assets' liquidity in the secondary market. In addition, the events of recent years show that
negative developments in foreign or local financial conglomerates may adversely affect the
cost of funds in the wholesale market for the banks belonging to these groups.
Accordingly, it is important that banks maintain a diversified funding base in terms of
counterparties and maturities. Also, banks should use in their liquidity management stress
tests and contingency plans that appropriately reflect their risks, business strategies,
financial condition and financing ability under different scenarios. In addition, it is important
that banks properly internalize the economic and reputational risks of their exposure to
related entities, for which a proper corporate governance framework is crucial.
In this context, I would like to bring to your attention four regulatory elements. First, the
Superintendence of Banks and Financial Institutions (SBIF) perfected its regulatory
framework on corporate governance in banks. Second, based on the possible contagion
effects in financial conglomerates the SBIF enhanced the regulations restricting transactions
with related debtors, increasing their supervision tools in this area. Third, in relation to
funding structures, the Central Bank is reviewing the liquidity rules governing the banks in
order to strengthen management policies in this field, include binding regulatory limits on a
consolidated basis, standardize the assumptions of our own models, expand information
disclosure to the market about the liquidity position of each bank and move towards the new
Basel liquidity standards. Finally, the bill of law sent to the National Congress to
institutionalize the Financial Stability Board (FSB) is an important step, because it grants
capabilities that provide more space to the authorities to monitor the risks facing the financial
system and coordinate responses to them.
To sum up, the Chilean economy is well positioned to address the changing internal and
external conditions that we are already seeing. The adjustments observed in relative prices,
the real exchange rate and interest rates have gone in the right direction to facilitate the
adjustment of the economy. 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% in
the policy horizon. At the same time, it will continue to improve financial legislation in order to
maintain and enhance this resilience, in those issues that are legally mandated.
Let me end with some final thoughts.
Final thoughts
As is customary in our presentations to the Senate, we have tried to present as clearly and
transparently as possible our assessment of the current economic situation and its
implications for managing the policy tools entrusted to us. Always keeping a watchful eye on
the compliance of the mandates we have been given.
The Chilean economy is on a good stand to face the challenges ahead, which certainly does
not mean that we feel immune to whatever happens beyond our borders. We have managed
economic policies seriously and responsibly in good times, which should allow us to move
with relative ease through a not so favorable period.
The country's domestic and external position is strong, our financial system has limited risks,
and the monetary policy is in a position that, if necessary, can deal with a different, more
complicated phase. In addition, a strong fiscal position with public debt that in net terms is
virtually nil, something that not many countries can show.
In the last two months we cut 50 basis points off the MPR, to 4.5 percent. The scenario that
today we see as the most likely does not envisages the need for significant additional
adjustments to the policy rate. However, in a different scenario where further adjustments are
called for, there is the room and the will to carry them out. We, as the Central Bank, will
continue to contribute with our assigned duty, that is, to safeguard the stability of our
currency and the normal functioning of the internal and external payment system, to Chile's
development and welfare.
Many thanks,
Figure 1
GDP growth
(annual change, percent)
12 12
8 8
4 4
0 0
-4 -4
-8 -8
-12 -12
07 08 09 10 11 12 13
Natural resources All other sectors
Source: Central Bank of Chile.
Figure 2
Private consumption and investment
(annual change, percent)
25 25
20 20
15 15
10 10
5 5
0 0
-5 -5
-10 -10
-15 -15
-20 -20
07 08 09 10 11 12 13
Private consumption Investment
Figure 3
Inflation indicators
(annual change, percent)
10 10
8 8
6 6
4 4
2 2
0 0
-2 -2
-4 -4
06 07 08 09 10 11 12 13
CPI EES two years hence CPISAE
Sources: Central Bank of Chile and National Statistics Institute (INE).
Table 1
International baseline scenario assumptions
2012 2013 (f) 2014 (f) 2015 (f)
Mar.13 Sep.13 Dec.13 Mar.13 Sep.13 Dec.13 Sep.13 Dec.13
Report Report Report Report Report Report Report Report
Growth (annual change, percent)
Trading partners' GDP 3.4 3.6 3.3 3.4 4.2 3.6 3.6 4.0 3.8
World GDP at PPP 3.1 3.3 3.0 3.0 3.9 3.5 3.5 3.9 3.7
United States 2.8 1.9 1.5 1.7 2.5 2.6 2.6 2.7 2.7
Eurozone -0.6 -0.4 -0.5 -0.4 1.3 1.0 1.0 2.1 1.4
Japan 1.9 1.1 1.7 1.8 1.3 1.0 1.3 0.8 1.0
China 7.7 8.1 7.5 7.6 8.2 7.4 7.4 7.5 7.2
India 5.1 6.3 5.4 4.1 6.4 5.8 5.3 6.3 6.3
Rest of Asia (excl. Japan, China and India) 3.8 4.3 3.8 3.8 4.7 3.9 4.0 4.1 4.5
Latin America (excl. Chile) 2.7 3.3 2.7 2.6 3.7 2.9 2.9 3.7 3.4
(levels)
LME copper price (US$cent/lb) 361 350 330 332 340 305 310 290 290
Brent oil price (US$/barrel) 112 108 108 109 101 108 106 97 100
(annual change, percent)
Terms of trade -4.1 -0.4 -5.2 -3.9 -1.6 0.1 0.2 -1.2 -1.5
(f) Forecast.
Sources: Central Bank of Chile based on a sample of investment banks, Consensus Forecasts, IMF, and respective statistics bureaus.
BIS central bankers' speeches
Table 2
External scenario
(annual change, percent)
2012 2013 (f) 2014 (f)
Mar.13 Sep.13 Dec.13 Sep.13 Dec.13
Report Report Report Report Report
GDP 5.6 4.5-5.5 4.0-4.5 4.2 4.0-5.0 3.75-4.75
Domestic demand 7.1 6.1 4.9 3.9 4.9 4.8
Domestic demand (w/o inventory change) 7.3 6.1 5.7 5.1 4.8 4.5
Gross fixed capital formation 12.3 7.2 5.6 3.9 4.5 4.1
Total consumption 5.8 5.7 5.6 5.4 5.0 4.7
Goods and services exports 1.0 3.1 4.0 5.3 3.3 3.1
Goods and services imports 4.9 5.9 5.6 4.4 4.5 4.6
Current account (% of GDP) -3.5 -4.4 -4.5 -3.2 -4.8 -3.7
December CPI 1.5 2.8 2.6 2.6 2.8 2.5
December CPIEFE 1.5 2.5 1.7 1.9 2.8 2.9
(f) Forecast.
Source: Central Bank of Chile.
Figure 4
CPI inflation (*) CPIEFE inflation (*)
(annual change, percent) (annual change, percent)
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 09 11 13 15
07 09 11 13 15
Sep.2013 Report
Dec.2013 Report
(*) Gray area, as from the fourth quarter of 2013, shows forecast.
Figure 5
MPR and expectations
(percent)
9 9
876543210 876543210
07 08 09 10 11 12 13 14 15
MPR FBS second half Nov. 2013
EES November 2013 Forward rate, Dec.2013 Report
Source: Central Bank of Chile.