Rodrigo Vergara: Chile's latest Monetary Policy 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, 2 April
2013.
* * *
The Monetary Policy Report of March 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.
Thank you for inviting me to present the view of the Bank's Board on recent macroeconomic
developments, together with the macroeconomic outlook and its and monetary policy
implications. This view is contained in detail in our March 2013 Monetary Policy Report.
There is no doubt that the Chilean economy is in good standing. In a complex international
context where growth in the developed world is still sluggish and particularly the Eurozone
continues in recession, Chile continues to grow at over 5 percent annually, unemployment
has fallen and inflation remains low. In these circumstances we must avoid complacency and
be alert to the risks facing our economy to reduce their likelihood of occurrence, or otherwise
be prepared to deal with them in the best way possible. Precisely our Monetary Policy Report
traditionally analyzes the baseline scenario, and also risk scenarios.
International economic conditions, while still complex, have improved in recent months from
the deteriorated conditions of the first half of 2012. China's economic growth has stabilized
and the U.S. has avoided much of the drastic fiscal adjustments that were legally
programmed for early 2013. This time around, we have revised the global growth outlook
slightly upward and external financial conditions have improved thanks to very expansionary
monetary policies in the main advanced economies. In contrast, the Eurozone remains in
recession with still fragile financial and fiscal conditions, as illustrated by the recent events in
Cyprus. World commodity prices remain high, although copper has had a relapse.
Chile continues to display a dynamic economy and limited inflation. GDP increased 5.6% in
2012, while domestic expenditure rose 7.1%, thus increasing the current account deficit to
3.5% of GDP (figure 1).
In this regard, it is worth noting that in recent years the dynamism of domestic demand has
been driven by investment, especially in mining. As shown in a box inside our Report, the
current level of mining investment is the highest of the past four decades. Most recently, the
implementation of these projects has had a number of direct and indirect effects on domestic
demand, other sectors' activity, the labor market, imports of capital goods and the current
account deficit. In the medium term, as these projects mature and the full expansion of the
capital stock is completed, the level of imports will be reduced, output and exports will rise,
and the growth rate of consumption will stabilize together with personal income.
The way the current account deficit is being financed is also important to underscore. Earlier
episodes of balance of payments crises have typically been associated with high debt and
liquidity and currency mismatches, which leave economies vulnerable to abrupt deterioration
of international financial conditions. In Chile, the present current account deficit is being
financed mainly by FDI flows, associated with reinvested earnings and new investments,
thus providing more strength to the capital account.
Despite these factors, we need to remain vigilant because an economic scenario like the
present one can favor the incubation of future risks. Domestically, a scenario of very dynamic
final sales and personal income, low unemployment and high utilization of installed capacity,
can exacerbate the response of domestic demand and further expand the current account
deficit. Abroad, the present abundance of international funding as a result of expansionary
monetary policies in developed economies may facilitate the financing of the external deficit
and push asset prices up, at the expense of incubating vulnerabilities for the future.
All this means that we must be particularly alert to prevent financial vulnerabilities from
incubating, since these situations can lead to higher leverage of households, firms and
financial intermediaries, as well as currency and liquidity mismatches. In this regard, one
reassuring element is that in recent months there has been a moderation in household
indebtedness, which in any case has remained in line with the income trajectory. It is also
important to continue to monitor the evolution of key financial prices and their interaction with
lending. This is a task that is not confined only to the Central Bank, but is for all economic
and financial policy makers.
Beyond these risks, in the scenario we consider today to be the most likely, the Chilean
economy will expand at a pace that is consistent with its trends. Inflation will gradually return
to 3% as specific temporary factors that have influenced recent indicators dissipate. Let me
describe this scenario and the risks identified in some detail.
Macroeconomic scenario
Since the last Monetary Policy Report, the Chilean economy has continued to show high
strength and inflation has remained limited. Contractionary risks coming from abroad have
eased, while expansionary risks originating domestically have gained importance. Domestic
output and demand growth exceeded projections, with a greater boost from investment and
more recently also from private consumption. Dynamic expenditure has resulted in a smaller
trade surplus and a high degree of internal resource utilization. Headline and core inflation
indicators have dropped to near 1% annually because of a number of temporary factors, and
forecasts are that they will return to 3% within the projection horizon. Internationally, the
threats associated with the situation in the Eurozone are still in full force, but other risks,
relating to the U.S. and China, have moderated. In this scenario, the Board has held the
Monetary Policy Rate (MPR) at 5%.
As I mentioned at the beginning, Chile's GDP grew 5.6% in 2012. The fourth-quarter figure
was slightly higher than estimated in the previous Monetary Policy Report and expected by
the market, largely due to the greater contribution of mining. In the last six quarters, the
expansion of sectors other than natural resources, that better reflect changes in the use of
installed capacity, has continued showing relatively stable rates, around 5.5%, not far above
the trend.
Domestic demand growth, in contrast, has picked up again. After falling steadily during 2011
and approaching GDP growth rates in early 2012, it rose again in the following quarters, to
end the year with a y-o-y expansion that outperformed GDP by 1.5 percentage points. This
reacceleration reflects stronger investment and, most recently, also stronger private
consumption.
On the investment front, the strong momentum of mining and energy projects has persisted,
while imports of capital goods have continued to reflect the strong increase in the purchases
of transport equipment. Moreover, in the real estate industry, sales have remained strong,
particularly for housing in construction stage, and other indicators such as dispatches, sales
and imports of materials for this sector have remained high despite some marginal
slowdown.
The expansion of consumption has found support in rising personal income, which reflects
the evolution of employment and real wages. In the fourth quarter of 2012 consumption grew
7.3% in real terms, owing primarily to durable goods. Partial data from the first quarter of this
year, such as retail, household items and car sales, signals dynamic private consumption.
Domestic financial conditions show no major changes in recent months. Importantly, unlike
previous cycles, this time consumer loans have not been an important catalyst for personal
spending, since such loans have been growing at a slower pace. This is important
information, because it reduces the probabilities of a strong deceleration or contraction in the
near future due to households' need to reduce their debt, a factor that has been behind the
weakness of developed economies for years already (figure 2).
The dynamism of domestic demand has manifested in increased imports, so its impact on
the use of internal resources and inflation has been limited. The fastest-growing components
of expenditure, namely investment in machinery & equipment and durable consumption,
have been favored by the drop in relative import prices. The deficit of the current account of
the balance of payments moved from 1.3% of GDP in 2011 to 3.5% in 2012, slightly less
than projected last December. As has been noted before, the bigger deficit is a matter of
concern, but its risks are mitigated by the greater investment flows to the tradable sector -
related to major mining projects - as well as by the weight of FDI flows in its funding.
Portfolio inflows and debt levels have remained at similar levels than previous years.
Inflation has continued to follow a downward trend. In February, the annual change in CPI
stood at 1.3% and core inflation - in its CPIEFE measure, which excludes food and energy -
reached 0.8% annually (figure 3). The recent trend has reflected a number of specific and
transient influences, such as the high basis for comparison of the same months of 2012, the
appreciation of the peso, the normalization of previous shocks to the prices of some
perishables, and the stamp tax reduction. These effects have also been expressed through
indexation mechanisms and expectations, and in the moderate services inflation rates
despite strong demand and tight domestic markets. Other more lasting effects cannot be
ruled out, such as the observed increase in productivity or the reduction in trade margins. In
any case, the procyclical behavior of these elements leads to conclude that the medium-term
inflationary risks associated to the intensity of use of installed capacity are still present.
However, it is worth noting that private expectations one and two years out remain anchored
around 3%.
Internationally, the outlook of slow growth in developed economies is maintained, but with
some improvements. In the U.S. there are signs that private spending is gaining momentum,
but growth prospects remain bounded because of the need for further fiscal adjustments.
The Eurozone is still in recession and its recovery is being held back by the need to advance
towards fiscal consolidation, persistent problems in the financial systems and the difficulty in
making the necessary relative-price adjustments within the region. Plus the political
difficulties to implement reforms that would allow raising trend growth rates. The emerging
world continues to exhibit higher growth rates, although its performance has been more
mixed. Fears of a pronounced slowdown in China have eased, and indicators point to a
stabilization of output. Other emerging Asian economies are also signaling an improvement.
In Latin America, the strong growth of Peru contrasts with the deceleration in Colombia and
slow growth in Brazil and Argentina. The growth rates of other developed economies and
commodity exporters have been affected by fiscal processes and lower prices of some of
their exports, simultaneously with high current-account deficits. From December, the
baseline scenario of this Report corrects the growth projection for our trading partners
upward to an average of 3.9% in the forecast horizon, the first upward revision in over a year.
Global financial conditions have improved in recent months, partly reflecting a perception of
lower probability of occurrence of extreme scenarios, particularly in the U.S., after learning
that only some of the drastic fiscal adjustments previously approved will take effect. The
greater confidence was reflected in greater preference for variable-income assets in
developed economies, where long-term interest rates and stock prices have risen. The U.S.
dollar has appreciated since December, mainly against the yen, reflecting expectations of a
more expansionary monetary policy in Japan. Most of the currencies of emerging economies,
including the Chilean peso, have appreciated against the dollar in the same time span.
The gasoline price has risen substantially this year so far, largely because of supply-side
factors. This results in an upward revision of its forecast for this year and next. The copper
price trend is forecast to slope downward, because of a larger response of supply than in
previous years, but it is revised up in 2013, incorporating actual first-quarter figures. Thus,
the baseline scenario assumes that the terms of trade will be slightly higher than foreseen
last December (table 1).
In the baseline scenario, GDP growth will be in the 4.5%-5.5% range in 2013, exceeding
December projections. The revision is partly explained by stronger growth foreseen in the
mining industry, as revealed by incoming indicators. It also considers that the external
impulse the Chilean economy will be receiving from abroad will be somewhat stronger, in line
with upward revisions to growth of our trading partners and terms of trade.
Domestic demand growth, because of both its dynamism of the end of 2012 and partial
indicators of early 2013, is also corrected upward, to 6.1% (5.7% in December). Annual
growth in investment and consumption is up from earlier projections, bringing the current
account deficit to 4.4% of GDP in 2013, compared with 4.6% forecast in December. In any
case, the path of domestic demand and investment assumes variation rates declining in the
coming quarters (table 2).
Y-o-y inflation will remain low in the short term, still affected by the specific factors that have
influenced recent indicators. As they dissipate, CPI inflation will start to rise, reaching 2% by
mid-year. In early 2014, both headline and core CPI inflation should hit 3% and stay there
until the end of the projection horizon, this time the first quarter of 2015 (figure 4). This
projection assumes that wages will adjust in line with productivity and the inflation target.
This forecast also uses as a methodological assumption that in the projection horizon, the
real exchange rate (RER) will remain around its recent values. This, because with the
nominal exchange rate and currency parities currently in effect, the RER is estimated to be
within - although in the lower part of - the range consistent with its long-term fundamentals.
Finally, the baseline scenario uses as a working assumption that the MPR trajectory will be
similar to what can be inferred from the latest surveys available at the statistical closing of
this Report (figure 5).
In the past few quarters, the Chilean peso has appreciated both bilaterally against the dollar
and in multilateral terms (figure 6). This gain in value has also resulted in an appreciation of
the RER. The factors behind this trend are varied, but in essence have to do with the cyclical
position of the Chilean economy relative to other countries, especially the developed world,
and the weight of commodities in its export basket. However, as we note in a box in this
Report, if these factors are taken into account, the appreciation of the Chilean RER is not
different from that of other emerging economies, other commodity-exporting countries and
other economies with closed output gaps (figure 7). When a longer period is used for the
comparison (e.g. the last ten or fifteen years) the conclusions are the same.
In this context, some economies have implemented foreign exchange measures, including
interventions to mitigate the appreciation of their currencies. While these actions may be
desirable in certain situations - Chile has actually used them in the past and they are part of
its policy toolkit - implementing them requires a careful evaluation of both the benefits and
costs to the country. These measures are appropriate to correct an over-reaction in the value
of the currency against its medium- and long-term fundamentals or as a way to build an
international reserve position, providing greater safety in the event of a sharp contraction of
external financing. These benefits are difficult to quantify objectively, but it is reasonable to
think that the lower the availability of reserves or the further away the real exchange rate is
from its long-term trend, the greater the benefits.
At the same time, we must always bear the costs associated with these interventions in
mind. First, there is the direct financial cost, because the reserves are invested in highly
liquid and safe instruments, but whose interest rates are lower than that of the local
instruments financing their acquisition. This generates a significant cost that eats into the
Central Bank's net worth. Moreover, it is important to preserve the flexibility of the exchange
rate in the Chilean economy because it facilitates accommodating external shocks. The
major external crises we have faced in the past have been associated with overly rigid
exchange rate regimes, which exacerbate credit cycles and mismatches, delay relative-price
adjustments and when they finally occur, they have high financial and real costs for the
economy.
As usual, our 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
biased upward for output and unbiased for inflation.
Internationally, the probability of negative scenarios in the United States have moderated in
recent months and in China the threat of a sharp correction in growth has eased. However,
the possibility of tensions intensifying in the Eurozone has not receded. The fiscal and
financial fragility in this region persists and the ability of policy makers to implement reforms
is weakened due to meager growth prospects. The recent episode of Cyprus is a case in
point. Italy also deserves special concern, because of the size of its public debt and its
weight in the European banking system. New stress episodes in international financial
markets could lead to adjustments in the prices of financial assets and commodities, and in
global growth prospects. In particular, a sharp and persistent decline in copper prices
originating in real or financial factors would have significant effects on the current account,
domestic demand and inflation.
The emerging world is facing big challenges in the conduct of economic policies in a scenario
that foresees that the strongly expansionary monetary policy of developed economies will
continue for a long period. This, because of the possible effects of interest rate differentials
between emerging and developed countries on capital flows, asset prices, credit growth and
currency behavior. Currency-related tensions may create frictions that may hamper
international trade and world growth.
The greatest risks have to do with the persistence of highly dynamic domestic demand. On
one hand, the economy is already using its internal resources intensively, so if the current
expansion of domestic expenditure continues, it could generate, in the medium term,
additional pressures on the labor market, the use of installed capacity and inflation. On the
other hand, because of its incidence in the behavior of the current account deficit and its
potential impact on the vulnerability of the Chilean economy. Any sudden change in external
conditions, say, a reduction in the terms of trade or unfavorable financial conditions, could
expose the country to costly adjustments. History provides several episodes of this nature.
While the Chilean economy has refined its economic policy framework to make it more
resilient to external shocks, and both the funding of the current account deficit and the
destination of its resources mitigate these risks, it is essential to prevent the incubation of
imbalances.
The opposing forces facing monetary policy remain. Some external risks have eased, but the
European situation is delicate. Inflationary risks in the medium term remain in place due to
strong demand. The MPR is within an estimated neutral range, but its current level is high by
international standards. (figure 8).
Interest rate differentials with the developed world pose challenges for policy making in
emerging economies, including Chile. The Board follows closely the evolution of the external
and internal macroeconomic scenarios and their impact on inflation, and reiterates its
commitment to conduct monetary policy so that projected inflation stands at 3% over the
policy horizon.
Allow me some final thoughts.
Final remarks
The Chilean economy has made great progress in the past several decades. The
improvements to our economic and financial policy regimes, together with an external
environment that has been relatively favorable for our country - particularly the price of
copper, which owes in turn to the strength of the Chinese economy - permitted us to
successfully weather the worst international crisis of the last sixty years. We healed quickly
and today we are close to full employment, with personal income growing steadily and low
inflation. Plus high investment levels that will help us sustain this growth trend into the future.
Still, there are big challenges ahead. Risks are present and the policies we need to adopt to
confront them are not always evident. So it is essential that we keep the road clear and take
good care of that which has taken so much effort to achieve. Let me say again what I said at
the beginning: self complacency is one of the worst mistakes the entities responsible for our
country's economic policies can make. Thus we must pay close attention to events. As a
central bank our focus is on ensuring the stability of prices and the financial system. This is
the best contribution we can make to the well-being of our population.
Thank you.
Figure 1
GDP and demand
(annual change, percent)
18 18
12 12
6 6
0 0
-6 -6
-12 -12
09 10 11 12
GDP GDP minus natural resources Domestic demand
Source: Central Bank of Chile.
Figure 2
Nominal loans by type of credit
(annual change, percent)
30 30
25 25
20 20
15 15
10 10
5 5
0 0
-5 -5
03 04 05 06 07 08 09 10 11 12 13
Consumer Housing Commercial
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 CPIEFE goods CPIEFE services
Sources: Central Bank of Chile and National Statistics Institute (INE).
Table 1
International baseline scenario assumptions
2011 2012 (e) 2013 (f) 2014 (f)
Dec.12 Mar.13 Dec.12 Mar.13 Dec.12 Mar.13
Report Report Report Report Report Report
Growth (annual change, percent)
Trading partners' GDP 4.2 3.3 3.4 3.5 3.6 4.0 4.2
World GDP at PPP 3.9 3.0 3.0 3.3 3.3 3.8 3.9
United States 1.8 2.3 2.2 1.9 1.9 2.3 2.5
Eurozone 1.4 -0.5 -0.6 -0.3 -0.4 1.2 1.3
Japan -0.6 1.9 2.0 0.5 1.1 0.9 1.3
China 9.3 7.7 7.8 8.0 8.1 8.2 8.2
India 7.9 5.6 4.9 6.6 6.3 6.4 6.4
Rest of Asia (excl. Japan, China and India) 4.2 3.5 3.8 4.3 4.3 4.7 4.7
Latin America (excl. Chile) 4.5 2.8 2.8 3.3 3.3 3.7 3.7
(levels)
LME copper price (US$cent/lb) 400 361 361 340 350 350 340
Brent oil price (US$/barrel) 111 112 112 105 108 100 101
(annual change, percent)
Terms of trade -0.6 -5.0 -4.1 -0,8 -0.4 1.3 -1,6
(e) Estimate.
(f) Forecast.
Table 2
Economic growth and current account
(annual change, percent)
2011 2012 (e) 2013 (f)
Dec.12 Mar.13 Dec.12 Mar.13
Report Report Report Report
GDP 5.9 5.5 5.6 4.25-5.25 4.5-5.5
Domestic demand 9.1 6.6 7.1 5.7 6.1
Domestic demand (w/o inventory change) 9.4 6.8 7.3 6.0 6.1
Gross fixed capital formation 14.7 11.3 12.3 7.6 7.2
Total consumption 7.9 5.3 5.8 5.5 5.7
Goods and services exports 5.2 2.7 1.0 3.0 3.1
Goods and services imports 14.5 5.5 4.9 5.9 5.9
Current account (% of GDP) -1.3 -3.8 -3.5 -4.6 -4.4
(e) Estimate.
(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 08 09 10 11 12 13 14 15
07 08 09 10 11 12 13 14 15
Dec.2012 Report Mar.2013 Report
(*) Gray area, as from the first 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, March 2013.Q2 EES, March 2013
Source: Central Bank of Chile.
Figure 6
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 1993-2012 average 1998-2012 average
Figure 7
RERs of commodity-exporting countries (*)
(index, 2000-2007 average=100)
Emerging Developed
120
120 120
110 110
110 110
100
100 100
90 90
90 90
80
80 80
70 70
70 70
60
60 60
50 50 50 50
40 40 40
30 30 30 30
05 06 07 08 09 10 11 12 13 05 06 07 08 09 10 11 12 13
Chile Colombia
Canada Chile
Peru Brazil
New Zealand Norway
(*) An increase indicates depreciation.
Source: BIS.
Figure 8
Monetary policy rate
(percent)
8 8
6 6
4 4
2 2
0 0
USA
Rep.
Peru
Chile
Brazil
Mexico Europe
Norway Canada
Sweden
Zealand
Australia
Colombia
N.
Czech
Sources: Central Bank of Chile and central banks of respective countries.