Rodrigo Vergara: The Central Bank of Chile and the external crisis
Presentation by Mr Rodrigo Vergara, Governor of the Central Bank of Chile, at a special
session held by the Honorable Senate to "analyze and evaluate the economic policy
measures that have become indispensable to confront the severe symptoms of international
recession and with the purpose of becoming familiar with the Contingency Plan announced
by the Supreme Government", Santiago de Chile, 31 January 2012.
* * *
Mr. President of the Senate, Senator Guido Girardi, Honorable senators.
Thank you for your invitation to discuss the international economic situation and the
measures that can be adopted in our country to address an external crisis. These instances
are important for communicating the vision of the Central Bank of Chile (CBC) on these
issues.
In the past several years, the advanced economies have gone through a severe crisis. The
causes and consequences of the Great Recession of 2008-2009 have not yet been resolved
and we are again enduring periods of external stress that put to the test the strength of our
economy and its fundamentals. This forces us to carefully evaluate the current environment,
its implications on the performance of our economy, and the measures we can implement if
deemed necessary.
During the past year, the biggest tensions have originated in the frail fiscal and financial
conditions of some economies in the Eurozone. This situation has persisted for a long time
and no definitive solution is foreseen in the near term. Progress has been made in several
areas, but the problems' complexities and the political difficulties to deal with them are huge.
This, coupled with the delicate position of consumers and firms, has translated in
deteriorating economic expectations in the region, anticipating a recession during this year.
The situation in the United States, while less severe than that in Europe, is also complex,
especially because of the slow recovery and little room for fiscal and monetary policies to
stimulate the economy. The emerging world, Chile included, will undergo a period of slower
growth than in the past few years. Market consensus forecasts, last week's IMF projections,
and also those in our December 2011's Monetary Policy Report point in the same direction
(table 1).
Most recently, the information coming from the U.S. shows a somewhat better performance
than was forecast some weeks back, but does not modify medium-term problems and risks
affecting its economy. In fact, last week the Federal Reserve extended from mid-2013 to
end-2014 the period during which it would hold the fed funds rate at the minimum level where
it is today, which reflects the magnitude of the problem. Meanwhile, information from China
reveals its economy is growing strongly. It also shows a relief of inflationary pressures in that
country, providing more space for policy-making. The prices of commodities, especially
copper, have recovered significantly in the past few weeks. Actually, today's price of this
metal is substantially higher than we had forecast for the year.
The baseline scenario in our December Monetary Policy Report is still totally valid. Our
aforementioned report and the market expect a moderate deceleration of Chile's growth. Our
economy is forecast to grow in the range of 3.75% to 4.75% in 2012, with y-o-y rates for
every expenditure component below those of 2011. This would be the response both to a
normal, sound convergence of the economy to trend-consistent growth rates, and to the
effects of a less favorable external environment.
The latest data show our economy gradually adjusting to lower growth rates, at the same
time that expenditure indicators are still showing substantial growth. Sure enough, there are
differences across sectors. In some branches of manufacturing, especially export-oriented
ones, dynamism is milder. In other sectors, such as retail, there is some degree of higher
caution in inventory management. By contrast, the consumption of durable and capital
goods, which are normally the first to react to a change in the agents' expectations, remains
strong, the same as the construction sector. Meanwhile, various indicators signal a tight labor
market. It has been recently reported that in December, the unemployment rate as measured
by the Universidad de Chile survey for Greater Santiago dropped to a 15-year low, and that
the creation of new jobs has, for the most part, been accounted for by salaried employment.
Turning to the debt burden of households and firms, as we noted in our Financial Stability
Report of the second half of last year, the financial indicators of the corporate sector look
favorable, with a stable and limited currency mismatch. The household average shows no
financial deterioration because the increase in private consumption has been accompanied
by an increase in labor income. However, households as well as firms must keep a watchful
attitude facing possible risk scenarios. As for banks, the sector has adequate capital levels to
absorb the materialization of a severe risk scenario. As shown in our last Financial Stability
Report, stress tests indicate that the banking system's current levels of capitalization would
permit it to absorb an episode of sharp GDP slowdown, an increase in the cost of credit in
pesos and an exchange rate depreciation. Meanwhile, the State keeps a net creditor
position, contributing to the access to external loans at low spreads.
Our terms of trade, although lower than some months ago, are high by historic standards,
and our external credit access conditions are good, also by historic standards as well as
compared with other emerging economies. Annual inflation is somewhat above 4%. The
latest monthly CPI figure was unexpected, but given its characteristics it does not change our
evaluation of the medium-term inflation trend, which remains centered on 3%, just as we
stated in our Monetary Policy Report. Private inflation expectations are also stable around
3% y-o-y. This body of information leads us to establish that our baseline scenario remains in
full force.
But still in this conjuncture, which looks fairly favorable for the Chilean economy and the
Chileans' financial situation, it is necessary to warn about the high risks that persist and that
is why the CBC keeps risks for growth biased towards more negative scenarios. In particular,
among these risks there is the possibility of new episodes of international financial volatility
ultimately affecting the agents' expectations, global demand and international credit. The
possibility is still there of a deeper than forecast recession in the Eurozone, as well as of a
disorderly evolution of the continent's problems or even of a fragmentation. And one must
also consider the possibility of a sharper adjustment of growth in China. Neither should
geopolitical tensions in the Middle East be overlooked, with its potential implications on the
oil price. All these external contingencies are part of the preoccupations we monitor closely
at the CBC in cooperation with the Finance Ministry and superintendences of the financial
sector, within the framework of our coordination meetings and those of the Financial Stability
Committee.
The preoccupation motivating this session is which measures we could take to confront a
further worsening of the global situation that could wash over our domestic economy. The
Central Bank of Chile has the necessary tools and policy space to act to mitigate the effects
of adverse external scenarios over the Chilean economy. The capacity of the Bank to react
to a global worsening has been already proven during the episode of 2008-2009. The Board,
as has been said time and again, has the flexibility and disposition to use these tools as
needed.
In this scenario, our latest Monetary Policy Report assumed that a somewhat more
expansionary monetary policy would be necessary in order to accommodate and reduce the
negative effects of the forecast external developments. The 25 basis point reduction in the
monetary policy rate we applied in our last monetary policy meeting goes in this direction. At
present our policy rate is at normal levels, and projected inflation and expectations two years
ahead are aligned with the target for this variable. This situation grants us the flexibility we
need to conduct monetary policy in the eventuality of a sharper deterioration of the external
scenario with significant consequences to the Chilean economy.
The financial markets have exhibited an increase in external credit premiums paid by Chilean
banks and firms abroad, offset to some extent by base rates in record lows. In the local
money market we have seen some frictions. As a response, the Bank has applied more
active management of liquidity in domestic currency, in order to make sure that the money
market operates in consistency with the orientation of our monetary policy. In fact, with the
measures adopted last year and specific factors cleared out, the money market's interest
rates have shifted toward levels in line with the current and forecast levels of the policy rate
(figure 1).
Beyond the recent measures, the Bank has at its disposal a toolkit it can use when the need
arises. On one hand, in the years 2008 and 2009 we devised new ways to provide domestic
and foreign currency liquidity which can be activated quickly but which in the present
conjuncture have not been thought necessary. In case of a worsening of external financial
conditions, the Central Bank has to possibility of alleviating its effects by using a number of
guaranteed financing instruments, such as swaps, long-term REPOs and collateral
extension, among others. Moreover, there are reserves available of close to 40 billion dollars,
augmented with the reserve hoarding plan we carried out in 2011 and which has helped to
strengthen the liquidity position of the Chilean economy.
It is worth noting that these measures are an alternative for providing subsidiary support,
whose adoption is warranted only in the presence of major distortions in monetary and
financial markets. In this complex environment, agents, banks, financial intermediaries and
firms need to carefully evaluate the associated risks and take prudent action to properly
manage their liquidity and financial risks. Any hasty behavior of the authority may mistakenly
signal bad conditions to a market that is operating normally.
Similarly, keeping a floating exchange rate policy points in the same direction, as it provides
the proper incentives for prudent management of external liquidity and borrowing. It also
helps in the economy's process of real adjustment when facing a deterioration in the external
scenario. In terms of both the exchange rate and access to credit, it is of high importance not
to distort the incentives of financial institutions and firms to prudently administer their risks in
a complex environment.
To sum up, I would like to point out once again that the Board of the Central Bank of Chile
strongly believes that as a country, and particularly as a Bank, we are well prepared to
confront periods of stress. We are certainly not immune to the events outside our borders,
and risks are very high today. We have at our disposal the necessary tools to mitigate the
effects of more adverse external conditions but, most importantly, we can and will use them
whenever the situation calls for it. Solid proofs of this are the measures we have taken in the
last weeks.
Thank you.
Table 1
World growth
(annual change, percent)
Average 2010 2011 (f) 2012 (f) 2013 (f)
Dec.11 Dec.11 Dec.11
00-07 (e) Jan.12 Jan.12 Jan.12
MP Report MP Report MP Report
WEO WEO WEO
World at PPP (1) 4.2 5.0 3.8 3.8 3.5 3.3 4.1 3.9
World at market exchange rate (2) 3.2 3.9 2.8 2.8 2.7 2.5 3.2 3.2
United States 2.6 3.0 1.7 1.8 1.8 1.8 2.2 2.2
Eurozone 2.2 1.9 1.6 1.6 -0.1 -0.5 1.0 0.8
Japan 1.7 4.4 -0.7 -0.9 2.0 1.7 1.6 1.6
China 10.5 10.4 9.1 9.2 8.2 8.2 8.5 8.8
Rest of Asia 5.1 7.8 4.5 4.9 4.4 5.0 4.8 5.0
Latin America (excl. Chile) 3.5 6.3 4.2 4.2 3.6 3.6 4.0 3.9
Commodity exporters 3.1 2.9 2.0 2.1 2.5 2.4 2.8 2.6
Trading partners 3.6 6.1 4.2 4.2 3.8 3.8 4.2 4.3
Terms of trade 8.1 23.8 -2.9 --6.7 --3.5 -
(levels)
LME copper price BML (US$cent/lb) -342 401 -350 -340 -
Gasoline price (US$/m3) -598 804 -784 -748 -
(e) Estimate. (f) Forecast.
(1) Assuming average economic growth for the rest of the world of 3.2% in the three-year period 2011-2013.
(2) Assuming average economic growth for the rest of the world of 1.7% in the three-year period 2011-2013.
Sources: Central Bank of Chile based on a sample of investment banks, Consensus Forecasts, the IMF and statistics bureaus of respective countries.
Figure 1
(2)
Conditions of 90-day rates in CLP market(1)
(percent)
12 12
10 10
8 8
6 6
4 4
2 2
0 0
08 09 10 11 12
(1) Prime deposit rate.
(2) Dotted vertical line marks date of CBC's REPOS purchase announcement.
Source: Central Bank of Chile.