SOUTHERN CONE AND ANDEAN OPPORTUNITIES CONFERENCE
THE VIEW FROM THE
CHILE: CENTRAL BANK
Mario Marcel1/
Governor, Central Bank of Chile
April 2017
Current macroeconomic conditions and prospects in the monetary policy scenario
1. The last few months have brought mixed signals for the Chilean economy. On the one
hand, 2016 ended in a low tone, with a slowdown in activity and inflation. A series of
oneoff events extended economic weakness into the first quarter of 2017, lowering forecasts for
the year as a whole. On the other, the global outlook appears more favorable, both for the
growth of trade partners and terms of trade. This suggests a gradual improvement of
economic prospects for the Chilean economy which should be further supported by an
expansionary monetary policy as long as inflation remains below target.
2. Activity data and expectations in advanced economies have been more upbeat, marked by
better than expected performance by the manufacturing sector and a broadening of the growth
outlook across countries following years of stagnation. As a result, deflationary risks have
dissipated, as inflation is expected to return to more normal levels. The Federal Reserve (Fed)
has continued to normalize monetary policy and monetary authorities in Europe and Japan
appear to have set aside the possibility of additional stimulus measures. Markets have
incorporated these changes in their expectations avoiding any serious disruptions. Along with
better signs in advanced economies, activity in China has remained relatively stable, which
contrasts with what had been observed one year ago.
3. In this context, there has been an increase in the willingness to take on risk in financial
markets, increasing stock market indices, reducing sovereign risk premiums and increasing
capital flows to emerging markets. Commodity prices have also benefitted. Copper, our main
export product, has been trading at prices near two year highs and prospects for the next few
years have improved, which has had a material impact on the Chilean terms of trade. Thus,
based on better growth prospects for our trading partners, favorable external financial
conditions and increased terms of trade, the baseline scenario included in the Monetary
Policy Report published at the beginning of April, considered that, for the next two years, the
Chilean economy will receive an external impulse higher than considered at the end of 2016
(Figure 1).
Figure 1
Trading partners GDP Terms of trade (*)
(annual change, percent) (index; 2013=100)
4.5 4.5 105 105
4.0 4.0
Mar.17
100 100
Mar.17
3.5 3.5
Dec.16
Dec.16 95 95
3.0 3.0
Sep.16
Sep.16
2.5 2.5
90 90
Avg. Avg. 16 17 18
13 14 15 16 17 18
00-07 10-15
(*) For comparison effects with the new 2013 Benchmark Compilation, the ToT of previous Reports are adjusted to 100
for 2013.
Source: Central Bank of Chile.
4. On the domestic front, inflation has been consistent with what was expected in December.
The annual variation of the CPI fell to 2.7% in March, a significant drop compared to the
4.5% figure of a year ago. The behavior of the nominal exchange rate, which has appreciated
relative to its level one year ago, has been a fundamental driver of these dynamics. The
appreciation has had a greater impact in the decline of the goods component of the CPIEFE
index (our core inflation measure). In fact, the goods component of core inflation dropped
from nearly 5% at the beginning of 2016 to 0.3% in March. The services component has been
stickier, and has dropped from the same levels the first few month of last year to 3.3% in
March. Approximately 3⁄4 of the prices included in this component are managed or indexed
prices, which enhances their inertia and, as such, makes them less sensitive to exchange rate
fluctuations (Figure 2).
Figure 2
Inflation indicators (*)
(annual change, percent)
8 8
CPI
Core services
6 6
4 4
2 2
Core CPI Core goods
0 0
-2 -2
-4 -4
13 14 15 16 17
(*) Starting from January 2014 the new indexes with base year 2013=100 are used, and are thus not strictly
comparable with previous figures.
Sources: Central Bank of Chile and National Statistics Institute.
5. Although in the baseline scenario headline inflation is expected to continue declining in
the coming months towards the lower bound of our tolerance range, it is foreseen to return
to 3% by the end of 2017 and fluctuate close to target towards the first quarter of 2019.
Market expectations are very similar to our forecasts. Convergence of inflation rests on two
main assumptions: first, that our RER will remain relatively stable at its current levels --a
level we believe is consistent with fundamentals-- and, second, that the output gap will
gradually close by the end of this year (Figure 3).
Figure 3
CPI Inflation (*) Core inflation (*)
(annual change, percent) (annual change, percent)
6 6
6 6
5 5 5 5
4 4 4 4
3 3 3 3
2 2 2 2
1 1 1 1
0 0 0 0
11 12 13 14 15 16 17 18 19 11 12 13 14 15 16 17 18 19
Dec. 2016 Report
Mar. 2017 Report
(*) The grey area, starting from the first quarter of 2017, corresponds to the forecast.
Sources: Central Bank of Chile and National Statistics Institute.
6. Activity has been somewhat weaker than expected. According to recent data the output
gap is currently larger than we anticipated in December. GDP grew by 1.6% in 2016, in line
with what was anticipated. However, revised national account data suggests the economy
was somewhat stronger towards the beginning of 2016 and weaker towards the end of the
year, leaving a low starting point for 2017 and a higher base of comparison for the beginning
of the year. The new data also point to weakness in investment-related areas and in sectors
that tend to be more persistent, such as business services (Figure 4).
Figure 4
GDP Non-natural resources GDP
(annual change, percent) (annual change, percent)
8 8 8 Personal 8
Construction
services
Wholesale and
6 6 6 6
retail trade
4 4 4 4
Rest
2 2
2 2
Total
0 0 0 0
Manufacturing
-2 -2
-2 -2
Natural Business services
-4 -4 -4 -4
Resources
14 15 16
14 15 16
Source: Central Bank of Chile.
7. On the expenditure side, domestic demand-excluding changes in inventories-also
tended to decelerate throughout last year. Weakness was most evident in investment in
construction and other works, which contracted by 4.9% in annual terms during the fourth
quarter (average growth of 0.5% between the first and third quarters).
8. Private consumption, in line with its behavior in previous years, provided support to the
economy, growing by more than 2% annually throughout 2016, on the basis of wage growth
and a low unemployment. However, it should be noted that while consumption of
nondurables and services has remained relatively stable, durable goods have recovered, partly
due to the appreciation of the peso during the last year and the necessary replenishment of
inventories following several years of weak growth and even contraction. Something similar
is observed with gross fixed capital formation in machinery and equipment. Excluding the
purchase of non-regular transport machinery, this component of investment has improved in
recent months.
9. In our baseline scenario, gross fixed capital formation should experience a slightly
positive growth in 2017, after three consecutive years of contraction. A key factor in the
negative figures of the last few years is the ending of the mining investment cycle, which
reached its peak in 2012. More recently the deterioration of housing construction has added,
as the boom triggered by tax incentives finished and a modification of loan-to-value norms
reduced home sales. Going forward, our forecasts rely on an increase in non-mining and
nonresidential investment (mainly machinery and equipment). While mining investment will
eventually return to positive territory during 2018, the gradual adjustment in residential
investment is expected to continue during the following quarters (Figure 5).
Figure 5
Real annual contribution to GFCF (*)
(percentage points)
16 16
12 12
Other
8 8
Non-mining
4 4
0 0
-4 -4
Housing
-8 -8
Mining
-12 -12
-16 -16
09 10 11 12 13 14 15 16 17 18
(*) For sectoral GFCF, variations of the 2008 Benchmark Compilation are used. Since total GFCF is expressed using
the 2013 Benchmark Compilation, annual variation of other GFCF is adjusted for consistency purposes.
Estimations for 2015 and 2016 based on available information from listed companies (FECU), Capital Goods
corporation surveys, Chilean Chamber of Construction and National Accounts by institutional sector. For 2017
and 2018, Central Bank projection models and sectoral sources are used, including investment plans and Capital
Goods Corporation surveys.
Source: Central Bank of Chile.
10. The labor market continues to gradually adjust and runs the risk of becoming a drag on
consumption. Wage employment declined by 2% annually in the moving quarter ending
February, and annual wage growth moderated. In addition, working hours declined due to
demand rather than supply reasons. Yet this has not translated into an increase in open
unemployment, due to flexibility in the Chilean labor market: the unemployment rate is still
low from an historic perspective. In fact, despite being more precarious, self-employment
has acted as a significant buffer to the loss of dynamism in wage employment (Figure 6).
Figure 6
Job creation by category Wages (*)
(annual change, percent) (annual change, percent)
9 15 8 8
Self-employment 7 7
Nominal
6 10
Wage
6 6
5 5
3 5
4 4
0 0
3 3
Real
2 2
-3 -5
1 1
0 0
-6 -10
11 12 13 14 15 16 17
11 12 13 14 15 16 17
(*) Both the nominal and the real correspond to the average of the annual variation of IREM and CMO.
Source: National Statistics Institute (INE).
11. Domestic financial conditions remain favorable, particularly in terms of interest rates.
Notwithstanding, credit volumes have decelerated with respect to previous years, as a result
of overall subdued demand. Despite some increase in recent data, NPL ratios remain low, a
clear sign that slower growth has not affected the financial health of companies and
households.
12. The evolution of the local stock market has caught some attention lately, since the IPSA
has increased about 17% this year and more than 30% since December 2015. Although these
numbers might ring some bells, the performance of the Chilean index does not differ
significantly from other regional stock markets and its recent behavior might just be a catch
up from very low levels. Measured in real terms, its current value does not seem to be an
outlier either (Figure 7).
Figure 7
MSCI: Latin America Real IPSA
(fixed-base index: January 2013=100) (fixed-base index: January 2001=100)
350 350
120 120
Mexico
Latin
America
Chile
Brazil
250 250
90 90
Colombia
150 150
60 60
Peru
30 30 50 50
13 14 15 16 17 01 03 05 07 09 11 13 15 17
Sources: Central Bank of Chile and Bloomberg.
13. The prolonged strike at La Escondida, the world ́s largest open-pit copper mine, will
have a very important effect on the first quarter GDP figures. It already did in the Imacec of
February, which showed a yoy contraction of 1.3%, with a fall of 17.1% of its mining
component. Since the strike ended in late March and resumption of production is not
immediate, figures for that month will also be affected. Adding up the continued weakness
in construction, the economy could experience an expansion close to 0% in the first quarter
of the year. However, one should not forget that the strike at La Escondida, while very
relevant to explain the first quarter figure, is a one-off event that is not expected to generate
significant spillovers on activity elsewhere in the economy, nor on inflation.
14. On the basis of these data the Central Bank reduced its growth forecast for 2017 to 1-
2%, compared to 1.5-2.5% in December. At the same time, for 2018 we are expecting the
economy to grow between 2.25 and 3.25% (Table 1), based on the fact that the economy does
not appear to have any relevant imbalances, the mining-related investment adjustment is
expected to end, and a more favorable external outlook. Fiscal policy is assumed to follow
the fiscal consolidation path announced by the Government.
Table 1
Domestic scenario
(annual change, percent)
2015 2016 (e) 2017 (f) 2018 (f)
Dec.16 Mar.17 Dec.16 Mar.17 Mar.17
Report Report Report Report Report
GDP 2.3 1.5 1.6 1.5-2.5 1.0-2.0 2.25-3.25
Domestic demand 2.0 1.1 1.1 2.6 2.3 4.1
Domestic demand (w/o inventory change) 1.7 2.0 2.0 2.0 1.9 2.8
Gross fixed capital formation -0.8 -0.6 -0.8 0.7 0.2 3.0
Total consumption 2.4 2.8 2.8 2.4 2.5 2.8
Goods and services exports -1.8 0.1 -0.1 2.0 1.6 2.7
Goods and services imports -2.7 -1.4 -1.6 4.1 4.3 7.2
Current account (% of GDP) -2.0 -1.7 -1.4 -1.9 -0.9 -2.1
Gross national saving (% of GDP) 21.4 19.3 20.2 19.2 20.3 20.5
GFCF (% of nominal GDP) 23.6 22.2 23.2 21.7 22.5 22.6
(e) Estimate.
(f) Forecast.
Source: Central Bank of Chile.
15. Our base scenario assumes that monetary policy will remain accomodative throughout
the policy horizon. Following the adoption of an expansionary bias in December, the policy
rate has been cut 75bp, acting promptly upon the prospects of a softer economy. In the April
monetary policy meeting, while adopting the last 25bp cut in this series, the Central Bank
Board signaled that it could consider some further policy easing if economic prospects
remained subdued. This is reflected in the evolution of market expectations (Figure 8).
Compared to a neutral real rate of 1%-1.5% Chile ́s monetary policy continues to be one of
the most expansionary among comparable economies.
Figure 8
MPR and expectations
(percent)
5 5
Financial asset
MPR
4 4
prices, March
Financial asset
Report (*)
prices, December
2016 Report (*)
3 3
EES
Financial asset
FBS
prices (17 April)
2 2
14 15 16 17 18 19
(*) Constructed using interest rates on swap contracts up to 10 years.
Source: Central Bank of Chile.
16. As usual with forecasts, this macroeconomic scenario is exposed to risks. External risks
include political and policy risks, especially concentrated on fiscal and monetary policy
decisions in the US. China remains a concern although its authorities appear to have
successfully managed a gradual deceleration without a major disruption thus far. External
risks are particularly relevant for a small open economy like Chile ́s. Upside risks essentially
emerge from a more robust expansion of the world economy and additional improvement in
terms of trade.
17. On the domestic front, several years of subdued growth may have caused some underlying
the economy's ability to grow
erosion that could compromise in the medium term.
Deterioration of the labor market is particularly risky because it could weaken household
consumption, which, by growing 2%-2.5% annually over the last three years has provided
support for domestic demand and, ultimately, inflation. On the other hand, private investment
may recover faster if export demand and expectations improve faster than expected.
Longer-term perspectives
18. In 2012-2013 the Chilean economy was exposed to a substantial external shock given by
the end of the commodities super cycle. However, contrary to past episodes, the economy
did not fall into a recession. In fact, despite a substantial slow down, the signs of an economic
contraction are not visible. Salaried employment slowed down but no massive layoffs have
taken place. Companies saw their margins compressed by rising input costs and weak
demand, but bankruptcies have not picked up. The demand for loans has weakened, but NPLs
have remained stable.
19. The former is due to two major reasons. First, the macroeconomic policy framework has
provided countercyclical support while allowing relative prices to adjust to the new
circumstances via the exchange rate. Between mid-2013 and early 2016 the Chilean peso
depreciated some 55%, putting some pressure on inflation, but the Central Bank kept
monetary policy on a steady course until inflation decelerated from nearly 5% to less than
2% in less than a year.
20. The second reason is that domestic markets and economic agents have been able to adapt
to changing circumstances. In the labor market there has been substantial mobility between
sectors and from salaried to self-employment, while nominal wages and working hours have
adjusted gradually. The corporate sector has cut on costs, improved operational efficiency
and refinanced its debt. Financing conditions have remained historically favorable and banks
have adjusted loan-loss provisions without rationing credit.
21. The above indicates not only that the Chilean economy has become more resilient than in
the past but also that it is well prepared to resume growth. In fact, there are no major
macroeconomic constraints to grow beyond the current rates. On the one hand, financial
conditions are highly favorable and corporations and financial institutions face no liquidity
constraints. On the other, with a current account deficit of 1.6% of GDP, Chile has little
pressure from external savings. Finally, public net debt is only slightly positive and there is
very little risk of crowding out private investment.
Figure 9
Public sector balance
(percent of GDP)
9 Chile 9
4 4
Latin America:
1995-2015 average (*)
2 2 6 6
1.1
0 0 3 3
-0.5
-0.9
0 0
-2 -1.5 -2
-3.1
-4 -3.4 -4 -3 -3
-6 -6 -6 -6
90 94 98 02 06 10 14 18(f)
Peru
Chile
Brazil
Mexico
Colombia
Effective Structural
Argentina
(*) General Government Financial Balance.
(f) For 2017 to 2019, forecasts obtained from the 2016 Public Finances Report.
Sources: Moody's and National Budget Department, Ministry of Finance of Chile.
22. This is one of the factors that explain the CB estimates of growth at 2.25%-3.25% in 2018.
Other factors include improving external conditions, the expansionary monetary policy and
the gradual disappearance of idiosyncratic factors that have dragged down economic activity
in recent years. According to the CB growth should resume gradually from the second quarter
of 2017 to gain speed and start reducing the output gap, currently at 1 1⁄2 per cent, in the
second half of the year (Figure 10).
23. The above compares to a potential growth between 2.5% and 3%, according to the latest
Central Bank estimates. This is indeed significantly lower than trend growth rates close to
5% in the mid-2000s. However, the same Central Bank analysis indicates that reallocating
resources beyond the shorter term, recovering the historical investment/GDP ratios and
resuming the increase of participation rates of women in the labor force could allow the
country to attain trend growth of about 3.5% per year. This suggests that the Chilean economy
still has considerably headroom to grow.
The challenges
24. Speeding up growth with price stability in Chile still faces some important challenges.
First and foremost, closing the current output gap would require recovering productive
investment that has remained particularly weak over the last four years. Part of this is due to
a substantial drop in investment in the mining sector, but gross capital formation in sectors
other than mining has also faltered. While recent data points towards an increase in
machinery imports, a more substantial change would require an improvement in business
expectations that have remained in negative territory for some time.
25. The possibility of raising potential growth beyond the figures quoted above relies
mainly on: (1) increasing human capital accumulation through increased labor participation,
raising working skills above the already projected levels or the migration of workers with the
competences required by the Chilean system; and (2) making productivity improvements via
enhancing companies' efficiency, lowering production and trading costs, and changing
output composition toward more competitive and productive sectors, while advancing in
terms of innovation and technological development.
As Chile's concern for growth has intensified, many ideas about public policies have
26.
emerged that could help enhance productivity, with proposals coming from the government,
private agents and the National Productivity Commission. In particular, policies have been
developed that have permitted to diversify the energy matrix, increase supply reliability and
reduce costs. There have been other factors, however, that pose a risk to productivity,
including initiatives that may overburden corporate costs, generate new trading costs or
reduce savings. Last, but not least, any discussion about productivity must necessarily cover
technological development and innovation, which in Chile is limited by low private and
public investment in R&D and by discontinuity in long-term policies aiming at economic
diversification.
27. A third key challenge for the Chilean economy is to strengthen its institutions and making
them more trustworthy. Even though Chile enjoys a substantial advantage in this respect over
other emerging countries, trust in public and private institutions has suffered from a series of
scandals in recent times and rebuilding such trust would require consistent action over a
number of years. Such effort, however, would be well justified since a low-trust economy is
likely to suffer from high transaction costs, free-riding behavior and low policy effectiveness.
28. The former three elements-investor expectations, potential growth and institutional
trust-are certainly not part of the conventional agenda of central banks. However, even a
narrow focus on stable and low inflation requires monitoring the key developments affecting
the future path of the economy. While the Central Bank can contribute indirectly to these
goals by reducing economic instability and uncertainty, it would greatly benefit from the
additional flexibility, effectiveness and welfare that they would be able to build.