Chile: the macroeconomic scenario

Rodrigo Vergara
Governor

Central Bank of Chile, May 2016

 Introduction

Like many other emerging economies, Chile is facing a very complex international scenario
that poses major challenges to policy makers.

The global economy has deteriorated: the commodity super-cycle came to an end and the
extraordinarily expansionary financial conditions are fading away.

Chile has made a smooth, timely adjustment to the change in its external conditions. Domestic
activity is undergoing a phase of economic slowdown in a context of above-target inflation.

The Central Bank of Chile has helped to smooth the business cycle by keeping an expansionary
monetary policy in place.
For several years, Chile and other Latin American economies received a
major impulse from abroad, in the form of large increases in commodity
prices, among others. This has changed during the last years.

Commodity prices (*)

(index, 2000-2016=100)

260 260
Energy
220 220

180 180

140 140

100 Grains 100

Metals
60 60

20 20
00 02 04 06 08 10 12 14 16

(*) Goldman Sachs aggregate index. 3

Source: Bloomberg.
 World growth has been disappointing.

World growth and forecasts evolution (*)

(annual change, percent)
6 6

5 5
Apr.11 Apr.12
Apr.13

Apr.14
4 4
Apr.15

3 World GDP PPP Apr.16 3

2 2
10 12 14 16 18

4
(*) Forecasts included in the IMFs WEO.
Source: World Economic Outlook, IMF.
 In this new scenario, but also because of idiosyncratic problems in some
economies, the growth outlook for Latin America has been sharply revised
downward.

Latin America: Change in the 2016 growth forecast

(percentage points)

Chile
0 0
Mexico
-1 -1
Colombia

-2 Peru -2

-3 -3

-4 -4
Brazil

-5 -5

-6 -6
Jan.15 Apr.15 Jul.15 Oct.15 Jan.16 Apr.16

5
Source: Consensus Forecasts.
Meanwhile, in Chile the expectations of consumers and businesses have
remained pessimistic for quite some time.

Consumer (IPEC) and business expectations (IMCE)(*)

(index)

70 70
IMCE excl. mining

60 60

50 50

40 IPEC 40

30 30
07 08 09 10 11 12 13 14 15 16

(*) A value over (under) 50 indicates optimism (pessimism). 6

Sources: Adimark and Icare/Universidad Adolfo Ibez.
 In this context, Chiles domestic output and demand have decelerated
and are growing slowly: around 2% in 2015.

GDP and domestic demand

(annual change, percent)

20 20

15 Domestic demand 15

10 10

5 5
GDP
0 0

-5 -5

-10 -10

-15 -15
09 10 11 12 13 14 15

Source: Central Bank of Chile. 7

Our estimates for this years GDP are in the 1.25% - 2.25% range, with a
moderate recovery towards 2017: between 2% and 3%.

Domestic scenario
(annual change, percent)
2014 2015 (e) 2016 (f) 2017 (f)
Report Report Report Report Report
Dec.15 Mar.16 Dec.15 Mar.16 Mar.16

GDP 1.9 2.1 2.1 2.0-3.0 1.25-2.25 2.0-3.0

Domestic demand -0.3 2.3 1.8 2.6 1.5 2.6
Domestic demand (w/o inventory change) 1.1 2.0 1.3 2.5 1.5 2.3
Gross fixed capital formation -4.2 0.7 -1.5 1.7 0.5 1.0
Total consumption 2.8 2.4 2.2 2.7 1.8 2.7
Goods and services exports 1.1 -1.7 -1.9 1.0 0.6 2.4
Goods and services imports -5.7 -1.4 -2.8 1.6 -0.6 2.1
Current account (% of GDP) -1.3 -1.7 -2.1 -2.6 -2.5 -2.0
Gross national saving (% of GDP) 20.9 20.0 20.4 19.1 19.9 20.2
Gross national investment (% of GDP) 23.0 22.0 22.7 21.9 22.6 22.1

(e) Estimate.
(f) Forecast. 8
Source: Central Bank of Chile.
The change in external conditions drove a significant depreciation of the
peso.

Latin America: Nominal exchange rate

(index, May 2013=100)

220 220
Brazil
200 200

180 180

160 160
Mexico
140 140
Chile
120 120
Peru
100 100
Colombia
80 80
may.13
May.13 ene.14
Jan .14 sep.14
Sep . 14 may.15
May.15 ene.16
Jan.16

9
Source: Bloomberg.
 The counterpart of such depreciation has been that inflation in many
countries of the region has been above the central banks target ranges
and has stayed there for longer than expected initially.

Latin America: Inflation

(annual change, percent)

12 12

Brazil
10 10

8 8

Colombia
6 6
Peru Mexico
4 4

2 2
Chile
0 0
11 12 13 14 15 16

10
Sources: Bloomberg and National Statistics Institute (INE).
In Chile, inflation has remained above 4% for several quarters. We expect inflation
to gradually converge to 3% over the coming quarters.

CPI inflation(*) CPIEFE 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 11 12 13 14 15 16 17 18

Mar. 2016 Report Dec. 2015 Report

(*) Gray area, as from the first quarter of 2016, shows forecast. 11
Sources: Central Bank of Chile and National Statistics Institute (INE).
 The Central Bank has contributed to the relative price adjustment
necessary for dealing with the changed conditions inside and outside
the country by applying an expansionary monetary policy and
accommodating a significant depreciation of the peso.
Nominal monetary policy rate (MPR)
(percent)

9 9
8 8
7 7
6 6
5 5
4 4
3 3
2 2
1 1
0 0
01 02 03 04 05 06 07 08 09 10 11 12 13 14 15 16

12
Source: Central Bank of Chile.
 The Central Banks credibility and policy scheme has allowed for
expectations remaining anchored to the target.

Deviation of expected inflation from the target (*)

(percentage points)

1.2 1.2
Peru
1.0 1.0

0.8 0.8

0.6 0.6
Mexico
0.4 0.4

0.2 Colombia 0.2

Chile
0.0 0.0

-0.2 -0.2
15 Apr. Jul. Oct. 16 Apr.

(*) Difference between inflation expected at December 2017 and target inflation for Peru and Mexico. For Chile and 13
Colombia: difference between inflation expected two years ahead and target inflation.
Sources: Bloomberg and central bank of respective country.
Moreover, Chiles current MPR is among the most expansionary in
Latin America and a group of comparable economies.

Real MPR (*)

(percent)

8 Brazil 8

6 6

4 4

Colombia
2 2
N. Zeland
Canada Chile Mexico
0 0
Australia Peru Indonesia

-2 Norway
Noruega Canada Australia Chile Mxico Per Nueva Zelanda Indonesia Colombia Brasil

-2

(*) Calculated as the current MPR less expected inflation one year ahead. Inflation expectations derived from market 14
survey, except for Canada, Norway and New Zealand , where central bank forecasts are used.
Sources: Bloomberg and central bank of each country.
This expansionary monetary policy reflects in the low level of long-term
interest rates.

Interest rates on Central Bank of Chile documents

(percent)
Nominal rates Real rates
9 9 5 5
BCU-10
8 8 BCU-2
BCP-10
4 4
7 BCP-5 7
6 6
3 3
5 5
4 4 BCU-5
2 2
3 BCP-2 3
2 2 1 1
1 1
0 0 0 0
03 05 07 09 11 13 15 03 05 07 09 11 13 15

15
Source: Central Bank of Chile.
It also reflects in lending rates, which have remained near historic lows.

Lending rates (1) (2)

(percent)

20 40 8 8

Mortgage (3)
7 7
15 35

Commercial 6 6
10 30
5 5

5 25
Consumer 4 4

0 20 3 3
02 04 06 08 10 12 14 16 02 04 06 08 10 12 14 16

(1) Weighted average rates of all operations in the month. (2) The horizontal dotted lines indicate the 2002-2016 16
average for each series. (3) Mortgage interest rates are in UFs.
Source: Central Bank of Chile, based on SBIF data.
This has resulted in a real increase in credit which, although lower than it
was in previous years, is significantly higher than the average expansion
of the economy.

Real annual growth rate of loans

(percent)

25 25
Consumer
20 Housing 20

15 15

10 10

5 5
Commercial

0 0
Total
-5 -5
00 02 04 06 08 10 12 14 16

17
Source: Central Bank of Chile, based on SBIF data.
 In the most likely scenario defined in the last Monetary Policy Report, for
inflation to converge to the target it is necessary to partially withdraw the
monetary stimulus in place. Still, monetary policy will remain expansionary.

MPR and expectations

(percent)

5 5

MPR EES
4 Financial asset prices March 4
Report (*)

FBS Spot financial assets (*)

3 3

2 2
14 15 16 17 18

(*) Built using interest rates on swap contracts up to 10 years. Spot prices as of May, 5th 2016. 18
Source: Central Bank of Chile.
The Board estimates that the balance of risks is unbiased for both output and
inflation.
International financial markets:
Repeated volatility episodes (China; differential between market rate and Fed rate, and
among G3).

But also, the recent higher appetite for risk could go on.

World activity prospects:

Doubts about China and the strength of US recovery; also, electoral debates in several
countries and a possible shift to more protectionist policies.

Impulse policies, particularly in the developed world and China, could be more
successful in promoting greater global growth.

Latin America :
Several countries need to make substantial, costly adjustments.
Complicated political issues in some of them.
Negative scenarios with effects on funding costs and external demand.
The Board estimates that the balance of risks is unbiased for both output and
inflation.

Output:
Slower growth if the labor market deteriorates further and/or expectations become
more pessimistic.

Faster recovery: the economy is well balanced from a macro perspective, has a
responsible fiscal policy, well-anchored inflation expectations and a stable, well-
regulated financial system.

Inflation:
Inflation has remained high for a long time, which might affect the velocity of its
convergence to the target, because of both indexation effects and potential
impact in the formation of expectations.

Over the short term, its dynamics will continue to be closely tied to the evolution
of the exchange rate, which will be determined by external scenarios, so there
are risks in either direction. The recent appreciation of the peso could diminish
inflationary pressures.
Lately, the labor market has shown a more latent weakness, which was
one of the risks for domestic growth identified in the last Report.

Labor market
(percent)

8 8
Unemployment rate

6 6

4 4
Salaried employment (y/y)

2 2

0 0
11 12 13 14 15 16

Source: National Statistics Institute (INE) . 21

 Aside from monetary policy, there are many elements complementing
and reinforcing one another, putting the Chilean economy on a good
stand to face present and future challenges.

An autonomous Central Bank and a floating exchange rate regime.

Fiscal policy has helped with a spending trajectory consistent with a fiscal rule and the
governments commitment with pursuing a path of fiscal consolidation.

Our stable, well-regulated financial system has also played a part.

Plus, significant integration to international markets.

 The fiscal rule allows us to have a responsible, predictable fiscal
policy. This has granted us a very favorable position compared
with other economies of the world.

Net Public Debt 2015 (1) (2)

(percent of GDP)

Japan
UK
USA
Germany
Hungary
Israel
S. Africa
Korea Rep.
Poland
Philippines
Czech Rep.
Chile
Peru
Brazil
Venezuela
Mexico
-20 0 20 40 60 80 100 120 140

Latin American Economies Other Emerging Economies Advanced Economies

(1) Net Debt of the Central Government (excluding reserves, central bank debt and social security). (2) With the
exception of Chile, data was estimated by WEO or, when not available, by Moodys. Sources: Central Bank of Chile, 23
Bloomberg, IMF, Ministry of Finance of Chile and Moody's.
Chile has more liquid external funds available than it had in earlier low-
growth periods.

Availability of net foreign financial liquidity (1)

(percent of GDP)
100 100

80 80

60 60

40 40

20 20

0 0
99 01 03 05 07 09 11 13 15
Banks Institutions RSTED (3)
Other sectors Unrestricted Reserves (2)
Central Government Other Official International Reserves of the CBC

(1) GDP at constant real exchange rate (index June 2015 = 100). External liquidity includes short-term loans, currency
and time deposits, and portfolio investment. Excludes derivative positions. (2) Official reserves minus short-term
commitments in foreign currency (BCX maturities, BCD, swaps). (3) Residual short-term external debt. 24
Source: Central Bank of Chile.
 Chile has been integrated to financial and commercial markets. For
example, it has diversified its exports destinations, which also
helps to cushion economic cycles.
Exports destinations
(share of total exports)
1990 2015

Latin Latin
America Others America
Others
12% 19% 18%
15%

Japan USA
USA 17%
16% 13%
Europe
16%

Japan
China 9%
0.4 % China
Europe
26%
39%

Source: Central Bank of Chile. 25

 As a result, the Chilean economy succeeded in making a timely
and significant adjustment in response to the change in external
and internal conditions.
Current-account balance (*)
(percent of GDP)

6 6

4 4

2 2

0 0

-2 -2

-4 -4

-6 -6
90 95 00 05 10 15

(*) Red bars correspond to forecast included in the Monetary Policy Report, March 2016.
26
Source: Central Bank of Chile.
 Our strong policy framework sets us apart from other economies in the
region. In Chile, long-term interest rates have remained low and
significantly stable.

Sovereing spreads (1) Nominal 10-year government bond rates (2)

(basis points) (percent)
550 550 10 18

450 450 8 16

350 350 6 14

250 250 4 12

150 150 2 10

50 50 0 8
13 14 15 16 13 14 15 16

Chile Mxico Per Colombia Brasil

(1) Measured by five-year CDS spreads. (2) Includes Central Bank and Treasury bonds. 27
Sources: Central Bank of Chile and Bloomberg.
 Many economies in the region have yet to make some complex
adjustments requiring substantial funding.

Current account Fiscal balance

(percent of GDP) (percent of GDP)

6 6 9 9

4 4 6 6

2 2 3 3

0 0 0 0

-2 -2 -3 -3

-4 -4 -6 -6

-9 -9
-6 -6
-12 -12
-8 -8
00 02 04 06 08 10 12 14 16 00 02 04 06 08 10 12 14 16

Brazil Chile Colombia Mexico Peru

28
Sources: Central Bank of Chile and International Monetary Fund (WEO April 2016).
 Conclusions

The emerging economies are dealing with a complex macroeconomic scenario.

The end of the commodity super-cycle and less favorable financial conditions pose a significant
challenges for economic policies.

From a macroeconomic point of view, Chile is a very solid, stable and balanced economy.

Therefore, our economy is on a good stand to face the challanges posed by the external
scenario and resume higher rates of growth.
Chile: The macroeconomic scenario

Rodrigo Vergara
Governor

Central Bank of Chile, May 2016