Economics Group Special Commentary Eugenio J. Alemán, Senior Economist eugenio.j.aleman@wellsfargo.com (704) 410-3273 Chilean Economy Struggles in Early 2016 Weak Global Growth Having Impact on Chile The Chilean economy has been one of the most negatively affected economies due to the unraveling of the commodity boom cycle spearheaded by the strong growth in the Chinese economy during the past several decades. As an economy highly dependent on the performance of only one commodity, copper, the Chilean economy rode the boom as it went up and it is feeling the pain as copper prices have come back down. But as the price of copper has faltered, the most important consequence of this decline and in Chinese growth has been on the ability of the Chilean government to spread or distribute the gains from this boom. Of course, this is not a problem limited only to Chile, as other Latin American countries are experiencing the same issues. However, what makes Chile different is policy consistency even during the boom, which is something that few Latin American neighbors are able to match. For example, in Brazil, Argentina, Venezuela and many other Latin American countries, the benefits from higher commodity prices were mostly squandered in the provision of subsidies for consumption of goods, and few of these resources were used to improve the country s productive infrastructure or the country s ability to produce more. Figure 1 600 Chilean Copper Production Thousands of Tons Copper Production: Apr @ 432.3K 600 Figure 2 $6.0 Chilean Copper Exports Billions of U.S. Dollars Copper Exports: May @ $2.27 Billion $6.0 The Chilean economy has been one of the most negatively affected economies due to the unraveling of the commodity boom cycle. 500 500 $5.0 $5.0 400 400 $4.0 $4.0 300 300 $3.0 $3.0 200 200 $2.0 $2.0 100 100 $1.0 $1.0 0 80 82 84 86 88 90 92 94 96 98 00 02 04 06 08 10 12 14 16 0 $0.0 96 98 00 02 04 06 08 10 12 14 16 $0.0 Source: IHS Global Insight and Wells Fargo Securities Thus, fiscal expenditures, which were mostly financed by high commodity prices and strong export growth increased considerably in all of these Latin countries. However, once commodity prices and exports started to falter, all this expansion in fiscal expenditures had to be rolled back, which has created all sorts of problems, from very weak growth to very high inflation in some of the countries that have been dismantling the extensive, and expensive, subsidy schemes. In the case of Brazil, this negative fiscal environment occurred simultaneously to the president s reelection campaign, which seems to have pushed the administration to hide fiscal efforts to win reelection, according to the impeachment accusation. Thus, the current impeachment process is This report is available on wellsfargo.com/s and on Bloomberg WFRE.
WELLS FARGO SECURITIES The current environment is much more manageable in Chile than in the rest of the region. Since commodity prices and Chinese growth started to weaken, the Chilean economy has grown at an average of 2.0 percent per annum. predicated on the Rousseff administration s borrowing money from government-owned banks to finance the reelection campaign. Now the country is facing a very tough fiscal environment and a severe recession, which has produced an explosion of the fiscal deficit to 10.1 percent of GDP in April of this year from a deficit of only 2.5 percent of GDP in 2010. In Chile, which is one of the best, if not the best, managed economy in the region things are difficult, but not as bad as in other countries. Chileans have been able to figure out how to counteract the ups and downs of the business cycle by implementing counter-cyclical fiscal policies that accumulate in the good times and then use those funds when things get tough. Of course, we are not saying that things are rosy in Chile compared to other countries of the region. They are not. However, the current environment is much more manageable in Chile than in the rest of the region. Still, the Chilean economy will need to continue to adjust to the new global realities and implement its own adjustment process. Meanwhile, President Bachelet s second term in office may not be as positive as her first term, but we do not expect the Chilean economy to deviate from its sound macro path that has characterized the country over its history. President Bachelet s first term in office occurred during the boom years, and she is realizing how different a presidency can be when available resources are limited. Furthermore, the country s speed to a more egalitarian distribution of income will probably weaken, compared to the recent past because current conditions are not as good as they were during the commodity boom cycle. However, we are confident that growth will continue and the country will successfully overcome the current slow environment and will remain the most effective and dependable economy in Latin America. Let us look at the Chilean economy s recent performance. The Economy Is On the Mend, For Now The Chilean economy has slowed down considerably during the past several years as Chinese growth started to slow down and commodity prices declined. Furthermore, the administration of President Bachelet passed a tax reform to help fund free public education for all, which, according to some analysts, has affected confidence in the economy during the past several years. Average real GDP growth for the period 1997-2013, which included two years of negative growth, was 4.3 percent. Since commodity prices and Chinese growth started to weaken, the Chilean economy has grown at an average of 2.0 percent per annum, less than half the average for the previous 17 years. Furthermore, the consensus forecast looks for real GDP growth to remain close to this average of 2 percent for the next several years, which will test the limits of President Bachelet s long list of social reforms. Figure 3 12% 1 Chilean Real GDP Not Seasonally Adjusted Year-over-Year Growth: Q1 @ 2. 12% 1 Figure 4 2 15% Chilean Real Exports Not Seasonally Adjusted Year-over-Year Growth: Q1 @ 2.4% 2 15% 8% 8% 6% 6% 1 1 4% 4% 5% 5% 2% 2% -2% -2% -5% -5% -4% 04 05 06 07 08 09 10 11 12 13 14 15 16-4% -1 04 05 06 07 08 09 10 11 12 13 14 15 16-1 Source: IHS Global Insight and Wells Fargo Securities The latest trend continued during the first quarter of the year when the Chilean economy grew at a 2.0 percent rate, year over year, (Figure 3) after slowing down to a 1.3 percent year-over-year rate during the last quarter of 2015. The partial recovery from the weak performance in Q4 2015 2
WELLS FARGO SECURITIES, LLC was a result of a better export sector, which grew 2.4 percent, year over year, (Figure 4) and a relatively weaker import sector, which dropped 3.0 percent. Recall that imports enters GDP with a negative sign; thus, a drop in imports boosts the growth in GDP. Interestingly, the improvement in the export sector was not related to an improvement in copper exports, which is a good sign for the Chilean economy and, if sustained, can only presage better times ahead if the copper export sector recovers some of its past splendor. Figures 1 and 2 on page 1 show Chilean copper production and copper exports, and it is clear that production as well as copper exports have continued to come down. One of the strongest growth sectors from the supply and export side during the first quarter of the year was the agricultural sector, which experienced an output increase of 4.5 percent during the period, year over year, after declining 2.4 percent during the previous quarter. Public utilities were the strongest supply sector during the quarter. Its output rose an impressive 9.8 percent during the quarter after another strong print, an increase of 5.1 percent, during the last quarter of last year. At the same time, personal consumption expenditures (PCE) improved somewhat during the quarter, increasing 1.6 percent compared to a 1.1 percent improvement during the last quarter of 2015. The improvement in PCE, while not very strong, was a relatively important reversal to what had happened to PCE during 2015. Although PCE grew 2.2 percent in the first quarter of 2015, it slowed down to 1.2 percent in Q2, 1.3 percent in Q3 and, as we said before, 1.1 percent in the last quarter of the year. Furthermore, gross capital formation returned to a positive rate of growth in the first quarter after falling during three of the four quarters in 2015. However, growth in this important and dynamic sector of activity was only 1.2 percent after dropping 1.3 percent for the last quarter of 2015. Fiscal Deficit Impacted By Slowdown As it is usually the case, a weak environment means a deteriorating fiscal environment, and Chile is not immune to this deterioration. However, as has always been the case, Chile s political system and macro management have already taken note of the deterioration and has started to put solutions in place to bring the deficit under control. After recording large fiscal surpluses during the first decade of the century, the country posted a deficit of 4.4 percent of GDP in 2009 and a deficit of 0.4 percent of GDP in 2010. This result was an important deterioration even as the country spent $9.3 billion dollars from the counter-cyclical fund to support activity during the worst of the 2009 recession. By comparison, the country spent $150 million, $499 million, and $464 million in 2010, 2014, and 2015, respectively, to help fund the pension fund sovereign fund. Fiscal accounts recovered somewhat in 2011 and 2012 but started to deteriorate once again in 2013 and 2014. The deficit continued on its deteriorating trend in 2015 to close the year at about -2.2 percent of GDP and closed April of this year at -2.3 percent of GDP. The 2009 recession signified a big drain of the counter-cyclical fund. Before the recession, the fund had almost $20 billion in assets, whereas today, those assets stand at $14 billion. Meanwhile, the pension fund has continued to accumulate assets almost continuously. In 2009, the fund had approximately $3 billion, whereas today, the fund is $8.3 billion strong. Altogether, the two funds total about $22.3 billion. This means that the Chilean government will have to continue to reign in fiscal expenditures this year; therefore, government help for the economy will be limited. For now, however, a few cutbacks have been seen from the government as government consumption increased a strong 5.4 percent in the first quarter of the year. However, we expect this strength in government consumption to weaken during the rest of the year as the Bachelet administration reigns in expenditures. Likely, the relatively strong performance of exports during the first quarter of the year gave the administration some more leeway to spend a bit more, but we do not think this performance is sustainable during the rest of the year. A weak environment means a deteriorating fiscal environment, and Chile is not immune to this deterioration. 3
WELLS FARGO SECURITIES Conclusion As we said at the beginning, the Chilean economy is the best-managed economy in the Latin American region, and the strengths of this macro management will help the economy navigate the tumultuous waters of the current global environment. However, this does not mean that there are no costs to Chile or other economies in Latin America. The pain being experienced in many neighboring Latin American countries is a testimony to the severity of the current adjustment in the region. Although the Chilean economy s high dependency on copper prices and copper exports is a negative for growth, today the economy has, nonetheless, managed to grow. Our expectation is for the economy to continue to grow at close to 2 percent per year until the global environment improves. 4
Wells Fargo Securities Economics Group Diane Schumaker-Krieg Global Head of Research, Economics & Strategy (704) 410-1801 (212) 214-5070 diane.schumaker@wellsfargo.com John E. Silvia, Ph.D. Chief Economist (704) 410-3275 john.silvia@wellsfargo.com Mark Vitner Senior Economist (704) 410-3277 mark.vitner@wellsfargo.com Jay H. Bryson, Ph.D. Global Economist (704) 410-3274 jay.bryson@wellsfargo.com Sam Bullard Senior Economist (704) 410-3280 sam.bullard@wellsfargo.com Nick Bennenbroek Currency Strategist (212) 214-5636 nicholas.bennenbroek@wellsfargo.com Anika R. Khan Senior Economist (704) 410-3271 anika.khan@wellsfargo.com Eugenio J. Alemán, Ph.D. Senior Economist (704) 410-3273 eugenio.j.aleman@wellsfargo.com Azhar Iqbal Econometrician (704) 410-3270 azhar.iqbal@wellsfargo.com Tim Quinlan Senior Economist (704) 410-3283 tim.quinlan@wellsfargo.com Eric Viloria, CFA Currency Strategist (212) 214-5637 eric.viloria@wellsfargo.com Sarah House Economist (704) 410-3282 sarah.house@wellsfargo.com Michael A. Brown Economist (704) 410-3278 michael.a.brown@wellsfargo.com Jamie Feik Economist (704) 410-3291 jamie.feik@wellsfargo.com Erik Nelson Economic Analyst (212) 214-5652 erik.f.nelson@wellsfargo.com Alex Moehring Economic Analyst (704) 410-3247 alex.v.moehring@wellsfargo.com Misa Batcheller Economic Analyst (704) 410-3060 misa.n.batcheller@wellsfargo.com Michael Pugliese Economic Analyst (704) 410-3156 michael.d.pugliese@wellsfargo.com Julianne Causey Economic Analyst (704) 410-3281 julianne.causey@wellsfargo.com Donna LaFleur Executive Assistant (704) 410-3279 donna.lafleur@wellsfargo.com Dawne Howes Administrative Assistant (704) 410-3272 dawne.howes@wellsfargo.com Wells Fargo Securities Economics Group publications are produced by Wells Fargo Securities, LLC, a U.S. broker-dealer registered with the U.S. Securities and Exchange Commission, the Financial Industry Regulatory Authority, and the Securities Investor Protection Corp. Wells Fargo Securities, LLC, distributes these publications directly and through subsidiaries including, but not limited to, Wells Fargo & Company, Wells Fargo Bank N.A., Wells Fargo Advisors, LLC, Wells Fargo Securities International Limited, Wells Fargo Securities Asia Limited and Wells Fargo Securities (Japan) Co. Limited. Wells Fargo Securities, LLC. is registered with the Commodities Futures Trading Commission as a futures commission merchant and is a member in good standing of the National Futures Association. Wells Fargo Bank, N.A. is registered with the Commodities Futures Trading Commission as a swap dealer and is a member in good standing of the National Futures Association. Wells Fargo Securities, LLC. and Wells Fargo Bank, N.A. are generally engaged in the trading of futures and derivative products, any of which may be discussed within this publication. Wells Fargo Securities, LLC does not compensate its research analysts based on specific investment banking transactions. Wells Fargo Securities, LLC s research analysts receive compensation that is based upon and impacted by the overall profitability and revenue of the firm which includes, but is not limited to investment banking revenue. The information and opinions herein are for general information use only. Wells Fargo Securities, LLC does not guarantee their accuracy or completeness, nor does Wells Fargo Securities, LLC assume any liability for any loss that may result from the reliance by any person upon any such information or opinions. Such information and opinions are subject to change without notice, are for general information only and are not intended as an offer or solicitation with respect to the purchase or sales of any security or as personalized investment advice. Wells Fargo Securities, LLC is a separate legal entity and distinct from affiliated banks and is a wholly owned subsidiary of Wells Fargo & Company 2016 Wells Fargo Securities, LLC. Important Information for Non-U.S. Recipients For recipients in the EEA, this report is distributed by Wells Fargo Securities International Limited ("WFSIL"). WFSIL is a U.K. incorporated investment firm authorized and regulated by the Financial Conduct Authority. The content of this report has been approved by WFSIL a regulated person under the Act. For purposes of the U.K. Financial Conduct Authority s rules, this report constitutes impartial investment research. WFSIL does not deal with retail clients as defined in the Markets in Financial Instruments Directive 2007. The FCA rules made under the Financial Services and Markets Act 2000 for the protection of retail clients will therefore not apply, nor will the Financial Services Compensation Scheme be available. This report is not intended for, and should not be relied upon by, retail clients. This document and any other materials accompanying this document (collectively, the "Materials") are provided for general informational purposes only. SECURITIES: NOT FDIC-INSURED/NOT BANK-GUARANTEED/MAY LOSE VALUE