Alphacast Highlight - Chile October 2022 Macro Brief

Chile was among the fast-growing economies before it was hit by political turmoil in 2019. Ten years' growth is 2.1%. It grew fast after the pandemic and is now 7% above, fueled by consumption financed by three partial withdrawals of pension savings. In 2022 It's the only economy in the region that is contracting and is expected to contract in 2023 and in terms of FX and inflation it was the worst performer of the year. The rejection of the constitutional amendment may lead to a more market-friendly proposition. However social unrest, violence in the south, volatile copper prices, and the government’s weak parliamentary position imply a highly uncertain scenario.

Activity

In 2023 GDP is expected to fall 1.0%. In August, Chile's Monthly GDP Estimate grew for the second time in the year, of 0.65% MoM, while in annual terms it remained without changes. This growth was pushed by the services sector (+1.9% MoM), offsetting the fall of the wholesale and retail trade (-2% MoM). The slowdown of activity in 2022 can be explained by the cease in the Covid-19 transfers and the lack of impulse that the withdrawals of pension savings gave to the economy the previous year.

Inflation

Headline inflation moderated in September (13.7% YoY vs. 14.1% YoY in August) and following the core inflation's behavior which rose 10.3% YoY (vs. 10.9% YoY in August), while more volatile prices such as food and energy went up, +21.9% YoY and +23.9% YoY respectively, highly permeable to the global acceleration of food prices. In addition, inflation expectations remained way above the 3% target: 2022 12.6% YoY, and for 2023 5.4% YoY.

Monetary Policy

The Chilean central bank's hikes have been particularly aggressive, raising the policy rate from 0.5% in October 2021 to over 10.75% in September 2022. This rapid rise could be explained by both the nation's extraordinarily high inflation rates, as well as its complex political context, with a major rethinking of the country's economic institutions underway. Even though nominal interest rates are significantly higher, they are still below the inflation rate, as seen in negative real rates over the past few months.

FX & Markets

The Chilean Peso had a bad performance in 2022, falling 15% since the beginning of the year, standing at 971.1 on October 26th. The CLP increasing risk premium has somehow dwindled after the referendum, and there was certain stress in the FX market towards the end of September due to the culmination of the FX intervention program by the Chilean Central Bank, but uncertainty over the political near feature looks like the main driver of the FX.

On the other hand, the most outstanding feature of the Chilean capital market is the smoothness of its risk premium compared to the rest of Latin America, which closed in September at 213bps (-318bps vs Latam), +50bps above its historical average. The stability of its risk perception has been positively incorporated into its bond yields. More sensitive to changes in its central bank's monetary policy cycles than to political issues, the EMBI Chile JPM Total Return Index maintained an uptrend from Sep-13 to Dec-21. Fully in line with global and regional bond markets, Chilean fixed income trades -21.8% YTD, impacted by the aggressive tightening of its MP rate.

Chile’s equity ETF, on the other hand, accumulated positive performance as of late October (ECH, +6.2% YTD). Although it is usually traded with a high correlation to Latam (ILF, +15% YTD), the Chilean ETF is 24% exposed to Sociedad Química y Minera de Chile (SQM, +86.7% YTD), the world's largest lithium producer. Because of the lithium bull run, ECH’s returns are influenced by the company's outstanding performance. As of October 25, the ECH was trading at USD 24.5 (+43.3% from the Mar-20 low), while in the last 18 months the index has traded sideways in the USD 22-29 range.

Fiscal

Chile shows an outstanding fiscal consolidation in 2022. The 2023 budget estimates a fiscal surplus of around 1.6% of GDP for 2022, a great improvement from the deficit of -7.7% in 2021. This can be explained by a sharp decrease in expenditures due to the fall in Covid-19 transfers from 2021, while income has been boosted by extraordinary payments received from lithium production contracts and higher-than-expected tax revenues. However, due to the forecast of a fall in activity for 2023 and hence the prospects of higher expenditures and lower tax revenue, the fiscal result is expected to be in deficit again next year.

Trade & Current Account

Since the beginning of the pandemic, Chile’s terms of trade rose, reaching a peak on June 2021, and then started following a descending path, mainly due to its close link to copper prices which have been falling lately. Also, the multilateral real exchange rate appreciated from early 2020 until April 2020 and started depreciating. The combination of both, descending terms of trade and appreciation of the multilateral exchange rate led to a deterioration in the trade balance, with imports growing faster and above exports.

As the current account is closely related to the trade balance, there is a notable deterioration of this indicator, at 8.5% of GDP in 2Q-22. The strengthening of the USD, the weakening of its main trade partners, and local uncertainty are key to understanding the decline of the current account balance. Also, the record high current account deficit is a weak spot of a country positively exposed to oil prices (aka, the war) and negatively exposed to metals/copper prices (aka, China deceleration).