CONTRIBUTORS
Michael Arno, CFA
Portfolio Manager & Senior Research Analyst,
Brandywine Global
I recently returned from a research trip through the Andean region, which included a stop in Santiago, Chile. Along with other portfolio managers and analysts, I met with members of the finance ministry and central bank, local investors, and economists. Following this trip and the recent International Monetary Fund (IMF) conference, I have been thinking about and assessing the continued normalization of monetary policy post-pandemic, inflation dynamics going forward, and fiscal policy throughout the region.
Chile’s pandemic response taps pensions
The COVID-19 pandemic saw a marked difference in the crisis policy responses from countries around the world. In Chile’s case, the central bank quickly cut its policy rate to 0.5%. Additionally, the government initiated several policy actions, including three pension fund withdrawals in July 2020, December 2020, and April 2021. Plan participants drained around $50 billion, the approximate equivalent of 20% of gross domestic product (GDP), from the pension system as a result of these withdrawals, according to Macrobond and government data. The influx of liquidity resulted in a sharp spike in money supply (see Exhibit 1). Prior to these withdrawals, Chile’s pension system assets were $200 billion, or 80% of GDP—a lot of potential fire power to support the economy during pandemic.
Exhibit 1: Chile Saw Surge in Money Supply during Pandemic
M1 CLP Trillions (left), Y/Y % Change (right), As of 4/1/2024
Source: Macrobond (© 2024)
Similar pattern, different ending
During the pandemic, consumption collapsed due to lockdowns. However, as restrictions eased, Chileans went on a spending spree with the money withdrawn from their pensions, sending consumption well above the historical trend (see Exhibit 2).
Exhibit 2: Chile GDP: Total Consumption vs. Trend
Billions, Chilean pesos, Seasonally adjusted, As of Q4 2023
Source: Banco Central de Chile / Haver Analytics (© 2024)
Goods imports rose from a trough of $60 billion to approximately $110 billion (see Exhibit 3), putting downward pressure on Chile’s current account. Ultimately, the current account deteriorated to a deficit of around -12% of GDP (see Exhibit 4).
Exhibit 3: Chile Merchandise Imports
$USD in billions, Not seasonally adjusted, 12-month moving total, As of April 2024
Source: Banco Central de Chile / Haver Analytics (© 2024)
Exhibit 4: Chile Current Account Balance, Real Consumption vs. Trend
% Seasonally adjusted (left), % of GDP (right), As of Q4 2023
Source: Banco Central de Chile / Haver Analytics (© 2024)
In short, the pension fund withdrawals created excessive liquidity, which in turn stimulated consumption. As expected, turbocharged excess domestic demand chasing limited supply became a textbook formula for inflation. Chile saw its inflation rate spike to a level well beyond the prior peak in 2008 (see Exhibit 5). However, what the Chilean central bank did next diverged from many developed market policy responses.
Exhibit 5: Chile: Consumer Price Index, Real Consumption vs. Trend
% Change – Year to Year, Seasonally adjusted, 2018=100 (left), % of GDP (right), As of April 2024
Source: Instituto Nacional de Estadisticas / Haver Analytics (© 2024)
Central bank gets aggressive
Chile’s central bank has been well regarded historically for its commitment to maintaining its inflation targeting over time and more recently for its response to the pandemic and subsequent monetary restraint. While central banks like the Federal Reserve waited to act on inflation, deeming it transitory at first, Chile’s central bank not only removed the punch—or pisco sour—bowl, it essentially shut down the party. The central bank took an extreme response to the inflation and current account crises, tightening policy rates aggressively. Nominal policy rates rose to 11.25% and real ex-ante rates to around 8% (see Exhibit 6), well above the estimated nominal neutral rate of 3.5% to 4.5%.
Exhibit 6: Chile Nominal and Ex-Ante Real Policy Rates Using Central Bank Survey
%, As of 4/30/2024
Source: Bloomberg (© 2022, Bloomberg Finance LP)
Mission accomplished?
As rates rose steeply and rapidly, the resulting credit crunch eventually led to a collapse in demand and consumption. Inflation also has been falling steadily, and expectations are back to their 3% target (see Exhibit 7).
Exhibit 7: Chile Inflation Expectations
% Change Y/Y, As of April 2024
Source: Bloomberg (© 2022, Bloomberg Finance LP)
Mission: Incomplete
The central bank started cutting rates aggressively in July 2023, well ahead of any developed market. After a series of rate cuts, Chile’s nominal rate now stands at 6.5%. The Chilean peso (CLP) has depreciated since September 2022, despite the strong rally in copper prices. CLP now offers significantly lower carry than other countries within Latin America, making it an attractive funding currency against other markets in the region.
So far, the central bank has not seemed too concerned with CLP underperformance. However, producer prices recently have been increasing, credit growth is turning (see Exhibit 8), and Chile could see an increase in consumer prices as well. The central bank’s mission on inflation appears to have been met, but they have yet to reach the mid-point of their target. Now, with signs of a return of inflation, we may likely see a pause or reduction in rate cuts further out. This repricing in rate cuts could be supportive of CLP going forward, assuming a stable copper market and some help from expected US Federal Reserve cuts.
Exhibit 8: Chile Bank Loans
%, As of 5/2/2024
Source: Banco Central de Chile, Haver Analytics (© 2024)
Definitions:
The International Monetary Fund (IMF) is an international organization of various member countries, established to promote international monetary cooperation, exchange stability, and orderly exchange arrangements.
Liquidity refers to the degree to which an asset or security can be bought or sold in the market without affecting the asset's price.
WHAT ARE THE RISKS?
Past performance is no guarantee of future results. Please note that an investor cannot invest directly in an index. Unmanaged index returns do not reflect any fees, expenses or sales charges.
Equity securities are subject to price fluctuation and possible loss of principal. Fixed-income securities involve interest rate, credit, inflation and reinvestment risks; and possible loss of principal. As interest rates rise, the value of fixed income securities falls. International investments are subject to special risks including currency fluctuations, social, economic and political uncertainties, which could increase volatility. These risks are magnified in emerging markets.
U.S. Treasuries are direct debt obligations issued and backed by the “full faith and credit” of the U.S. government. The U.S. government guarantees the principal and interest payments on U.S. Treasuries when the securities are held to maturity. Unlike U.S. Treasuries, debt securities issued by the federal agencies and instrumentalities and related investments may or may not be backed by the full faith and credit of the U.S. government. Even when the U.S. government guarantees principal and interest payments on securities, this guarantee does not apply to losses resulting from declines in the market value of these securities.