When the COVID-19 pandemic hit in March last year, Mario Marcel knew he had to act quickly as governor of the central bank of Chile. But how? “When you study economic cycles as an economist, you’re used to thinking about cycles that develop with a certain gradualness,” he tells LatinFinance.
The pandemic, however, was “something unprecedented,” says the University of Cambridge-trained economist, who has been at the helm of the central bank since December 2016. Unlike previous cycles triggered by financial crises or external shocks, the health crisis hit the real economy “directly and immediately.”
Marcel responded by slashing the monetary policy rate by 125 basis points to 0.5% in March, only days after the first case of COVID-19 was reported, and rolled out measures to bolster liquidity and shore up the financial market in a bid to limit the economic fallout.
The economy went on to shrink 5.8% in 2020, among the lowest of the larger economies in Latin America. Peru collapsed by 11.1%, Argentina by 9.9%, Mexico 8.3% and Colombia 6.8%, according to data from the World Bank. Only Brazil fared better with a 4.1% contraction. Chile’s rebound this year is also among the most robust, with the central bank recently revising its forecast to 10.5% to 11.5% growth, up from 6%-7% early in the year.
Nikhil Sanghani, an economist at Capital Economics in London, says the forecast may sound “wildly optimistic,” especially as the economy went back into lockdown for a time this year. But it is a sign of both how the economy is becoming “increasingly resilient to lockdown measures” and how the government’s stimulus program is proving to be effective, including a law passed in July last year allowing Chileans to withdraw some of their pension savings, he says.
“The central bank has been ahead of the curve on its estimates, and I think that’s been quite impressive,” Sanghani says.
This adept management of the crisis, including keeping inflation relatively low during the fast recovery, is a reason why Marcel wins LatinFinance’s Central Bank Governor of the Year Award. Voting came from a survey of central bank observers and economists based on who was most effective at managing monetary policy and controlling inflation between July 2020 and June 2021.
“Marcel showed no hesitation to loosen monetary policy at the start of a global economic crisis,” says Marcos Casarin, chief Latin America economist at UK-based Oxford Economics. “Mexico, by comparison, wanted to see the eventual impact on inflation, and then started to cut rates.”
Martín Castellano, head Latin America research at the Institute of International Finance in Washington, D.C., lauded the central bank’s stimulus efforts.
“They put together a very ambitious program to provide liquidity and to ensure banks lend to the private sector, not only to the formal private sector, but also to families and households and companies, particularly small and medium firms that do not have access to financing or financial services,” Castellano says.
A dress rehearsal
Marcel’s team did have an advantage over other central banks coming into the pandemic. Only six months earlier, in October 2019, social protests broke out in Santiago after a hike in subway fares, leading to riots and looting that spread across the country as people demanded more equality and better public services. Curfews, business closures and a drop in consumer spending ensued, spawning political upheaval and a referendum to write a new constitution.
“The social crisis was a kind of a small rehearsal of something that we were going to have face later on a much more massive scale,” Marcel says.
In response to the social unrest, the central bank began incorporating new tools to help it maintain financial and price stability in the country. It developed a monetary policy rate corridor to provide clear guidance on its expected rate movements over the subsequent two years, increasing the predictability of its actions to calm market expectations and the impact on the exchange rate.
The central bank also launched programs to replenish reserves and boost liquidity, including by buying bank bonds on the secondary market. A credit line guarantee scheme was rolled out for private banks. It was designed so that lenders would decide who receives the credits, helping to reduce the risk of loan portfolio deterioration while also encouraging private banks to cut their rates in order access that pool of money as long as they lent to companies at the preferred rate. “It was funding for more lending,” says Casarin.
The central bank also increased its arsenal to weather future crises after a constitutional reform opened the possibility for it to buy government bonds on the secondary market to boost liquidity.
“Hopefully we do not have to use it, but it is also available there well to face future crisis,” Marcel says. “But we have greatly expanded the toolkit of our faculties and the experience to use those faculties.”
The power of now
A big challenge during the pandemic, Marcel remembers, was how to gauge the impact on the economy. The usual indicators — manufacturing output, retail sales, wages — come with a one- to three-month delay, making it hard to make decisions during such a fast-moving crisis as a pandemic. For more immediate data, the central bank started nowcasting, or now forecasting, to monitor the state of the economy, such as by mining data on tax collections for consumer spending trends and the impact of a business closure on the supply chain.
“We had to understand what was happening in real time in the economy so that we could respond in time to the risks,” Marcel says.
The central bank also stepped up the use of ad hoc business questionnaires and surveys to spot trends, such as in layoffs or the use of employment insurance. This provided insight that couldn’t be gleaned from traditional statistics, such as how e-commerce activity surged to account for 40% of retail sales during the pandemic.
With the strategy, the central bank came to better understand how the government’s stimulus measures have played out, Marcel says. The pension withdrawals, for example, were highest among the richest 20% of the population, who proportionally had accumulated more in savings than the other 80%. This fueled faster-than-expected growth in domestic demand, which Marcel expects to grow 18% this year, a reason for his cheery forecast for up to 11.5% economic growth this year.
This microscopic understanding of the market also led the central bank to start withdrawing its monetary stimulus in July and to raise the policy rate by 100 basis points — 25 points in July and 75 in August — to 1.5% to try to keep inflation low and stable. The central bank plans to take the rate to a target of 3.5% in order to bring inflation down from an estimated average of 5.7% this year to less than 4% in 2022 and close to 3% at the end of 2023.
“With the expansion of consumption that we are having, we anticipate that inflationary pressures would lead us to miss this goal if we do not begin to withdraw the monetary tax,” Marcel says. “In other words, until four months ago we had fiscal policy and monetary policy at the maximum expansion rate. But as the economy has already recovered the level of activity prior to the crisis, it is evident that this generates pressures on inflation.”
Add in efforts to stabilize the local currency after plunging about 10% during the crisis, and the policies have saved the economy from what could have been far worse, according to central bank analysis.
“The drop in activity last year would have been more than double what it actually was, and the recovery would have been slower,” Marcel says.
The central bank is not out of the woods yet. Expectations are building that the US Federal Reserve and the European Central Bank may begin to taper their monetary stimulus programs, or pull back on the huge bond-buying programs they launched started at the start of the pandemic to revive their economies. This could also lead to higher interest rates in those markets, reducing investment inflows into Chile and other emerging markets, or the reverse: an exodus to developed markets.
Marcel is confident that Chile can ride it out. While some countries in Latin America are vulnerable because their high debt levels or inflation are limiting their capacity to react on the policy side, “Chile is less so because its economic recovery has been more robust, inflation is lower for Latin American standards, government debt — at 34% of GDP — is also comparatively low, and monetary policy is credible,” Marcel says. “The combination of these factors has allowed Chile to start rolling back the strong monetary impulse without risking stalling economic recovery.”