2009 Article IV Consultation: Staff Report; Staff Statement and Supplement; Public Information Notice on the Executive Board Discussion; and Statement by the Executive Director for Chile

This 2009 Article IV Consultation highlights that the Chilean economy has proved resilient in the face of the global financial crisis. The policy response to the crisis has been sizable, well balanced, and coordinated. Executive Directors have commended the Chilean authorities for their sound policy framework underpinned by an inflation target regime, a structural budget rule, and a flexible exchange rate regime. Directors have also endorsed the Central Bank of Chile’s decision to implement alternative means of monetary easing to support activity and a return of inflation to the target.


This 2009 Article IV Consultation highlights that the Chilean economy has proved resilient in the face of the global financial crisis. The policy response to the crisis has been sizable, well balanced, and coordinated. Executive Directors have commended the Chilean authorities for their sound policy framework underpinned by an inflation target regime, a structural budget rule, and a flexible exchange rate regime. Directors have also endorsed the Central Bank of Chile’s decision to implement alternative means of monetary easing to support activity and a return of inflation to the target.

I. Staff Appraisal and Executive Summary

1. Chile’s economy is in a significantly better position than most economies to face the global crisis. This owes much to its policy framework and track record of exemplary policies. Large fiscal savings over the past several years have been critical to preserve stability and cover financing needs. The imbalances in the financial and corporate sectors witnessed elsewhere have been absent—the banking system is well-capitalized, the supervisory framework is strong, and domestic capital markets are well-developed.

2. The policy response also played a critical role in buffering the impact of unprecedented global headwinds. The response has been vigorous, well balanced, and coordinated. Macroeconomic conditions have begun to stabilize in the second quarter of 2009, and bode well for early recovery prospects. Nevertheless, economic growth performance is expected to be less favorable than prior to the crisis, as global uncertainty still remains high, the global recovery could be sluggish, and global trend growth prospects have been marked down. All these factors could drag real GDP growth down in Chile in 2009–10. Risks to inflation appear balanced and highly dependent on external developments.

3. The global crisis may present additional challenges to the macroeconomic policy outlook. Chile’s skillful handling of the global crisis has been reflected in a marked appreciation of the peso in real effective terms during recent months, following the sharp depreciation in late 2008. Nonetheless, staff estimates the real exchange rate to be broadly in line with fundamentals. Were downside risks to materialize, further countercyclical measures would be required—a task to be led by monetary policy, given that the scope for further fiscal measures in 2009 is exhausted and potential challenges facing fiscal policy in 2010.

4. Alternative means of monetary policy easing may have to be carefully contemplated. With inflation expectations anchored around the 3 percent target, the reduction in policy interest rates, along with measures to facilitate access to credit and promote competition, should take increasing hold, support demand ahead and thus bring inflation back to the target. Imparting monetary policy with more countercyclical impulse could involve announcing a more explicit contingent commitment to maintain a low policy interest rate for an extended period; and extending the tenor of new liquidity instruments. Any “quantitative easing” should be limited to operations involving central bank securities. Other forms of easing, including those involving private instruments, would entail significant departures from the policy framework and could add credit risks to the central bank’s weak capitalization levels.

5. The effectiveness of additional large fiscal stimulus will need to be balanced against the economy’s high degree of openness. Staff recognizes the extraordinary circumstances that have contributed to a structural deficit in 2009. With global downside risks still clouding the outlook, staff is of the view that the fiscal stimulus should not be withdrawn too soon. The authorities could consider extending several of the measures implemented in 2009 through end-2010, while also ensuring that a balanced structural target is reinstated. Once the recovery is well entrenched, most of those measures should be unwound and consideration should be given to specifying a structural target. While Chile is in a privileged position to implement a strong countercyclical fiscal response, it is also essential that this does not compromise the structural rule framework.

6. Bringing more of a longer-term view to short-term fiscal policy formulation would help in this regard. The structural rule has embedded fiscal policy with a medium-term perspective, high predictability, transparency, and credibility, and should be preserved. However, this would benefit from bringing more of a long-term view to the existing 2–3 year fiscal policy formulation, as is done in many advanced economies.

7. Building on the significant progress made in recent years, staff sees further scope to deal with contingent liabilities. Staff welcomes the commitment to conduct long-term assessments of pension-related and central bank-related liabilities. Prospective budget deficits would limit the likelihood of fully recapitalizing the BCCh. The financial condition of some companies providing public services has deteriorated recently, and risks a potential call on public finances. Staff commends the authorities for the strengthening of governance and transparency in these companies and encourages them to persevere with such efforts.

8. Within a long-term approach to fiscal policy, there is a need to continue advancing reforms to boost per capita income growth. The cost of doing business in Chile compares unfavorably with the average for OECD countries and there is some scope to improve the balance between security and flexibility in the labor market.

9. The large presence of foreign-owned banks does not pose systemic risks. A new round of severe distress in global and some regional financial institutions—given the interconnectedness of their exposures—could affect domestic banks’ creditworthiness. Such risks, while manageable, could merit keeping some of the new liquidity instruments that have helped preserve orderly conditions. By contrast, the need to implement the recommendation of the Financial Advisory Committee to permanently expand the menu of SWF investments to deposits in the domestic financial system seems less urgent.

10. Credit risks to the banking system suggest contemplating some reforms, including broadening the perimeter of regulation. Staff commends the authorities for their sound prudential and supervisory framework. Staff’s stress tests confirm the authorities’ assessment that capital levels are adequate to withstand potential credit losses. With the full adoption of IFRS accounting standards in January 2009, some banks that appear to have lower provisioning levels relative to nonperforming loans are somewhat more dependent on external financing and could be more exposed to credit risks. Given the intrinsic uncertainty in the different models banks use to estimate provisions, it would be important to continuously assess the effectiveness of those models and provisioning levels, while exploring options to reduce procyclicality. It would be important to further solidify and broaden the perimeter of regulation to nonbank entities outside the Superintendency of Banks and Financial Institutions’ direct purview. Staff also commends the authorities for the progress in advancing capital market reforms.

11. It is expected that the next Article IV Consultation with Chile will take place on the standard 12-month cycle.

II. The Global Crisis and The Policy Response

12. The 2009 Article IV Consultation provided an opportunity to take stock of the policies implemented to safeguard the economy from the global crisis and to ensure sustained economic success. Chile’s economic policies over the past several years have been instrumental to face with relative more ease an exceptionally complex global environment. This owes much to a sound and exemplary policy framework—underpinned by the structural fiscal rule—which has allowed large savings of the terms of trade windfall and lower government liabilities. The economy entered the global financial crisis in a fundamentally robust position, especially when compared with 1998—the last time when the economy faced a major adverse external shock (Figure 1). With Presidential and congressional elections scheduled for December 2009, there is broad recognition among different sectors that prudent policies will be preserved and that the next administration (to take office in March 2010) will need to advance important reforms, including to enhance the business environment and productivity over the medium term.

Figure 1.
Figure 1.

Chile: A Short Tale of Two External Shocks, 1998 and 2008

Citation: IMF Staff Country Reports 2009, 271; 10.5089/9781451807691.002.A001

Source: IMF staff calculations.

Chile: Net International Investment Position and Fiscal Savings

Citation: IMF Staff Country Reports 2009, 271; 10.5089/9781451807691.002.A001

The Impact of the Global Crisis: A Severe and Synchronized Contraction

13. Being highly-integrated to the global economy, the Chilean economy was severely affected by global trends. Chile is the most open economy in Latin America, comparing favorably with OECD members.1 With domestic financial and capital markets among the deepest in Latin America, the global financial turmoil manifested quickly, mostly following the demise of Lehman Brothers in mid-September 2008, but the impact was less than in other emerging markets.

Trade and Financial Indicators 1/

(In percent of GDP, unless otherwise indicated)

article image
Sources: BIS, IMF Staff calculations; Investment Company Institute (ICI), OECD, National Authorities, and World Federation of Exchanges.

End 2008, unless otherwise indicated.

Corresponds to M3.

Correspond to the average of an OECD country. Pension and mutual funds assets as end-2007.

Includes mineral extraction, manufacturing, construction, production and distribution of enery, gas and water.

Domestic debt securities: Corporate issuers and Financial Institutions. Data as at December 2008

Domestic Debt Securities: Governments. Data as at December 2008

  • The external current account shifted from a surplus of 4½ percent of GDP in 2007 to a deficit of 2 percent of GDP in 2008. This shift was led by the sharp decline in copper prices and buoyant growth in imports, which reduced the trade balance in 2008 to roughly one-third of the US$23½ billion surplus in 2007 (Figure 2 and Table 1). The balance of payments posted a US$6 ½ billion surplus in 2008, as a result of continued strong net foreign direct investment. Following a trade deficit of about US$600 million in the fourth quarter of 2008 (driven by a 21 percent decline in the value of exports), the trade and current account balances shifted to surpluses in the first quarter of 2009, consistent with the sharp contraction in domestic demand.

  • The uncertain external environment prompted a sharp tightening in banks’ lending conditions. Banks’ credit conditions tightened severely, partly as their funding had become more reliant—at the margin—on external and domestic wholesale markets. In fact, over the past two years, private pension funds’ had shifted part of their investment portfolio to foreign assets, inducing banks to increase their external borrowing. Banks’ default probabilities also increased, reflecting partly the domestic presence of foreign-owned institutions, the rise in cross-border claims of creditor countries, and an expected rise in non-performing loans due to the economic slowdown. Bank credit growth to the private sector, particularly consumers, slowed markedly in real terms by April 2009.

  • The global asset price correction led to a sharp unwinding of the past gains of Chile’s international investment position. The value of the assets held by institutional investors (mostly private pension funds) declined by about 50 percent during 2008, mostly reflecting lower equity prices. Private banks and corporations also faced a deterioration in their net debtor position, while the public sector’s (including the central bank) creditor status improved to US$50 billion, about 30 percent of GDP. As a result, Chile’s net international investment position shifted to a debtor status of US$33½ billion by end-2008, equivalent to 20 percent of GDP.

Figure 2.
Figure 2.

Current Account and Capital Flows

Citation: IMF Staff Country Reports 2009, 271; 10.5089/9781451807691.002.A001

Sources: Haver and Banco Central de Chile

Chile. Bank Credit

Citation: IMF Staff Country Reports 2009, 271; 10.5089/9781451807691.002.A001


Chile. Bank’s External Financing

Citation: IMF Staff Country Reports 2009, 271; 10.5089/9781451807691.002.A001


Chile. Net International Investment Position by Sector

(In billions of U.S. dollars)

Citation: IMF Staff Country Reports 2009, 271; 10.5089/9781451807691.002.A001

14. Against this backdrop, the economy experienced a sharp shift in growth momentum. After growing at 4¼ percent on average (year-on-year) during the first three quarters of 2008, real GDP slowed sharply to 0.2 percent (y/y) in the fourth quarter of 2008 and declined by 2.1 percent (y/y) in the first quarter of 2009, led by an abrupt decline in inventories and private fixed investment (Figure 3).

Figure 3.
Figure 3.

Domestic Demand and Net Exports

Citation: IMF Staff Country Reports 2009, 271; 10.5089/9781451807691.002.A001

Sources: Haver, Chilean Authorities and Fund Staff estimates.

15. Global disinflation pressures spilled rapidly onto domestic inflation. After peaking at 9.9 percent in October, 12-month inflation decelerated to 1.9 percent by June 2009 (Figure 4).2 The disinflationary impulse associated with the global crisis was assisted by reforms to the Fuel-Price Stabilization Fund (FEPC), that accelerated the pass-through from international to domestic prices, as well as by an easing of energy constraints (Figure 5).3 Core inflation measures are hovering around 3–4 percent (y/y) and inflation expectations have also declined sharply, while wage and other cost pressures have begun to subside, with the seasonally-adjusted unemployment rate increasing to 9.9 percent in May 2009.

Figure 4.
Figure 4.

Inflation, Labor Markets and Monetary Policy

Citation: IMF Staff Country Reports 2009, 271; 10.5089/9781451807691.002.A001

Sources: Haver Analytics Inc, Reuters Group plc.
Figure 5.
Figure 5.

Energy Supply: Gradually Normalizing But Still Tight

Citation: IMF Staff Country Reports 2009, 271; 10.5089/9781451807691.002.A001

Sources: Chilean Authorities (CDEC-SIC, National Bureau of Energy and National Bureau of Statistics)

Fuel Price Disinflation

(January 2008=100)

Citation: IMF Staff Country Reports 2009, 271; 10.5089/9781451807691.002.A001


Inflation Expectations

(12-month, In percent)

Citation: IMF Staff Country Reports 2009, 271; 10.5089/9781451807691.002.A001

The Policy Response: Sizable, Well Balanced, and Coordinated

16. The authorities implemented several measures to minimize the strains from tighter credit conditions and maintain financial stability.

  • Liquidity management. Following foreign exchange purchases of US$6 billion between May and mid-September 2008, the Central Bank of Chile (BCCh) suspended its program of international reserve accumulation in late September. Several measures to support peso and U.S. dollar liquidity were also implemented, including repos and swap lines; collateral requirements were eased, while liquidity instruments were extended, eventually through end-2009 (Figure 6). In October, the Ministry of Finance shifted US$1 billion in deposits held abroad to domestic banks, to take advantage of lower risk in domestic banks and support domestic liquidity conditions. In mid-November, it established bank deposit auctions of its U.S. dollar cash flow, conducted by the BCCh.

  • Regulatory and other measures. In October, the Superintendency of Pensions (SP) extended the period to reduce pension funds’ position in foreign currency forwards in the domestic market from 10 to 90 working days, to minimize strains in the foreign exchange market and dollar liquidity. The Ministry of Finance also suspended the diversification of financial assets under sovereign wealth funds (SWFs) into corporate fixed-income and equity in November, and in January 2009, the Financial Advisory Committee recommended incorporating domestic banks’ deposits into the menu of SWFs investment options.4

Figure 6.
Figure 6.

Yields, Spreads, and Credit

Citation: IMF Staff Country Reports 2009, 271; 10.5089/9781451807691.002.A001

Sources: Bloomberg, Haver, Credit Suisse, BEL and Chilean Authorities.

Chile. Spread Between Onshore USD Rates and Libor (Basis points, daily) 1/

Citation: IMF Staff Country Reports 2009, 271; 10.5089/9781451807691.002.A001

1/ Onshore rates calculated form currency forwards and domestic currency deposits.

Chile. Foreign Investment of Pension Funds

Citation: IMF Staff Country Reports 2009, 271; 10.5089/9781451807691.002.A001

17. At the same time, the authorities adopted several countercyclical measures to support domestic demand.


Chile: Structural Balance

(in percent of GDP)

Citation: IMF Staff Country Reports 2009, 271; 10.5089/9781451807691.002.A001

  • Front-loaded monetary policy easing. The BCCh shifted the stance of monetary policy from an “easing bias” in the fourth quarter of 2008 to slashing its policy interest rate from 8¼ percent in January 2009 to a historic low of ¾ percent by June 2009.

  • Sizable fiscal stimulus. In January 2009, the government announced a stimulus package of US$4 billion, with measures representing about 2.9 percent of GDP. These measures entailed an increase in public investment, a transitory reduction in stamp taxes and other taxes (of almost 1 percent of GDP), and higher direct transfers and subsidies for low-income families, housing, and transportation (for about ½ percent of GDP). The structural surplus target of ½ percent of GDP was reduced to zero for 2009. The measures also included the recapitalizations of state-owned Banco Estado (announced in 2008) and Copper Corporation (CODELCO), as well as an increase in the operational capital of Chile’s Development Agency (CORFO) and the Insurance Fund for Small Enterprises (FOGAPE) (all amounting to about 1 percent of GDP), to support credit to exporters and small corporations, through guarantees. Since March, the government announced a series of initiatives to stimulate credit and competition in the financial system, employment, and further direct support to low-income groups (Table 9).

  • Fiscal savings for deficit financing. In mid-June, the authorities updated the 2009 Budget, projecting an overall deficit of 4.1 percent of GDP by end-year (compared with a deficit of 2.9 percent of GDP expected in January). The authorities also announced that a structural fiscal deficit of 0.4 percent of GDP would be expected in 2009, with staff estimating a fiscal impulse of about 5 percent of nonmining GDP.5 About US$10.7 billion in gross financing needs would be covered by US$8 billion from past savings under the Economic and Social Stabilization Fund (FEES) and from issuing bonds domestically.

  • Policy coordination to support the countercyclical response. To limit the impact of the government’s additional financing needs on long-term interest rates, the BCCh suspended the issuance of long-term securities (5-year and up maturities) for the remainder of 2009 (about US$0.7 billion are due) and would buyback up to US$1 billion of similar securities currently outstanding. The BCCh would also conduct open market operations to compensate the monetary impact of these measures.

Chile. Central Government’s Financing Needs in 2009

(In millions of U.S. dollars, unless otherwise indicated)

article image
Sources: Chilean authorities and Fund Staff calculations.

Below the line.

Original Budget, published in the Official Gazette on 12/12/2008.

Fund staff estimates based on announcements made by the authorities, beginning with the fiscal package of January 5, 2009.

“Budget update of 2009 forecasts,” presented to Congress on June 15.

18. Domestic financial market conditions have improved considerably, with incipient signs that the economy is bottoming out. Market interest rates have declined, liquidity conditions—particularly in U.S. dollars—have eased and the yield curve has steepened (Box 1). Chilean banks and corporates have been able to rollover most of their maturing external debt with domestic debt, with the issuance of fixed-income instruments by highly-rated corporates in domestic markets increasing markedly since October 2008, as institutional investors have provided a stabilizing source of financing. With credit risk diminishing, Moody’s upgraded the sovereign’s long-term foreign currency rating by one notch in late March. Recent indicators suggest that confidence has begun to rebound from recent lows, the peso has appreciated by almost 20 percent by early July, from its lows in late October 2008, tight bank lending standards are easing, although the monthly indicators for economic activity showed that the economy remained weak in April and May.

A Sequence of Policy Action and Risk during the Crisis

The chart below presents the difference between a put and call option for the U.S. dollar and Chilean peso, net of the VIX and copper price, providing a useful metric to assess risk and how it may have been influenced by the measures implemented by the authorities since September 2008.

article image
1/ Difference between call and put options for US dollar/Chilean Peso, net of VIX and copper price. Staff estimates based on Bloomberg.

Business Confidence

Citation: IMF Staff Country Reports 2009, 271; 10.5089/9781451807691.002.A001

1/ Source: ICARE

Business Inventories

Citation: IMF Staff Country Reports 2009, 271; 10.5089/9781451807691.002.A001

1/ Source: ICARE

III. The Economic Outlook and Risks

19. The short-term outlook remains uncertain, with risks largely external. Having reached an all-time high in 2008, the share of private investment to GDP (in real terms) is unlikely to sustain in the current global environment. Nevertheless, the current account deficit would deteriorate to around 3 percent of GDP in 2009, owing to lower copper exports and a sharp contraction in trading partner demand, which is particularly skewed toward the United States, the EU, and China. Net foreign direct investment would decline from recent highs but would still represent a high share of the current account deficit. The government’s decision to finance the bulk of its fiscal deficit with FEES assets, along with a decline in Chile’s risk premia relative to other economies, also bode well for financing large external needs in 2009–10. Institutional investors have played a stabilizing role by repatriating portfolio investment and would be expected to return to global markets gradually. Were global financial conditions to deteriorate, the high external rollover needs of banks and corporates (about US$30 billion) in 2009, could bring renewed pressures on credit, balance sheets, and investment. Public and private financial assets provide a significant buffer.


Chile. Fixed Capital Formation in percent of GDP

(In 2003 constant pesos)

Citation: IMF Staff Country Reports 2009, 271; 10.5089/9781451807691.002.A001

Chile. External Financing Needs, 2009–10 1/

article image
Source: IMF staff estimates.

In billions of U.S. dollars, unless otherwise stated.

20. The economy is well placed for an early recovery, but economic growth is expected be less favorable than previous to the crisis. Economic activity would be expected to recover starting in the second half of 2009, reflecting the strong countercyclical measures adopted by the authorities and the expected recovery in Chile’s main trading partners. Staff expects real GDP growth within a -0.5 to -1 percent range for 2009 and within a 3–4 percent range in 2010. 12-month inflation has declined sharply and is expected to remain below the lower bound of the target range in 2009. Nevertheless, the outlook for 2009–10 remains highly dependent on the strength and speed of the global recovery, and how this affects asset and commodity prices.

21. Medium-term prospects remain favorable and warrant sustaining the reform momentum. Significant private investment in recent years has enhanced potential output. However, global trend growth prospects have been marked down considerably, which would likely constrain investment and potential growth in the next few years (Box 2). Notwithstanding the impact of energy shortages on overall productivity growth in recent years, productivity has been lackluster since 1998. Therefore, it is imperative to advance reforms to enhance the business environment and flexibilize labor markets, to improve the contribution of productivity to medium-term per capita growth.

Chile. Labor Participation Rates

article image
Source: Estudio de Hacienda Publica, 2008.

Contribution of Productivity to Per Capita Growth 1/

article image

Based on Bosworth & Collyns (2003), Brookings Papers on Economic Activity.

Excludes China.

IV. Policy Discussions

22. Discussions focused on two broad areas:

  • The role for macroeconomic policies in the current juncture and the risks from the global financial deleveraging and economic contraction.

  • Reforms to solidify the policy framework, the financial system, and capital markets.

The Global Crisis and Potential Output in Chile

The global crisis has negatively affected copper prices, as well as investment and export prospects. These factors have been viewed as important for the determination of potential growth, and in consequence, for estimating the output gap in Chile.

The output gap was estimated using a structural vector autoregression (SVAR). The model includes three variables: real GDP growth, the unemployment rate and real copper prices. Potential output, and thus the output gap, are recovered from the data using an identification procedure similar to that used by Blanchard and Quah (1989). As output gap levels resulting from the SVAR are sensitive to the period chosen as the base, it was assumed that the levels of effective and potential output were similar to each other during 1994Q1, an assumption also used by the BCCh.1

The main results are as follows:

  • The positive output gap (output above potential) that had opened in 2006 seems to have closed during 2008Q4. In contrast, applying the Hodrick-Prescott filter results in a negative output gap at end-2008. With the economy growing below potential in 2009–10, this would suggest a negative output gap in the next couple of years.

  • The estimated potential growth rate was 4 percent, on average, since 1998. This is consistent with a structural break that may have occurred during this year. However, recent estimates by the BCCh using a production-function approach suggest potential growth rates at 4½–5 percent prior to the crisis. Based on these estimations, staff assumes a potential growth of 4 percent for the medium term.

  • Real copper prices appear to only affect the potential growth rate marginally. This is consistent with the structural fiscal rule, which has insulated the economy from copper price shocks. The effect of demand shocks are mostly felt during the year after impact, with is impact lasting for about 3 years. In addition, the variance of output forecast errors is mainly explained by domestic factors.

1/ See Fuentes et al. in Economía chilena, vol. 11, August 2008.

A. The Role for Macroeconomic Policies

Monetary Policy and the Exchange Rate: Facing a Sudden and Sharp Reversal of Risks

23. Monetary policy responded swiftly to a rapidly changing inflation outlook. With evidence that inflation expectations were well-anchored around the target and a widening output gap, the authorities saw plenty of scope to front-load the policy response and bring the policy interest rate to below-neutral-levels swiftly. This was also justified by the sharp tightening of bank lending conditions, reflecting heightened risk aversion (Box 3). The authorities were encouraged that the transmission from the policy rate and other “nonmonetary measures” to stabilize inflation, promote competition, and stimulate credit were taking increasing hold on market rates and lending standards, and expected these trends to intensify and credit growth to pick up ahead.


Chile. Market Real Interest Rates 1/

Citation: IMF Staff Country Reports 2009, 271; 10.5089/9781451807691.002.A001

1/ Deflated by expected inflation

Chile. Policy Interest Rate

(In real terms, in percent)

Citation: IMF Staff Country Reports 2009, 271; 10.5089/9781451807691.002.A001

24. The floating exchange rate was also instrumental in helping the economy absorb the rise in global risk aversion and sharp deterioration of terms of trade. Following the pre-emptive buildup of foreign exchange reserves in 2008, the authorities were satisfied that the use of new liquidity instruments had been successful in preserving orderly market conditions. The authorities viewed the large depreciation of the peso since the onset of the crisis as mostly reflecting the terms of trade deterioration and global risk aversion.


Chile. Real Exchange Rate (1986=100)

Citation: IMF Staff Country Reports 2009, 271; 10.5089/9781451807691.002.A001

Bank Lending Conditions and Monetary Policy

The tightening of global financial conditions has been reflected in a higher bank lending spread (BLS) in Chile. This resulted in a marked increase in the cost of funding, with implications for aggregate demand and inflation.

The Global Projection Model (GPM) was used to assess the impact of the BLS on macroeconomic conditions and monetary policy decisions. The GPM was extended to incorporate the BLS as a variable that provides information on factors affecting the output gap. In general, models that incorporate the BLS tend to have better accuracy of forecasts.

The results show that:

  • By incorporating the BLS, monetary policy decisions could anticipate and buffer the impact of shocks on inflation and output. The simulations confirm that in response to a negative demand shock, expected inflation tend to decline more pronouncedly when the BLS is factored into the model than otherwise. As a result, the central bank could anticipate and respond more actively so as to reduce output and employment losses.

  • As the economy recovers and slack vanishes, risks on inflation may intensify. This seems particularly to be the case when the changes to the policy interest rate are proportional to the BLS shock. Adjusting the policy rate proportionately could bias the direction of the adjustment in favor of demand shocks relative to supply shocks induced by the higher BLS.


Chile. Impulse Response for Expected Inflation

(to an output gap shock)

Citation: IMF Staff Country Reports 2009, 271; 10.5089/9781451807691.002.A001


Chile. Impulse Response for Output Gap

(to an output gap shock)

Citation: IMF Staff Country Reports 2009, 271; 10.5089/9781451807691.002.A001

25. The authorities agreed with the assessment that the real exchange rate was close to “equilibrium”. They recognized that such assessment was difficult to make in light of the nature of the global shock and the potential adjustment of exchange rates for advanced economies and commodity prices over the medium term.

Equilibrium Exchange Rate Estimates: CGER

article image
Source: CGER and IMF staff estimates. Reference period for CGER assessment is March 2009.

Ratio of current account balance to GDP.

Undervaluation =“-”.

Based on medium-term projections through 2014.

26. Going forward, the authorities were concerned about the risks of sustained strong disinflationary pressures. They expect sustained disinflation to continue for the next six months—with 12-month inflation envisaged to approach zero by end-year. With the policy rate close to its effective lower bound and continued external risks, they felt that ensuring that inflation would return to the 3 percent target over the 24-month horizon could prove potentially challenging, as additional budgetary financing needs could impart further disinflationary pressures, including through an exchange rate appreciation. The authorities were confident that a well-functioning credit market, the strong and preemptive policy response thus far and the credibility of the inflation target would be conducive towards to ensuring a return to the 3 percent inflation target over the 2-year horizon.

27. While the policy framework has worked well in stabilizing the economy, the authorities and staff agreed that some alternative means of easing may be needed in the event disinflationary pressures were more severe and protracted. The authorities noted that one possibility would be to announce a more explicit contingent commitment to maintain a path for the policy interest rate for an extended period, and staff pointed out that other options could be to extend the tenor of new liquidity instruments and to incorporate them to the policy framework permanently. The authorities noted that these measures could be supported by additional buybacks involving BCCh securities to affect long-term interest rates. Staff noted that other forms of easing, including by broadening the instruments that qualify for outright purchase, would entail a significant departure from the policy framework and could add credit risks to the BCCh’s weak capitalization levels.6 The authorities agreed but noted that in light of the extraordinary circumstances and lingering risks, they would not rule out any options.

Fiscal Policy: Imparting a Stronger Countercyclical Stance

28. The authorities stressed that fiscal policy had to take a leading role in stabilizing the economy in 2009. They felt it was important for the countercyclical fiscal measures to be large enough to signal Chile’s strong capacity to buffer the impact of the global shock on the economy and to be readily implemented. The authorities also noted that public spending would rise by 14 ½ percent in real terms in 2009 and stressed that the stimulus was comprised of transitory measures, which minimized long-term fiscal costs. With low public sector debt, a broad-mix of spending and tax measures, and the financing provided by past savings under the FEES, they were confident about the effectiveness of countercyclical fiscal policy in stabilizing the economy and supporting an early recovery in activity.

29. The need to impart fiscal policy with more countercyclical impulse and a larger-than-expected decline in nonmining tax revenue is expected to bring the structural balance into deficit. The authorities noted that while the structural rule has been instrumental in assisting macroeconomic stability, having maintained a structural balance would have undermined the role of automatic stabilizers and need for a stronger countercyclical response. They felt it was also a good opportunity to advance methodological changes to more accurately estimate nonmining structural revenues.7 Staff emphasized that the fiscal impulse in train was quite significant and that its effectiveness had to be balanced against the economy’s high openness. Mindful of the limits to active stabilization policies, the authorities did not envisage further fiscal measures, as many had been calibrated to be effectively implemented later this year and even through 2010.


Chile. Fiscal Impulse Indicators

Citation: IMF Staff Country Reports 2009, 271; 10.5089/9781451807691.002.A001

30. Potential challenges to fiscal policy in 2010 limit the scope for sustaining a large fiscal impulse. Structural revenues could be constrained by a lower long-term price of copper, which together with the temporary tax reductions made in 2009, could constrain public spending and force a more permanent reduction in the structural surplus target. The authorities recognized the uncertainties and challenges facing fiscal policy in 2010, particularly for copper prices and had yet to assess the outlook for the 2010 Budget. Nonetheless, they emphasized the importance of preserving the structural rule as an anchor, particularly when its credibility and acceptance have been strengthened with the downturn. They also noted the broad recognition that there would be no scope for sustaining the high public spending growth of recent years. Staff noted that in light of the risks facing the economy, it would also be important to consider not withdrawing the fiscal stimulus too soon. Several of the transitory measures implemented in 2009 could be extended—most notably the reduction in the stamp tax, while also bringing the structural target back to balance. Staff stressed the importance that the 2010 Budget be presented with a balanced target and that the merits of reinstating the ½ percent of GDP surplus target be reassessed, as global economic and domestic conditions normalize.

B. The Reforms to Solidify the Policy Framework, the Financial System and Capital Markets

Fiscal Framework: Extending the Horizon of Policy Formulation

31. There is a good opportunity to bring more of a medium-term view to fiscal policy formulation, in line with best international practice. The authorities and staff agreed that the structural surplus rule has been critical in embedding fiscal policy with a medium-term perspective—based on assumptions for the long-term price of copper and trend output provided by an external committee of experts—resulting in high predictability and transparency. The authorities noted that several long-term fiscal issues had been an important part of their ongoing policy agenda, assessments which have been presented in recent years, most notably on contingent liabilities and the pension reform.8 To further solidify Chile’s fiscal framework and better integrate the impact of future spending contingencies into budgetary projections, staff recommended bringing more of a long-term view to the existing 2–3 year horizon for planning and executing fiscal policy. Staff noted that such approach would strengthen the emphasis on demographic and productivity factors, by assessing the growth in public per capita spending relative to income per capita, and its implications for net public assets.

Length of Budgetary Projections

article image
Source: Fund staff calculations.

32. Such an approach would help better integrate the target for the structural rule and the net asset position, with the path of contingent and other fiscal liabilities. The authorities noted that significant progress has been made in identifying and quantifying contingent fiscal liabilities and some medium- and long-term social spending commitments, and viewed their outlook as manageable. They agreed that there was scope to extend the framework; indeed they have recently established a division in the Budget Planning Department (DIPRES) to look into medium and long-term fiscal pressures on health, education, and pension-related spending. Staff agreed that the outlook for contingent liabilities appeared manageable, but noted that under certain plausible long-term scenarios, the path for public spending could significantly exceed those associated with different targets for the structural rule and entail a significant deterioration in the government’s net asset position. Staff noted that it would be important to continue advancing reforms to minimize the following risks:


Chile. Central Bank Net Worth and Exchange Rate

Citation: IMF Staff Country Reports 2009, 271; 10.5089/9781451807691.002.A001

  • Despite significant progress in recent years, the BCCh remains undercapitalized. By end-2008, the government has retired all its outstanding debt with the BCCh and has made three capital injections totaling US$2.1 billion during 2006–08. This, along with the depreciation of the peso in 2008, brought the net worth to about ½ percent of GDP at end-2008, from -2.8 percent of GDP at end-2007. Nonetheless, staff noted that a value-at-risk approach (based on volatility of revenues) could justify a capital base of about 1–2 percent of 2008 GDP on a permanent basis, and with budget deficits envisaged for 2009–10, the prospect for further capital injections were unlikely to be met.9 The authorities emphasized that the recent crisis confirmed the BCCh’s ability to deal with difficult conditions despite its lack of capital, but acknowledged the importance of full recapitalization and have begun preparations for an analysis of the impact of recapitalization transfers on the BCCh’s balance sheet over a 20-year period, in line with commitments under the Fiscal Responsibility Law (FRL), results which they expected to have before end-2009.10

  • Financial risks from public sector enterprises (PSEs). The strong and transparent policy framework has been important in effectively managing market-related risks, investment, and indebtedness by PSEs, most of which are supervised by the System of Public Enterprises (SEP). The authorities submitted to Congress in 2008 proposals to strengthen the corporate governance of CODELCO and other PSEs. While PSEs net public debt stood at only 6¼ percent of GDP at end-2008, several large PSEs have recently faced deteriorating financial conditions, risking a potential call on public finances for recapitalization or debt guarantees. In addition, the authorities explained that the privately-run public bus system (TranSantiago) has continued to experience losses and could require direct and permanent budget support from 2010 on. Staff encouraged the authorities to evaluate options for improving their financial condition; including by presenting their current and projected balances in the Informe Anual de Finanzas Publicas. The authorities explained that several of these PSEs have been subject to restructuring plans, including the replacement of their management, and that the recent enactment of the Transparency Law would support efforts to strengthen their governance. They also noted that efforts would remain geared toward strengthening their governance in line with the proposed framework for CODELCO and a recent proposal to broaden the scope of companies under the SEP.

33. A longer-term approach to fiscal policy would also help sustain the focus on reforms to boost per capita income growth. Certain indicators—such as for starting and closing businesses—suggest that the administrative burden on the private sector compares unfavorably with the average for OECD members. One particularly useful international practice would be to review the burden imposed by regulations on all businesses, which could result in an annual agenda of “red-tape” reduction. The authorities indicated that efforts had been recently focused on simplifying regulatory procedures for micro and small and medium-sized firms. Staff also noted scope to improve the balance between security and flexibility in the labor market. The authorities explained that several reform proposals by the Meller Commission had been implemented, including to improve in-work benefits, child benefits, and job-related training; as well as to extend the coverage and benefits of the unemployment insurance scheme. The authorities and staff agreed that future efforts could focus on further promoting formal employment, by introducing reforms to the unemployment insurance system that help lower severance payments, as well as by easing some restrictions on contracts.


Strictness of Employment Protection Legislation

Citation: IMF Staff Country Reports 2009, 271; 10.5089/9781451807691.002.A001

Source: OECD. Scores 0–6 from lowest to highest

Indicators of Business Environment

article image
Source: Doing Business, World Bank.

34. The global financial turmoil and fiscal risks also underscore the need to continue strengthening the framework for Sovereign Wealth Funds (SWFs). Chile’s SWFs continue to rank among the most transparent, and significant progress has been made in establishing generally accepted principles and practices (the “Santiago principles”) and in designing a long-term strategic asset allocation, with technical assistance from MCM. The authorities explained that the decision to postpone the shift in the portfolio structure toward equities and corporate fixed-income securities was justified by current global conditions and that no decision had been made on when to proceed forward. The recommendation to expand SWF investments to deposits in domestic banks was motivated by a need to rebalance risk-return and financial-stability goals vis-à-vis macroeconomic stability and was still under evaluation. Staff also noted that diminishing risks in global financial institutions would lessen the need to implement such recommendation on a permanent basis.

35. With prospective budget deficits for 2009–10, staff noted that government assets could diminish in the years ahead. The authorities stressed that using FEES assets to finance deficits was critical to legitimize the structural rule framework and felt that there would be plenty of room to finance deficits comfortably, including through debt issuance. It was agreed that there was a good opportunity to continue to work toward embedding investment objectives and projected path for the FEES within a long-term fiscal framework.


Chile: Central Government Assets

(In percent of GDP)

Citation: IMF Staff Country Reports 2009, 271; 10.5089/9781451807691.002.A001

Source: Fund staff estimates.

The Banking System: Solid but Facing Credit Risks

36. The authorities stressed that the banking system was sound and well-protected from many of the problems witnessed in advanced economies. Financial soundness indicators show that banks are on average well-capitalized and liquid, reflected in credit ratings that are among the highest in the region. They explained that financial intermediation in Chile continued to be characterized by a more “traditional banking business” model, with most operations on-balance sheet, high reliance on retail deposits (about one-third of liabilities), limited exposure to structured products and investment in financial instruments (about 10 percent of assets and mostly in BCCh securities). Facing a change in funding associated with pension funds’ reallocation of investments abroad, banks have been gradually increasing their share of foreign borrowing, including long-term and for financing external trade operations.

Chile: Financial Soundness Indicators

(In percent; unless otherwise indicated)

article image
Sources: BCCh and SBIF.

Latest available data April 2009. Data for 2009 reflects new IFRS accounting rules.

Data for 2009 reflects new IFRS accounting. Excluding Banco Estado, the ratio was 94 percent in

Ratio of cash to deposits by end of year, unless otherwise noted. For 2009, data is as of March 2

Ratio of assets to liabilities with maturity of 1 year or less.

37. The authorities viewed the presence of foreign-owned banks posing no systemic risks. Senior officials from the Superintendency of Banks and Financial Institutions (SBIF) noted that while foreign banks represented more than half of the banking system’s assets and liabilities, several risks were contained by the prudent regulatory and supervisory framework.11 For example, most foreign banks are subsidiaries and the largest (foreign-owned) bank was required to keep a capital-to-asset ratio in excess of 11 percent (instead of 8 percent, as most other banks). Most banks had a long-standing presence in Chile and a stable deposit base. They also noted that the share of external funding was, on average, less than 10 percent of liabilities, and banks’ faced limited currency-related risk.

38. Staff agreed with this assessment, noting that the interconnectedness of global financial institutions’ exposures and the increasing claims by foreign banks on Chile still presented some risks. Staff analysis suggest that the banking system could face some deterioration in creditworthiness, were difficulties at global and some regional financial institutions to resurface and become severe. This could potentially be risky in the event parent-bank support was more uncertain. The authorities agreed that the global financial turmoil had heightened the risks of many financial institutions that have traditionally provided liquidity in foreign currency and market-making capabilities for derivatives, stressing that several of the measures recently implemented had successfully contained such risks. The SBIF had been actively monitoring potentially exposed domestic institutions closely, including through the provisions provided by memoranda of understanding with foreign supervisors.

Risk Codependence and Impact on Domestic Banks’ Ratings 1/

article image

Staff estimates based on Moody’s KMV data.

Rating corresponding to the EDF level as of end-February 2009.

Rating corresponding to the 95th percentile of the EDF distribution of Chilean institutions

Ratings calculated based on the EDF of the Chilean institution conditionalon the EDF of the foreign institution at its 95th percentile.

39. The authorities foresaw rising credit risks for the banking system. Credit risk indicators for households and corporates were expected to continue deteriorating, partly reflecting rising unemployment and weaker profitability. Stress tests conducted by the BCCh show the banking system would face losses associated with credit risk in the range of 1–8 percent of capital, and of 2 percent of capital for market risk.12 With the full adoption of IFRS in 2009, some domestic banks have lower provisioning levels relative to their nonperforming loans, which also tend to be more dependent on external financing and could be more exposed to credit risks, with adverse implications for capital requirements.13 The authorities viewed these risks as minimal—there was no evidence of segmentation in the domestic market and some external borrowing was long-term in nature. They also noted that the state-owned Banco Estado was recently recapitalized, that many private banks had recapitalized last year’s profits and were continuing to increase provisions relative to nonperforming loans, in recent months.


Chile: Bank Provisioning and Credit Risk

(in percent of bank capital)

Citation: IMF Staff Country Reports 2009, 271; 10.5089/9781451807691.002.A001

Source: Staff estimates based on SBIF data as of end-February 2009.

Chile: External Borrow ing and Credit Risk

Citation: IMF Staff Country Reports 2009, 271; 10.5089/9781451807691.002.A001

40. There has been continued progress in strengthening the prudential and supervisory framework.

  • Adoption of IFRS and progress toward Basel II. Starting in January 2009, IFRS accounting standards are in full force for banks, particularly regarding the valuation of assets and liabilities, and the definition of nonperforming loans. On Basel II, the authorities have finalized the draft amendment to the General Banking Law and expect to proceed with such reform during 2009–10. With the intrinsic uncertainty in the different models bank use to estimate provisions, staff encouraged the authorities to continue assessing provisioning levels and the effectiveness of their underlying models, while exploring options to reduce procyclicality, such as by introducing “dynamic provisioning.”

  • Improved coordination among supervisory agencies. The Committee of Superintendents has agreed to prepare a Memorandum of Understanding to strengthen coordination, as well as risk-based and consolidated supervision, particularly for domestic conglomerates. The Committee has begun to discuss implications from work undertaken by the regulatory agencies (such as the Superintendency of Securities, SVS) to better understand ownership and financial linkages among domestic conglomerates. In this regard, the SVS has finalized a draft framework to implement a risk-based supervision framework for the insurance sector.

  • Perimeter of regulation. SBIF senior officials agreed with the importance of broadening the perimeter of regulation to bring several nonbank entities that have been expanding their lending operations under the direct purview of the SBIF in order to minimize systemic risks. It was agreed that this could be an area to assess during an FSAP update in 2010.

Capital Markets: Promoting Competition and Accountability

41. The authorities stressed that the ongoing implementation of the pension reform had been timely in dealing with the risks posed by the global turmoil. Pension fund reform gives more flexibility to pension funds’ and contributors’ investment decisions, while strengthening oversight and accountability. Investment limits have been relaxed, including for investable securities. Pension funds are required to submit investment guidelines to the Superintendency of Pensions, which will be overseen by the newly established Technical Investment Board (CIT). Similarly, contributors can now switch investment funds provided they acknowledge the risks embedded in their chosen fund. To that end, pension funds need to provide additional information about the funds’ risks.

42. The authorities advanced important capital market reforms envisaged under the MKIII reform that help support the countercyclical policy response. New tax rules facilitate foreign investor participation in local fixed-income markets. Credit to SMEs could benefit from measures allowing high-yield investments by pension funds and the extension of CORFO’s partial guarantees for SME-related securitization. Insurance companies are now allowed to lend to individuals or corporations, as well as to participate in non-related syndicated bank lending up to certain specified limits. The authorities continued to work toward increasing domestic liquidity by allowing the participation of pension funds in repo operations.

Table 1.

Chile: Selected Social and Economic Indicators

article image
Sources: Central Bank of Chile, Ministry of Finance, Haver Analytics, and Fund staff estimates.

Contribution to growth.

Gross saving of the general government sector, including the deficit of the central bank.

Gross consolidated debt of the public sector (central bank, non-financial public enterprises, and general government).

Data as of May 2009.

Table 2.

Chile: Summary Operations of the Central Government

(In percent of GDP)

article image
Sources: Ministry of Finance (DIPRES) and staff estimates.

Based on the 2008 Budget and updated staff estimates.

Change in nonmining structural balance (-) as a share of GDP excluding extractive activities.

Excludes interest payments and income from government assets.

General government and Central Bank only.

Table 3.

Chile: Summary Operations of the Public Sector

article image
Sources: Ministry of Finance (DIPRES), Central Bank of Chile, and staff estimates.

Includes the effects of valuation changes (inflation) to the stock of UF debt and accrued interest on Treasury debt; excludes administrative expenses and provisions.

On a cash basis. Municipalities hold neither sizeable financial assets nor debt.

Table 4.

Chile: Indicators of External Vulnerability

(In percent; unless otherwise indicated)

article image
Sources: Central Bank of Chile, Haver Analytics, WEO, and Fund staff estimates.

Gold valued at end-period market prices. Data as at May 2009

As measured by the central bank; includes amortization of medium/long-term debt due during the following year but not trade credits.

Morgan-Stanley Capital International index (Dec/1987=100).