IMF Executive Board Concludes 2014 Article IV Consultation with Chile

KEY ISSUESPolitics: President Bachelet won the Presidential election on a platform to fosterinclusive growth and reduce inequality. Her government took office in March 2014 and is launching an ambitious policy agenda that includes important reforms in several areas, including taxation, education, productivity, and energy.Outlook and risks: Chile’s global environment is shifting, with a dimmer outlook for its main export, copper, and normalization of global monetary conditions. Growth has slowed markedly, resulting in a modest output gap. The peso has depreciated, feeding into inflation. Staff projects growth to bottom out in 2014 and then gradually recover. Key risks relate to a large and lasting drop in copper prices and global financial volatility.Policy mix: The freely floating peso is working as a shock absorber and will support the economic recovery. The policy mix with broadly neutral fiscal and accommodative monetary policy is appropriate. Room for further monetary easing has narrowed but space remains if domestic demand flounders, so long as inflation expectations remain well anchored. On fiscal, given the strong public finances, automatic stabilizers should be allowed to operate unimpeded and there is space for stimuli in the event of a major downturn. The commitment to close the structural fiscal deficit by 2018 is appropriate and should be phased in a way that avoids undue drag on the recovery. Should risks materialize, the freely floating currency is the first line of defense.Growth and equity reforms: Achieving strong growth while reducing inequality will require structural reforms. The authorities’ agenda focuses on the right areas but many details remain work in progress. Clarity on the details, timetables, and prioritization will reduce uncertainty and the risk of delays.Financial stability: Risks to financial stability appear contained, but it will be important to push through with regulatory reforms underway, including initiatives currently in Congress. Further effort will be needed to close regulatory gaps, in particular bankcapital requirements, relative to international benchmarks.

Abstract

KEY ISSUESPolitics: President Bachelet won the Presidential election on a platform to fosterinclusive growth and reduce inequality. Her government took office in March 2014 and is launching an ambitious policy agenda that includes important reforms in several areas, including taxation, education, productivity, and energy.Outlook and risks: Chile’s global environment is shifting, with a dimmer outlook for its main export, copper, and normalization of global monetary conditions. Growth has slowed markedly, resulting in a modest output gap. The peso has depreciated, feeding into inflation. Staff projects growth to bottom out in 2014 and then gradually recover. Key risks relate to a large and lasting drop in copper prices and global financial volatility.Policy mix: The freely floating peso is working as a shock absorber and will support the economic recovery. The policy mix with broadly neutral fiscal and accommodative monetary policy is appropriate. Room for further monetary easing has narrowed but space remains if domestic demand flounders, so long as inflation expectations remain well anchored. On fiscal, given the strong public finances, automatic stabilizers should be allowed to operate unimpeded and there is space for stimuli in the event of a major downturn. The commitment to close the structural fiscal deficit by 2018 is appropriate and should be phased in a way that avoids undue drag on the recovery. Should risks materialize, the freely floating currency is the first line of defense.Growth and equity reforms: Achieving strong growth while reducing inequality will require structural reforms. The authorities’ agenda focuses on the right areas but many details remain work in progress. Clarity on the details, timetables, and prioritization will reduce uncertainty and the risk of delays.Financial stability: Risks to financial stability appear contained, but it will be important to push through with regulatory reforms underway, including initiatives currently in Congress. Further effort will be needed to close regulatory gaps, in particular bankcapital requirements, relative to international benchmarks.

On June, 27, 2014, the Executive Board of the International Monetary Fund (IMF) concluded the Article IV consultation1 with Chile.

Chile is confronting a challenging macroeconomic environment. After several years of strong economic performance, Chile’s investment has weakened and growth slowed markedly due in part to a weaker copper price outlook, with the economy performing slightly below potential. At the same time, the depreciation of the peso has fed into higher inflation, but medium-term expectations remain anchored around the Central Bank’s target. The current account deficit has narrowed rapidly to 3.1 percent of GDP in the first quarter of 2014, but gross external financing needs, though smaller than in 2013, remain high at 17 percent of GDP. The labor market—albeit still tight—has softened.

Monetary policy has eased; fiscal policy has stayed broadly neutral. The central bank reduced the policy rate from 5 to 4 percent between October 2013 and April 2014 amid a weakening economic outlook and inflation below target. The cuts have been transmitted to interbank and lending rates and contributed to peso depreciation. Nonetheless, credit growth has moderated for all types of credit, except for mortgage credit, which remains brisk. The 2013 structural deficit was 0.8 percent of GDP (staff estimate). The fall in copper revenue shifted the headline balance to a deficit of 0.6 percent of GDP from a surplus of equal size in 2012. However, central government net assets remained at 6.7 percent of GDP.

Growth is expected to bottom out in 2014 and gradually return to trend. Growth will reach 3.2 percent in 2014 and recover to its potential level by 2016, supported by monetary easing, the peso depreciation, and recovery in the global economy. Key risks to the outlook stem from the potential of further declines in copper prices and global financial volatility. Although there are signs that investment is stabilizing and could pick up later in the year, consumption of durable goods has declined and further weakening cannot be ruled out. Net exports should continue to provide a boost to the recovery.

The government has launched an ambitious policy agenda to bolster long-term growth and reduce inequality. It includes important reforms in taxation, education, productivity, and energy. The authorities’ tax reform aims to create a more progressive tax structure and raise 3 percent of GDP in revenue to fund greater spending on education and health, while raising public savings. The education reform focuses on early childhood education, and fostering equal access and improving quality and accountability in education. The energy agenda aims to promote investment and efficiency and facilitate the use of clean technologies. The authorities’ plans to bolster competitiveness include improving infrastructure, promoting research and development and job training, and providing new services for small and medium-enterprises.

The financial sector is large, but risks are contained. Financial system assets exceed 200 percent of GDP. Bank capitalization appears adequate, profitability remains comfortable, and nonperforming loans are low and fully provisioned. Life insurers’ growing exposure to commercial real estate merits watching, but stress tests do not show significant concerns. Investment returns of the private pension system have declined, and the government has appointed a commission to propose parametric changes to ensure adequate replacement rates. The authorities have sent to congress legislation that establishes risk-based insurance supervision and a comprehensive credit registry, and strengthens the legal framework of the Securities and Insurance Supervisor and the Financial Stability Council.

Executive Board Assessment2

Executive Directors commended the authorities for their sound macroeconomic management, which has contributed to Chile’s robust economic performance in recent years. At the same time, Directors noted that the end of the copper price boom and the normalization of global monetary conditions pose challenges to the growth outlook. They acknowledged, however, that Chile, with its strong fundamentals and policy frameworks, including a floating exchange rate, is well placed to cope with these challenges.

Directors agreed that the current macroeconomic policy mix is broadly appropriate. They concurred that, with inflation expectations well anchored and some remaining slack in the economy, monetary policy can remain accommodative although continued vigilance is needed in light of recent inflation developments. Directors supported a broadly neutral stance of fiscal policy, with full operation of automatic stabilizers. They welcomed the authorities’ commitment to move toward a balanced structural fiscal position by 2018 while minimizing the drag on the recovery.

Directors emphasized the need for structural reforms to strengthen prospects for strong and inclusive growth. They agreed with the authorities’ focus on improving education, fostering female labor force participation, upgrading key infrastructure, and promoting energy efficiency. Directors also supported the tax reform’s objectives of increasing progressivity and generating permanent revenue to finance additional social spending, while maintaining incentives for private investment.

Directors commended the authorities for their track record of fiscal prudence, anchored in a credible fiscal rule. They welcomed the plan to strengthen the legal framework for the Fiscal Council, noting that consideration could be given in the medium term to increase its autonomy and broaden its mandate. In due course, further refinements to the rule-based fiscal framework could also be considered. Directors saw the benefits of setting a small structural surplus target over the cycle in preserving adequate buffers.

Directors recognized the progress in enhancing financial sector oversight and the resilience of the financial system, and looked forward to full implementation of the recommendations from the Financial Sector Assessment Program. They underscored the importance of focusing efforts on completing legislative initiatives, aligning capital standards with Basel III, and strengthening the independence of the Supervisor of Banks and Financial Institutions. The dominant role of financial conglomerates in the financial system also calls for a more consolidated approach to their oversight. Directors encouraged close monitoring of corporate leverage, the real estate sector, and the growing exposure of insurance companies to commercial real estate.

Chile: Selected Social and Economic Indicators

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Sources: Central Bank of Chile, Ministry of Finance, Haver Analytics, and IMF staff calculations and projections.

Contribution to growth.

The methodology to compute the unemployment rate changed in 2009.

Headline balance adjusted for the economic and copper price cycles.

In percent of non-mining GDP.

1

Under Article IV of the IMF’s Articles of Agreement, the IMF holds bilateral discussions with members, usually every year. A staff team visits the country, collects economic and financial information, and discusses with officials the country’s economic developments and policies. On return to headquarters, the staff prepares a report, which forms the basis for discussion by the Executive Board.

2

At the conclusion of the discussion, the Managing Director, as Chairman of the Board, summarizes the views of Executive Directors, and this summary is transmitted to the country’s authorities. An explanation of any qualifiers used in summings up can be found here: http://www.imf.org/external/np/sec/misc/qualifiers.htm.