Chile: Staff Report for the 2015 Article IV Consultation
Author: International Monetary Fund. Western Hemisphere Dept.
Publication Date:
06 Aug 2015
eISBN:
9781513551067
Language:
English
Keywords:
cost of capital; staff summary; replacement staff; staff appraisal; central bank of Chile; Global; baseline scenario
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Chile’s GDP growth slowed sharply in 2014, as lower copper prices hurt the mining sector while non-mining investment suffered from the decline in business confidence after the launch of an ambitious set of reforms by the new administration. The strong fiscal and monetary policy response helped stabilize the economy, but output is expected to recover only gradually to a lower medium-term growth rate than forecasted in the 2014 Article IV Consultation staff report, and the balance of risks remains tilted to the downside.

Abstract

Chile’s GDP growth slowed sharply in 2014, as lower copper prices hurt the mining sector while non-mining investment suffered from the decline in business confidence after the launch of an ambitious set of reforms by the new administration. The strong fiscal and monetary policy response helped stabilize the economy, but output is expected to recover only gradually to a lower medium-term growth rate than forecasted in the 2014 Article IV Consultation staff report, and the balance of risks remains tilted to the downside.

Context

1. GDP growth has remained lackluster since last year’s staff report, as Chile’s economy continues to adjust to the end of the commodity super-cycle. GDP growth was 1.9 percent in 2014, well below the last decade average of 4¾ percent. The main force behind the slowdown has been the sharp fall in private investment. To a certain extent, a more modest growth path is the inevitable consequence of the end of the mining boom, which boosted investment and GDP growth to above potential rates in the last few years. Staff estimates that the 20 percent decline in copper prices from their average level in 2006–14 may subtract about 3 percentage points (pps) from Chile’s GDP growth, cumulatively over the next 5 to 10 years (see Selected Issue Paper, Chapter 1).

A01ufig1

Copper Price and GDP Growth

(In percent, y/y)

Citation: IMF Staff Country Reports 2015, 227; 10.5089/9781513551067.002.A001

Source: Central Bank of Chile.

2. Chile’s growth weakness also reflects the uncertainty and adjustment costs from the structural reform agenda launched in 2014. The decline in investment in 2014 also owes to a sharp fall in business confidence which cannot be fully reconciled with the stage of the business cycle and the external shock (Box 1), but may also reflect the reaction of Chile’s business community to the uncertainty associated with the ambitious structural and economic reform agenda announced by the new administration in 2014. This agenda rightly aims at fostering stronger and more inclusive long-term growth, including by addressing well-known gaps in Chile’s education system and infrastructure. To help finance spending in these areas, a reform of the tax system was approved in September 2014 which gradually increases capital income taxation. If well implemented, the reforms have the potential to boost productivity and GDP growth, but the higher cost of capital is likely to have a negative short-term impact on activity (see Selected Issues Paper, Chapter 2). Moreover, the announced constitutional and labor market reforms appear to have increased private sector’s uncertainty over Chile’s future economic environment.1

A01ufig2

Business and Consumer Confidence Indices

(Above 50 optimism)

Citation: IMF Staff Country Reports 2015, 227; 10.5089/9781513551067.002.A001

Source: Haver Analytics, Inc.

The Role of Domestic and External Factors in the Fall of Private Investment

Investment fell by about 6 percent in 2014, owing to both external and domestic factors. While there are no data on private fixed investment in the National Accounts, staff estimates that it fell by about 7 percent in 2014. The strong fall of copper prices (as of June 2015, down 35 percent from their 2011 peak) put an end to the investment boom that began right after the great financial crisis and caused mining investment to reach about 7 percent of GDP in 2012 (from about 2 percent in early 2000s). The strong real effective depreciation of the peso also hurt both mining and non-mining investment, as it made imported capital goods more expensive (in 2013, the value of capital goods imported was more than 60 percent of fixed investment in equipment and machinery). Domestically, the business confidence index fell by 17 percent in 2014, hitting its lowest level since the great financial crisis. Staff analysis (based on a VAR with GDP, copper prices, and business confidence indicators) suggests that the fall in business confidence in 2014 has been much more pronounced than what could be explained by the decline in copper prices and economic activity. An alternative explanation is that it might reflect the negative impact on business sentiment of the reform agenda announced at the beginning of 2014.

Staff estimates suggest that external factors were the most important driver of the decline in private fixed investment. To assess the relative weight of external and domestic factors, we estimated equations for private investment in mining and non-mining sectors. The decline in private fixed investment in 2014 is largely explained by external factors. In particular, the depreciation of the peso and lower copper prices together account for about two-thirds of the decline in overall private fixed investment in 2014. Among domestic factors, an important variable behind the decline in mining investment was the increase in labor costs. Non-mining investment was also affected by the drop in business confidence and the fall in Tobin’s Q (proxied by the price-to-book value for listed companies) which may also reflect the higher cost of capital from the tax reform.

A01ufig3

Confidence, External Factors and Investment Growth

(In percent, y/y)

Citation: IMF Staff Country Reports 2015, 227; 10.5089/9781513551067.002.A001

Sources: Central Bank of Chile and Fund staff calculations.
A01ufig4

Business Confidence: Actual Vs. Estimated 1/

(Log IMCE, non-mining sectors)

Citation: IMF Staff Country Reports 2015, 227; 10.5089/9781513551067.002.A001

Sources: University of Chile and Fund staff calculations.1/ Estimated from VAR, Grey area indicates downturns.
A01ufig5

Investment Growth in 2014

(In percent)

Citation: IMF Staff Country Reports 2015, 227; 10.5089/9781513551067.002.A001

Source: Fund staff calculations.

Recent Developments

3. Economic activity picked up somewhat towards the end of 2014 and early this year (Figure 1). The pickup was propelled by very stimulative macroeconomic policies: in particular, fiscal policy has turned highly expansionary in 2014 and this year, with a strong acceleration of infrastructure spending in the last quarter of 2014 (Figure 2). On the monetary side, Central Bank has kept the policy rate at 3 percent (well below its neutral level, estimated by staff at 4½–5 percent) after reducing it by 200 basis points between September 2013 and November 2014. Lower gasoline prices sustained private consumption, while the weaker peso supported non-mining exports, in particular agriculture and forestry products (the real effective exchange rate depreciated by about 15 percent in 2014 relative to early 2013).

Figure 1.
Figure 1.

Chile: Economic Activity

Citation: IMF Staff Country Reports 2015, 227; 10.5089/9781513551067.002.A001

Sources: Central Bank of Chile, Ministry of Finance, Haver Analytics, and Fund staff calculations.
Figure 2.
Figure 2.

Chile: Fiscal Policy and Public Finances

Citation: IMF Staff Country Reports 2015, 227; 10.5089/9781513551067.002.A001

Sources: Ministry of Finance, Central Bank of Chile, and Fund staff calculations.1/ For 2012, includes capital gains tax windfall.2/ For 2014, includes the expected yield of the 2014 tax reform as submitted to Congress.* Projections.

4. However, recent indicators suggest that the economic recovery has lost momentum in the last few months. After improving in the first quarter of 2015, business confidence deteriorated again in the second quarter. Imports of capital goods have continued to decline on a year-on-year basis. Non-mining export growth has slowed, although partly because of one-off factors. Labor market conditions have been softening, with slower growth in private sector employment and nominal wages since early 2015. After remaining relatively low at about 6 percent in the last six months, the unemployment rate increased to 6.6 percent in May 2015, as labor force participation inched up.

5. Inflation has remained stubbornly high. Headline inflation has exceeded the central bank’s target band (2–4 percent) for 15 consecutive months (Figure 3). After peaking at 5.7 percent in October 2014, inflation has declined steadily as the pass-through from the sharp peso depreciation of 2014 dissipated, and has hovered around 4 percent in the last few months. In the non-tradable (service) sector, disinflation has been slower, reflecting the sustained growth of nominal wages (in turn largely explained by the high degree of wage indexation to the CPI). Nonetheless, inflation expectations at the 24-month horizon have remained well anchored at 3 percent.

Figure 3.
Figure 3.

Chile: Monetary Policy and Inflation

Citation: IMF Staff Country Reports 2015, 227; 10.5089/9781513551067.002.A001

Sources: Central Bank of Chile, Haver Analytics, and Fund staff calculations.1/ Core inflation excludes fuels, fresh fruits, and vegetables.
A01ufig6

Imports of Capital Goods

(Index, July 2008 and July 2013=100 and t=0)

Citation: IMF Staff Country Reports 2015, 227; 10.5089/9781513551067.002.A001

Source: Fund staff calculations.
A01ufig7

CPI Inflation

(In percent, y/y)

Citation: IMF Staff Country Reports 2015, 227; 10.5089/9781513551067.002.A001

Source: National Statistics Institute (INE).

6. The external position has improved significantly. The current account deficit fell by over two percentage points of GDP in one year, from 3.7 percent in 2013 to 1.2 percent in 2014, mainly driven by the strong contraction in investment-related imports (Figure 4). EBA-based estimates suggest that the currency was modestly undervalued in 2014 in real effective terms. However, as the REER has appreciated somewhat in 2015 (its average in January–May 2015 was about 2½ percent above the 2014 average), the peso may be now closer to its equilibrium value (Annex I).

Figure 4.
Figure 4.

Chile: External Sector

Citation: IMF Staff Country Reports 2015, 227; 10.5089/9781513551067.002.A001

Sources: Central Bank of Chile, Haver Analytics, Inc., World Bank WITS, and Fund staff calculations.1/ Assessing Reserve Adequacy, IMF.

7. The financial sector appears generally healthy, although recent developments in Chile’s non-banking sector warrant close attention (Figure 5). Banks’ profitability remained strong in 2014, although it has declined so far in 2015 mainly due to a smaller positive impact of inflation. Banks’ non-performing loans have decreased slightly from already low levels, and capital ratios are above regulatory thresholds. On the other hand, life insurance companies and pension funds continue to be pressured by the low-yield environment and have kept on restructuring their portfolios towards riskier or less liquid assets, notably, real estate, lower rating domestic and foreign corporate bonds (life insurance companies) and foreign mutual funds and equity (pension funds). Mutual funds grew by almost 40 percent in 2015 compared to end-2013, with the fastest growth observed in mutual funds investing in medium- and long-term fixed-income instruments.

Figure 5.
Figure 5.

Chile: Financial Sector

Citation: IMF Staff Country Reports 2015, 227; 10.5089/9781513551067.002.A001

Sources: Superintendiencia Valores y Seguros (SVS), Superintendencia de Bancos e Instituciones Financieras (SBIF), Central Bank of Chile, IMF Financial Soundness Indicators 2015, and Fund staff calculations.* Projections.
A01ufig8

Structure of Life Insurance Sector’s Investments

(In percent of total)

Citation: IMF Staff Country Reports 2015, 227; 10.5089/9781513551067.002.A001

Source: Superintendencia de Valores y Seguros (SVS).

8. Non-financial corporate and household debt continues to increase. The debt-to-GDP ratio of Chilean non-financial firms was about 100 percent at end-2014, a relatively high level compared to other emerging economies (Box 2). Household debt-to-disposable income also rose to about 60 percent in 2014, driven by higher mortgage debt (Figure 6). Mortgage credit has grown at a much faster rate than consumer and commercial credit, with households bringing forward their home purchasing over the last few quarters in anticipation of the scheduled increase in VAT on housing from 2016. Despite higher debt, household debt service-to-income ratios have remained at low level due to low interest rates.

Figure 6.
Figure 6.

Chile: Housing Market Developments

Citation: IMF Staff Country Reports 2015, 227; 10.5089/9781513551067.002.A001

Sources: Central Bank of Chile, Superintendence of Banks and Financial Institutions, Chilean Chamber of Construction, Global Property Guide, SuSeso, SVS and Fund staff calculations.1/ Compiled by the Central Bank of Chile controlling for home characteristics.2/ Includes purchase commitments.3/ Latest data available for OECD and EM Europe is 2013. MEX 2012.
A01ufig9

Corporate (Non-financial) and Household Indebtedness

Citation: IMF Staff Country Reports 2015, 227; 10.5089/9781513551067.002.A001

Source: Central Bank of Chile.

Corporate Sector Vulnerabilities

A significant part of the increase in corporate debt-to-GDP ratio reflects Chilean firms’ increasing reliance on foreign currency funding. Foreign currency funding associated with FDI and external bond issuances accounted for about 90 percent of the increase in the corporate debt-to-GDP ratio in 2014 relative to 2013. At the end of 2014, 52 percent of corporate debt was in foreign currency, compared to 40 percent as of 2010. Given the sharp depreciation of the peso, this increase also reflects valuation effects on the existing stock, rather than “new” debt. Based on staff estimates, roughly half of the increase in the external corporate debt-to-GDP ratio in 2014 can be attributed to valuation effects caused by the depreciation of the peso. While Chilean companies appear to have increasingly relied on FDI and bond issuances, higher debt ratios for non-listed companies also reflect an increased reliance on domestic bank loans.

A01ufig10

Corporate Debt-to-GDP Ratio

(In percent of GDP)

Citation: IMF Staff Country Reports 2015, 227; 10.5089/9781513551067.002.A001

Sources: Central bank of Chile, SVS and SBIF.1/ Corporations, including their direct subsidiaries, who report to the Chilean regulating institution for Securities and Insurance (SVS).

While on average the leverage of Chilean non-financial firms has remained stable over the past two years, the share of firms with relatively high leverage has increased. Leverage (debt-to-equity) for the firms in the top 25 percent of the distribution has moved up over the past few years. On a sectoral basis, the increase in leverage in 2014 was concentrated in retail, forestry, and energy, with a few large firms in these sectors financing their expansion plans abroad. Over the last decade, the increase in leverage appears more broad-based, and leverage for Chilean listed non-financial companies is relatively high compared to other economies in Latin America.

A01ufig11

Corporate Sector Debt-to-Equity Ratio 1/

Citation: IMF Staff Country Reports 2015, 227; 10.5089/9781513551067.002.A001

Sources: Central Bank of Chile and SVS.1/ End of period data.

Risks to financial stability are moderated by a series of mitigating factors. Rollover risks on domestically issued corporate bonds seem moderate, as the average time to maturity of outstanding issues has increased since 2011 (from 10 to 14 years). Also, the increased reliance on foreign currency funding does not seem to be associated with greater currency mismatches. Data for the 20 largest Chilean corporations as of end 2014 show that, on average, their net foreign currency exposure was small and relatively unchanged since 2013. While a few firms have large net foreign currency liabilities, those are usually associated with significant natural hedges. Moreover, about 40 percent of this foreign currency debt is FDI-related and is typically less sensitive to external financial shocks. Finally, market perceptions of the underlying credit risk of Chilean non-financial firms have remained stable (measured by Moody’s CreditEgde+ one -year ahead expected default frequencies).

A01ufig12

Foreign Currency Exposure of Corporations 1/

(In percent of total assets, unless otherwise stated)

Citation: IMF Staff Country Reports 2015, 227; 10.5089/9781513551067.002.A001

Sources: Orbis, SVS and Fund staff calculations.1/ Top Chilean coporations, excluding ENAP and affiliates.

However, high leverage makes Chilean firms less resilient to a further slowdown of economic activity and external financial shocks. In 2014, average profitability and liquidity indicators across Chile’s non-financial firms have remained at levels close to 2013, but, as in the case of leverage, there are large differences across firms and sectors. While average profitability ticked up in 2014, the distribution had been on a downward trend since 2011. Profitability of firms in retail and construction sectors has been particularly affected, and remains much below historical averages. At the same time, the relatively greater reliance of non-listed firms on bank funding suggests that lower profitability across these firms may affect the banking sector.

A01ufig13

EBIT: Profitability of Coporate Sector 1/

(In percent of total assets)

Citation: IMF Staff Country Reports 2015, 227; 10.5089/9781513551067.002.A001

Sources: Central Bank of Chile and SVS.1/ Twelve months accumulated earnings before interest and taxes.

Outlook and Risks

9. Growth is expected to firm up this year and the next, though remaining well below its potential. Staff expects GDP growth to average 2½ percent in 2015, mainly on the back of a strong fiscal impulse, and to accelerate to 3.1 percent in 2016 as private domestic demand gradually strengthens. Inflation is projected to slowly decline towards 3 percent by mid-2016, under the combined effects of the negative output gap and the waning pass-through of the peso depreciation in 2014.

10. The main assumptions underlying the expected recovery of private domestic demand in 2016 are as follows:

  • A moderate pick-up in non-mining investment, as monetary policy conditions remain highly accommodative and business sentiment gradually improves. This will more than offset continued weakness in mining investment, as copper prices are expected to remain stable in 2016 after falling by another 10 percent in 2015.

  • Stronger non-mining exports, mainly thanks to the more competitive real effective exchange rate as trading partners’ growth fails to increase substantially (going from 3.2 percent in 2015 to 3.4 percent in 2016, based on the July 2015 update of the World Economic Outlook).

  • A modest firming of private consumption, reflecting a gradual return of consumer confidence, still easy access to credit, and some pick-up in real income as lower inflation partly offsets slower nominal wage growth in the context of weaker labor market conditions.

11. The balance of risks is mainly on the downside (see Risk Assessment Matrix (RAM), and Annex II on spillovers). The main risk to staff’s baseline scenario is a more persistent weakness of private sector confidence and investment, amid continued uncertainty over the structural reform agenda and the external outlook. On the external front, a further decline in copper prices (for example associated with a deeper-than-expected downturn in China) would imply more depressed activity in the mining sector. Tighter and more volatile global financial conditions also pose risks to Chile’s economic recovery. Although Chile’s deep local capital market, sound macroeconomic fundamentals, and credible policy framework are likely to reduce the risk of a “sudden stop” of capital inflows, a sharp asset price adjustment and decompression of credit spreads could reduce the availability, and increase the cost, of funding for the non-financial corporate sector and banks. Moreover, high leverage and heavy reliance on foreign currency debt make Chile’s corporate sector relatively vulnerable to a tail-risk downside scenario, where foreign interest rates increase sharply, the peso depreciates strongly, and the economic slowdown accentuates.

12. Staff revised down its estimate of medium-term GDP growth, although a successful completion of the reform agenda has the potential to boost growth in the long run. Capital accumulation is expected to slow from its historical average, as lower copper prices and higher taxes on capital income depress investment (Table). Population aging should reduce labor input growth from 2⅓ in the 2000s to about 1 percent in 2020, lowering total hours worked. The slowdown in TFP growth, from an average 2½ percent in the 1990s to around ¼ percent since the early 2000s, is likely to have an important trend component, reflecting declining productivity in the mining sector and infrastructure bottlenecks. While the positive impact of some of the structural reforms (particularly of the education system) may take a long time to fully materialize, starr expects greater spending on infrastructure to start contributing to TFP and capital growth over the next few years. In particular, TFP growth and capital accumulation are likely to be boosted by recent progress in addressing energy bottlenecks, including by increasing electricity generation capacity (by about 30 percent by 2020) and reducing electricity costs (with spot marginal costs lowered by a more competitive tender process among distributing firms). As a result of all these factors, staff expects potential GDP growth at 3.7 percent in 2020.

Growth Assumptions: Medium-Term Scenarios

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A01ufig14

Total Dependency Ratio 1/

(In percent)

Citation: IMF Staff Country Reports 2015, 227; 10.5089/9781513551067.002.A001

Source: United Nations World Population Prospects (2012).1/ Share of population aged 0-14 and 65+ in population aged 15-64.
A01ufig15

Electricity Generating Capacity by Technology

(In gigaawatts)

Citation: IMF Staff Country Reports 2015, 227; 10.5089/9781513551067.002.A001

Sources: Chilean National Energy Commission and OECD.

Risk Assessment Matrix

Citation: IMF Staff Country Reports 2015, 227; 10.5089/9781513551067.002.A001

Note: Colored boxes on left hand side represent shock likelihood and colored boxes on right hand side represent severity of impact.Red = High, Yellow = Medium, and Green = Low.

Policy Discussion

A. Policy Mix

13. Staff argued in favor of a macroeconomic policy mix that combines tighter fiscal policy with continued monetary policy accommodation.

  • Fiscal policy: The strong fiscal impulse in 2015 was appropriate, given the severity of the slowdown, the need to cushion the temporary effects of structural reforms, the low level of debt, and the emphasis on infrastructure and education spending (which account for about half of the 9 percent projected increase in public expenditure this year). However, a steady process of fiscal consolidation is warranted beginning from 2016, given that the economy is expected to recover gradually. Reaffirming the commitment to a structural balanced budget position in the medium term would also help anchor expectations and boost private sector confidence. Based on staff’s assumptions about long-term GDP growth and copper prices, the structural deficit in 2015 is about 2¾ percent of GDP (against 1.1 percent in the last Budget). Moreover, achieving the target of a balanced structural fiscal position in 2018 would require an average growth of public spending of just below 3 percent in real terms over 2016–2018. Given the strong credibility of Chile’s fiscal framework and lack of debt sustainability issues (Table A.2), staff noted that the authorities have room to proceed with a slower pace of fiscal consolidation if the fiscal tightening were to weigh excessively on pro-growth expenditures (such as infrastructure and education). At the same time, if the return of business confidence were to be slower than expected, the fiscal policy stance should not be relaxed, as sticking to the commitment to eliminate the structural fiscal deficit over time would likely contribute more to supporting private sector demand than fine-tuning public spending.

  • Monetary policy has room to remain accommodative until there are strong signs that the economic recovery consolidates. The central bank’s baseline scenario (as presented in the June 2015 Monetary Policy Report) projects no interest rate increase until early 2016. Staff sees this stance as appropriate, and noted that there is room to adopt a wait-and-see attitude until the risks surrounding the economic recovery dissipate, given the well-anchored inflation expectations, the projected decline in headline inflation, and the downside risks to growth. Fiscal consolidation would give the Bank more room to maintain an accommodative monetary policy even with a slower return of inflation toward the mid of the target band, and to cut rates if the economy weakened further or the downside risks materialized.

Authorities’ and Staff Fiscal Projections

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Sources: Ministry of Finance of Chile and Staff calculations.Note: Authorities’ figures for 2015 incorporate the 2015 mid-year fiscal projections update (issued July 6th 2015). Staff incorporate 2015 updates and new interests schedule received from authorities.

14. The authorities broadly concurred with staff. They agreed that the beginning and pace of normalization of interest rates should remain conditional on the strength of the economic recovery, and noted that the large fiscal impulse in 2015 is not sustainable and needs to be followed by a process of fiscal consolidation, safeguarding the credibility of the fiscal framework. They also agreed that restating the commitment to a structural budget over the medium run would support confidence and reduce uncertainty, although the pace of consolidation would depend on the new assumptions on long-term growth and copper prices, which will be made public at the time of the Budget in the fall of 2015. However, they noted that staff’s assumptions on long-term GDP growth and copper prices appear relatively pessimistic. Hence, the reduction in real public expenditure growth required to reach a balanced budget in 2018 may not be as pronounced as envisaged by staff. They also highlighted their intention to simplify the implementation of the tax reform by providing more guidance to firms, and are preparing a new fiscal responsibility law that would strengthen the role and governance of the Fiscal Council.

B. Reforms

15. The labor market reform, currently under discussion, aims at expanding the coverage and scope of collective bargaining by empowering trade unions (Table). While its unionization rate is not exceptionally low, Chile has a relatively low coverage of collective bargaining agreements compared to other OECD economies. Chile’s labor market is also characterized by a highly dual structure: about one-third of employees have temporary jobs (against the 12 percent OECD average) and nearly 15 percent do not have written contracts. In the authorities’ view, the highly fragmented nature of bargaining implies a relatively inefficient and unbalanced system of industrial relations, with frequent illegal strikes and heavy involvement of the legislator in addressing labor market disputes, and may contribute to Chile’s high income inequality. They argued that the reform would make industrial relations more balanced, promote social cohesion by enhancing the cooperation between employers and workers, and reduce income inequality.

A01ufig17

Unionization and Coverage of Collective Bargaining Agreements 1/

(In percent of total number of wage and salary earners)

Citation: IMF Staff Country Reports 2015, 227; 10.5089/9781513551067.002.A001

Source: OECD, Economic Policy Reforms 2015: Going for Growth.1/ Number of workers covered by wage bargaining agreements can be higher than the number of trade union members as a result of extensions of collective bargaining contracts to non-negotiating parties.

Labor Reform: Overview of Selected Areas

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Note: Staff summary based on Moderniza el sistema de relaciones laborales, introduciendo modificaciones al Código del Trabajo, No. Boletin 9856-13. The labor reform is presently under discussion in Congress. Therefore, some of the specific changes mentioned in the table may undergo some changes as a consequence of the legislative process.

16. Staff stressed that fostering Chile’s labor market efficiency and flexibility should remain a priority. Empirical evidence suggests that greater unionization and more extensive collective bargaining may help reduce wage inequality and promote social dialogue. But changes in labor market institutions should not happen at the cost of reducing labor market efficiency. In this regard, it is particularly important that the reform maintains collective bargaining at the firm level and introduces more flexible work arrangements within the collective bargaining process (independently of the level of unionization within the firm). Protecting workers’ right to strike should be balanced by clearly defining the range of “minimum services” that are guaranteed in case of strikes while remaining mindful of the effects of the reform on small firms. Staff welcomed recent changes in unemployment insurance (which have increased the amount and duration of the benefits from a relatively low base, and linked them to mandatory training), and the efforts to improve skill training programs for youth and women outside of the labor force. Lowering the relatively high severance payments could also contribute to reducing the duality of Chile’s labor market.

17. The education reform has the potential to raise the quality of Chile’s human capital, increase productivity, and lower income inequalities. The legislation approved early this year (that ends the for-profit education, co-payment, and discrimination practices at primary and secondary levels) could deliver higher quality and equity in education by reducing the level of segregation in Chile’s school system. The proposed introduction of a national teaching policy could also increase the quality of education by raising entry wages for teachers and linking teachers’ evaluation with their professional and career development. The authorities reiterated their willingness to extend free tertiary education to all students (beyond those currently covered by scholarships and subsidized loans), but noted that the implementation period would be determined by the growth outlook and availability of public resources. Staff recognized that a reform of higher education appears warranted, in light of the relatively high tuition fees and more difficult access to financing in Chile’s public universities compared to many other OECD economies. At the same time, staff stressed that careful consideration should be given to the implications of universal free university education on income distribution (also given the significant private return to tertiary education) in addition to its fiscal costs.

A01ufig18

Public Institutions’ Tuition Fees and Students Benefitting from Assistance Programs

Citation: IMF Staff Country Reports 2015, 227; 10.5089/9781513551067.002.A001

Source: OECD, 2011.

18. The authorities highlighted the legislative efforts to strengthen public and private sectors’ governance and institutions. A series of political and corporate scandals in the recent past may have undermined investors’ confidence in Chile’s public and corporate sectors, contributing to the fall in business confidence. The authorities’ response has been admirably swift, with a series of legislative and regulatory measures announced over the past few months (under the government’s “Transparency Agenda”). A host of measures aim at improving corporate governance, investor protection, and market transparency, including by tightening internal and external audit processes, improving transparency about the composition and practices of publicly trade corporations’ boards, and giving additional intervention, enforcement, and sanction powers to the new Securities and Insurance Commission. A series of legislative efforts is also underway that aim at restoring confidence in public institutions, including by regulating funding to both political parties and campaigns and tightening norms over conflicts of interest, corruption, and lobbying. Finally, the institutional framework for PPP arrangements is strengthened by a law proposal that establishes a centralized unit within the Minister of Public Works tasked with the responsibility of assessing, approving and developing new concessions. The bill also improves the transparency and terms of renegotiations of old concessions, and introduces minimum standards of service. Staff welcomed the initiative that, if well implemented, could contribute to mobilizing the private financial resources needed to fill Chile’s infrastructure gap, as well as promoting a more efficient use of public funds.

C. Financial and Corporate Sector

19. Staff discussed with the authorities the policy implications of high corporate and household debt. Staff stressed that prudential measures might need to be considered if corporate debt continues to grow, in order to reduce Chile’s vulnerability to adverse shocks. In particular, consideration could be given to higher risk weights or higher provisioning for commercial credit, in order to increase the resilience of the banking sector to shocks in the corporate sector. The authorities noted that the best indicator of debt is leverage (debt-to-equity ratio) which has been relatively stable over the past two years and comparable to other economies. They also noted that imposing prudential measures that have a broad reach over the corporate sector may be inappropriate at this stage, given the weak economy and the lack of systemic risks from corporate leverage. On household debt, staff welcomed the new provisioning regulation for mortgage loans, which from 2016 onwards will increase provisions for high loan to value (LTV) ratios and delinquent mortgages. Staff argued that tighter LTVs and debt service-to-income ratios could be considered if mortgage credit growth were to accelerate. The authorities responded that the new regulation on provisions was sufficient to address the risks, particularly because mortgage credit growth should decelerate in 2016, after the VAT on first homes is introduced.

20. Forthcoming changes in the General Banking Law will bolster the resilience of the banking sector. The authorities expect to send the new Banking Law to Congress during the second half of 2015. The new law will adapt Basel III capital standards to Chilean banks on a transitional basis and introduce a capital surcharge for domestic systemically important banks. Staff also welcomed the new liquidity regulation (effective from August 2015) and the authorities’ plans to specify the minimum requirements for the liquidity coverage ratio (LCR) and net-funding stable ratio (NSFR). This will strengthen liquidity risk management and address the risks stemming from the reliance on wholesale funding, particularly for medium and small banks. The authorities noted that the banking sector in general is well prepared to implement Basel III capital and liquidity requirements on a transitional basis. The authorities are also planning to implement a legal framework for bank resolution, broadly in line with the 2011 FSAP recommendations. While the authorities are willing to strengthen the SBIF operational independence, staff emphasized the importance of ensuring that SBIF is given sufficient financial resources to conduct effective implementation of the new regulatory requirements.

21. The search for yield by life insurance companies warrants close attention. Staff stressed the importance of monitoring the potential implications for financial stability from the insurance sector’s expansion to riskier investments. The authorities shared the concerns, although their stress tests suggest that the insurance sector is resilient to large shocks. A new regulation was introduced in 2015 that asks insurance companies to define their risk appetite and introduces a concept of own risk and solvency assessment. But the legislative proposal that introduces risk-based supervision for insurance companies is still in Congress. Staff also enquired on the rapid increase in Chilean pension funds’ exposure abroad, as this could signal a shift of funds’ appetite towards riskier assets. The authorities noted that pension funds are subject to strict regulation regarding their foreign investment, and that the expansion abroad was mainly in response to the lack of investment opportunities in the domestic market.

A01ufig19

Structure of Pensions Funds’ Investments

(In percent of total, unless otherwise stated)

Citation: IMF Staff Country Reports 2015, 227; 10.5089/9781513551067.002.A001

Source: Superintendencia de Pensiones (SP).

22. Improving the supervision of conglomerates would reinforce the resilience of the financial sector. The Financial Stability Council (FSC) law represents an important step toward strengthening consolidated supervision of financial conglomerates. The law removed all barriers to information-sharing among supervisors; expanded their power to request information from the final owners of financial institutions within the conglomerate; and established solvency requirements for the controlling shareholders of banks and insurance companies. However, supervisors still lack the powers and authority to conduct comprehensive group-wide supervision (including setting risk-based minimum prudential standards and monitoring conglomerates’ compliance with limits on risk exposure). The 2011 FSAP recommended stronger coordination among supervisors and the identification of a group-level supervisor with enhanced powers, including that of establishing risk-based minimum prudential standards for financial conglomerates. The authorities said the biggest challenges are to design a crisis management framework for conglomerates and to supervise mixed conglomerates, and said they are waiting the final report from a recent technical assistance mission of the IMF.

D. Other Structural Issues

23. Staff welcomed the authorities’ efforts to increase female labor force participation, which is one of the lowest in the OECD and Latin America (Annex III). Recognizing the main impediments to female participation, the authorities plan to increase the relatively low coverage of early childhood education by building childcare institutions, and are replacing the mandated employer-provided childcare with a universal system. They have also launched an ambitious training program (‘Más Capaz”), with an objective to train 450,000 youth and women in 2015–18 and facilitate their entrance into the job market. Furthermore, the “adaptability” provisions in the proposed labor market reform could foster female participation, by allowing for more flexible work arrangements. Reducing commuting time by improving transportation infrastructure would also encourage women’s participation in the labor market.

A01ufig20

Female Labor Force Participation Rates

(In percent aged 15-64)

Citation: IMF Staff Country Reports 2015, 227; 10.5089/9781513551067.002.A001

Sources: World Development Indicators and OECD.

24. The authorities agree with the need to diversify the economy away from copper. Staff noted that Chile’s economic structure is not as diversified as that of neighboring countries, and diversification seems to have declined over time (see WHD Regional Economic Outlook, April 2015). In addition to better infrastructure and greater human capital, new policies to boost innovation are needed to address this issue. At 0.4 percent of GDP, Chile’s R&D spending is the lowest in the OECD (2 percent of GDP on average), particularly in the private sector. The government has put in place a number of initiatives to boost innovation (such as “Start-up Chile”, a program that provides seed money to start ups) and productivity, but there is room to expand and rationalize these programs, as well as to strengthen collaboration between firms and universities or other research institutions. The authorities also see potential for developing managerial skills through the creation of a series of Small Business Centers that provide technical assistance to small businesses and aspiring entrepreneurs, following international experience; and for reducing the red tape associated with creating a new company. Staff also welcomed the announcement of a new agency to attract foreign investment with a more proactive strategy. The authorities also emphasized that developing better infrastructures was key to improving access to the international market and boosting non-mining exports.

A01ufig21

Export Diversification

(Index, 5-year rolling average; higher index=less diversification)

Citation: IMF Staff Country Reports 2015, 227; 10.5089/9781513551067.002.A001

Sources: Hausmann, Hidalgo, et. al. (2014); IMF, World Economic Outlook; and Fund staff calculations.

25. Access to credit should be strengthened for small and medium-size firms. The authorities mentioned that the productivity gap between SMEs and large firms in Chile is relatively large (about twice as large as in Europe, for example), and argued that this may also reflect a relatively more difficult access to credit. Staff welcomed the authorities’ intention to accelerate the approval of a bill that introduces a Public Credit Bureau. A swift approval of the bill could improve access to credit, particularly for SMEs, by reducing information gaps and improving financial institutions’ assessment of credit risks. The authorities also plan to introduce a registry of firms’ mobile assets, which will make it easier for banks to assess the value of that type of collateral. Finally, the authorities noted that they intend to implement a regulated crowd-funding framework that will increase competition in the credit market, with greater incentives for non-bank institutions to provide credit to SMEs.

Staff Appraisal

26. Growth has remained lackluster over the past year, as the economy continues to adjust to the end of the mining boom. The main force behind the slowdown has been the sharp fall in fixed investment. To a large extent, this reflects the inevitable adjustment of the Chilean economy to the end of the commodity boom, which had pushed investment and GDP growth to above potential rates over the past few years. The external position has improved markedly, with a large decline in the current account deficit and a real exchange rate now closer to a level consistent with macroeconomic and policy fundamentals.

27. But the economy has also been negatively affected by the adjustment costs from the structural reform agenda launched in 2014. The decline in fixed investment partly reflects the fall in business confidence which cannot be fully reconciled with the external shocks, and likely results from the uncertainty generated by the structural reform agenda and its short-term costs. If well implemented, the reforms have the potential to boost productivity and long-term growth, but the higher cost of capital and the complexity of the new tax regime are likely to have a negative effect on economic activity in the short-term. Moreover, the announced constitutional and labor market reforms appear to have increased private sector’s uncertainty over Chile’s future economic environment.

28. Staff expects GDP growth to increase modestly in 2015 and 2016, but the balance of risks is tilted to the downside. In staff’s baseline scenario, GDP growth picks up modestly to 3.1 percent in 2016 from 2½ percent in 2015. Continued accommodative monetary policy conditions and a gradual recovery of business sentiment will improve non-mining business investment, more than offsetting continued weakness in mining investment. The main risk to the baseline scenario is a more persistent weakness of private sector confidence and investment, amid protracted uncertainty over the structural reform agenda and the external outlook. On the external front, a further decline in copper prices from a deeper than expected downturn in China’s economy would imply more depressed activity in the mining sector, while renewed bouts of global financial volatility and disruptive asset price shifts may tighten external financial conditions for Chile’s highly leveraged corporate sector.

29. Against this background, the macroeconomic policy mix should combine tighter fiscal policy with continued monetary policy accommodation. As the economy is expected to recover gradually, starting a process of fiscal consolidation next year is warranted. Reaffirming the commitment to fiscal discipline after the fiscal impulse in 2015 would also help boost business confidence. The pace of fiscal consolidation would need to take into account the deterioration of the long-term prospects for GDP growth and copper prices. On the other hand, the beginning of fiscal consolidation, the well-anchored inflation expectations, and the downside risks to growth all give room for monetary policy to remain accommodative until there are strong signs that the economic recovery consolidates.

30. Nurturing the return of business confidence also requires a careful design and implementation of the structural reform agenda. It is important to minimize the potential for short-term negative effects on growth, including those related to higher uncertainty. In this regard, effective action could be taken to clarify the procedures of the constitutional reform; ensure that the reform of the labor market improves its efficiency; and pursue the education reform with a view to raising the quality of Chile’s human capital, increasing productivity, and lowering income inequalities.

31. Staff welcomed the authorities’ efforts to strengthen public and private sectors’ governance and institutions. The measures that aims at improving corporate governance, investor protection, and market transparency, could bolster business confidence, increase market liquidity and reduce the cost of capital. Improvements in the institutional framework for PPP arrangements could contribute to mobilizing private financial resources needed to fill Chile’s infrastructure gap, as well as promoting the efficient use of public funds. The recent efforts to restore confidence in public institutions are also needed and timely.

32. While Chile’s financial sector is healthy, there are a few areas where financial oversight could be strengthened further. The relatively high level of corporate and household debt does not appear to pose risks to economic and financial stability per se, but it may reduce Chile’s resilience to negative shocks and needs to be monitored closely. If the increase in corporate leverage were to accelerate in the future, the authorities could consider adopting additional prudential measures to safeguard Chile’s financial sector against these shocks. Staff welcomes the adoption of minimum liquidity standards and the authorities’ plan to send the new General Banking Law to Congress during the second half of 2015 (which will introduce Basel III bank capital standards). While the Financial Stability Council law represents an important step forward, the authorities should keep strengthening the supervision of financial conglomerates. As the insurance companies’ expansion into riskier and less liquid investments continues, it is essential to approve the bill proposal that implements risk-based supervision and introduces new solvency requirements for insurance companies.

33. Staff proposes to hold the next Article IV consultation on the standard 12-month cycle.

Table 1.

Chile: Selected Social and Economic Indicators (2010–16)

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

Contribution to growth.

Headline balance adjusted for the economic and copper price cycles.

Table 2.

Chile: Summary Operations of the Central Government

(In percent of GDP unless otherwise indicated)

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Sources: Ministry of Finance and Fund staff calculations.

Based on the authorities’ medium-term fiscal projections in the 2015 Budget Law, adjusted for staff’s GDP and copper price projections.

Based on staff’s output gap estimates and WEO copper prices.

Table 3.

Chile: Balance of Payments

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Sources: Central Bank of Chile, Haver Analytics, and Fund staff calculations and projections.

In 2010 reflects insurance payment associated with the earthquake.

Excluding change in reserves.

Table 4.

Chile: Monetary Survey

(In billions of pesos, unless otherwise indicated)

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Sources: Central Bank of Chile and Haver Analytics.