CHILE: 2016 Article IV Consultation—Press Release; Staff Report; and Statement by the Executive Director for Chile

This 2016 Article IV Consultation highlights that GDP growth in Chile has been weak, with activity slowing in October. However, conditions are in place for the economy to recover. After expanding by a moderate 1.7 percent in 2016, growth is forecast to increase to 2 percent in 2017. Faster growth in main regional partners and more stable copper prices are expected to lift exports and investment. The recovery is, however, projected to be gradual, held back by slow wage and job growth and still low business confidence. The financial sector appears healthy. Banks' profitability is declining, but capital buffers are adequate and nonperforming loan rates are low.


This 2016 Article IV Consultation highlights that GDP growth in Chile has been weak, with activity slowing in October. However, conditions are in place for the economy to recover. After expanding by a moderate 1.7 percent in 2016, growth is forecast to increase to 2 percent in 2017. Faster growth in main regional partners and more stable copper prices are expected to lift exports and investment. The recovery is, however, projected to be gradual, held back by slow wage and job growth and still low business confidence. The financial sector appears healthy. Banks' profitability is declining, but capital buffers are adequate and nonperforming loan rates are low.

Chile’s Growth and Inequality Challenge

1. New realities are shaping Chile’s economic prospects. Economic rebalancing in China, less buoyant income growth in the U.S. and Europe, and structural problems in Latin America— notwithstanding a better outlook for next year—are generating a less dynamic external environment beyond the near-term. Domestically, population aging, infrastructure bottlenecks, and low human capital are dampening trend growth. Meanwhile demand for adequate provision of public services are mounting amidst still high income inequality and poverty, raising trade-offs between growth, fiscal, and social objectives. Structural reforms aimed at addressing these challenges are forging new avenues for growth, but are also generating adjustment costs. In particular, a new labor reform, while upgrading labor relations, is creating uncertainty given legal ambiguities. The next general election is slated for November 2017.


New Realities Shaping Chile’s Economic Prospects

Citation: IMF Staff Country Reports 2016, 376; 10.5089/9781475559675.002.A001

Source: IMF Global Economic Environment database.

2. Despite these challenges, Chile has grown faster than others in the region. This owes to a credible and effective fiscal and monetary framework, a modern and stable financial system, and a flexible exchange rate. Since 2014, growth averaged 2 percent, substantially below rates of 4 percent a few years ago, but well above the Latin-American six largest countries average of 0.3 percent during the last 3 years.

A. Recent Developments

3. The growth slowdown is coming to an end (Figure 1, 2). GDP decelerated to 1.6 percent (saar) in the first half of 2016, mainly in response to flagging external demand from the region, and a second round of copper price declines in 2015. The contraction in mining contributed more than half to the overall growth slowdown, while ex-mining activity remained sluggish owing to soft domestic demand. Private consumption slowed to 1.8 percent y/y in 2Q2016 in line with decelerating wage and employment growth (Figure 4). Business investment continues to be low owing to uncertain external conditions,1 diminishing construction activity (payback from last year’s tax-policy induced advancing of residential investment), and depressed sentiment. However, signs of a turnaround have emerged. Mining exports and the trade balance improved over the summer, and an uptick in real incomes from rapid disinflation is helping private consumption.

Figure 1.
Figure 1.

Chile: Economic Activity

Citation: IMF Staff Country Reports 2016, 376; 10.5089/9781475559675.002.A001

Sources: Central Bank of Chile, Ministry of Finance, Haver Analytics, and IMF staff calculations./1 IMACEC is a monthly economic activity indicator.
Figure 2.
Figure 2.

Chile: Macroeconomic Effects of Copper Prices

Citation: IMF Staff Country Reports 2016, 376; 10.5089/9781475559675.002.A001

Sources: Central Bank of Chile; Haver Analytics, Inc.; U.S. Geological Survey; IMF staff calculations.1/ Staff analysis finds high sensitivity of Chile’s investment to copper price uncertainty, reflecting the large irreversibility component inherent to mining investment (Comelli and Perez Ruiz, 2016, “To Bet or not to Bet: Copper Price Uncertainty and Investment in Chile, IMF Working Papers No. 16/216).
Figure 4.
Figure 4.

Chile: The Softening of the Labor Market

Citation: IMF Staff Country Reports 2016, 376; 10.5089/9781475559675.002.A001

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

4. Business confidence is improving. Sentiment is still depressed, but has risen slightly since July. A better regional outlook and moderately stronger-than-expected activity since the summer appear the main factors. Also, passage of large parts of a controversial reform agenda have reduced uncertainty, although legal ambiguities in the new labor law and implementation costs associated with a complex new business tax continue to weigh on sentiment.


Business Confidence and Economic Activity

Citation: IMF Staff Country Reports 2016, 376; 10.5089/9781475559675.002.A001

Source: Haver Analytics, Inc.

5. A supportive macro policy mix is set to turn less accommodative next year. Amidst weak growth and steady disinflation, the central bank has kept the policy rate unchanged at 3½ percent since the beginning of the year. Forward guidance has reduced interest rate expectations, and financial conditions (text chart) have in parallel shifted from slightly tight to neutral (relative to the historical 1996-2015 average). Fiscal policy delivered stimulus of ½ percent of potential GDP per year during 2013-16 but starting 2017, the structural deficit is set to narrow at the yearly pace of ¼ percent.


Financial and Monetary Conditions

Citation: IMF Staff Country Reports 2016, 376; 10.5089/9781475559675.002.A001

B. Outlook, Macro-Financial Linkages, and Risks

6. Conditions are in place for a modest recovery next year. GDP is forecast to grow moderately faster at 2 percent in 2017, slightly up from 1.7 percent this year (Table 1). Faster external demand growth in key trading partners—up by 0.3 ppts. to 3 percent in 2017—and more stable copper prices are projected to lift exports. Spillovers to business investment are, however, slow to materialize: business confidence will likely continue to improve only at a moderate pace as the effects of new labor legislation—effective in April 2017—take time to be understood by social partners. Private consumption will be held back by slow wage growth and rising unemployment (expected to peak at almost 8 percent by mid-2017). Beyond the near-term, growth is expected to accelerate as ongoing reforms remove growth bottlenecks.2

Table 1.

Chile: Selected Social and Economic Indicators

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

Contribution to growth.


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

7. Financial conditions are staying broadly neutral. External conditions are set to remain favorable and capital inflows to emerging economies with strong fundamentals, such as Chile, are expected to remain robust as expected gradual monetary policy normalization in the U.S. commences. The slowdown in credit growth since June 2016 is set to extend into next year, reflecting both sluggish domestic demand and some tightening of banks’ credit conditions. In particular, moderately higher credit risks will dampen bank lending conditions for SMEs, consumer credit, and mortgages under the baseline. Banks will also focus more on strengthening capital buffers in anticipation of an expected phased-in adoption of Basel III minimum solvency requirements.

8. Disinflation is set to continue into 2017 (Figure 3). Inflation has returned to the target band after decelerating rapidly from 4 percent in July to 3.1 percent in September. Peso appreciation (7½ percent against the dollar since January), slower services inflation, and a soft labor market all contributed. With the output gap widening next year, inflation is projected to decline to 2.7 percent in 2017.

Figure 3.
Figure 3.

Chile: Inflation and Monetary Policy

Citation: IMF Staff Country Reports 2016, 376; 10.5089/9781475559675.002.A001

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

Consumer Prices

(In percent, y/y)

Citation: IMF Staff Country Reports 2016, 376; 10.5089/9781475559675.002.A001

Source: Haver Analytics, Inc.

9. Risks are tilted to the downside (Risk Assessment Matrix (RAM), text table, and Box 2). On the downside, an unexpected slowdown in China or setbacks from pending adjustments in Brazil could dampen exports and investment, and tighten financing conditions as investor risk aversion increases. Sustained uncertainty about U.S. domestic policies, a shift towards protectionism, and faster than expected tightening of monetary policy could dampen external demand while raising inflation as the peso depreciates. Domestically, the recovery in confidence could be further delayed by a drawn-out resolution of legal uncertainty embedded in the new labor bill. Also, implementation costs of a complex new corporate tax code could be larger than expected. Moreover, should the pension reform be approved, an increase in contribution rates could dampen growth over the medium-term relative to the baseline. Finally, a sharper-than-anticipated cooling in the labor-intensive real estate market could create headwinds to consumption via higher unemployment. On the upside, approaching the presidential elections next year, private sentiment could rebound more rapidly than expected as perceived policy uncertainty diminishes.

Simulated GDP Impact of Risk Scenarios 1/

(percentage points deviation from October 2016 WEO baseline)

article image
Source: IMF staff.

Table shows the impact on the level of GDP over the course of two years as informed by Blagrave and Vesperoni (2016), Spring 2012 and Spring 2014 Regional Economic Outlook, Western Hemisphere Department. The probability-of-default scenario relies on a TVP-FAVAR approach (see Box 2).


An increase in the average median probability of default from 0.17 currently to 0.27 represents a 3.4 standard deviation deterioration in the FCI.

10. The impact of downside risks materializing could be amplified through macro-financial linkages. Although balance sheets in key sectors appear to be healthy (Annex II.A), historically high household debt (60 percent of GDP), high leverage among non-financial corporates, and strong inter-sectoral balance-sheet linkages are sources of vulnerability (network chart). Among large corporates, foreign currency debt is substantial (55 percent in 2016Q1), although long maturities, a substantial share of FDI related debt, and financial and natural hedges are containing risks from currency mismatches. Compared to other countries in Latin America, cross-sector liability positions appear elevated and are complex—for example, households have significant claims on other financial corporates (88 percent of GDP). On the other hand, linkages between the copper and the domestic financial sector are limited, due to large-scale funding of mining via FDI.


Non-Financial Corporate Debt

(In percent of GDP)

Citation: IMF Staff Country Reports 2016, 376; 10.5089/9781475559675.002.A001

Source: Central Bank of Chile.

11. Against this background, a deterioration in external growth or financing conditions could force firms to deleverage at an accelerated pace. Under the baseline of a moderate recovery, staff does not expect firms’ investment plans and banks’ credit supply to be constrained by high leverage, given long maturities of debt and low interest costs. However, under a risk scenario, an associated rise in job losses and/or a rapid decline in real estate prices could, via macro-financial linkages, lead to larger-than-expected defaults on mortgages and consumer credit—all resulting in tightening credit and shrinking domestic demand. To illustrate the growth implications, an increase in Chile’s EMBI spread by 100 basis points (equivalent to a one standard-deviation deterioration in the Financial Condition Index) would cause growth to drop by roughly 0.3 percentage points within less than one year (Annex I). Severe stress tests of corporate balance sheets, which substantially raise default probabilities of externally exposed firms, show that credit losses would be substantial. Even so, the banking sector would manage to absorb a rise in credit costs thanks to sufficient capital buffers (Box 2).


Gross Liabilities and Cross Sectoral Linkages

Citation: IMF Staff Country Reports 2016, 376; 10.5089/9781475559675.002.A001

Authorities’ Views

12. The authorities’ broadly shared staff’s views on the outlook. They also saw growth accelerating only mildly in 2017, with the recovery in domestic demand being dampened by a loosening labor market but helped by a gradual improvement in private sentiment. On the positive side, they felt that the continuation of favorable financial conditions, a depreciated peso (relative to 2013), and lower energy costs all provided strong incentives for investment in tradable sectors. Faster regional growth alongside measures taken to facilitate service exports and competition in specific sectors should help exports. They also underscored that the absence of macroeconomic imbalances left Chile well placed to take advantage of improvements in the external environment. They viewed China’s growth sustainability and economic transformation as the main concern. Owing to largely anticipated U.S. monetary policy normalization, the authorities expected limited volatility and, on net, they saw improved growth prospects leading to an increase in capital flows to the Chilean economy.

13. The authorities did not see significant risks originating in the corporate sector. They noted that increases in foreign currency debt were mostly linked to past peso depreciation, but that financial expenditures were low, and currency mismatches limited. Central bank stress tests found corporate balance sheets were only mildly sensitive to exchange or interest rate shocks, and that a very large shock to GDP was needed for substantial stresses to emerge. The authorities also noted that NPLs were low despite several years of slow growth, although the real estate sector and SMEs posed pockets of vulnerabilities. With the external environment getting stronger, especially in the region, they saw the overall outlook for the corporate sector improving.

C. Medium-Term Challenges

14. Demand for more inclusive growth is growing. Large skill disparities in the labor market and duality between formal and informal sectors continue to sustain wage inequality. Job reallocation is hampered by transportation bottlenecks and limited effective retraining programs. Old-age poverty is high (18 percent of population compared to 12 percent for OECD average) and related to inadequate pensions. Population aging will further raise social demands in the coming years.

15. A secular decline in growth is difficult to reverse. GDP growth in Chile has more than halved over the past three decades from 6.8 percent on average in the golden 1990-94 lustrum to around 2 percent in recent years. The decline has been broad-based and affected all sectors of the economy.

16. Underlying reasons differ across sectors:3

  • Mining: disinvestment. The slowdown in the capital-intensive mining sector (10 percent of total potential GDP) is explained by flagging productivity due to declining quality of ore grade, as well as slower capital accumulation amidst low and uncertain copper prices in the long term.

  • Non-mining: a broader story. Potential growth—the maximum rate without creating excessive inflation or labor market imbalances—has deteriorated from 5 percent in 2011 to 2½ percent in 2015-16 according to new IMF estimates. About half of the decline can be attributed to weaker capital accumulation related to the persistence of the terms of trade shock. The other half comes from lower labor and TFP growth (about 20 and 30 percent of the total slowdown, respectively). Declining TFP growth is likely linked to the investment drought but also to infrastructure bottlenecks4 and low average skill levels. Population aging and a tapering off of past gains in female labor force participation are constraining labor supply growth.


Chile: Potential Growth

Citation: IMF Staff Country Reports 2016, 376; 10.5089/9781475559675.002.A001

Source: IMF staff calculations.

17. Projected trend growth is insufficient to narrow the income gap with advanced economies. Under the baseline, the cyclical pick-up in investment over the medium-term would lift growth contributions from capital and productivity, although ebbing labor force growth is limiting gains. Staff projects trend growth of 3¼ percent in 2021 in the non-mining sector (chart), and 2¾ percent for the economy as a whole. This trend growth rate—the rate when the economy is at full employment—is comparable to estimates in emerging economies with similar per capita income levels. However, at 2¾ percent it is not much higher than rates in advanced economy commodity exporters (e.g., Australia, Canada) which substantially higher per capita income levels. Hence at currently projected rates, Chile would catch up only very slowly to income levels of comparable developed economies.

Authorities’ Views

18. The authorities stressed the role of the reform agenda in tackling both inequality and low growth, all the while being cognizant of short-run trade-offs. They also saw trend growth as having declined but stressed that estimates were uncertain and, in particular, the recovery in productivity growth could be stronger than projected by staff. They also noted that the reform package was aimed at raising skills levels which should help with inequality, while old-age poverty needed to be tackled by expanding the social safety net.

D. External Balance

19. External adjustment has been facilitated by a flexible exchange rate (Figure 6). The current account deficit narrowed from 3.7 percent of GDP in 2013 to 2 percent in 2015, helped by significant peso depreciation (10 percent in real effective terms), marked contraction in investment-related capital imports, and strong imports substitution for intermediate inputs. Staff projects a current account deficit of 2.2 percent of GDP this year, as lagged effects from a weaker peso and low internal demand balance out soft copper exports. Over the medium term when internal demand recovers, the current account is expected to widen to around 2.5 percent of GDP.

Figure 6.
Figure 6.

Chile: External Stability

Citation: IMF Staff Country Reports 2016, 376; 10.5089/9781475559675.002.A001

Sources: Central Bank of Chile, Haver Analytics, Inc., and IMF staff calculations.1/ LA6 includes Brazil, Colombia, Mexico, Peru and Uruguay.2/ Assessing Reserve Adequacy, IMF.

Real Effective Exchange Rate

(Index, avg. 1996-2016=100)

Citation: IMF Staff Country Reports 2016, 376; 10.5089/9781475559675.002.A001

Source: IMF Information Notice System.1/ LA6 includes Brazil, Colombia, Mexico, Peru and Uruguay.

20. Chile’s external position is broadly in line with medium-term fundamentals. EBA-based estimates (Annex IV) suggest that the REER was moderately undervalued in 2016 (between 5 and 10 percent). But the IMF’s EBA model estimates do not take into account the effects of unusually low business sentiment related to the large-scale reform package, which has suppressed investment and imports. By implication, adjusting model estimates for this effect, Chile’s external position is broadly in line with medium-term fundamentals and desirable policies. Should confidence and investment remain structurally weak, Chile’s external position would be stronger than warranted by macro fundamentals.

Authorities’ Views

21. The authorities noted that the external position was market determined and that the peso appeared somewhat strong, given real fundamentals. The authorities explained that the currency depreciation over 2013-15 explained the resilience in non-mining tradables investment, as well as some of the expected pick-up in investment next year. However, they felt that economic rebalancing was slow to materialize and indicated that the exchange rate, heavily influenced by financial developments, appeared somewhat strong given weak external demand from the region and the slow growth in non-copper exports. They reiterated their commitment to free-capital-mobility and a flexible-exchange-rate framework.

Macroeconomic Policies

A. Fiscal Policy

22. For some time, the government has made use of fiscal space. Chile’s strong net worth position and credibility of the structural balance rule have allowed fiscal policy to counter the sharp growth slowdown.5 On average fiscal stimulus reached around ½ percent of potential GDP since 2013. The headline deficit is expected to widen to 3.1 percent of GDP in 2016 as expenditure increases related to the government’s reform program (education, infrastructure) have exceeded revenue gains from the 2014 enacted tax reform, partly as a result of a weak economy.


Government Budget Balance, Net Debt, and Sovereign Debt Premiums

Citation: IMF Staff Country Reports 2016, 376; 10.5089/9781475559675.002.A001

Sources: Central Bank of Chile, Ministry of Finance, and Bloomberg.

23. The 2017 budget has appropriately tilted the needle towards fiscal consolidation. The budget proposal is in line with the consolidation path announced last year of about ¼ percent per annum in structural terms although reaching fiscal balance has become more difficult given weaker growth.6 It aims to largely maintain pro-growth spending plans, in particular education and health care and to a lesser extent infrastructure, within a tight budget envelope. Permissible expenditure growth under the fiscal rule has more than halved relative to 2015 (staff estimates), reflecting downgraded long-term copper prices and trend growth (USD 2.56/lb and 3 percent, respectively, down from USD 2.98/lb and 3.6 percent in the 2016 budget). To limit the scaling back of pro-growth spending, a concerted effort should be made to identify and eliminate inefficiencies in public spending.

24. Fiscal consolidation needs to continue, but Chile can proceed slowly for now. Debt is projected to increase rapidly and reach 25 percent of GDP next year and to 30 percent by 2021. Government financial assets are sizeable at about 21 percent of GDP in 2016, of which more than 50 percent are highly liquid. The general government debt position is resilient to a series of macro and fiscal shocks in the medium term (see Annex IV). A gradual adjustment path over 2017—18 can be justified by the government’s positive net worth position; low financing costs; and the focus of the budget on building human capital and infrastructure. However, as growth recovers, and spending needs are addressed, a more ambitious fiscal consolidation path should be adopted. In the meanwhile, any new spending commitments should be part of a budget balance-neutral package. Expenditure programs should be evaluated for effectiveness and targeting improved including by linking free access to tertiary education to means-testing. To buttress fiscal credibility, the Advisory Fiscal Council could be given financial independence and its mandate broadened to assessing annual and medium-term fiscal targets.

Authorities’ Views

25. The authorities broadly concurred with staff. The authorities agreed that maintaining fiscal credibility was a priority and that addressing skill and infrastructure gaps requires a careful balancing act. With regard to the near-term, they reiterated their commitment to fiscal adjustment as a means to safeguard the credibility of the fiscal framework, while using fiscal space. For the medium-term, they saw merit in a comprehensive expenditure review, going beyond the regular program evaluation conducted under the 2017 budget. They also reinstated their intention to strengthen the independence and mandate of the Advisory Fiscal Council, though the legislative agenda is deemed crowded.

B. Pension Reform

26. Chile’s pension system is rooted in sound principles. Created in 1981, Chile’s pension system is based on individual savings accounts administered by privately-owned corporations (Administradoras de Fondos de Pensiones) and was complemented in 2008 by a publicly-funded solidarity pillar which provides minimum pensions. Over the last 30 years, the fully-funded defined-contribution system has raised national savings, helped develop capital markets, and reduced fiscal risks. The governance of the system is sound, pension investments are well protected, and supervision is effective.

27. The system is, however, not delivering adequate benefits for a large share of retirees. Chile’s average pension is below the minimum wage and estimated replacements rates are very low relative to the OECD average of 63 percent (text table), particularly for women. Low mandatory contribution rates of 10 percent and short contribution periods—largely reflecting discontinuous career paths—are the main reasons. In addition, contributions have not been adjusted to rising life expectancy and dependency ratios. Furthermore, the coverage of workers under the system is narrow (e.g., self-employment, informal labor), and the solidarity pillar does not provide adequate minimum pensions.

Chile: Median Replacement Rates

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Source: Comisión Bravo (2015).

28. The government outlined the broad contours of a pension reform. Drawing on recommendations of a 2015 commission report (Comisión Bravo), the government has announced plans to gradually increase contribution rates by 5 percentage points over 10 years; allocate the additional revenue in yet-to-be-determined shares to individual accounts and for solidarity related payments (improving pensions of current retirees); and reduce costs of the pension fund administration.

29. The reform should preserve the current system, but strengthen its delivery (Annex III). Adequate pensions can be achieved through a variety of policies including increases in contribution rates, retirement ages, expansion of mandatory coverage, and an augmented solidarity pillar. A reform package should give consideration to the following measures:

  • For future retirees, contribution rates for individual accounts should be raised alongside other measures. An increase of contribution rates to 15 percent would raise replacement rates close to OECD country averages. A gradual increase in the retirement age (currently at 65 years for men and 60 for women) would also similarly increase replacement rates, but given the projected rise in life expectancy by 5 years in 2050 are likely necessary regardless. Importantly, for women a gradual increase of the retirement age to 65 years should be strongly considered given discontinuous lifetime-employment and contributions. Contributions of self-employed should be made mandatory to cover a larger share of workers under the individual accounts.

  • For current retirees, pension and solidarity pillar benefits should be increased. Given fiscal constraints, any increases in benefits need to take future aging-related commitments into account. Specifically, growth and equity implications of different financing modalities should be studied carefully. For instance, IMF simulations suggest that a pension reform package funded by a mix of higher contributions and indirect taxes would carry lower growth costs than one funded exclusively by increased contribution rates (Annex III).

Overall, such a pension reform would lead to more stable life-time incomes for broader segments of the population and likely raise Chile’s savings. Over the near to medium-term, however, higher tax or contribution rates could generate growth costs. For these reasons, the economic effects of any reform need to be assessed carefully alongside its impact on current and future pensions.

Authorities’ Views

30. The authorities agreed with the key principles of staff’s recommendations, though noted that any reform needs to support the retired middle class in the short run. Both the authorities and staff agreed that any reform proposal needed to be carefully evaluated for its implications on current and future economic growth, for its long-term fiscal costs and risks, and for the implications on inter and intra-generational fairness. In doing so, any final proposal should then carefully weigh the tradeoffs between efficiency, incentives, inequality, and fiscal considerations.

C. Monetary Policy

31. Central bank policy has become more accommodative this year. After remaining above the 2-4 percent target band for over two years, inflation has slowed since the beginning of this year. In parallel, the policy rate has remained unchanged at 3½ percent and the central bank has softened its policy guidance in successive policy meetings, dropping its tightening bias in August.7 In recent months, inflation has decelerated more rapidly than expected, from 4 percent in July to 3.1 percent in September. Although largely the result of a stronger peso since earlier this year,8 the risk of disinflation spreading to the non-tradable sector has risen given weak economic activity.

32. The central bank should cut rates if disinflation pressures become broad based and persistent, and if the growth slowdown intensifies in coming months. The expected widening of the output gap and slowing wage growth have raised the risk that inflation could undershoot the target for some time. The decision whether to ease now or wait for further evidence needs to weigh the benefits from safeguarding against the risks of a decline in inflation expectations, versus the costs of prematurely reacting to temporary factors. Balancing these considerations, staff agrees with the central bank’s recent adjustments to its forward guidance, its decision to keep rates for now, and to remain data dependent.


Distribution of Inflation Expectations at 24 Months

(In percent of respondents, surveys 2015M1-2016M10)

Citation: IMF Staff Country Reports 2016, 376; 10.5089/9781475559675.002.A001

Sources: Central Bank of Chile and IMF staff calculations.

Authorities’ Views

33. The central bank shared staff’s assessment. The authorities stressed that monetary policy had become more accommodative this year in response to the slowdown in activity and a more subdued inflation outlook. They saw the recent disinflation as broadly in line with the central bank’s baseline forecast, but noted that the pace has been somewhat faster than expected. Going forward, the authorities concurred that policy should remain data dependent.

D. Macro Policy Mix

34. The current policy mix is broadly adequate. Permanently lower copper revenue and trend growth suggest that fiscal policy needs to adjust, albeit moderately. Given dampened potential growth, fiscal policy needs to remain geared toward growth-enhancing education and infrastructure spending. Although inflation expectations are stable, monetary authorities should be prepared to ease. Enhanced financial sector supervision and broadly unchanged macro-prudential stance can contain feedback effects from rising credit costs and financial tightening, all the while mitigating pro-cyclicality.

35. In a downside scenario, monetary policy should be the first line of defense. If external conditions weaken, more accommodation is warranted as disinflationary pressures are likely to accelerate because of a further widening output gap and continued fiscal consolidation. However, given long transmission lags, the impulse on demand may be small. Hence, in case of a severe slowdown, fiscal tightening should be paused and the attainment of a structural balanced budget goal further delayed, while tilting spending to pro-growth infrastructure and education programs.

36. The authorities broadly agreed with this assessment. The central bank noted that its reaction to downside risks would be guided by the type of the risk materializing and its impact on the inflation forecast.

Upgrading Growth and Securing Stability

37. Subdued trend growth, high inequality, and risks to stability are intersecting policy challenges. Infrastructure bottlenecks and demographic trends are slowing investment, productivity growth, and labor force participation. Income inequality is high—the post-tax-and-transfers Gini index is 15 percentage points above the OECD average— as a result of large wealth inequality and a substantial skill divide. Finally, the financial sector has been stable, but high corporate leverage, substantial foreign currency debt and exposure to the region, and a slowdown in the real estate sector are vulnerabilities.

A. Growth Reforms

38. Structural reforms adopted since 2014 are setting the stage for stronger growth. Bottlenecks in the electricity sector have lessened, costs for attending secondary and tertiary education are declining, and 50,000 additional childcare facilities have been created. Staff assesses these and other measures undertaken since 2014 to be growth positive over the medium term (Santoro, 2015, op. cit.), although transitional costs, in particular from frontloaded tax increases, are inevitable and should be managed carefully. Complementing these efforts, new competition and productivity laws passed in 2016 are good enhancement of the business environment.

Chile: Structural Reform Agenda

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39. There is scope to strengthen the effectiveness of the reform agenda:

  • The creation of a new Infrastructure Fund (IF)—geared to attract private capital—should be fast-tracked. Chile has a successful record of collaborating with the private sector in developing and managing transportation projects via Private-Public-Partnerships (PPPs). The scope of the IF should be narrowed to infrastructure projects suitable for PPPs and additional safeguards should be adopted to strengthen proposed governance provisions and to limit fiscal risks from contingent liabilities.

  • Workers’ skills should be enhanced further to strengthen labor supply. Labor force participation has risen in the past, but its growth rate is slowing owing to population aging. Moreover, labor productivity is substantially below the average in OECD countries. More targeted professional and vocational training is essential to raise effective (skill-weighted) labor supply. Efforts should be directed to fostering linkages between industries and education institutions and by enhancing incentives for on-the-job training especially at SMEs and apprenticeship programs.


    Labor Force Participation

    (In percent)

    Citation: IMF Staff Country Reports 2016, 376; 10.5089/9781475559675.002.A001

    Source: International Labor Organization.

  • The ability of productive firms to grow should be strengthened further. New competition and productivity laws are easing the financing of productive investments, supporting service exports, and cutting red tape. Further efforts are needed to help SMEs grow. Programs to improve business management skills and record keeping should be expanded. At 0.4 percent of GDP, Chile has also one of the lowest R&D spending rates in the OECD (2 percent of GDP on average). The government has put forward a number of initiatives to boost innovation: seed money to start ups (“Start-up Chile”), SME-specific credit lines (CORFO), loan guarantees for innovative investments (“Cobertura pro-inversión”), and a registry of firms’ mobile assets. To further enhance technology development, regulatory requirements for accessing capital markets could be tailored to different firm sizes to help medium-sized firms tap domestic capital.

Chile: Selected Innovation Indicators

(percentile rank; higher means better score)

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Sources: World Economic Forum (WEF), Global Competitiveness Rankings

Mean. LA6 includes Brazil, Chile, Colombia, Mexico, Peru and Uruguay.

40. Legal uncertainties related to the new labor bill need to be addressed. A new labor law coming into force next year is redefining collective bargaining. It mandates full disclosure of firms’ balance sheets ahead of wage negotiations and defines conditions for exercising the right to strike, which taken together lay the basis for well-structured discussions between workers and employers around the bargaining table. However, legal ambiguities about key elements, including the definition of minimum services that need to be provided during strikes, the possibility to extend benefits to those workers not participating in the negotiations, and the status of the negotiating groups following a Constitutional Court ruling have created broad-based uncertainties. To avoid multi-year judicial processes to settle disputes and limit implementation costs, not least given the visible deterioration of the labor market, ambiguities need to be removed swiftly in an effort to balance efficiency with equity considerations.

Authorities’ Views

41. The authorities considered continued progress on structural reforms to be of high importance. They noted that the reforms were already lifting bottlenecks in the electricity sector. But given the economic environment they needed to proceed gradually, remain flexible to address emerging needs, while devising eclectic solutions to reach consensus amongst stakeholders, with the pensions reform being cited as an example. They recognized that the new labor bill had not lived up to expectations, but thought that uncertainties would largely resolve upon implementation. In their view, the new framework puts a premium on improved social dialogue and the ability of social partners to overcome the challenge. The authorities shared the staff’s diagnosis that trend potential growth has declined, and that firms’ ability to grow needed to be strengthened. They emphasized the importance of productivity-enhancing measures, with the Agenda on Productivity, Innovation and Growth launched in 2014 being followed by the 2016 package. They remain committed to complete the education reform.

B. Financial and Corporate Sector Stability

42. Financial sector balance sheets are healthy, but risks to financial stability bear close monitoring (Figure 7). Banks’ earnings slowed in 2016 as a result of low economic activity. However, non-performing loans remained low at about 2 percent of total loans and capital buffers are well above the current regulatory requirements built on Basel I principles (text chart). Life insurance companies and pension funds—with assets exceeding 90 percent of GDP in 2015—continue to be pressured by the low-yield environment and have kept on shifting their portfolios towards higher yield but potentially riskier or less liquid assets. Weaker-than-expected growth could strain the solvency of highly leveraged firms and less resilient SMEs, with potential for amplification via strong inter-sectoral balance sheet linkages. Recent stress tests conducted by the central bank find that the average banks’ CAR would decline by 2 percentage points from a 13 percent of risk-weighted assets at end 2015.9 Staff’s stress test based on accelerated corporate defaults find a similar decline (Annex II.B). These vulnerabilities call for a continued strengthening of financial sector regulation and supervision.

Figure 7.
Figure 7.

Chile: Financial Sector

Citation: IMF Staff Country Reports 2016, 376; 10.5089/9781475559675.002.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.1/ Includes Argentina, Brazil, Colombia, Mexico, Peru and Uruguay.2/ Simple average of monthly returns across fund types for 2016H1.

43. Prudential policies appropriately aim at credit risk. Provisioning for commercial loans appears adequate. For mortgages, provisions were recently raised for delinquent loans and loans with high LTV ratios. Given the slowing credit growth and neutral financial conditions, no further tightening of macro-prudential policies is currently warranted.


Chile: Selected Banking Indicators

Citation: IMF Staff Country Reports 2016, 376; 10.5089/9781475559675.002.A001

Sources: Haver Analytics; IMF, Financial Soundness Indicators database; national authorities; and IMF staff calculations.

44. A proposed new General Banking Law (GBL) aims to bolster resilience. The proposal would close the gap with Basel III minimum solvency requirements, provide new resolution and financial stabilization tools to the regulator, and improve the governance of the supervisory agency (SBIF).


Regulatory Tier 1 Capital

(In percent of risk-weighted assets)

Citation: IMF Staff Country Reports 2016, 376; 10.5089/9781475559675.002.A001

Sources: Haver Analytics; IMF, Financial Soundness Indicators database; and national authorities.
  • New minimum solvency requirements. The law aligns the definition of regulatory capital with international standards. Banks have six years to increase the minimum total solvency requirement to 10.5 percent from 8 percent of RWA. The draft law mandates a capital surcharge of up to 3.5 percent of RWA for systemically important domestic banks.

  • New bank resolution tools. The draft law gives SBIF greater powers to regulate, transfer, or liquidate troubled banks. At an early normalization stage, the SBIF is granted the power to intervene in order to restore the troubled banks’ condition. If problems persist, a prior-to-liquidation bank resolution stage will implement asset separation (good bank/bad bank resolution tool) and allow for certain degrees of bail-in. The current creditor preference would remain unchanged and the existing central bank guarantee on current accounts and deposits would be maintained.10

  • Supervisory governance structure. Details of the banking supervisor’s governance structure reform are yet to be finalized but could lead to a possible integration under the recently proposed Financial Markets Commission (FMC), which includes for now the insurance and capital markets supervisor (SVS). In time, the FMC is expected to incorporate the SBIF and the SP.

45. The creation of the Financial Markets Commission (FMC) is an opportunity to upgrade the governance of financial supervisors. Guaranteeing the operational independence of such a body should be a priority. Governance reform should also ensure a selection and appointment process in line with Basel Core Principles of Effective Banking Supervision and international best practices. Similarly, rules on post-employment restrictions and legal protection for staff involved in sanction processes should follow international best practices.

46. Proposed amendments to the GBL would bolster resilience but its adoption is at risk of falling behind schedule. The revised GBL would greatly contribute to enhance the credibility of Chile’s financial sector, to strengthen its resilience against domestic and external shocks, and to more efficient supervision. Adjusting to the new capital requirements appears manageable for the system as a whole. In the case of Banco Estado, the government-owned bank and main provider of loans to SME, staff recommends a capital injection to address an estimated capital shortfall of $US1.4 billion, as well as an upgrade of its corporate governance, a review of operational risks, and measures to increase efficiency. A delay in the adoption of the new GBL implies that Chile would fall behind in the adoption of international standards and best practices—which could create uncertainty.

47. Better coordination and information sharing among financial sector supervisors and the central bank is key. The proposed creation of the FMC is an important step towards an integrated view of financial sector supervision that may allow a more effective oversight of financial conglomerates (including monitoring conglomerates’ compliance with limits on risk exposure and designing a tailored crisis management framework). Chile’s conglomerates are a potential source of financial fragility as they are large (consolidated assets likely exceeding 125 percent of GDP), complex, and relatively opaque. However, the implementation of the FMC should not delay the adoption of other longstanding, important reforms (that is, Basel III and risk-based supervision of insurers)11 and should be used as an opportunity to broaden the scope of supervision to shadow banking activities (for instance, factoring companies and cajas de compensación).

48. There is scope to improve corporate governance and investor protection (Box 4). Chilean companies are, on average, relatively opaque, ownership of large conglomerates is concentrated, and levels of compliance with best practices in corporate governance are low. Given their important role in Chile’s financial system, institutional investors, such as pension fund administrators, can encourage Chilean businesses to improve corporate governance (Brandao-Marques 2016). For instance, institutional investors could give preference to investments in companies with high governance standards and protection of minority shareholder interests. These standards could be enshrined in a new governance code (also known as Stewardship Codes) which firms could subscribe to on a voluntary basis. Such codes have been successfully introduced in the UK and Japan.


Closely Held Shares

(Percent of outstanding shares; market value weighted averages)

Citation: IMF Staff Country Reports 2016, 376; 10.5089/9781475559675.002.A001

Sources: OECD Corporate Governance Factbook, Thomson Reuters Datastream, and IMF staff calculations.

Authorities’ Views

49. The authorities are intent to move ahead with the financial sector policy agenda.

They see passing of the new GBL and creating the FMC as an important step towards a more integrated approach to financial sector supervision and to more coordination among supervisors. In addition, the FMC constitutes an opportunity to improve the regulation and supervision of certain parts of the shadow banking sector and to strengthen the supervision of financial conglomerates. However, the authorities noted there were risks that a lengthy discussion in Congress of the GBL could further postpone the adoption of Basel III solvency requirements for banks. They noted, however, that banks were already meeting liquidity requirements and that capital buffers were strong and would not require substantial upgrading to meet the new standards.

Staff Appraisal

50. Chile is facing a challenging macroeconomic outlook. Growth prospects are dampened by waning tailwinds from slower growth in trading partners and a decline in trend growth. High income inequality amid ageing population are raising the urgency to address social needs, especially from low old-age pensions. An ambitious reform package aims to address these challenges, but it will take time for results to become tangible.

51. Despite these challenges, Chile has grown faster than others in the region. Since 2014, growth averaged 2 percent, substantially below rates of 4 percent a few years ago, but well above the Latin-American six largest countries average. This owes to a credible and effective fiscal and monetary framework, a modern and stable financial system, and a flexible exchange rate.

52. The policy mix remains moderately supportive of activity. The freely floating exchange rate is helping with economic rebalancing following the large terms-of-trade shock. Monetary policy is appropriately accommodative. If disinflationary pressures broaden and become more persistent, interest rates should be lowered. Fiscal policy is appropriately shifting towards consolidation given the sizable structural deficit. Chile can, however, proceed slowly with consolidation in the near term given its strong public net-asset position. The role of the Advisory Fiscal Council could be strengthened to buttress policy credibility.

53. Chile’s pension system is rooted in sound principles, but low coverage, insufficient lifetime savings, and low minimum pension need to be addressed. Any pension reform should preserve the current system, but strengthen its delivery for current and future generations by expanding the public solidarity pillar and raising contribution rates for the contributory pillar. The mandatory retirement age should be adjusted in line with rising life-expectancy.

54. Structural reforms adopted since 2014 are setting the stage for stronger growth. The

closing of Chile’s infrastructure gap could be facilitated by the creation of a new Infrastructure Fund geared at attracting private capital. Workers’ skills should be enhanced further through improved and more specialized education and training programs. Legal uncertainties related to the new labor bill should be tackled. Cutting red tape and improved access to capital by small- and medium-sized companies could help dynamic firms to grow faster and enhance productivity.

55. The financial sector is healthy, but risks to financial stability bear close monitoring and regulatory reforms should be adopted swiftly. Credit risks have risen as a result of slow growth, but non-performing loans have so far remained low. Financial sector supervision is sound, but the regulatory framework risks falling behind international standards. Adoption of Basel III capital requirements and risk-based supervision of the insurance sector should be a priority. Improving coordination and information sharing among financial sector supervisors and the central bank remains important. Finally, there is scope to strengthen corporate governance and investor protection.

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


Risk Assessment Matrix

Citation: IMF Staff Country Reports 2016, 376; 10.5089/9781475559675.002.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. The RAM reflects staff views on the source of risks and overall level of concern as of the time of discussions with the authorities. Non-mutually exclusive risks may interact and materialize jointly

Spillovers from China’s Economic Rebalancing

Slower and less investment-driven growth in China is putting downward pressure on commodity prices. Evidence from a structural VAR and regression analyses find that shocks to China’s industrial production have large effects on commodity prices. Particularly, the impact on copper prices is large, given China’s dominant global role as a copper importer (Kolerus, N’Diaye and Saborowski, 2016).

Given Chile’s strong trade linkages, China’s rebalancing has a sizable impact on exports growth. Using a multi-country panel VAR, staff estimates that a 1 percentage point decline in China’s final demand lowers average export growth by around 0.5 percentage points over the course of a year (Blagrave and Vesperoni, 2016). The size of the impact is smaller than that in Australia, but larger than in most Latin American economies.


Futures-Price Response to China Industrial-Production News Surprise

Citation: IMF Staff Country Reports 2016, 376; 10.5089/9781475559675.002.A001

Source: Kolerus, N’Diaye, and Saborowski 2016.Note: 1-std = one standard deviation.

Impact on Average Export Growth Rate (over 1 year) of a 1 Percentage Point Shock to China Demand

(In percent)

Citation: IMF Staff Country Reports 2016, 376; 10.5089/9781475559675.002.A001

Source: IMF staff calculations.

The Impact of Financial Shocks on Economic Activity

In Chile, tighter financial conditions have a sizable impact on real economic activity. Using a newly developed Financial Conditions Index (FCI) for Chile, a VAR analysis finds that a 1 standard deviation tightening of financial conditions lowers GDP growth by about 0.3 percentage points within one year. Estimates are robust to different specifications and estimates and exclude the effects of monetary policy and exchange rate changes which are controlled for separately (Annex I).1

The growth impact of financial shocks in Chile varies with global financial conditions. In 2010, a period of relatively adverse external conditions, the effect of financial tightening on economic activity was three times as high as in 2016. An important channel of transmission is the deterioration of the balance sheets of non-financial corporations. Empirical analysis shows that an adverse shock to the FCI is associated with a more than doubling of expected default rates of moderately risky firms within one year.

1 Granger causality tests finds that FCI granger-causes output but not vice-versa.

Corporate Stress Tests and Shock Amplification

Rising credit risks could have substantial economic implications via macro-financial linkages. Using corporate default data for listed companies and a Bottom-up Default Analysis (BuDA) tool developed by Duan, Sun, and Wang (2015) staff estimates firm-level probability of defaults as a function of macroeconomic conditions, firm-specific balance sheet information, and market-based factors (Annex II.B). Staff then estimates increases in corporate default rates and implied capital costs to the banking system using a variety of severe stress scenarios.


Probabilities of Default: Regional Shock

(Basis points)

Citation: IMF Staff Country Reports 2016, 376; 10.5089/9781475559675.002.A001

Sources: IMF staff estimates based on BuDA and Moody’s rating grades.
  • Corporate stress tests show elevated risks to a severe external shock (Annex II.B). Under a scenario where Chile’s Latin American partners fall into a deep recession, risk of default among large Chilean corporations with significant exposures to the region could double (albeit from a very low base).

  • Banks can absorb associated credit costs, although financial tightening could be substantial. Staff estimates that the necessary increase in provisions could amount to 1 percent of assets (80 percent of annual profits). Due to substantial holdings of corporate debt, balance sheets of life insurers could also weaken, further exacerbating financial conditions under a stress event. The associated tightening of financial conditions would weigh on activity.


    Stocks under Fire Sale


    Citation: IMF Staff Country Reports 2016, 376; 10.5089/9781475559675.002.A001

    Sources: SVS; IMF staff calculations. Note: The chart shows the percentage of stocks owned by Chilean mutual funds that are experiencing a fire sale according to Coval and Stafford’s (2007) definitition.

  • The potential for shock amplification bears watching (Annex II.C). An adverse shock could be amplified given strong financial linkages between sectors. For instance, a simultaneous increase in mortgage defaults or accelerated redemptions from mutual funds— observed during the global financial crisis or the 2013 taper tantrum—could transmit to asset prices through credit losses or fire sales, respectively.1 Banks’ funding could also be sensitive to confidence-induced fluctuations in wholesale deposits, particularly in institutional and corporate deposits which represent about 30 percent of total funding. An additional illustration of the intensity of inter-sectoral linkages can be gained by tracing out the effects of a hypothetical impairment of sector capital. Linkages are the strongest between non-financial corporates, households and institutional investors (OFC), and the banking sector. There are also substantial linkages between households and insurance companies through their role in originating mortgages.

Capital Impairment of Sector (column) Resulting from 10 Percent Default by Corresponding Sector (row)

(Percent of pre-shock capital)

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1 The Coval and Stafford (2007) measure of fire sales shows the percentage of firms in each month falling under that 10th percentile of a price-pressure measure for the entire sample (January 2013 through June 2016). The price-pressure measure for each stock is the difference between the sales of a stock by the mutual funds in the top decile of outflows and the purchases of the same stock by the mutual funds in the top decile of inflows.

Policies to Enhance Corporate Governance

Chile has high-quality institutions, but compares less favorably in terms of corporate governance and corporate transparency. Chile has the highest quality of the rule of law among emerging markets. However, its largest corporations, on average, display low corporate governance scores, especially in terms of transparency and executive compensation practices (Figure 4.1). The discrepancy between the high quality of institutions and the level of corporate governance and transparency can be explained, in part, by the highly concentrated ownership of its firms and the prevalence of conglomerates (OECD, 2015a and 2015b).


The Quality of Corporate Governance in Chile

Citation: IMF Staff Country Reports 2016, 376; 10.5089/9781475559675.002.A001

Sources: IMF; Thomson Reuters Datastream (Asset4).

International experience shows that equity ownership by institutional investors, such as mutual funds, insurance companies, and pension funds is typically associated with better firm governance. Studies using data from U.S. companies have found that higher institutional ownership tend to improve firm governance (Crane, Michenaud, and Weston, 2016). In addition, the engagement of institutional investors with firm governance seems stronger when they are large blockholders with a long investment horizon (MCahery, Sautner, and Starks, 2016 forthcoming).

In Chile, where institutional investors are important minority shareholders, the introduction of a voluntary stewardship codes could be a powerful tool to promote good corporate governance among investee companies. The goal of such codes is to ensure that institutional investors are effectively engaged in the promotion of long-term success of the companies they own. Stewardship codes typically are voluntary and use a “principle-based” approach to increase disclosure and encourage monitoring by institutional investors, including asset managers, insurance companies, and pension funds. The first country to adopt a stewardship was the United Kingdom, in 2010. In Japan, a similar Code was adopted in 2014 and led to a broad-based uptake among institutional investors, investment managers, and pension and insurance funds.

Incentivized governance codes could also be used to enhance transparency in Chile’s non-financial sector. Governance codes for listed non-financial corporates have been a successful in strengthening corporate transparency and accountability in the UK. As of 2014, over 90 percent of firms in the FTSE 350 index are compliant with the governance code. Adoption in Chile could be incentivized by linking its subscription to the inclusion of a listed company in key equity market indices.

Figure 5.
Figure 5.

Chile: Public Finances

Citation: IMF Staff Country Reports 2016, 376; 10.5089/9781475559675.002.A001

Sources: Ministry of Finance, Central Bank of Chile, and IMF 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.
Figure 8.
Figure 8.

Chile: Housing Market Developments

Citation: IMF Staff Country Reports 2016, 376; 10.5089/9781475559675.002.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, EM Europe, and Mexico are 2014.
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 and projections.

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


In percent of potential GDP. Based on staff’s output gap estimates and WEO copper prices.

Table 3.

Chile: Balance of Payments

(In millions of USD, unless otherwise stated)

article image
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.
Table 5.

Chile: Medium-Term Macroeconomic Framework

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

Contribution to growth.


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