Public Information Notice: IMF Concludes Article IV Consultation with Chile

August 9, 2000

Public Information Notices (PINs) form part of the IMF's efforts to promote transparency of the IMF's views and analysis of economic developments and policies. With the consent of the country (or countries) concerned, PINs are issued after Executive Board discussions of Article IV consultations with member countries, of its surveillance of developments at the regional level, of post-program monitoring, and of ex post assessments of member countries with longer-term program engagements. PINs are also issued after Executive Board discussions of general policy matters, unless otherwise decided by the Executive Board in a particular case.

On July 7, 2000, the Executive Board concluded the Article IV consultation with Chile.1


Chile’s overall economic performance during 1990–97 was very strong. Real GDP grew at an annual average rate of 7.7 percent, inflation declined gradually from 26 percent to 6 percent, and social indicators improved significantly. This performance was based on important structural reforms, strong banking supervision, an open trade regime, and prudent macroeconomic policies. During this period, the authorities targeted a declining year-end inflation rate, adjusted short-term interest rates to achieve that objective, and maintained strong public sector finances; they also managed the exchange rate within a sliding band and administered a set of controls on capital flows.

By early 1998, Chile faced the difficult combination of a widening external current account deficit and a slowdown of capital inflows. The authorities scaled back expenditure plans, and tightened monetary policy strongly to prevent a large depreciation of the currency. In the event domestic demand fell sharply and the current account deficit started to narrow. However, from late 1998 through most of 1999, Chile experienced declining output and rising unemployment.

In 1999, as the size of the drop in demand became apparent, the authorities responded with expansionary monetary and fiscal policies. These policies, helped by an improving external environment, succeeded in initiating a recovery of output and employment in the latter part of the year. For 1999 as a whole, however, real GDP declined by about 1 percent, and inflation dropped to 2.3 percent by year-end. The current account deficit shrank from 5.7 percent of GDP in 1998 to near-zero in 1999, reflecting cyclically weak domestic demand, but also supported by a real depreciation of the currency and strong export volume growth. With moderate net capital outflows and some negative valuation effects, the stock of international reserves declined by about 8 percent during the year, but at end-1999 still remained at a comfortable level of more than three times the estimated level of short-term debt on a residual maturity basis (excluding trade credits).

The economic recovery that began in late 1999 is by now well-established. In the first quarter of 2000, real GDP was up 5½ percent from the same quarter of 1999, and unemployment continued to ease gradually. Accordingly, the authorities began to firm both monetary and fiscal policies with respect to the expansionary stance of 1999. For 2000 real GDP is expected to grow by 6 percent, inflation would be around 4 percent at year’s end, and the external current account deficit would widen moderately.

Since mid-1999 the authorities have launched a set of major policy initiatives. Regarding the monetary policy regime, they abandoned the exchange rate band in favor of a transparently-conducted float and enhanced their approach to inflation targeting by establishing a continuous inflation target band of 2–4 percent (starting in 2001) and by taking steps to increase the transparency of monetary policy. They also introduced a number of measures to further liberalize the capital account, including the abolition of the one-year minimum stay requirement. On the side of fiscal policy, the new government has expressed its commitment to further strengthen the fiscal position over the medium term, with future fiscal objectives to be set in terms of a measure of structural fiscal balance that excludes the fiscal effect of fluctuations in output and copper prices that are perceived to be temporary.

Proposals for a number of other significant policy steps have been submitted to Congress. These include a revision of the mechanism for administering fuel prices to prevent persistent subsidies; regulations on corporate governance to protect minority shareholders; regulations on bank concentration aimed at limiting the risk of moral hazard and the possibility of market control by a single bank, and a new system of unemployment protection. The authorities are also working on other labor market reform proposals.

In 1999 the new trade safeguards law was applied to a number of agricultural products, allowing the import tariffs generated by a price-stabilization scheme to exceed Chile’s WTO-agreed maximum tariff. However, Chile maintains a very open trade regime in general and continues to unilaterally implement a phased reduction of its general external tariff rate.

Executive Board Assessment

Executive Directors praised Chile’s long record of sound economic policies, which in the 1990s had resulted in high economic growth and a gradual decline in inflation. Directors noted that the deterioration in the external environment and surging domestic demand in 1998 had created new challenges and prompted a sharp tightening of monetary policy and a scaling back of public expenditure plans, resulting in a downturn in economic activity in 1999. Directors considered that the shift to a more accommodating monetary and fiscal stance in 1999 had been appropriate, as it had succeeded in reversing the recessionary trend relatively quickly, leading to a recovery that was now on track.

Directors saw the authorities’ move early this year toward a more neutral macroeconomic policy stance as still consistent with strong output growth, low inflation, and a moderate widening of the external current account deficit this year.

Directors welcomed the new three-pillar framework for policies consisting of conservative, rules-based fiscal and monetary policies, greater emphasis on sound supervisory and regulatory frameworks, as well as new social policies. They considered that this framework would provide a solid foundation for a durable continuation of Chile’s impressive overall record of economic performance.

Directors welcomed the authorities’ decision to enhance their inflation targeting framework by shifting the focus from a specific year-end inflation level to a continuous inflation band starting next year, and by taking steps to increase transparency in the formulation and implementation of monetary policy. They considered that this new approach would add to the credibility of monetary policy and help the country maintain its low and stable inflation. In this regard, a few Directors considered that early progress in recapitalizing the central bank would help consolidate credibility in its operational independence, and that the time was appropriate to do so, given the low level of government debt and the improving economic situation. Several Directors felt that current demand conditions did not provide clear evidence to justify an increase in interest rates at present, while several other Directors considered a further increase in interest rates to be appropriate, particularly with a view to strengthening the credibility of the new inflation band.

Directors welcomed the authorities’ intentions to further strengthen the fiscal position beyond this year, although a few regarded the structural fiscal surplus envisaged as slightly ambitious. Directors also supported the idea of formulating fiscal policy on the basis of a measure of structural fiscal balance that would exclude the effects of transitory fluctuations in output and copper prices. They also considered that a comprehensive definition of the public sector balance, including central bank losses, would be appropriate, although some questioned the merits of this approach, citing the instability of such losses over the business cycle.

Directors supported the authorities’ decision to float the peso, as the added flexibility would help the country deal with external shocks while allowing monetary policy to remain focused on achieving the inflation target. Several Directors commended the authorities on the smoothness and appropriate timing of the exit from the sliding exchange rate band. They also supported the proposed new regulations on corporate governance and the recent measures to liberalize capital flows, citing Chile as exemplifying an effective and well-sequenced approach to the use of capital controls and their eventual replacement by prudential controls.

Available indicators suggest that the banking system remains strong, and Directors encouraged the authorities to continue to implement strict supervision practices and to advance in the introduction of supervision of consolidated balance sheets of financial holdings. Directors also stressed the need to implement the proposed regulations on bank concentration cautiously, with the focus kept on limiting moral hazard and avoiding monopolistic behavior on the part of banks.

Directors praised the continued unilateral reduction of Chile’s uniform external tariff and highlighted the strong contribution to economic performance of the country’s very open trade regime. Several Directors noted that the price band scheme currently implemented on the basis of a new law on safeguards had resulted in high tariffs on a few agricultural products, and they urged the authorities to reconsider the price band scheme because of its possible distortionary effects. Several other Directors, however, pointed out that these measures were intended to be temporary and in line with WTO rules, and should be seen against Chile’s overall strong record of openness and the planned tariff reductions going forward.

Directors welcomed the authorities’ intention to improve the system of unemployment protection, but suggested caution in its application because of the potential increase in indirect labor costs. Directors also recommended that the package of other labor reforms be crafted in a way that preserves the flexibility of Chile’s labor markets.

In discussing the indicators of external vulnerability presented by the staff, some Directors observed that, in general, assets held abroad, and not just external liabilities, should be considered in assessing a country’s susceptibility to adverse external conditions. This was particularly relevant in the Chilean case because of the country’s large holdings of external financial assets. On this point, a number of other Directors suggested that, at times of financial turmoil, balances held abroad could not necessarily be counted on to meet external obligations.

Directors considered that the medium-term outlook for the economy was favorable, on the basis of the continued implementation of prudent monetary and fiscal policies, and of further advances with structural measures, including unilateral tariff reduction, capital account liberalization, privatization, and educational reform. They thought that Chile’s comfortable level of international reserves, strong banking system, and increased exchange rate flexibility would provide a good buffer against external risks.

Chile regularly provides the staff with timely data that are broadly adequate for surveillance purposes. Directors welcomed the authorities’ progress in clarifying the differences between official and BIS data on Chile’s short-term external debt, and encouraged them to continue improving Chile’s statistical base, especially in the fiscal and external areas.

Chile: Selected Economic Indicators

    1995 1996 1997 1998 Est.

  Real economy (annual percentage change) 1/            
Real GDP growth 10.6 7.4 7.4 3.4 -1.1 6.0
Unemployment (in percent) 7.4 6.5 6.1 6.2 9.7 ...
Change in consumer prices (end of period) 8.2 6.6 6.0 4.7 2.3 4.0
Money and credit (year-end percentage change) 1/            
Broad money (M3) 27.4 22.0 13.0 8.5 5.2 13.3
Bank credit to the private sector 27.5 20.8 18.0 11.2 3.0 10.7
Three-month real interest rate 2/ 6.1 7.3 6.8 9.6 6.0 ...
External sector (in percent of GDP) 1/            
Trade balance 2.1 -1.6 -2.1 -3.5 2.5 0.8
Current account balance -2.1 -5.1 -5.0 -5.7 -0.1 -2.4
Capital account balance 3/ 3.7 6.8 9.2 2.9 -0.9 3.1
Overall balance of payments 1.6 1.7 4.3 -2.8 -1.0 0.7
Gross official reserves (in percent of short-term
external debt 4/
286.2 347.6 496.4 403.7 376.9 215.1
External debt 5/ 33.3 33.5 35.6 43.6 50.4 50.6
Real effective exchange rate (in percent change) 6/ 1.2 4.0 9.7 -6.1 -6.3 ...
Terms of trade (annual percentage change) 14.5 -15.5 2.6 -12.6 0.9 5.8
Copper price (U.S. cents per pound) 133.2 103.2 103.2 75.0 71.3 81.0
Public finances (in percent of GDP)            
Combined public sector balance 3.0 1.4 -0.1 -2.3 -3.6 -2.1
Central government balance 3.6 2.6 2.1 -0.1 -2.4 -1.0
Public enterprise balance 0.0 -0.5 -1.1 -1.1 -0.1 -0.3
Central bank balance -0.6 -0.7 -1.1 -1.1 -1.1 -0.8
Memorandum item:            
Central government balance (official presentation) 7/ 2.6 2.3 2.0 0.4 -1.5 -0.1

Sources: Central Bank of Chile; and IMF staff estimates.

1/ Unless otherwise indicated.
2/ Yield on 90-day indexed central bank paper, in percent per annum (period average).
3/ Including errors and omissions.
4/ Based on the official figures on short-term debt (which include amortization of medium- and long-term debt falling due during the following year). These figures exclude trade credits.
5/ Figures do not include short-term trade credits.
6/ End of period, as reported by the IMF’s Information Notice System. A decline indicates a depreciation of the Chilean peso.
7/ The staff’s presentation differs from the official presentation in the treatment of the operations of the Copper Stabilization Fund and the capital gains from privatizations.

1 Under Article IV of the IMF’s Articles of Agreement, the IMF holds bilateral discussions with members, usually every year. A staff team visits the country, collects economic and financial information, and discusses with officials the country’s economic developments and policies. On return to headquarters, the staff prepares a report, which forms the basis for discussion by the Executive Board. At the conclusion of the discussion, the Managing Director, as Chairman of the Board, summarizes the views of Executive Directors, and this summary is transmitted to the country’s authorities. In this PIN, the main features of the Board’s discussion are described.


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