Transcript of a Conference Call on Chile Arcicle IV Consultation

July 30, 2008

Washington, D.C., Wednesday, July 23, 2008

MR. ADRIANO: Good morning. This is Andreas Adriano with the IMF Media Relations. Thank you for joining us today for this conference call on Chile's Article IV consultation.

We have here today Martin Mühleisen, He's the Chief of the Pacific Division of the IMF of the Western Hemisphere Department and also Mission Chief for Chile. He will make some opening remarks, and then we will turn to your questions.

MR. MÜHLEISEN: Thank you very much. Let me start with a few opening remarks.

Chile has obviously faced a very difficult economic environment over the past year. Global food and energy prices have increased sharply. Global financial markets fell into turmoil, and the IMF's World Economic Update just cautioned about lower global growth. On top of these developments, Chile had to cope also with shortages of natural gas and a severe drought which has pushed up local food prices and limited the capacity for hydroelectric power generation.

Yet, the Chilean economy has proved remarkably resilient in the presence of all these head winds. The latest monthly GDP numbers are consistent with an annual growth rate of 4.25 percent. Activity is being held up in part by investments including in the mining and energy sectors that have received significant FDI inflows. High import growth reflects purchases of heavy machinery and equipment that will boost productive capacity going forward.

Of course, the risks to the growth outlook are still to the downside, given the uncertainties of global developments, high energy prices and tightening credit conditions both in Chile and the rest of the world. Yet, we feel comfortable projecting that growth will improve in 2009 including because of gradual improvements in the energy sector as the prospect for rainfall has improved and new investment is coming online.

The recent shocks, however, have hit much harder on the inflation front. The analysis in our documents highlights just the magnitude of the food price shocks that hit Chile. We also emphasized that global price increases were quickly being passed through to domestic prices. While this pushed annual inflation close to a 9.5 percent in June, it also means that Chile is ahead of many other countries that subsidize prices more broadly and will benefit the moment the shocks begin to unwind.

There was broad agreement at the discussion of the IMF's Executive Board that monetary policy has been appropriately geared toward returning inflation to the 3 percent target over the two-year horizon. The central bank, in our view, has been successful in limiting second round effects. Nominal wage growth has been up but has broadly kept pace with inflation, and modest productivity gains have helped contain unit labor costs. Here, the risks are still on the upside, however, and short-term inflation expectations have risen substantially. Hence, we support the recent rate increases by the central bank as well as the signal that monetary policy could be tightened further, if needed, to meet the target.

Let me also say a few words on the exchange rate. We agree with the central bank that the peso, in real effective terms, is about where it should be relative to underlying economic and financial fundamentals. More importantly perhaps, the recent volatility of the exchange rate reminds us that Chile, as a small open commodity exporting economy, remains subject to sudden swings in global markets that could have potentially harmful effects on the economy. This makes it all the more important to adhere to Chile's excellent macroeconomic policy framework whose benefits we have again documented in part of our background work.

The central bank's decision to acquire additional reserves has been both prudent and consistent with the overall policy framework. Our analysis suggests that the central bank has picked a reasonable level for the purchase of international reserves and, most importantly, the decision is being implemented in the manner that's consistent with the bank's commitment to a floating exchange rate.

Finally, on fiscal policy, the authorities have used some funds to alleviate price shocks on the weaker segments of the population and to cushion the impact of the energy crisis through temporary means. Yet, the mid-year update provided by the Budget Office, which came out after the IMF's Executive Board discussed our report, notes that the government is again on course to meet the structural surplus target of half a percent of GDP. As a result, Chile will be able to further bolster its financial position which puts it in a strong position to weather any future turmoil.

You will also have seen our discussion of government initiatives-welcome initiatives-in the area of sovereign wealth funds, financial sector reform and financial management, and I won't go into further detail on this. Instead, I'm looking forward to answer any questions you may have. Thank you very much.

QUESTIONER: Hi. Just a quick check, it sounds as if you've lowered your growth forecast since the end of May. I think in the report it was 4.5%. I heard you say 4.25%—so if I could just check that.

And have your changed your views on growth and on the relative value of the peso in the light of what's happened since you were in Chile?

MR. MÜHLEISEN: The answer to your first question on growth, I think you're referring probably to our past WEO forecast. Yes, we have lowered that by about a quarter percent for 2008, reflecting the ongoing data that we received.

On the exchange rate, the material that will be posted on the web site will also contain a statement that we gave to the Board on the day of the discussion. There, you will find that indeed, yes, our assessment now is that the peso in line with fundamentals rather than slightly on the upside as it was at the time when we finished the report. Basically, that just reflects the slight depreciation that has happened in the meantime. It wasn't a major movement, but this is now our assessment, and I think that is very much shared by our Research Department in their CGER exercise and by the central bank.

QUESTIONER: I see what you've suggested that you would back any further tightening by the central bank if needed. I mean how would further rate increases, do you think, affect the wider picture? I mean in terms of current kind of stagflation environment, high inflation, slowing growth, how will that pan out for Chile?

MR. MÜHLEISEN: Well, Chile has really been hit by a series of supply shocks which, of course, complicate monetary policy because, as you mentioned on the one side, they tend to depress growth; on the other side, they tend to rise inflation and inflation expectations. Therefore, the decision has always been kind of a close one between how much to rein in inflation and how much to take into account that growth will also suffer.

Lately, the balance has been more on the inflation side because, as I said, there were really a series of shocks, and one has seen short-term inflation expectations go up.

On the long term, they still remain anchored more or less to the target, and that will be the important, I think, achievement that has to be preserved. The central bank's target is to return inflation to 3 percent over a 2-year policy horizon. So everything that will need to be done to achieve that target will have to be done, but it remains obviously a decision that will, going forward as well, have to be balanced between the risks to growth and the inflation outlook.

The economy, in our view, has some excess capacity despite the nature of the supply shock that also tends to push down potential output. It is common to supply shocks that once the shocks are over, usually there is room to lower interest rates after that. But given the uncertainty, the global uncertainty that we're facing on that front still, it is too early to say when these shocks will be over. So that remains to be an assessment that will have to made on an ongoing basis.

QUESTIONER: The question is the following, two questions in fact. The first has to do with fiscal measures. You've talked about how the fiscal measures in fact are, at the present time, trying to offset the shock of food prices. I'd also like to refer to the fact that there is a subsidy on fuel. Do you think that this is a positive situation that should be maintained or do you think basically that it would be best to move toward an elimination of the subsidies on the cost of fuel?

Secondly, with reference to your comment earlier on international reserves, there is the view that perhaps through these international reserves the central bank may be in fact, let us say, favoring a certain exchange rate rather than another vis-à-vis keeping a more open approach on the floating exchange rate. What is your view in that respect?

MR. MÜHLEISEN: First, on the subsidies, we think that the authorities have reacted very comprehensively to these food and energy price shocks that I mentioned earlier. Basically, the exchange rate has continued to float. Monetary policy has tightened appropriately, and fiscal policy has provided cash subsidies to people that were particularly affected by these shocks. That began with some subsidies to the export sector and was then widened to transfers to the poorer segments of the population and the elderly.

On the fuel price subsidies, I think the important thing here is to recognize two things:

One, the energy crisis that hit Chile is, to some extent, temporary because we know that by the end of next year there will be additional capacity online and there will be LNG terminals in place that will then combine to improve the situation and hopefully lower prices. So, in the transition to that, Chile has had to import a lot of diesel products to basically use them as the marginal source for fuel, as the marginal source for electricity generation.

In our view, the subsidies have not been overly large. They've been justified because of the extraordinary nature of the energy crisis, and the subsidies themselves are temporary because they are linked to the fuel stabilization fund. The overall objective is to, and that's the second point, is to maintain the fiscal surplus target and that is, as I mentioned earlier, the case.

On the reserves question, I think one has to really see it in two distinct ways. On the one hand, there's the objective of acquiring additional reserves, and we have some analysis on that in the paper, why we think this is a prudent idea. On the other hand, there's the interest in maintaining the floating exchange rate which is being achieved by implementing that decision to augment reserves in a very transparent and predetermined way. I think the results confirm the two objectives of this policy.

The central bank has raised reserves on the one hand and on the other hand, as we have seen, the exchange rate continues to fluctuate freely and it moves in both directions. Therefore, I don't see a conflict between these two objectives.

QUESTIONER: Hi. Two questions really, both on inflation. I wonder if perhaps you could give us a bit more detail about whether the central bank's policy of accumulating reserves may conflict with their policy of fighting inflation. It would appear that lowering the peso tends to fuel inflation rather than the other way around.

The other question is whether or not Chile's fiscal policy could be doing a bit more to support the central bank against inflation. I think in your notes, the growth projection, you projected fiscal spending would expand at about 8 percent this year, and I was wondering if that was inflationary and whether or not maybe cutting fiscal spending or reducing fiscal spending growth could help.

MR. MÜHLEISEN: Let me again answer in turn, first on the question whether intervention contributes to inflation, we don't think so. First, the intervention is fully sterilized. In fact, the announcement of the central bank's issuance program after the intervention was announced has led to a rise in local interest rates in the bond markets, and that should take care of that, of that concern.

Also, our estimates are that the inflation pass-through from exchange rate changes in Chile in general is relatively small. There may have been some changes, some increases to that over the past months. I won't argue with that. But overall, I would be more concerned about other factors that are causing inflation, and that includes the global inflationary trends that we have seen and the shocks from further food and energy prices, if there are any.

On fiscal policy, whether it contributes to inflation, here, the answer is that fiscal policy in Chile is determined by the structural surplus rule and maintaining that rule as part of the overall macro framework has benefits all by itself that we have documented in the selected issues paper. Now that's how this rule right now works, and it is being maintained.

Does this contribute to inflation? Again, we think that the policy, the fiscal policy impulse is relatively moderate, of the order of maybe half a percent of GDP. That comes in a situation where the economy is still with a positive output gap. That means with excess capacity. So one could argue that, yes, there is some additional demand that comes from the fiscal sector, but overall we don't see the contribution to inflation as a big issue.

It is more important in this circumstance to obey the rule and let it work, and I think looking forward the impulse provided by fiscal policy according to what we have projected may not be as large as in this year.

QUESTIONER: I'd like to speak to public expenditure and particularly the fact that a number of expenditures in fact have not been marked down as fiscal elements but rather as credit. For instance, we have the case of ENAP where you have 250 million that in fact do not appear as the fiscal outlay that it might have been accounted as, but rather it's a credit.

I wondered how the IMF approaches these different elements in the actual handling of public expenditure in the effort to particularly determine what it is. How do you calculate that public expenditure in view of these different accounting practices?

MR. MÜHLEISEN: The way we do it is that capital transfers usually are treated like a below the line item. What we look at in determining public expenditure—and here we are guided by the principles and the accounting of the Budget Office which follows our international guidelines—is that the actual amount that is being spent is counted as expenditures.

Let me use the example of the fuel stabilization fund. There, 500 million already were transferred and maybe up to a billion in total, but that is not expenditure in the current year. The actual expenditure is determined by the actual amount of subsidies that is paid out by that fund, and the same applies to other entities that are within the accounting framework.

MR. ADRIANO: Well, if there are no more questions, we are going to wrap up this conference call. I would like to make just a few quick announcements before we finish.

The public information notice, the staff report and the selected issues paper that Martin mentioned will be uploaded on the IMF web site, at 11:00 a.m. Washington time. So all the documents and the Spanish version of the PIN will also be available.

I would also like to say thank you all for participating and if you have any further questions, please feel free to call me, Andreas Adriano. My phone number is 202-623-4188 and my email is


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