IMF Executive Board Concludes 2010 Article IV Consultation with ChilePublic Information Notice (PIN) No. 10/136
September 29, 2010
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. The staff report (use the free Adobe Acrobat Reader to view this pdf file) for the 2010 Article IV Consultation with Chile is also available.
On September 13, 2010 the Executive Board of the International Monetary Fund (IMF) concluded the Article IV consultation with Chile.1
Chile’s economy has withstood successfully two consecutive large negative shocks—the global financial crisis and the February 2010 earthquake. Its resilience has been underpinned by substantial macroeconomic easing, a well-capitalized banking system, and absence of imbalances in the private sector. Strong growth has resumed since the second half of 2009, and the earthquake caused only a temporary disruption in economic activity. The unemployment rate has declined and annual Consumer Price Index (CPI) inflation increased to 2.2 percent in July.
The financial system has weathered the crisis well and the cyclical deterioration of credit quality has been moderate. Non-performing loans remain relatively low at 3 percent of all loans. Banks are well capitalized and have a relatively stable domestic funding base. Financing conditions have eased since the second half of 2010 and credit growth has resumed. As liquidity conditions normalized, the central bank has unwound unconventional policy measures implemented during the crisis. The temporary short-term bank liquidity facility was terminated in mid-June 2010, and the policy rate has been raised to 2 percent by August.
Large fiscal savings accumulated over the past decade allowed the authorities to put in place a substantial fiscal stimulus in 2009, followed by an ambitious earthquake reconstruction program, while preserving trust in the soundness of public finances. The overall fiscal balance shifted to a deficit of 4.4 percent of Gross Domestic Product (GDP) in 2009. The structural fiscal deficit is expected to remain high in 2010 due to reconstruction spending. Nonetheless, fiscal credibility remains strong. Moody’s raised Chile’s government debt rating to Aa3 in June, and the recent turbulence in Europe has had little impact on risk premia.
Looking ahead, the economic recovery is expected to continue. GDP is expected to grow by 5 percent in 2010, accelerating to 6 percent in 2011. Large scale private and public reconstruction spending should continue to boost growth. At the same time, net exports are likely to weaken further, as some of the domestic demand growth spills over to imports. CPI inflation is expected to exceed the 3-percent target by the end of 2010, before coming down gradually in 2011, as the effect of interest rate increases filters through.
Executive Board Assessment
Executive Directors commended the authorities’ skillful responses to the global financial crisis and to the devastating earthquake of last February, capitalizing on Chile’s robust policy framework. As a result, the economy is back on track for a sustainable recovery. Directors viewed the authorities’ decision to accommodate relief and reconstruction spending through a combination of tax and expenditure measures, and some debt issuance, as timely and prudent. Looking ahead, the government’s commitment to firm expenditure restraint starting in 2011 will anchor expectations, help reduce the risk of overheating and limit appreciation pressures.
Directors supported the authorities’ target of lowering the structural deficit of the central government to 1 percent of GDP by 2014. Returning to a zero structural balance over a longer horizon would be desirable. Directors also encouraged the government to renew its commitment to fully recapitalize the central bank.
Directors welcomed the government’s decision to review the fiscal rule. While Chile’s fiscal rule has served the country well in the last decade, it could be made even more effective by making it more transparent; introducing an explicit escape clause and features to limit spending procyclicality; and complementing it with an explicit medium-term policy framework that extends beyond the government’s term. Directors encouraged the government to outline a clear timetable for adopting any revisions to the rule, once the fiscal rule commission has issued its final report.
Directors supported the gradual tightening of the monetary policy currently underway. They recognized the risk that widening interest rate and growth differentials with major advanced economies could result in a surge in capital inflows, and agreed with the central bank’s approach to let exchange rate flexibility be the first line of defense. In addition, macroprudential measures could be useful to protect domestic balance sheets and prevent excessive growth in credit.
Directors noted that Chile’s financial sector is sound and has weathered the crisis well. They welcomed the authorities’ intentions to enhance the supervision of the financial sector, including the planned move towards consolidated supervision of financial conglomerates. They recommended continued strengthening of the prudential framework by adopting a functional approach to regulation and supervision; formalizing cooperation arrangements among the supervisory agencies; and strengthening cross-border coordination with international counterparts.
Directors supported the government’s initiatives to reduce the cost of doing business by facilitating the entry of new firms, making credit more accessible to small and medium enterprises, and reforming the corporate bankruptcy procedures. Increasing labor market efficiency should be another key objective.