IMF Executive Board Concludes 2013 Article IV Consultation with ChilePublic Information Notice (PIN) No. 13/77
July 8, 2013
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 2013 Article IV Consultation with Chile is also available.
On July 1, 2013, the Executive Board of the International Monetary Fund (IMF) concluded the Article IV consultation with Chile, and considered and endorsed the staff appraisal without a meeting.1
After growing strongly over the past three years, the economy appears to be decelerating toward potential. Chile recovered rapidly from the global financial crisis and the February 2010 earthquake, and the growth surprised on the upside in 2012, powered by strong private domestic demand—in particular investment in mining. Real gross domestic product (GDP) growth slowed in the first quarter of 2013 to 4.1 percent (year on year) from 5.7 percent in the fourth quarter of 2012. Credit growth has been on a declining trend although is still quite strong. The labor market remains tight, with the unemployment rate at a historically low level.
The current account, which shifted from a surplus in 2010 to a deficit in 2011, deteriorated further in 2012 and early 2013. Imports remained robust, underpinned by resilient domestic demand, while exports have suffered from the weakening of still high copper prices and lower demand in the euro area. The current deficit is financed mostly by foreign direct investment (FDI) (about half to the mining sector), though within FDI, the share of intercompany loans has increased significantly in recent years. Both gross capital inflows, in particular FDI, and outflows increased significantly in 2012, but net inflows declined as a result of increased portfolio outflows by Chilean pension funds. The real effective exchange rate is broadly in line with fundamentals.
Inflation has been low and declining, as a result of the peso appreciation last year, an increase in labor productivity, and falling energy prices. There is also downward bias in at least one component of the consumer price index, but this bias does not seem to materially change the inflation picture. Inflation expectations remain anchored at the official target of 3 percent. The central bank has left the policy rate at 5 percent, a broadly neutral rate, since January 2012.
The government recorded a small fiscal surplus in 2012 as it saved revenue overperformance and underspent the budget. The structural deficit improved to ½ percent of GDP, beating the authorities’ 1 percent target two years ahead of time. The fiscal impulse—measured as the change in the non-mining structural primary balance—was negative (mildly) for the third year in a row, provided some welcome dampening effect. The 2013 budget targets a structural deficit of 1 percent, and would inject some fiscal impulse.
Macro-financial risks are contained. Despite strong domestic demand, capital inflows, and ample liquidity, there are no clear signs of generalized asset or credit bubbles. The banking system is sound−banks are well-capitalized and liquid, and nonperforming loans are low and fully provisioned. That said, there has been a marked increase in average loan-to-value ratios in mortgages since late 2011, and some mid-sized banks are expanding fast, with relatively high reliance on wholesale funding.
Real GDP is expected to grow 4.6 percent in 2013, broadly in line with potential growth. The current account deficit is expected to widen further in 2013 amid lower copper prices. Inflation is expected to move toward 3 percent over the next year. The near-term challenge is to support a soft landing in the context of a widening current account deficit, swelling capital inflows, and an uncertain outlook for copper. Boosting productivity growth is a key medium-term challenge.
Executive Board Assessment
In concluding the 2013 Article IV consultation with Chile, Executive Directors endorsed staff’s appraisal, as follows:
Growth in recent years has been strong, led by domestic demand, but a slow down appears underway. Growth surprised on the upside in 2012 and on the downside in the first quarter of 2013. These ups and downs appear to be part of a bumpy transition toward a more sustainable rate of expansion in economic activity. The moderation in activity is also reflecting a shifting outlook for copper prices.
The main cloud over the strong performance is the rapid shift in the current account. The ballooning current account deficit and the increased reliance on debt financing have raised balance of payment risks. Still, staff’s assessment is that the peso is on the strong side but not clearly overvalued.
Macroeconomic policies have been prudent. In recent years, fiscal policy has provided a welcome dampening effect on demand, thereby helping prevent overheating and a more substantial real appreciation and current account deterioration. Monetary policy has been on hold since early 2012 and is broadly neutral.
And macro-financial risks appear contained thanks in large part to the authorities’ active supervision and monitoring. There are no clear signs of broad asset price or credit bubbles. Liquidity and solvency indicators and stress tests suggest that the financial sector is generally healthy and robust. That said, some mid-sized banks are expanding fast, with relatively high reliance on wholesale funding. As for real estate, aggregate price developments do not suggest bubbles but continued close monitoring will be important, including of commercial real estate construction which remains very dynamic.
The near-term priority is to support the ongoing moderation in domestic demand and activity, amid swelling capital inflows and a widening current account deficit. In this context, a neutral fiscal stance would be desirable and can be achieved through a tight grip on spending in the remainder of the year, and saving any revenue over performance. This would bring the structural balance closer to zero.
There is a great deal of uncertainty and risks surrounding the outlook stemming both from real and financial channels. The main downside risks to the outlook are a sharp and lasting drop in copper prices, re-emergence of financial stress in the euro area, or a sudden stop in capital inflows. At the same time, there is also a chance that domestic demand does not abate as envisaged, raising overheating risks.
Monetary policy should be ready to respond to changes in the economic outlook and fiscal automatic stabilizers should be allowed to operate unimpeded. As a last resort, there is ample space for fiscal stimulus if output falls. The floating currency provides a natural buffer against external shocks and the ample reserves could be used to avoid excessive depreciation.
Further strengthening of the medium-term fiscal framework is appropriate. Staff recommends aiming for a small structural surplus over the next few years, as this would help maintain strong fiscal buffers while stabilizing net assets as a share of GDP. The establishment of the Fiscal Council is welcome as it would further strengthen the transparency of the fiscal framework. Staff also commends plans to incorporate long-run expenditure and revenue projections into the budget framework.
The staff applauds the authorities’ proactive work on financial stability issues. Recent progress in strengthening supervision of nonbanks and financial conglomerates is welcome. Current legislative initiatives, notably the General Banking Law, the law on the Financial Stability Council, the law on risk-based supervision of insurance companies, the legislation to expand the credit registry, and the corporate bankruptcy law, will strengthen prudential oversight. Looking ahead, the broad-based banking regulation reform scheduled for this year will be an important improvement. However, addressing pending Financial Sector Assessment Program (FSAP) recommendations, including a legal framework for consolidated oversight of financial conglomerates, should remain a priority. And while there are no systemic risks that warrant immediate action, the authorities should consider extending some form of loan-to-value and debt-to-income regulation to all mortgages.
The medium-term challenge is to foster sustained and inclusive growth. Boosting productivity and labor force participation will be needed to sustain growth without the benefit of the tailwind of rising copper prices and with slowing growth of working-age population. To this end, key areas for further reform include: make access to high-quality education and training more equal, and consider well-targeted social transfers to spread growth benefits; promote investments in the energy sector to ensure sufficient and competitive energy supply; and make the labor market more flexible.
A prompt and transparent resolution of the recent statistical controversies would protect Chile’s long tradition of high quality data. Staff welcomes authorities’ outreach efforts among local analysts and data users, and their plans to obtain advice from international experts.