## 1chlea2021003

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---

### Context
- The pandemic hit the Chilean economy while it was recovering from the 2019 social unrest.
- Authorities’ swift and strong economic policy efforts and Chile’s very strong institutional frameworks helped buffer the economic and social consequences.
- Ongoing economic recovery supported by:
  - ample policy stimulus,
  - a rapid vaccination process,
  - well-anchored inflation expectations,
  - a resilient export base,
  - continued market confidence.

### Risks
- External risks: tied to the evolution and the impact of the pandemic.
- Domestic risks: particularly the uncertain outcome of a New Constitution process.
- Offsetting/mitigating factors:
  - the rise in copper prices,
  - the fast pace of the vaccination program domestically,
  - Chile’s demonstrated sound record of policy reaction,
  - very strong institutional policy frameworks,
  - remaining fiscal space.

### Flexible Credit Line (FCL)
- Purpose and impact:
  - The FCL has provided a valuable buffer and has helped boost market confidence during the COVID-19 pandemic by supporting Chile’s policy and institutional strength.
  - Drawings under the FCL arrangement are not tied to ex-post conditionality.
- Arrangement details:
  - Chile’s 24-month FCL arrangement was approved on May 29, 2020, in the amount of SDR 17.443 billion (1000 percent of quota, around US$23.93 billion).
  - The authorities expect to continue to treat the FCL as precautionary, and maintain their intention to exit as soon as the 24-month period is completed, conditional on developments and risks.
- Role:
  - Provides a substantial buffer which can readily supplement foreign reserves in case of tail risk.
  - Access to FCL resources has been supporting market confidence.

### Qualification and Staff Recommendation
- Staff view: Chile continues to meet the qualification criteria for access to FCL resources specified under the Executive Board decision on FCL arrangements (Decision No. 14283-(09/29), adopted on March 24, 2009, as amended).
- Recommendation: Staff recommends that the Board completes this review that would allow Chile to make purchases, if needed, until the expiration of the FCL arrangement on May 28, 2022.

### Recent Developments
- Growth and activity:
  - Economic activity declined by 5.8 percent in 2020.
  - Monthly economic activity in both January and February 2021 was only 2 percent below the levels prevailing a year before.
  - Copper production remained mostly steady despite the pandemic.
- Policy response:
  - Government implemented a multi-year fiscal package and additional measures to safeguard health, protect incomes and jobs, support credit, and buttress the recovery.
  - Central Bank of Chile (BCCh) undertook monetary stimulus and unconventional measures supporting liquidity.
  - Financial sector policies adjusted to facilitate flow of credit, especially to households and SMEs.
  - International reserves were about US$3 billion higher at end-2020 than at the time of the FCL approval.
  - In January 2021, the BCCh initiated a program to gradually increase FX reserves by US$12 billion over 15 months.
- Exchange rate and prices:
  - NEER depreciated by over 7 percent in 2019Q4 relative to the first three quarters of 2019, and by an additional 7 percent until end-April 2020; then strengthened resulting in overall appreciation of 2 percent during 2020.
  - REER (CPI-based) appreciated by 3.5 percent in 2020 (yoy December), reversing some of the 10 percent drop in 2019.
  - Exchange rate appreciation continued until April 2021, with copper prices above historical averages.
  - Central Bank let the exchange rate adjust without intervention in 2020.
- Inflation and expectations:
  - Headline inflation peaked close to 4 percent in early-2020, moderated in mid-2020, and rose close to the BCCh’s policy target of 3 percent in the second half of the year.
  - Core inflation remained subdued at 2.6 percent in February 2021—below target.
  - Two-year ahead inflation expectations remain well anchored.
- Financial sector soundness:
  - Capital adequacy ratio is 14.3 percent (banks have capital above regulatory minimum).
  - Non-performing loan ratio is 1.6 percent of total loans in February 2021.
  - Return on equity dropped below 8 percent (from 16.2 percent in 2019Q4) due to higher provisions.
  - Credit growth slowed in 2020 despite government support via FOGAPE guarantees.
  - Credit-to-GDP ratios for non-financial corporations and households are in line with countries of similar development; credit to non-financial corporates relative to GDP is high compared to regional peers but largely FDI-related and hedged against exchange rate risk.
  - Housing market risks mitigated by long-term maturity, low and fixed interest rates, and limited leverage.
- Market resilience:
  - Non-resident portfolio outflows exceeded those from past episodes but have recovered since.
  - Compared to LA5 and other EMs, Chile experienced a smaller increase in spreads and yields on domestic sovereign bonds and exchange rate depreciation was substantial but not among the highest.

### Outlook and Policies
- Growth forecast:
  - Economic activity is expected to grow at 6.5 percent in 2021, supported by vaccination, accommodative policies, relaxation of mobility restrictions, a surge in copper prices, and improved global growth expectations.
  - Over the medium term, growth is expected to gradually converge to potential of 2½ percent.
- External sector:
  - Temporary factors that pushed the current account into surplus in 2020 are expected to dissipate, leaving the current account balance close to zero in 2021 and towards a small deficit over the medium term.
- Fiscal policy and stimulus:
  - Government implementing a multi-year fiscal package of about US$34 billion (13 percent of 2020 GDP, after an additional 2 percent of GDP was announced in March 2021) to safeguard health, protect incomes and jobs, keep funding costs low, support credit, and buttress the recovery.
  - Main elements of the stimulus package include:
    - higher healthcare spending;
    - enhanced subsidies and unemployment benefits;
    - tax deferrals;
    - credit provision for SMEs via Banco Estado;
    - transfers for the most vulnerable and the middle-class;
    - a credit-guarantee scheme for firms (via FOGAPE) and for households;
    - enhanced public investment.
- Pension withdrawals and financial market implications:
  - Two rounds of withdrawals from private pension funds in July and December 2020; a third round approved in April 2021.
  - By early-April 2021:
    - about 10.5 million people used the first withdrawal,
    - 8 million used the second withdrawal,
    - total withdrawals about US$37 billion (or about 15 percent of 2020 GDP, or 19 percent of June 2020 pension assets).
  - Staff estimated the net present value cost from the first two withdrawals at about of 3½ percent of 2020 GDP.
  - After the first two withdrawals, about 3 million people (or ¼ of pension system participants) have exhausted their pension funds.
  - For the third round, US$18 billion in withdrawals are expected, which would exhaust the accounts of a further 2 million people (bringing the total to about 5 million).
  - Impact on liquidity needs of financial markets from the first two rounds was muted, cushioned by BCCh reaction including a facility with cumulative purchases of US$8.5 billion.
- Monetary policy and BCCh measures:
  - Policy rate lowered by 125 basis points in March 2020 to 0.5 percent (considered by the BCCh as the “effective lower bound”).
  - Monetary policy stance is appropriately accommodative; the policy rate is about 350 basis points below the BCCh’s estimates of the neutral nominal interest rate range (3.75 to 4.35 percent).
  - BCCh support measures included:
    - offering FX swaps;
    - introducing funding-for-lending programs (up to US$40 billion);
    - expanding collateral framework (including corporate bonds and the credit guarantee scheme);
    - introducing a bank-bonds purchase program;
    - relaxing the liquidity coverage ratio (ratio remains unchanged but temporary deviations could be tolerated on a case-by-case basis).
  - BCCh negotiated access to the Foreign and International Monetary Authorities Repo Facility.
- Outlook risks:
  - External: evolution and impact of the pandemic.
  - Domestic: uncertain outcome of the New Constitution process.
  - Offsetting factors: rising copper prices, fast vaccination pace, strong policy frameworks, remaining fiscal space.

### Fiscal Measures in Response to COVID-19 (selected figures)
- Total size of the stimulus package (percent GDP): 11.3 13.3 12.5 6.1 4.2 2.1
- On-budget measures (announced as of June 2020; revised in March 2021 with outturns for 2020; nets out the effect of tax deferrals):
  - Temporary (no effect on end-year deficit): 1.3 1.3 1.3 1.3
    - i. Deferred taxes: 0.5 0.5 0.5 0.5
      - CIT for SMEs 0.2 0.2 0.2 0.2
      - Property taxes 0.3 0.3 0.3 0.3
    - ii. Accelerated pay of liabilities (no affect on the accrual def) 0.8 0.8 0.8 0.8
      - Early CIT refunds for SMEs 0.4 0.4 0.4 0.4
      - Accelerated pay of public procurement obligations 0.4 0.4 0.4 0.4
  - Permanent: 7.4 9.5 8.7 3.7 2.9 2.0
    - i. Revenues 2.5 1.6 0.8 1.2 -0.4 0.0
      - Suspension of CIT payments 1.0 0.9 0.3 0.9 -0.5 -0.1
      - VAT delay 0.6 0.2 0.0 0.2 -0.2
      - Reduction of the stamp & seals tax 0.2 0.2 0.2 0.2
      - Reduction CIT rate to 12.5% 0.3 0.0 0.0 0.0 0.0 0.0
      - Instantatenous 100% depreciation 0.4 0.4 0.4 0.0 0.3 0.1
    - ii. Spending 4.9 7.9 7.9 2.5 3.3 2.0
      - Additional Fiscal Resources for health expenditures 0.9 0.6 0.6 0.5 0.1 0.0
      - Other spending 0.0 0.2 0.2 0.1 0.1 0.0
      - Transfers for most vulnerable 1.8 2.9 2.9 1.5 1.3 0.0
      - Middle-class bonus 0.4 0.9 0.9 0.4 0.5 0.0
      - Public investment 1.2 1.2 1.2 0.0 0.4 0.8
      - Employment subsidies 0.6 1.0 1.0 0.0 0.7 0.3
      - Unallocated 0.0 1.1 1.1 0.0 0.2 0.9
- Off-budget (below the line)
  - Total off-budget: 2.6 2.5 2.5 1.1 1.3 0.1
    - Injection to the UI Solidarity Fund 0.8 0.0 0.0 0.0 0.0 0.0
    - Banco Estado capitalization 0.2 0.3 0.3 0.1 0.2 0.0
    - Public loan guarantees (FOGAPE), including Fogape Reactiva 1.2 0.8 0.8 0.4 0.3 0.1
    - Solidarity loan for middle class 0.4 1.2 1.2 0.6 0.6 0.0
    - Unallocated 0.0 0.2 0.2 0.0 0.2 0.0

### Financial sector and liquidity measures
- CMF measures to facilitate the flow of credit include:
  - (i) special treatment in the establishment of provisions for deferred loans (while credit quality exposures remain carefully monitored);
  - (ii) use of mortgage guarantees to safeguard loans for SMEs;
  - (iii) adjustments in the treatment of assets received as payment and margins in derivative transactions;
  - (iv) delay by one year of the implementation of Basel III standards.
- Coordination:
  - The BCCh funding-for-lending program, the Ministry of Finance credit-guarantee scheme, and CMF regulatory requirements show strong coordination.
- Implementation timelines:
  - Regulation related to risk weighted assets and conservation buffer will start in Dec 2021, while the one on systemic charge and capital discounts in Dec 2022.

### BCCh extraordinary measures (selected figures as reported)
- Amount of the Program: 8,514 BCP 5,595 BCU 983 Others 83
- Cumulative Buybacks: 6,662
- 8,000 Inflation Linked Bank Bonds 3,621
- CLP Denominated Bank Bonds 240
- Cumulative Purchases 3,861
- 8,000 Total Bought (Whole Program) 4,785
- BCP 628 BCU 187 Cumulative Buybacks (BCP and BCU) 815
- Inflation Linked Bank Bonds 3,940 CLP Denominated Bank Bonds 30 Cumulative Purchases 3,970
- 10,000 Cumulative Purchases 8,455 Outstanding Amount 2,777
- Purchase of Bank Term Deposits (August 7th, 2020) 8,000 Cumulative Purchases 521
- FCIC 1-LCL (March 30th, 2020-March 30th, 2024) 24,000 Current Usage 25,240
  - 4,800 FCIC Usage 2,140 LCL Usage 3,150 Total Usage, Initial Line 5,290
  - 19,200 FCIC Usage 16,163 LCL Usage 3,786 Total Usage, Initial Line 19,949
- FCIC 2 (July 9th, 2020- July 1st, 2024) 16,000 Current Usage 5,428
- Notes:
  - Bond buybacks reported with one day of delay; amounts correspond to total liquidity injection related to buybacks.
  - Amounts dollarized using the average exchange rate of February, usage dollarized using the last observed exchange rate.
  - Source: Central Bank of Chile. 1/ Last Updated on March 1, 2021.

### Fiscal outlook, framework, and policy guidance
- Fiscal projections and targets:
  - Headline fiscal deficit expected to decline to 4.1 percent of GDP in 2021 from 7.3 percent in 2020.
  - Structural balance deficit expected to worsen from 2.6 to 6.0 percent of GDP (in 2021).
  - Gross debt expected to increase to 34.6 percent of GDP by end-2021.
  - Authorities plan structural consolidation: reducing the structural deficit by about 2 percent of GDP in 2022 and then 1 percent of GDP per year starting in 2023, to reach a structural deficit target of 0.9 percent of GDP by 2025 (estimated to stabilize gross debt at about 40 percent of GDP).
- Policy priorities:
  - Short term: implement targeted measures to protect health, income, and jobs, especially for the most vulnerable segments of the population.
  - Medium term: adopt permanent revenue and spending measures to finance additional social spending, face fiscal contingencies, and rebuild buffers while preserving debt stability.
  - Consider recommendations from a Commission of Experts (aligned with IMF/OECD joint report) for gradually reducing tax exemptions, deductions, and special regimes; additional measures may include broadening direct taxation, raising green taxes towards international standards, and rationalizing expenditures.
- Fiscal framework enhancements recommended:
  - Complement current rule with a medium-term debt anchor (ideally encompassing a debt ceiling and buffer zone);
  - A formal escape clause for temporary relaxation or suspension of the structural balance target;
  - An adjustment mechanism to offset temporary deviations from targets.
  - The Autonomous Fiscal Council recently issued valuable recommendations.

### Monetary policy and reserves
- Monetary policy stance:
  - Authorities reiterated commitment to inflation targeting with a free-floating exchange rate.
  - Policy rate at the effective lower bound; BCCh kept the policy rate unchanged in its March 2021 monetary policy meeting.
  - BCCh continues unconventional liquidity and credit support measures and intends to allow the peso to fluctuate freely with intervention only limited to address exceptional volatility.
  - BCCh does not envisage the need for any capital flow management measures (CFMs).
- Reserves and adequacy:
  - Ratio of reserves to the Fund’s reserve adequacy metric (ARA) is 85 percent at end-2020; 90 percent on average over the preceding three years.
  - Adding an additional buffer for Chile’s exposure to copper price volatility gives a ratio of reserves to commodity-augmented ARA metric of 74 percent.
  - Reserve coverage of prospective imports is 7 months.
  - Coverage of broad money is 18 percent and of short-term external debt (remaining maturity) is 99 percent.
  - Central government holds about US$22 billion in usable liquid external assets, including US$8.7 billion in the sovereign wealth fund for economic stabilization at end-February 2021 (which, if counted as reserves, correspond to approximately 20 percent of the ARA metric).
  - Banks’ external debt was US$23.8 billion (at end-2020); banks’ foreign assets US$25.8 billion.

### Financial sector soundness and risks
- Staff assessment and risk environment:
  - Emergency measures are facilitating the flow of credit and supporting income, thus preventing a deterioration in credit quality.
  - Stress tests performed by the authorities indicate that financial stability appears well guarded at this juncture.
  - Continue monitoring developments closely, stand ready to intervene to avoid disorderly conditions, and encourage financial institutions to maintain prudential lending standards and adequate reporting.
  - Implementation of Basel III requirements would improve resilience by requiring banks to maintain larger capital buffers.
  - Authorities should address pending deficiencies in the regulatory framework, including bank resolution, deposit-insurance, insurance companies, financial conglomerates, and FinTech activities; the upcoming 2021 Financial Sector Assessment Program (FSAP) will conduct a detailed analysis of financial stability policies and risks.
- External position and capital flows:
  - Staff assessed current account gap of 1.7 percent of GDP (2020).
  - 2020 current account surplus: 1.4 percent of GDP.
  - Net international investment position (IIP): -14 percent of GDP at end-2019 and improved to -10 percent of GDP during 2020.
  - As of end-2020, gross foreign assets and liabilities were US$431.7 billion and US$456.7 billion, respectively.
  - More than four-fifths of foreign assets (86 percent) and 92 percent of external liabilities are private (as of end-2020).
  - Sovereign bond spreads: EMBIG and five-year CDS spreads stood at 128 and 59 bps as of March 25, 2021.
  - Chile maintains uninterrupted access to international capital markets and investment grade status with foreign-currency ratings A1 (Moody’s), A (S&P), and A- (Fitch).

### Reserve accumulation and other sources of external liquidity
- BCCh reserve accumulation program (announced January 2021):
  - Evenly executed over a fifteen-month period.
  - Will lift reserves by US$12 billion (approximately one quarter of the ARA metric).
  - Daily purchases of US$40 million.
  - Target reserve level: in the vicinity of 18 percent of GDP.
  - By mid-April 2021, the central bank had added approximately US$2.8 billion to reserves through sterilized purchases.
- Other precautionary financing sources:
  - Bilateral RMB-CLP currency swap facility with the People’s Bank of China increased from RMB22 billion to RMB50 billion (about US$7 billion) in July 2020; scope expanded beyond supporting bilateral trade transactions.
  - Footnote: original 2015 agreement created a line up to RMB22 billion (about US$3 billion); agreement never drawn upon and resources are not included in Chile’s international reserves.
- Key liquid asset magnitudes (US$ billions):
  - Usable Liquid External Assets: 21.8
  - Economic and Social Stabilization Fund: 8.7
  - Pension Reservation Fund: 10.1
  - FX-denominated Assets of the Public Treasury: 3.0
  - Other Liquid Assets: 3.8
  - Peso-denominated Assets of the Public Treasury: 2.5
  - Education Fund: 0.2
  - Regional Support Fund: 0.7
  - Fund for High-Cost Diseases: 0.4
  - Total: 25.7

### Exit strategy for FCL and safeguards
- Exit intentions:
  - Authorities intent on exiting the FCL arrangement at the end of the 24-month period (May 28, 2022), conditional on interim developments.
  - Permanent strategy for medium-term resilience anchored in strong macroeconomic policies, strengthened regulatory environment, and buffers.
  - In preparation for exit, authorities commenced increasing reserves through FX intervention purchases.
- Safeguards:
  - Staff completed safeguards procedures for Chile’s FCL arrangement.
  - BCCh’s external audit and financial reporting reflect leading practices.
  - KPMG Chile issued an unmodified audit opinion on BCCh financial statements for 2019, prepared and audited in accordance with international standards; comprehensive disclosures published on a timely basis.
  - No significant issues emerged from safeguards procedures.

### Staff appraisal and recommendation
- FCL arrangement supported deep and effective policy efforts amid uncertainty and contributed to resilience during the pandemic.
- Chile continues to meet FCL qualification criteria given very strong fundamentals, institutional frameworks, and sustained policy track record.
- Authorities are not requesting a change in access and intend to treat the FCL as precautionary and exit in May 2022.
- Staff recommends completion of the review under the FCL arrangement for Chile.

### External Economic Stress Index (Box 1) — construction and scenarios
- ESI construction steps: (i) identify key external risks based on economy structure; (ii) choose proxies for risks; (iii) weigh them. Index is weighted sum of standardized deviations of each proxy from its mean.
- Main external risks and proxies and weights:
  - Risks to exports: output growth in the U.S. and China (weight 0.15).
  - Risks to copper industry and inward FDI: international copper prices (weight 0.35).
  - Global financial conditions: VXEEM (weight 0.25) and yield on 10-year U.S. Treasuries (detrended) (weight 0.25).
- Baseline and adverse scenarios:
  - Baseline uses WEO projections for U.S. and Chinese growth, copper prices, and U.S. 10-year bond yield; VXEEM assumed to return to its average level.
  - Adverse scenario assumes prolonged pandemic, lower copper prices, and another spike in global risk aversion: copper prices assumed to fall towards approximately $3,200 per ton (equivalent to about 160 cents per pound); VXEEM moves up by two standard deviations.
  - Adverse scenario consequence: Chile would remain under significant external stress through 2021, with pressure abating gradually in 2022.
- Export shares: China and the U.S. account (directly) for 32 and 14 percent, respectively, of Chile’s total exports in 2019.

### Annex I. Public Debt Sustainability Analysis — key points
- Overview:
  - Debt in Chile is sustainable with a high probability, conditional on implementation of the authorities' medium-term structural fiscal consolidation.
  - Authorities committed to bringing the structural deficit to 0.9 percent of GDP by 2025.
  - Staff calculations: envisaged medium-term fiscal consolidation would stabilize the debt ratio at about 42 percent of GDP.
- Baseline projections (selected indicators):
  - Real GDP growth (in percent): 2021 = 6.5; 2022 = 3.7; 2023 = 2.7; 2024 = 2.6; 2025 = 2.5; 2026 = 2.5.
  - Inflation (GDP deflator, in percent): 2021 = 4.3; 2022 = 2.7; 2023 = 2.4; 2024 = 2.3; 2025 = 2.4; 2026 = 2.6.
  - Primary Balance (in percent of GDP): 2021 = -3.5; 2022 = -2.5; 2023 = -1.6; 2024 = -0.8; 2025 = -0.2; 2026 = -0.1.
  - Effective interest rate (in percent): 2021 = 3.7; 2022 = 3.4; 2023 = 3.4; 2024 = 3.4; 2025 = 3.4; 2026 = 3.4.
  - Public gross financing needs (selected years, in percent of GDP): 2019 = 3.0; 2020 = 5.0; 2021 = 11.9; 2022 = 6.0; 2023 = 3.2; 2024 = 3.6; 2025 = 1.5; 2026 = 4.0.
- Debt dynamics and identified debt-creating flows (selected):
  - Cumulative change in gross public sector debt (percent of GDP, selected): 2019 = 2.2; 2020 = 2.6; 2021 = 4.3; 2022 = 2.0; 2023 = 3.5; 2024 = 2.4; 2025 = 1.1; 2026 = 0.5; cumulative to 2026 = -0.3.
  - Identified debt-creating flows (percent of GDP, selected): 2019 = 2.0; 2020 = 2.6; 2021 = 3.9; 2022 = 2.2; 2023 = 3.7; 2024 = 2.6; 2025 = 1.3; 2026 = 0.6; cumulative through 2026 = 10.3.
  - Primary (noninterest) revenue and grants (percent of GDP): 2019 = 20.9; 2020 = 21.1; 2021 = 19.5; 2022 = 22.8; 2023 = 22.2; 2024 = 22.1; 2025 = 22.5; 2026 = 22.5.
  - Primary (noninterest) expenditure (percent of GDP): 2019 = 21.9; 2020 = 23.6; 2021 = 26.3; 2022 = 26.3; 2023 = 24.7; 2024 = 23.7; 2025 = 23.3; 2026 = 22.6.
  - Automatic debt dynamics (percent of GDP, contribution): 2019 = -0.2; 2020 = 0.5; 2021 = 0.2; 2022 = -2.2; 2023 = -1.0; 2024 = -0.6; 2025 = -0.6; 2026 = -0.6; cumulative = -5.7.
- Alternative scenarios and stress tests:
  - Alternative scenarios include Historical Scenario; Constant Primary Balance Scenario (Primary Balance = -3.5 percent of GDP in all projection years).
  - Macro-Fiscal Stress Tests considered: Primary Balance Shock; Real GDP Growth Shock; Real Interest Rate Shock; Real Exchange Rate Shock; Combined Shock; Contingent Liability Shock.
  - Stress-test outcomes: under most individual shocks the gross nominal public debt path rises relative to baseline but vulnerabilities remain manageable under baseline and many shocks.

*Source: IMF staff text and tables from the provided content unit.*

### EXECUTIVE SUMMARY

### EXECUTIVE SUMMARY

### Context
- The pandemic hit the Chilean economy while it was recovering from the 2019 social unrest.
- Authorities’ swift and strong economic policy efforts and Chile’s very strong institutional frameworks helped buffer the economic and social consequences.
- Ongoing economic recovery supported by:
  - ample policy stimulus,
  - a rapid vaccination process,
  - well-anchored inflation expectations,
  - a resilient export base,
  - continued market confidence.

### Risks
- External risks: tied to the evolution and the impact of the pandemic.
- Domestic risks: particularly the uncertain outcome of a New Constitution process.
- Offsetting/mitigating factors:
  - the rise in copper prices,
  - the fast pace of the vaccination program domestically,
  - Chile’s demonstrated sound record of policy reaction,
  - very strong institutional policy frameworks,
  - remaining fiscal space.

### Flexible Credit Line (FCL)
- Purpose and impact:
  - The FCL has provided a valuable buffer and has helped boost market confidence during the COVID-19 pandemic by supporting Chile’s policy and institutional strength.
  - Drawings under the FCL arrangement are not tied to ex-post conditionality.
- Arrangement details:
  - Chile’s 24-month FCL arrangement was approved on May 29, 2020, in the amount of SDR 17.443 billion (1000 percent of quota, around US$23.93 billion).
  - The authorities expect to continue to treat the FCL as precautionary, and maintain their intention to exit as soon as the 24-month period is completed, conditional on developments and risks.
- Role:
  - Provides a substantial buffer which can readily supplement foreign reserves in case of tail risk.
  - Access to FCL resources has been supporting market confidence.

### Qualification and Staff Recommendation
- Staff view: Chile continues to meet the qualification criteria for access to FCL resources specified under the Executive Board decision on FCL arrangements (Decision No. 14283-(09/29), adopted on March 24, 2009, as amended).
- Recommendation: Staff recommends that the Board completes this review that would allow Chile to make purchases, if needed, until the expiration of the FCL arrangement on May 28, 2022.

### Recent Developments
- Growth and activity:
  - Economic activity declined by 5.8 percent in 2020.
  - Monthly economic activity in both January and February 2021 was only 2 percent below the levels prevailing a year before.
  - Copper production remained mostly steady despite the pandemic.
- Policy response:
  - Government implemented a multi-year fiscal package and additional measures to safeguard health, protect incomes and jobs, support credit, and buttress the recovery.
  - Central Bank of Chile (BCCh) undertook monetary stimulus and unconventional measures supporting liquidity.
  - Financial sector policies adjusted to facilitate flow of credit, especially to households and SMEs.
  - International reserves were about US$3 billion higher at end-2020 than at the time of the FCL approval.
  - In January 2021, the BCCh initiated a program to gradually increase FX reserves by US$12 billion over 15 months.
- Exchange rate and prices:
  - NEER depreciated by over 7 percent in 2019Q4 relative to the first three quarters of 2019, and by an additional 7 percent until end-April 2020; then strengthened resulting in overall appreciation of 2 percent during 2020.
  - REER (CPI-based) appreciated by 3.5 percent in 2020 (yoy December), reversing some of the 10 percent drop in 2019.
  - Exchange rate appreciation continued until April 2021, with copper prices above historical averages.
  - Central Bank let the exchange rate adjust without intervention in 2020.
- Inflation and expectations:
  - Headline inflation peaked close to 4 percent in early-2020, moderated in mid-2020, and rose close to the BCCh’s policy target of 3 percent in the second half of the year.
  - Core inflation remained subdued at 2.6 percent in February 2021—below target.
  - Two-year ahead inflation expectations remain well anchored.
- Financial sector soundness:
  - Capital adequacy ratio is 14.3 percent (banks have capital above regulatory minimum).
  - Non-performing loan ratio is 1.6 percent of total loans in February 2021.
  - Return on equity dropped below 8 percent (from 16.2 percent in 2019Q4) due to higher provisions.
  - Credit growth slowed in 2020 despite government support via FOGAPE guarantees.
  - Credit-to-GDP ratios for non-financial corporations and households are in line with countries of similar development; credit to non-financial corporates relative to GDP is high compared to regional peers but largely FDI-related and hedged against exchange rate risk.
  - Housing market risks mitigated by long-term maturity, low and fixed interest rates, and limited leverage.
- Market resilience:
  - Non-resident portfolio outflows exceeded those from past episodes but have recovered since.
  - Compared to LA5 and other EMs, Chile experienced a smaller increase in spreads and yields on domestic sovereign bonds and exchange rate depreciation was substantial but not among the highest.

### Outlook and Policies
- Growth forecast:
  - Economic activity is expected to grow at 6.5 percent in 2021, supported by vaccination, accommodative policies, relaxation of mobility restrictions, a surge in copper prices, and improved global growth expectations.
  - Over the medium term, growth is expected to gradually converge to potential of 2½ percent.
- External sector:
  - Temporary factors that pushed the current account into surplus in 2020 are expected to dissipate, leaving the current account balance close to zero in 2021 and towards a small deficit over the medium term.
- Fiscal policy and stimulus:
  - Government implementing a multi-year fiscal package of about US$34 billion (13 percent of 2020 GDP, after an additional 2 percent of GDP was announced in March 2021) to safeguard health, protect incomes and jobs, keep funding costs low, support credit, and buttress the recovery.
  - Main elements of the stimulus package include:
    - higher healthcare spending;
    - enhanced subsidies and unemployment benefits;
    - tax deferrals;
    - credit provision for SMEs via Banco Estado;
    - transfers for the most vulnerable and the middle-class;
    - a credit-guarantee scheme for firms (via FOGAPE) and for households;
    - enhanced public investment.
- Pension withdrawals and financial market implications:
  - Two rounds of withdrawals from private pension funds in July and December 2020; a third round approved in April 2021.
  - By early-April 2021:
    - about 10.5 million people used the first withdrawal,
    - 8 million used the second withdrawal,
    - total withdrawals about US$37 billion (or about 15 percent of 2020 GDP, or 19 percent of June 2020 pension assets).
  - Staff estimated the net present value cost from the first two withdrawals at about of 3½ percent of 2020 GDP.
  - After the first two withdrawals, about 3 million people (or ¼ of pension system participants) have exhausted their pension funds.
  - For the third round, US$18 billion in withdrawals are expected, which would exhaust the accounts of a further 2 million people (bringing the total to about 5 million).
  - Impact on liquidity needs of financial markets from the first two rounds was muted, cushioned by BCCh reaction including a facility with cumulative purchases of US$8.5 billion.
- Monetary policy and BCCh measures:
  - Policy rate lowered by 125 basis points in March 2020 to 0.5 percent (considered by the BCCh as the “effective lower bound”).
  - Monetary policy stance is appropriately accommodative; the policy rate is about 350 basis points below the BCCh’s estimates of the neutral nominal interest rate range (3.75 to 4.35 percent).
  - BCCh support measures included:
    - offering FX swaps;
    - introducing funding-for-lending programs (up to US$40 billion);
    - expanding collateral framework (including corporate bonds and the credit guarantee scheme);
    - introducing a bank-bonds purchase program;
    - relaxing the liquidity coverage ratio (ratio remains unchanged but temporary deviations could be tolerated on a case-by-case basis).
  - BCCh negotiated access to the Foreign and International Monetary Authorities Repo Facility.
- Outlook risks:
  - External: evolution and impact of the pandemic.
  - Domestic: uncertain outcome of the New Constitution process.
  - Offsetting factors: rising copper prices, fast vaccination pace, strong policy frameworks, remaining fiscal space.

### Fiscal Measures in Response to COVID-19 (text table excerpt)
- Total size of the stimulus package (percent GDP): 11.3 13.3 12.5 6.1 4.2 2.1

*Prepared by a team comprising Luca Antonio Ricci (head), Metodij Hadzi-Vaskov, Karim Youssef, José Torres, Samuel Pienknagura, Christopher Evans, Chiara Fratto (all WHD), Shakill Hassan (SPR), Junghwan Mok (MCM), and Roberto Schatan (FAD) with support from Ivan Burgara and Adriana Veras (both WHD). Approved By Patricia Alonso-Gamo (WHD) and Gavin Gray (SPR). April 30, 2021.*

### 1. On Budget:8.710.810.05.02.92.0

### 1. On Budget:8.710.810.05.02.92.0

### On-budget measures (announced as of June 2020; revised in March 2021 with outturns for 2020; nets out the effect of tax deferrals)
- Temporary (no effect on end-year deficit): 1.3 1.3 1.3 1.3
  - i. Deferred taxes: 0.5 0.5 0.5 0.5
    - CIT for SMEs 0.2 0.2 0.2 0.2
    - Property taxes 0.3 0.3 0.3 0.3
  - ii. Accelerated pay of liabilities (no affect on the accrual def) 0.8 0.8 0.8 0.8
    - Early CIT refunds for SMEs 0.4 0.4 0.4 0.4
    - Accelerated pay of public procurement obligations 0.4 0.4 0.4 0.4
- Permanent: 7.4 9.5 8.7 3.7 2.9 2.0
  - i. Revenues 2.5 1.6 0.8 1.2 -0.4 0.0
    - Suspension of CIT payments 1.0 0.9 0.3 0.9 -0.5 -0.1
    - VAT delay 0.6 0.2 0.0 0.2 -0.2
    - Reduction of the stamp & seals tax 0.2 0.2 0.2 0.2
    - Reduction CIT rate to 12.5% 0.3 0.0 0.0 0.0 0.0 0.0
    - Instantatenous 100% depreciation 0.4 0.4 0.4 0.0 0.3 0.1
  - ii. Spending 4.9 7.9 7.9 2.5 3.3 2.0
    - Additional Fiscal Resources for health expenditures 0.9 0.6 0.6 0.5 0.1 0.0
    - Other spending 0.0 0.2 0.2 0.1 0.1 0.0
    - Transfers for most vulnerable 1.8 2.9 2.9 1.5 1.3 0.0
    - Middle-class bonus 0.4 0.9 0.9 0.4 0.5 0.0
    - Public investment 1.2 1.2 1.2 0.0 0.4 0.8
    - Employment subsidies 0.6 1.0 1.0 0.0 0.7 0.3
    - Unallocated 0.0 1.1 1.1 0.0 0.2 0.9

### Off-budget (below the line)
- Total off-budget: 2.6 2.5 2.5 1.1 1.3 0.1
  - Injection to the UI Solidarity Fund 0.8 0.0 0.0 0.0 0.0 0.0
  - Banco Estado capitalization 0.2 0.3 0.3 0.1 0.2 0.0
  - Public loan guarantees (FOGAPE), including Fogape Reactiva 1.2 0.8 0.8 0.4 0.3 0.1
  - Solidarity loan for middle class 0.4 1.2 1.2 0.6 0.6 0.0
  - Unallocated 0.0 0.2 0.2 0.0 0.2 0.0

- Notes:
  - 1/ Annouced as of June 2020.
  - 2/ Revised in March 2021 with outturns for 2020.
  - 3/ Nets out the effect of tax deferrals.

### Financial sector and liquidity measures
- The Financial Market Commission (CMF) measures to facilitate the flow of credit include:
  - (i) special treatment in the establishment of provisions for deferred loans (while credit quality exposures remain carefully monitored);
  - (ii) use of mortgage guarantees to safeguard loans for SMEs;
  - (iii) adjustments in the treatment of assets received as payment and margins in derivative transactions;
  - (iv) delay by one year of the implementation of Basel III standards.
- The combination of the BCCh funding-for-lending program, the Ministry of Finance credit-guarantee scheme, and the regulatory requirements from the CMF shows strong coordination of the Ministry of Finance, the BCCh, and the CMF.
- Implementation timelines cited:
  - Regulation related to risk weighted assets and conservation buffer will start in Dec 2021, while the one on systemic charge and capital discounts in Dec 2022.

### BCCh extraordinary measures (selected figures as reported)
- Amount of the Program: 8,514 BCP 5,595 BCU 983 Others 83
- Cumulative Buybacks: 6,662
- 8,000 Inflation Linked Bank Bonds 3,621
- CLP Denominated Bank Bonds 240
- Cumulative Purchases 3,861
- 8,000 Total Bought (Whole Program) 4,785
- BCP 628 BCU 187 Cumulative Buybacks (BCP and BCU) 815
- Inflation Linked Bank Bonds 3,940 CLP Denominated Bank Bonds 30 Cumulative Purchases 3,970
- 10,000 Cumulative Purchases 8,455 Outstanding Amount 2,777
- Purchase of Bank Term Deposits (August 7th, 2020) 8,000 Cumulative Purchases 521
- FCIC 1-LCL (March 30th, 2020-March 30th, 2024) 24,000 Current Usage 25,240
  - 4,800 FCIC Usage 2,140 LCL Usage 3,150 Total Usage, Initial Line 5,290
  - 19,200 FCIC Usage 16,163 LCL Usage 3,786 Total Usage, Initial Line 19,949
- FCIC 2 (July 9th, 2020- July 1st, 2024) 16,000 Current Usage 5,428
- 2/ Bond buybacks are reported with one day of delay; amounts correspond to the total liquidity injection related to the buyback of bonds.
- 3/ Amount of the program dollarized using the average exchange rate of February, while the usage is dollarized using the last observed exchange rate.
- Source: Central Bank of Chile. 1/ Last Updated on March 1, 2021.

### Fiscal outlook, framework, and policy guidance
- Fiscal projections and targets:
  - Headline fiscal deficit expected to decline to 4.1 percent of GDP in 2021 from 7.3 percent in 2020.
  - Structural balance deficit expected to worsen from 2.6 to 6.0 percent of GDP (in 2021).
  - Gross debt expected to increase to 34.6 percent of GDP by end-2021.
  - Authorities plan structural consolidation: reducing the structural deficit by about 2 percent of GDP in 2022 and then 1 percent of GDP per year starting in 2023, to reach a structural deficit target of 0.9 percent of GDP by 2025 (estimated to stabilize gross debt at about 40 percent of GDP).
- Policy priorities:
  - Short term: implement targeted measures to protect health, income, and jobs, especially for the most vulnerable segments of the population.
  - Medium term: adopt permanent revenue and spending measures to finance additional social spending, face fiscal contingencies, and rebuild buffers while preserving debt stability.
  - Consider recommendations from a Commission of Experts (aligned with IMF/OECD joint report) for gradually reducing tax exemptions, deductions, and special regimes; additional measures may include broadening direct taxation, raising green taxes towards international standards, and rationalizing expenditures.
- Fiscal framework enhancements recommended:
  - Complement current rule with a medium-term debt anchor (ideally encompassing a debt ceiling and buffer zone);
  - A formal escape clause for temporary relaxation or suspension of the structural balance target;
  - An adjustment mechanism to offset temporary deviations from targets.
  - The Autonomous Fiscal Council recently issued valuable recommendations.

### Monetary policy and reserves
- Monetary policy stance:
  - Authorities reiterated commitment to inflation targeting with a free-floating exchange rate.
  - Policy rate at the effective lower bound; BCCh kept the policy rate unchanged in its March 2021 monetary policy meeting.
  - BCCh continues unconventional liquidity and credit support measures and intends to allow the peso to fluctuate freely with intervention only limited to address exceptional volatility.
  - BCCh does not envisage the need for any capital flow management measures (CFMs).
- Reserves and adequacy:
  - Ratio of reserves to the Fund’s reserve adequacy metric (ARA) is 85 percent at end-2020; 90 percent on average over the preceding three years.
  - Adding an additional buffer for Chile’s exposure to copper price volatility gives a ratio of reserves to commodity-augmented ARA metric of 74 percent.
  - Reserve coverage of prospective imports is 7 months.
  - Coverage of broad money is 18 percent and of short-term external debt (remaining maturity) is 99 percent.
  - Central government holds about US$22 billion in usable liquid external assets, including US$8.7 billion in the sovereign wealth fund for economic stabilization at end-February 2021 (which, if counted as reserves, correspond to approximately 20 percent of the ARA metric).
  - Banks’ external debt was US$23.8 billion (at end-2020); banks’ foreign assets US$25.8 billion.

### Financial sector soundness and risks
- Staff assessment and risk environment:
  - The emergency measures are facilitating the flow of credit and supporting income, thus preventing a deterioration in credit quality.
  - Stress tests performed by the authorities indicate that financial stability appears well guarded at this juncture.
  - It remains essential to continue monitoring developments closely, stand ready to intervene to avoid disorderly conditions, and encourage financial institutions to continue assessing credit quality carefully and maintain both prudential lending standards and adequate reporting.
  - Implementation of Basel III requirements would improve resilience by requiring banks to maintain larger capital buffers.
  - Authorities should address pending deficiencies in the regulatory framework, including bank resolution, deposit-insurance, insurance companies, financial conglomerates, and FinTech activities; the upcoming 2021 Financial Sector Assessment Program (FSAP) will conduct a detailed analysis of financial stability policies and risks.
- External position and capital flows:
  - Staff assessed current account gap of 1.7 percent of GDP (2020).
  - 2020 current account surplus: 1.4 percent of GDP.
  - Net international investment position (IIP): -14 percent of GDP at end-2019 and improved to -10 percent of GDP during 2020.
  - As of end-2020, gross foreign assets and liabilities were US$431.7 billion and US$456.7 billion, respectively.
  - More than four-fifths of foreign assets (86 percent) and 92 percent of external liabilities are private (as of end-2020).
  - In 2020, gross foreign assets and liabilities and private-sector shares noted above; private sector accounted on average for about 83 percent of total assets and about 94 percent of total IIP liabilities over the preceding three years.
  - Sovereign bond spreads: EMBIG and five-year CDS spreads stood at 128 and 59 bps as of March 25, 2021.
  - Chile maintains uninterrupted access to international capital markets and investment grade status with foreign-currency ratings A1 (Moody’s), A (S&P), and A- (Fitch).

### Evolution of risks and exposures
- Key risk drivers and observations:
  - Uncertainty about near-term global growth and asset prices have subsided since the FCL request but remain significant, with risks related to the pandemic, copper prices, and the New Constitution process.
  - Copper accounts for about half of Chile’s merchandise exports and about 12 percent of GDP.
  - Copper prices fell by about 25 percent in the first three months of 2020 but then recovered vigorously.
  - Downside scenario: prolonged pandemic effects could keep Chile under high external stress for longer, with severe effects on the economy and balance of payments.
  - A renewed spike in global risk aversion would curtail net capital inflows, particularly portfolio inflows, placing pressure on the financial account.

*Source: IMF staff text and tables from the provided content unit.*

### 30.      Reserve accumulation and other sources of external liquidity. In January 2021,

### 1chlea2021003 - 30.      Reserve accumulation and other sources of external liquidity. In January 2021,

### Reserve accumulation and precautionary external liquidity
- The central bank announced and began a program of gradual reserve accumulation in January 2021, anticipating exit from the FCL when it expires in mid-2022.
- Pre-announced purchases:
  - Evenly executed over a fifteen-month period.
  - Will lift reserves by US$12 billion (approximately one quarter of the ARA metric).
  - Daily purchases of US$40 million.
  - Target reserve level: in the vicinity of 18 percent of GDP.
- By mid-April 2021, the central bank had added approximately US$2.8 billion to reserves through sterilized purchases.
- Other precautionary financing sources:
  - Bilateral RMB-CLP currency swap facility with the People’s Bank of China increased from RMB22 billion to RMB50 billion (about US$7 billion) in July 2020; scope expanded beyond supporting bilateral trade transactions.
  - Footnote: original 2015 agreement created a line up to RMB22 billion (about US$3 billion); agreement never drawn upon and resources are not included in Chile’s international reserves.

### Key liquid asset magnitudes (US$ billions)
- Usable Liquid External Assets: 21.8
- Economic and Social Stabilization Fund: 8.7
- Pension Reservation Fund: 10.1
- FX-denominated Assets of the Public Treasury: 3.0
- Other Liquid Assets: 3.8
- Peso-denominated Assets of the Public Treasury: 2.5
- Education Fund: 0.2
- Regional Support Fund: 0.7
- Fund for High-Cost Diseases: 0.4
- Total: 25.7

### Sustainable public debt position and fiscal policy
- Fiscal rule operationalized via annual structural deficit targets.
- Authorities committed to bringing the structural deficit to 0.9 percent of GDP by 2025 through additional revenue and expenditure measures if necessary.
- Staff calculations: envisaged medium-term fiscal consolidation would stabilize the debt ratio at about 42 percent of GDP.
- Debt sustainability analysis: debt trajectory robust to standard shocks (growth, exchange rate, interest rates).
- Contributing factors to sustainability:
  - Low debt levels.
  - Adequate reserves and significant buffers.
  - Sound macro-fundamentals and strong policy track record.
  - Large domestic banking sector able to absorb issuance in case of external financing disruptions.
  - Substantial fiscal buffers including a sovereign wealth fund and other assets.

### Monetary and exchange rate framework, inflation
- Exchange rate regime: free-floating.
- Inflation targeting since 1999:
  - BCCh maintained inflation around the 3 percent target since 1999 (with an average of 3.2 percent).
  - Inflation expectations at the 12-month horizon firmly anchored over the past 10 years.
  - Exchange rate pass-through to domestic prices among the lowest in the region due to high credibility.
- BCCh financial position and governance:
  - BCCh has had a small and negative equity for a long time; this has not compromised policy solvency and does not require immediate recapitalization.
  - Independence is well-established.
  - BCCh voluntarily underwent an independent external evaluation; expert panel highlighted high standards of policy analysis, conduct, and independence.
  - BCCh is undergoing a pilot review of its transparency system under the new IMF Central Bank Transparency Code; monetary policy transparency ranked high among inflation-targeting regimes.

### Financial system soundness and supervision
- Financial sector assessment:
  - Financial sector appears sound overall.
  - Implementation of the new Basel III standard delayed by one year to confront the pandemic; could result in a temporary decline in the capital adequacy ratio but not a meaningful deterioration in banking sector solvency.
  - Authorities’ stress tests indicate financial stability is well guarded; continued monitoring and readiness to intervene remain essential.
  - Systemic risk from non-financial sector external debt is low (about half is FDI-related; the rest generally hedged).
  - Pension funds are well-supervised and soundly managed.
- Supervision and reforms:
  - 2011 FSAP concluded Chile’s regulatory and supervisory system is robust; 2021 Article IV report found no substantial supervisory concerns.
  - An FSAP update is underway (delayed to 2021 due to COVID-19) and will focus on: financial institutions and interlinkages, reorganization of supervisory arrangements, crisis management, bank resolution arrangements, and deposit insurance need.
  - Restructuring supervisory framework expected to reduce regulatory arbitrage from conglomerate structures.
  - Basel III alignment and new supervisory structure expected to close many gaps; progress needed in early intervention and bank resolution regime.
  - Chile undergoing an assessment against the FATF AML/CFT standard by GAFILAT, which was delayed due to COVID-19 and will include recommendations to strengthen the AML/CFT framework.

### Data transparency and institutional strengths
- Since March 2020 Chile is an adherent to the Fund’s Special Data Dissemination Standard (SDDS) Plus.
- Track record:
  - Sustained track record of strong policy implementation, including during the COVID-19 pandemic.
  - Very strong fiscal and monetary institutional frameworks and high policy credibility and regulatory quality among emerging markets.
  - Strong countercyclical fiscal and monetary responses; reliance on free-floating exchange rate and open capital accounts as shock absorbers.
- Core indicators: staff assessment indicates all relevant core indicators were met in each of the five most recent years.

### Exit strategy for FCL and safeguards
- Exit intentions:
  - Authorities intent on exiting the FCL arrangement at the end of the 24-month period (May 28, 2022), conditional on interim developments.
  - Permanent strategy for medium-term resilience anchored in strong macroeconomic policies, strengthened regulatory environment, and buffers.
  - In preparation for exit, authorities commenced increasing reserves through FX intervention purchases.
- Safeguards:
  - Staff completed safeguards procedures for Chile’s FCL arrangement.
  - BCCh’s external audit and financial reporting reflect leading practices.
  - KPMG Chile issued an unmodified audit opinion on BCCh financial statements for 2019, prepared and audited in accordance with international standards; comprehensive disclosures published on a timely basis.
  - No significant issues emerged from safeguards procedures.

### Staff appraisal and recommendation
- FCL arrangement supported deep and effective policy efforts amid uncertainty and contributed to resilience during the pandemic.
- Chile continues to meet FCL qualification criteria given very strong fundamentals, institutional frameworks, and sustained policy track record.
- Authorities are not requesting a change in access and intend to treat the FCL as precautionary and exit in May 2022.
- Staff recommends completion of the review under the FCL arrangement for Chile.

### External Economic Stress Index (Box 1) — construction and scenarios
- ESI construction steps: (i) identify key external risks based on economy structure; (ii) choose proxies for risks; (iii) weigh them. Index is weighted sum of standardized deviations of each proxy from its mean.
- Main external risks and proxies:
  - Risks to exports: output growth in the U.S. and China (weight 0.15).
  - Risks to copper industry and inward FDI: international copper prices (weight 0.35).
  - Global financial conditions: VXEEM (weight 0.25) and yield on 10-year U.S. Treasuries (detrended) (weight 0.25).
- Weights rationale: reflect balance of payments and international investment position data expressed in shares of GDP and normalized.
- Baseline and adverse scenarios:
  - Baseline uses WEO projections for U.S. and Chinese growth, copper prices, and U.S. 10-year bond yield; VXEEM assumed to return to its average level.
  - Adverse scenario assumes prolonged pandemic, lower copper prices, and another spike in global risk aversion: copper prices assumed to fall towards approximately $3,200 per ton (equivalent to about 160 cents per pound); VXEEM moves up by two standard deviations.
  - Adverse scenario consequence: Chile would remain under significant external stress through 2021, with pressure abating gradually in 2022.
- Export shares: China and the U.S. account (directly) for 32 and 14 percent, respectively, of Chile’s total exports in 2019.

*Source: IMF staff report (Chapter excerpt: Reserve accumulation and other sources of external liquidity; FCL-related sections, tables, and Box 1 as supplied).*

### Annex I. Public Debt Sustainability  Analysis

### Annex I. Public Debt Sustainability  Analysis

### Overview and Key Conclusions
- Debt in Chile is sustainable with a high probability, conditional on implementation of the authorities' medium-term structural fiscal consolidation.
- The authorities remain committed to a medium-term structural fiscal consolidation to provide space for necessary short-run stimulus while stabilizing the debt ratio in the medium run.
- If the structural consolidation is implemented, the debt would still stabilize under plausible shock scenarios.
- The authorities continually manage state-contingent debts and publish details in an annual report.
- Withdrawals from private pensions and the expansion of credit guarantees (FOGAPE) are expected to result in modest fiscal costs in the medium term.

### Baseline Projections (selected indicators)
- Real GDP growth (in percent): 2021 = 6.5; 2022 = 3.7; 2023 = 2.7; 2024 = 2.6; 2025 = 2.5; 2026 = 2.5.
- Inflation (GDP deflator, in percent): 2021 = 4.3; 2022 = 2.7; 2023 = 2.4; 2024 = 2.3; 2025 = 2.4; 2026 = 2.6.
- Primary Balance (in percent of GDP): 2021 = -3.5; 2022 = -2.5; 2023 = -1.6; 2024 = -0.8; 2025 = -0.2; 2026 = -0.1.
- Effective interest rate (in percent): 2021 = 3.7; 2022 = 3.4; 2023 = 3.4; 2024 = 3.4; 2025 = 3.4; 2026 = 3.4.
- Public gross financing needs (selected years, in percent of GDP): 2019 = 3.0; 2020 = 5.0; 2021 = 11.9; 2022 = 6.0; 2023 = 3.2; 2024 = 3.6; 2025 = 1.5; 2026 = 4.0 (table shows additional year values as well).
- Gross debt and fiscal developments (narrative): fiscal deficit = 7.3 ppt of GDP in 2020; gross debt increased to 32.5 ppt of GDP in 2020; Treasury assets declined to 8.3 ppt of GDP. Headline deficit is expected to decline to 3.8 ppt of GDP in 2021. Structural deficit will increase to 5.0 ppt of GDP reflecting accommodative stance. Structural budget planned to return to gradual consolidation to stabilize gross debt around 40 ppt of GDP by 2025.

### Debt Dynamics and Identified Debt-Creating Flows (selected figures)
- Cumulative change in gross public sector debt (percent of GDP, selected): 2019 = 2.2; 2020 = 2.6; 2021 = 4.3; 2022 = 2.0; 2023 = 3.5; 2024 = 2.4; 2025 = 1.1; 2026 = 0.5; cumulative to 2026 = -0.3 (table entries preserved as presented).
- Identified debt-creating flows (percent of GDP, selected): 2019 = 2.0; 2020 = 2.6; 2021 = 3.9; 2022 = 2.2; 2023 = 3.7; 2024 = 2.6; 2025 = 1.3; 2026 = 0.6; cumulative through 2026 = 10.3.
- Primary (noninterest) revenue and grants (percent of GDP): 2019 = 20.9; 2020 = 21.1; 2021 = 19.5; 2022 = 22.8; 2023 = 22.2; 2024 = 22.1; 2025 = 22.5; 2026 = 22.5; cumulative = 134.6.
- Primary (noninterest) expenditure (percent of GDP): 2019 = 21.9; 2020 = 23.6; 2021 = 26.3; 2022 = 26.3; 2023 = 24.7; 2024 = 23.7; 2025 = 23.3; 2026 = 22.6; cumulative = 143.2.
- Automatic debt dynamics (percent of GDP, contribution): 2019 = -0.2; 2020 = 0.5; 2021 = 0.2; 2022 = -2.2; 2023 = -1.0; 2024 = -0.6; 2025 = -0.6; 2026 = -0.6; cumulative = -5.7.
- Other identified debt-creating flows (percent of GDP, selected): 2019 = 1.2; 2020 = -0.4; 2021 = -3.0; 2022 = 0.9; 2023 = 2.2; 2024 = 1.7; 2025 = 1.1; 2026 = 1.1; cumulative = 7.4.
- Net acquisition of financial assets (negative) (percent of GDP): 2019 = 0.7; 2020 = -0.6; 2021 = -3.2; 2022 = 0.7; 2023 = 2.1; 2024 = 1.6; 2025 = 1.1; 2026 = 1.1; cumulative = 6.9.
- Contingent liabilities (percent of GDP): all years reported as 0.0 in the table.

### Alternative Scenarios and Stress Tests
- Alternative scenarios shown: Historical Scenario; Constant Primary Balance Scenario (Primary Balance = -3.5 percent of GDP in all projection years; Effective interest rate in that scenario ranges: 3.7, 3.4, 3.3, 3.3, 3.2, 3.3).
- Macro-Fiscal Stress Tests considered: Primary Balance Shock; Real GDP Growth Shock; Real Interest Rate Shock; Real Exchange Rate Shock; Combined Shock; Contingent Liability Shock.
- Stress-test parameter examples (from scenario tables):
  - Real GDP Growth Shock path (selected): 2021 = 6.5; 2022 = 0.3; 2023 = -0.6; 2024 = 2.6; 2025 = 2.5; 2026 = 2.5.
  - Real Interest Rate Shock: Effective interest rate rises to 3.9 in 2023, 4.4 in 2024, 4.6 in 2025, 5.0 in 2026 in that shock.
  - Combined Shock: Effective interest rate rises to 4.0 in 2022, 4.5 in 2023, 4.7 in 2024, 5.1 in 2025.
- Stress-test outcomes (depicted in figures): under most individual shocks the gross nominal public debt path rises relative to baseline but the heat-map risk assessment indicates vulnerabilities remain manageable under baseline and many shocks (visual assessment shown in figures).

### Fiscal and Policy Context
- Pandemic fiscal response: unprecedented multi-year fiscal package amounting to 13 ppt of GDP.
- Vaccination progress (narrative): as of May 10, 56 percent of the adult population has received at least one dose and 47 percent has been fully vaccinated.
- Growth outlook (narrative projections): Real GDP is projected to grow between 6 to 7 percent in 2021, and 3 to 4 percent in 2022, after contracting 5.8 percent in 2020.
- Monetary and exchange rate policy: inflation has been around 3 percent for last two decades; Central Bank of Chile operates inflation targeting and a free-floating regime; the peso is free floating and acted as a shock absorber in 2020.
- Financial sector: remains liquid, solvent, and well capitalized; measures taken during the pandemic included easing of liquidity coverage ratio, transitory provisioning regimes, capital treatment adjustments for public credit-guarantees, and delay in phasing-in additional capital requirements under Basel III. Phasing-in of new Basel III regulations scheduled for completion in 2025.
- Fiscal framework and reforms: Chile’s fiscal policy guided by a structural rule and sovereign stabilization fund, Fiscal Responsibility Law, and Autonomous Fiscal Council (CFA). Authorities are considering enhancements to the fiscal rule including dual targets on net public debt and structural balance, formal escape clauses, and correction mechanisms.

### FCL (Flexible Credit Line) Access and Exit Strategy (authorities' statement highlights)
- Authorities will maintain FCL access unchanged at this midterm review and treat the FCL as a precautionary and temporary arrangement.
- Conditional on a reduction of global risks, authorities intend to exit the FCL arrangement once the 24-month period is completed.
- Preparations to strengthen external liquidity position include participation in the FIMA Repo Facility of the NY Federal Reserve, a Bilateral Swap Agreement with the People’s Bank of China for three years, and since January implementation of a reserve accumulation program to lift reserves to approximately 18 percent of GDP.
- Authorities remain open to exploring other precautionary sources of international liquidity, including access to the Short-Term Liquidity Line (SLL).
- Authorities appreciate IMF support through the FCL arrangement as a confidence signal and buffer during unprecedented uncertainty.

*Source: IMF staff (Annex I. Public Debt Sustainability Analysis, as presented in the supplied content).*

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_Source: https://www.imf.org/-/media/files/publications/cr/2021/english/1chlea2021003.pdf_