## 1. Constitutional Reform ## Source details **Canonical URL:** [1. Constitutional Reform](https://www.imf.org/-/media/files/publications/cr/2023/english/1chlea2023002.pdf) ## Other formats - [Markdown version](/-/media/files/publications/cr/2023/english/1chlea2023002.pdf.md) - [Structured JSON version](/-/media/files/publications/cr/2023/english/1chlea2023002.pdf.json) --- ### Context - Chile’s economy transitioning toward sustainable growth amid a difficult external environment. - Fast recovery from COVID-19 followed by macroeconomic imbalances: positive output gap, inflationary pressures, and an elevated CA deficit. - Authorities tightened macroeconomic policies to cool the economy, preserve stability, and rebuild buffers. - Constitutional reform process to continue; uncertainty over outcomes has narrowed. - After rejection of a draft constitution in September (record turnout roughly 86 percent; 62 percent rejected), authorities advanced a roadmap for a new reform process (see Box 1). - Broad consensus to amend contentious proposals while preserving Chile’s institutional framework and responding to social demands. ### Recent Developments (relevant to reform and macro context) - FCL arrangement and buffers - IMF Executive Board approved on August 29, 2022 a two-year FCL arrangement of SDR 13.954 billion (800 percent of quota). - Arrangement intended to be precautionary; authorities plan to exit at expiry conditional on favorable developments. - Activity and labor - Growth: 11.7 percent in 2021. - IMACEC slowed from 21.4 percent y/y (mid-2021) to -0.8 percent (October). - Employment rate about 3.5 percentage points below pre-pandemic trends in September. - Current account (CA) - CA deficit: 6.3 percent of GDP in 2021 (from 1.7 percent in 2020). - Projected to narrow to 5.3 percent of GDP in last quarter of 2022. - Inflation - Headline (core excluding food and energy) inflation: 13.3 (9.5) percent in November, down from 14.1 (10.9) percent in August. - Wage bargaining pressures contained; wholesale inflation decelerating. - Financial sector - Chilean longer-term yields in peso-denominated sovereign bonds remained relatively stable; equity index increased relative to LA5 peers. ### Box: Constitutional reform process (summary) - Referendum (September 4): turnout roughly 86 percent; 62 percent rejected draft. - Political agreement (December 12) on new process requiring congressional approval by constitutional amendment: - Congress to appoint 24 experts to draft initial proposal in January. - A 50-member constitutional council to be elected in April 2023 with mandatory voting. - New draft delivered by October 2023; referendum with mandatory voting in November 2023. ### Box: Current Account Developments (key points) - Pension withdrawals and fiscal support - Pension withdrawals equivalent to 20 percent of 2020 GDP contributed to import surge and CA deterioration. - Real goods import growth: 35 percent in 2021 vs 11.7 percent real GDP growth. - Staff estimates pension withdrawals led to transitory CA increase of about 0.8-1.2 percent of GDP in 2021 and about 1.2 percent of GDP Jan–Aug 2022 (assumes marginal propensity to consume 0.5 and import content of consumption 0.33). - Increase in remittances contributed about 0.6 percent of GDP to CA deterioration in 2021. - Ongoing policy tightening projected to deliver fiscal surplus of 1.6 percent of GDP in 2022. ### Outlook and Risks (implications for reform and policy) - Growth and inflation projections - GDP growth: 11.7 percent (2021); projected 2.7 percent (2022); -1.5 percent (2023); return to potential ~2.5 percent medium term. - Inflation projected to converge to target by end-2024 amid a negative output gap given BCCh tightening. - Structural fiscal deficit projected: 11.7 percent of GDP (2021) → 0.7 percent of GDP (2022) → broadly balanced over medium term. - CA deficit: projected 8.7 percent of GDP (2022) then gradually revert to ~3 percent of GDP historical average. - Balance of risks - Tilted to the downside; external risks: abrupt global slowdown/recession, de-anchoring of inflation expectations, commodity price shocks, spillovers from Russia’s war. - Domestic risks: persistent high inflation, social discontent, slow progress on social demands. - Resilience supported by low public debt, ample liquidity buffers (international reserves, FX liquidity lines, sovereign wealth fund assets, FCL), sustainable external position, track record of strong policies, and strong institutions. ### Macroeconomic Policies and Reforms — Key Policy Messages - Monetary policy - BCCh raised policy rate from 0.5 percent (July 2021) to 11.25 percent (October) and kept it at that level in December. - Two-year ahead inflation expectations: 3.5 percent in November (from 4.0 percent peak in August); longer-term expectations anchored at 3 percent target. - BCCh communicated policy rate to remain at current level as long as necessary; further tightening if upside inflation risks prevail. - Effective communication vital to preserve low-inflation credibility. - FX policy and buffers - July–September FX intervention program prevented disorderly conditions; interventions fully sterilized and transparent. - Flexible exchange rate to remain primary shock absorber; FX intervention only in exceptional circumstances. - FX liquidity buffers: about US$40 billion in reserves, US$9 billion in FX liquidity lines, US$18 billion from the FCL. - Recommendation: replenish reserves through accumulation programs when conditions permit. - Fiscal policy - Policy tightening projected to deliver fiscal surplus of 1.6 percent of GDP in 2022 and broadly balanced structural position medium term. - In adverse scenarios, target relief to most vulnerable while allowing automatic stabilizers given fiscal space. - Policy in adverse scenarios - Stagflation with persistently high inflation: maintain relatively tight policies to ensure convergence. - Global recession where inflation abates: ease policies starting with monetary policy, consistent with medium-term fiscal consolidation. - In both scenarios, exchange rate should act as shock absorber. ### Monetary policy stance and outlook (further detail) - BCCh stance considered sufficiently contractionary to ensure convergence of inflation to target. - Acknowledged upside short-run inflation risks and medium-run downside risks from rapid domestic demand contraction. - BCCh ready to alter stance if balance of risks deteriorates. - Staff appraisal: contractionary stance adequate and expected to prevail until inflation pressures abate; further tightening if upside risks materialize. ### Exchange rate policy and external buffers (further detail) - Commitment to flexible exchange rate as shock absorber. - Intention to rebuild reserves when market conditions conducive; FCL to be treated as precautionary. - Liquidity lines comprise: - bilateral swap with PBOC: US$8 billion; - liquidity line with FLAR: US$1.25 billion; - subscription to FED’s FIMA repo facility; - new swap with BIS for about US$3.7 billion (amount to be confirmed upon effectiveness in 2023). - Gross international reserves corresponded to 72 percent of IMF EMs adequacy metric at end-November. ### Safeguarding financial sector stability - Banking sector soundness indicators (September): - Capital adequacy ratio: 15.1 percent. - Liquid assets: about 20 percent of total assets. - NPL ratios: 1.5 percent. - Profitability returned to pre-pandemic levels. - Pockets of vulnerability: low-income indebted households, smaller firms, sectors hit by pandemic and higher costs. - Concentration risk: loans to real estate developers and construction account for 26 percent of commercial loans. - Pandemic-era liquidity measures: - US$42 billion temporary funding-for-lending facilities (FCIC) expire in March and June 2024. - FCIC accounts for about 8 percent of banks' liabilities. - Authorities intend to ensure adequate bank liquidity and provisions, tighten monitoring of real estate and construction lending, and maintain prudential standards. - Regulatory progress: BCCh modified haircuts and collateral; adoption of Basel III, review of deposit insurance, consolidated supervision pursued by CMF and BCCh. - AML/CFT and fintech: - Strengthen AML/CFT risk-based supervision of banks and virtual assets service providers; improve customer due diligence and beneficial ownership compliance. - New Fintech Law integrates fintech, crypto-assets, and open finance into regulatory perimeter; CMF empowered to regulate fintech financial services; crypto-assets treated as financial instruments under CMF; stablecoins and payment initiation providers under BCCh. - BCCh advancing CBDC discussions and assessing financial integrity risks related to virtual assets and CBDC. ### Fiscal sustainability while protecting the most vulnerable - 2022 fiscal position - 2022 headline fiscal balance projected: 1.6 percent of GDP (first surplus in over a decade); 2021 deficit was 7.7 percent of GDP. - 2022 headline deficit consistent with budget structural target: 1.7 percent of GDP. - Government replenishments H1 2022: US$6 billion to sovereign wealth fund; US$0.5 billion to pension reserve fund. - Reallocated spending to mitigate high energy and food prices, support employment in lagging sectors, and targeted household transfers. - 2023 Budget and staff assessment - Budget envisages higher mandated spending on universal guaranteed pensions (PGU), other social areas, and higher public investment. - Staff estimates fiscal stance would be expansionary with stimulus of about 0.5 percent of GDP (change in non-mining structural primary fiscal balance) while inflation and CA remain elevated. - Recommendation: save stronger-than-projected revenues and wait to disburse unallocated funds to aim for broadly neutral fiscal stance while continuing targeted support. - Medium-term consolidation - Fiscal effort required: about 3 percent of GDP in next five years with targeted protection of vulnerable groups. - PGU approved in March entails additional spending of about 0.8 percent of GDP per year. - Draft pension reform expansion would cost extra 0.4 percent of GDP per year. - Staff assesses public debt would remain sustainable with high probability, stabilizing somewhat below authorities’ prudent ceiling of 45 percent of GDP. ### Chile: Staff's Baseline Fiscal Projections (percent of GDP) - 2022 revenues: 25.6; 2023 revenues: 22.2 - Non-mining tax revenues: 19.1 (2022) and 17.4 (2023) - Income on assets: 1.5 (2022) and 0.8 (2023) - Expenditure: 24.0 (2022) and 24.6 (2023) - Transfers and grants: 9.5 (2022) and 9.1 (2023) - Social benefits, inc. PGU: 4.0 (2022) and 4.6 (2023) - Public investment: 1.4 (2022) and 1.7 (2023) - Headline Fiscal Balance: 1.6 (2022) and -2.4 (2023) - Structural Non-Mining Primary Balance: -2.6 (2022) and -3.1 (2023) - Fiscal framework enhancements: improved structural balance rule parameters, medium-term fiscal path, prudent debt ceiling, disclosure of sensitivity to macro shocks; consideration of explicit escape clause and natural disaster fund. ### Advancing structural reforms - Priorities: ambitious tax and pension reforms, climate agenda, deepening capital markets, boosting productivity. - Tax reform (June unveiling) - Objectives: raise revenues for social services, increase progressivity, simplify compliance, reduce aggressive tax planning, foster green economy. - Personal income tax: reinforces weak pillar but exemption threshold remains high; low/middle brackets’ rates modest by international standards. - Staff cautions yields from tax administration and wealth tax may be difficult to realize; recommendation to condition spending reforms on revenue performance and medium-term consolidation. - Pension reform - System issues: low replacement rates due to low contribution rates/density, declining returns, rising life expectancy. - PGU introduced March, financed with general revenues, virtually eliminated old-age poverty at sizable fiscal cost. - Draft reform (November) proposes further PGU expansion contingent on tax reform approval, overhaul of private pillar, new contributory social security pillar. - Concerns: retirement age (65/60 men/women) lags life expectancy; risks include increased redistribution spending, higher cost of formal labor, weaker savings incentives, uneven playing field among investment managers. - Recommendation: avoid new pension withdrawals. - Capital markets deepening - Chile has deep capital markets; APFs critical. - Pension withdrawals and AFP uncertainty hurt market depth and liquidity. - Authorities plan to establish a repo market, develop primary dealer system, promote fintech, and foster internalization of the peso. - Climate policy - Framework Law on Climate Change published June; decommission coal-fired plants by 2040; carbon neutrality by 2050. - Current carbon tax: US$5/tCO2e. - CPAT simulations: - Gradual carbon price increase to US$60/tCO2e by 2030 coupled with higher diesel excises needed to reach NDC goals. - US$150/tCO2e would keep Chile on track to net-zero. - Carbon pricing proceeds (up to 2 percent of GDP) could be recycled for targeted transfers and public investment to offset impacts and boost potential growth. ### Authorities’ views (summary) - Affirmed commitment to flexible exchange rate, prudent FCL use, and rebuilding reserves when feasible. - Proactive adoption of FSAP recommendations, engagement with fintech, and monitoring pockets of vulnerability. - Commitment to medium-term fiscal consolidation, conservative 2023 revenue projections, and cautious spending until permanent revenues secured. - Structural reforms seen as central to inclusion, inequality reduction, and climate action; proceed cautiously with spending until revenues secured. ### Exchange rate policy and external buffers (additional findings) - FX intervention program reduced FX volatility and prevented disorderly conditions. - Gross international reserves declined in 2022. - Net IIP deteriorated since end-2021 to -15.8 percent of annualized GDP in 2022Q3. - External demand grew 2.2 percent in 2022Q3. - Policy recommendation: use FX interventions only in exceptional circumstances; implement substantial reserve accumulation when conditions permit. ### Financial sector resilience and supervision (additional findings) - Financial sector resilient; banking sound with adequate funding, profitability, low impairments. - Adoption of Basel III, consolidated supervision, FSAP follow-up, and AML/CFT strengthening support resilience. - Policy recommendation: closely monitor pockets of vulnerability amid tightening conditions. ### Fiscal performance and consolidation (additional findings and recommendations) - 2022 headline fiscal balance projected to be first surplus in over a decade; 2023 Budget expansionary amid negative output gap. - Authorities committed to consolidation of about 3 percent of GDP over next five years and to keep gross public debt below 45 percent of GDP. - Policy recommendations: save revenue overperformance, disburse unallocated funds cautiously, continue targeted support, and maintain multi-year consolidation path. ### External sector and current account (selected projections and levels) - Current account (percent of GDP): -5.2 (2019); -1.7 (2020); -6.3 (2021); -8.7 (2022); projected -4.9 (2023); -4.1 (2024); -3.5 (2025); -3.3 (2026); -3.1 (2027); -3.0 (2028). - Current account (USD billions): -14.4 (2019); -4.3 (2020); -20.1 (2021); -26.5 (2022); projected -16.3 (2023); -14.5 (2024); -12.6 (2025); -12.5 (2026); -12.2 (2027); -12.7 (2028). - Exports (USD billions): 68.8 (2019); 74.0 (2020); 94.7 (2021); 97.7 (2022); projected 96.5 (2023); 100.2 (2024); 103.8 (2025); 108.0 (2026); 112.4 (2027); 116.7 (2028). - Gross international reserves (USD billions): 40.7 (2019); 39.2 (2020); 51.3 (2021); 39.6 (2022); projected 39.6 (2023–2028). ### Macro outlook and medium-term framework (selected) - Real GDP growth (annual percent): 0.9 (2019); -6.1 (2020); 11.7 (2021); 2.7 (2022); projected -1.5 (2023); 1.9 (2024); 2.1 (2025); 2.2 (2026); 2.5 (2027–2028). - Potential growth (percent): 2.1 (2019); -0.6 (2020); 1.5 (2021); 2.7 (2022); projected 2.7 (2023); 1.7 (2024); 2.0 (2025); 2.2 (2026); 2.5 (2027–2028). - Output gap (percent): 0.0 (2019); -5.5 (2020); 4.0 (2021); 4.0 (2022); projected -0.3 (2023); -0.1 (2024); 0.0 (2025–2028). ### Financial soundness indicators (selected) - Total assets (billions CLP): 203,609 (2015); 211,687 (2016); 220,365 (2017); 246,266 (2018); 290,500 (2019); 323,127 (2020); 351,920 (2021). - Regulatory Capital to RWA (percent): 12.6 (2015); 13.8 (2016); 13.8 (2017); 13.3 (2018); 12.8 (2019); 14.7 (2020); 14.9 (2021). - Return on Equity (percent): 14.7 (2015); 11.5 (2016); 12.4 (2017); 12.5 (2018); 12.4 (2019); 5.6 (2020); 16.6 (2021). - NPLs to Gross Loans (percent): 1.7 (2015); 1.8 (2016); 1.9 (2017); 1.9 (2018); 2.1 (2019); 1.6 (2020); 1.2 (2021). ### Annex highlights (selected) - Annex II (External Sector Assessment): 2021 NIIP: -4.9 percent of GDP; gross assets: 142.6 percent of GDP; gross liabilities: 147.4 percent of GDP; debt liabilities: 75.4 percent of GDP. - Annex III (RAM): External risks such as abrupt global slowdown, commodity price shocks, and war spillovers assessed with likelihood High and impact High; policy advice emphasizes using exchange rate as shock absorber, tightening monetary policy if inflationary pressures build, and targeted fiscal support to vulnerable groups. - Annex VI (2021 FSAP recommendations): Immediate (I) and Near Term (NT) actions across bank solvency/liquidity, supervision, pension funds, insurance, mutual funds, crisis management, systemic liquidity, macroprudential frameworks, and AML/CFT. - Annex IX (Tax Reform Proposal): Revised net gains to 3.5 percent of GDP by 2026 (from 4.1 percent); pillars include PIT changes, new wealth tax (1 percent above US$5 million; 1.8 percent above US$15 million), CIT adjustments, mining royalty adjustments, carbon and corrective taxes, and tax administration measures. - Estimated revenue impacts (percent of GDP) — Total increase in revenues: 0.6 (2023); 1.8 (2024); 3.0 (2025); 3.8 (2026). Net increase in revenues: 0.6 (2023); 1.4 (2024); 2.7 (2025); 3.5 (2026). *Source: IMF staff report for Chile (chapter "1. Constitutional Reform").* ### 1. Constitutional Reform _________________________________________________________________________ 5 ### 1. Constitutional Reform ### Context - Chile’s economy is undergoing a necessary transition towards sustainable growth in a difficult external environment. - Thanks to an effective, sizable, and multi-pronged policy response, the economy recovered very fast from the fallout of the COVID-19 pandemic, but macroeconomic imbalances built up. - Amid a positive output gap, inflationary pressures, and an elevated CA deficit, the authorities adequately tightened macroeconomic policies to cool down the economy, preserve macroeconomic stability, and rebuild buffers. - Policy tightening is taking place against a gloomy and uncertain global outlook. - The constitutional reform process will continue, but uncertainty over possible outcomes has narrowed. - Following the rejection of a draft constitution in a national referendum in September, the authorities are advancing a roadmap for a new reform process (Box 1). - There is broad consensus on the need to amend some of the most contentious proposals of the previous draft, including those entailing substantial changes to the form of government, while preserving Chile’s very strong institutional framework and responding to social demands. Box 1. Chile: Constitutional Reform - On September 4, Chilean voters overwhelmingly rejected a draft constitution proposal. Amid record turnout (roughly 86 percent of the electorate), 62 percent of voters rejected the proposal, a significantly wider margin than the 10 percentage points anticipated by polls. - The constitutional reform process will continue. On December 12, politicians reached an agreement on a new reform process that will need to be approved as a constitutional amendment by both houses of Congress. - Under the agreement, Congress would appoint 24 experts to begin drafting an initial proposal in January. - A new 50-member constitutional council would be elected in April 2023, with mandatory voting and following the election rules of the Senate. - A new draft proposal would be delivered by October 2023, with a referendum with mandatory voting in November 2023. ### Recent Developments (relevant to reform and macro context) - The FCL arrangement augmented precautionary buffers and provides substantial insurance against unusually large global risks. - The IMF Executive Board approved on August 29, 2022, a two-year FCL arrangement in the amount of SDR 13.954 billion (800 percent of quota) to enhance buffers and provide insurance against adverse scenarios. - The authorities intend to treat the arrangement as precautionary and exit at its expiry, conditional on favorable developments in risk scenarios. - Chile qualified for the FCL by virtue of its very strong fundamentals and institutional policy frameworks, sustained track record of implementing very strong policies, and the authorities’ commitment to maintaining very strong policies in the future. - Economic activity is rapidly cooling down to more sustainable levels. - Growth surged to 11.7 percent in 2021, substantially above potential. - The seasonally adjusted monthly activity indicator (IMACEC) slowed from a peak of 21.4 percent y/y in mid-2021 to -0.8 percent in October. - Employment growth plateaued in March, with the employment rate still about 3.5 percentage points below pre-pandemic trends in September. - The current account (CA) deficit remains elevated. - The CA deficit increased to 6.3 percent of GDP in 2021 (from 1.7 percent of GDP in 2020), mostly due to a transitory surge of imported durable goods financed with generous COVID-19 stimulus measures, particularly the exceptional pension fund withdrawals. - The CA deficit is projected to narrow to 5.3 percent of GDP in the last quarter of 2022, on the back of stronger import contraction amid tight macroeconomic policies. - Inflation pressures have been persistent but seem to have peaked. - Headline (core, excluding food and energy) inflation declined to 13.3 (9.5) percent in November, from 14.1 (10.9) percent in August. - Wage bargaining pressures have remained contained, while wholesale inflation is decelerating fast. - Financial sector resilience. - Chile’s financial sector remained resilient despite tighter global financial conditions. Chilean longer-term yields in peso-denominated sovereign bonds have remained relatively stable, while the equity index increased unlike in other LA5 economies. Box 2. Chile: Current Account Developments - The exceptional pension withdrawals played a major role in the transitory deterioration of the CA deficit. - Pension withdrawals of 20 percent of 2020 GDP and sizable fiscal support led to an unprecedented and temporary increase in imports of almost 3 percent of GDP in 2021 relative to pre-pandemic levels. - Real goods import growth surged to 35 percent in 2021, compared to 11.7 percent growth in real GDP. - Based on the increase in households’ disposable income (7 percent of GDP in 2021), as well as the decline in private demand deposits, staff estimates on a conservative basis that pension withdrawals led to a transitory increase of the CA deficit of about 0.8-1.2 percent of GDP in 2021, and of about 1.2 percent of GDP between January and August 2022 (assuming a marginal propensity to consume of 0.5 and an import content of consumption of 0.33). - The large fiscal deficit also weighed on the CA deficit in 2021, but ongoing policy tightening is projected to deliver a fiscal surplus of 1.6 percent of GDP in 2022. - An increase in remittances, including due to pension withdrawals, also contributed to a deterioration of the current account of about 0.6 percent of GDP in 2021 relative to the pre-pandemic average. ### Outlook and Risks (implications for reform and policy) - Growth and inflation projections - GDP growth is projected to slow from 11.7 percent in 2021, to 2.7 percent in 2022 and -1.5 percent in 2023, before returning to an estimated potential rate of 2.5 percent over the medium term. - Inflation is projected to converge to target by end-2024 amid a negative output gap, given the BCCh’s decisive monetary tightening. - The structural fiscal deficit is projected to decline from 11.7 percent of GDP in 2021 to 0.7 percent of GDP in 2022 and broadly balanced over the medium term. - The CA deficit in 2022 is projected to remain elevated at 8.7 percent of GDP but gradually revert to historical averages of about 3 percent of GDP. - Balance of risks - The balance of risks is tilted to the downside, but very strong fundamentals and policies underpin Chile’s resilience. - External risks include: abrupt global slowdown or recession with a spike in global risk premia and commodity price volatility; possible de-anchoring of inflation expectations in major economies alongside further tightening of global financial conditions; commodity price shocks; or intensification of spillovers from Russia’s war in Ukraine. - Domestic risks include: high inflation persisting for longer than expected, social discontent over high food and energy prices, or slow progress to meet social demands. - The constitutional reform process is expected to continue but uncertainty over possible outcomes has narrowed. - Low public debt, ample liquidity buffers (international reserves, FX liquidity lines, assets in sovereign wealth funds, and the FCL), a sustainable external position, a sustained track record of very strong policies, and very strong institutional policy frameworks support Chile’s resilience. ### Macroeconomic Policies and Reforms — Key Policy Messages - Monetary policy - The BCCh’s monetary policy response has been forceful and fully in line with the inflation targeting framework. - The BCCh raised the policy rate from 0.5 percent in July 2021 to 11.25 percent in October and kept it at that level in December. - Two-year ahead inflation expectations edged down to 3.5 percent in November (from a peak of 4.0 percent in August), while longer-term inflation expectations have remained anchored at the 3 percent target. - The BCCh communicated that the policy rate will remain at its current level for as long as necessary to ensure inflation converges to target over the policy horizon. - If upside risks to inflation prevail, further tightening would be needed despite short-term output costs. - Effective communication is key to preserving long-term gains of low inflation and well-anchored expectations. - FX policy and buffers - The FX intervention program from mid-July to end-September succeeded in preventing disorderly market conditions and reduced unusually high FX volatility; interventions were fully sterilized and implemented with high transparency. - The flexible exchange rate should continue to play its role as a shock absorber; FX intervention should be used only in exceptional circumstances to prevent disorderly market conditions. - The BCCh’s FX liquidity buffers comprise about US$40 billion in reserves, US$9 billion in FX liquidity lines, and US$18 billion from the FCL. - When market conditions are conducive, a substantial reserve accumulation program would be advisable to replenish buffers. - Fiscal policy - Ongoing policy tightening is projected to deliver a fiscal surplus of 1.6 percent of GDP in 2022 and a broadly balanced structural fiscal position over the medium term. - In adverse scenarios, fiscal policy should target relief to the most vulnerable while allowing automatic stabilizers to operate given existing fiscal space. - Policy in adverse scenarios - In a stagflation global scenario with persistently high inflation, macroeconomic policies would need to remain relatively tight to ensure convergence of inflation to target. - In a global recession scenario where inflationary pressures abate, macroeconomic policies could be eased, starting with monetary policy given its ability to adjust rapidly and consistent with medium-term structural fiscal consolidation goals. - In both scenarios, the exchange rate should continue to act as a shock absorber. *Source: IMF staff report for Chile (chapter "1. Constitutional Reform").* ### 17. The BCCh considered the monetary stance to be sufficiently contractionary to ### 17. The BCCh considered the monetary stance to be sufficiently contractionary to ### Monetary policy stance and outlook - The BCCh considered the monetary stance to be sufficiently contractionary to ensure the convergence of inflation to target over the policy horizon. - The BCCh acknowledged upside risks to inflation in the short run and downside risks over the medium run as they expect domestic demand to contract rapidly. - The BCCh stressed vigilance to risks to the macroeconomic scenario and readiness to alter policy stance if the balance of risks deteriorates or shocks materialize. - Staff appraisal: the contractionary monetary stance is adequate and expected to prevail until inflationary pressures have firmly abated; if upside risks to inflation prevail, further tightening would be needed. ### Exchange rate policy and external buffers - Authorities remain strongly committed to the flexible exchange rate; exchange rate flexibility is viewed as a critical shock absorber. - Intention to rebuild reserve buffers when market conditions are conducive; the FCL is to be treated as precautionary. - Liquidity lines comprise: - bilateral swap facility with the PBOC (US$8 billion); - liquidity line with FLAR (US$1.25 billion); - subscription to the FED’s FIMA repo facility; - a new swap line with the BIS for about US$3.7 billion (precise amount to be confirmed upon effectiveness in 2023). - Gross international reserves corresponded to 72 percent of the IMF’s Emerging Markets (EMs) adequacy metric at end-November. ### Safeguarding financial sector stability - Banking sector soundness indicators: - banks’ capital adequacy ratio stood at 15.1 percent in September; - liquid assets accounted for about 20 percent of total assets; - NPL ratios were 1.5 percent in September; - profitability has returned to pre-pandemic levels. - Pockets of vulnerability: low-income indebted households, smaller firms, sectors more affected by the pandemic and higher costs. - Concentration risks: loans to real estate developers and the construction sector account for 26 percent of commercial loans. - Pandemic-era liquidity measures and transition risks: - US$42 billion temporary funding-for-lending facilities (FCIC) for banks will expire in March and June 2024; - the FCIC accounts for about 8 percent of banks' liabilities. - Authorities intend to ensure banks hold adequate liquidity and provisions, tighten monitoring of real estate and construction lending, and maintain prudential lending standards. - Regulatory and supervisory progress: - BCCh modified haircuts and collateral requirements; - adoption of Basel III, review of deposit insurance, and implementation of consolidated supervision pursued by the Financial Market Commission (CMF) and BCCh; - further follow-up on FSAP recommendations includes implementing a risk-based capital framework in insurance companies and strengthening the mutual fund liquidity management framework. - AML/CFT and fintech: - efforts to strengthen AML/CFT framework in line with the Mutual Evaluation Report recommendations; enhance AML/CFT risk-based supervision of banks and virtual assets service providers; improve compliance with customer due diligence and beneficial ownership. - New Fintech Law brings fintech activities, crypto-assets, and open finance into regulatory perimeter; CMF empowered to regulate fintech financial services; crypto-assets considered financial instruments subject to CMF regulation; stablecoins and payment initiation service providers subject to BCCh regulation. - BCCh advancing discussions on Central Bank Digital Currency (CBDC) and assessing financial integrity risks related to virtual assets and CBDC. ### Fiscal sustainability while protecting the most vulnerable - 2022 fiscal position: - 2022 headline fiscal balance projected to improve to 1.6 percent of GDP (first surplus in over a decade); - 2021 deficit was 7.7 percent of GDP; - 2022 headline deficit consistent with budget’s structural target was 1.7 percent of GDP. - Fiscal adjustments in 2022 were driven half by removal of COVID-19 stimulus measures and half by revenue overperformance (supported by high yields from January 2020 tax reform and one-off factors). - Government replenishments in first half of 2022: - US$6 billion to the sovereign wealth fund; - US$0.5 billion to the pension reserve fund. - Reallocated spending to support vulnerable groups included measures to mitigate high energy and food prices, employment subsidies in lagging sectors, and targeted transfers to households. - 2023 Budget and staff assessment: - Budget envisages higher mandated spending on universal guaranteed pensions (PGU) and other social areas, higher public investment; - staff estimates fiscal stance would be expansionary with stimulus of about 0.5 percent of GDP (measured as the change in the non-mining structural primary fiscal balance) while inflation and the CA remain elevated; - recommendation: save any stronger than projected revenues and wait to disburse unallocated funds to aim for a broadly neutral fiscal stance while continuing targeted support for vulnerable households. - Medium-term fiscal consolidation: - Delivering on authorities’ plan requires a fiscal effort of about 3 percent of GDP in the next five years, accompanied by targeted measures to protect the most vulnerable. - The PGU approved in March entails additional spending of about 0.8 percent of GDP per year. - Expansion proposed in the draft pension reform would cost an extra 0.4 percent of GDP per year. - Staff assesses public debt would remain sustainable with high probability, with the debt ratio stabilizing somewhat below the authorities’ prudent ceiling of 45 percent of GDP. - Chile: Staff's Baseline Fiscal Projections (In percent of GDP): - 2022 revenues: 25.6; 2023 revenues: 22.2 - Of which: Non-mining tax revenues 19.1 (2022) and 17.4 (2023) - Income on assets 1.5 (2022) and 0.8 (2023) - Expenditure 24.0 (2022) and 24.6 (2023) - Of which: Transfers and grants 9.5 (2022) and 9.1 (2023) - Social benefits, inc. PGU 4.0 (2022) and 4.6 (2023) - Public investment 1.4 (2022) and 1.7 (2023) - Headline Fiscal Balance 1.6 (2022) and -2.4 (2023) - Structural Non-Mining Primary Balance -2.6 (2022) and -3.1 (2023) - Fiscal framework enhancements: improved structural balance rule parameters, medium-term fiscal path, prudent debt ceiling, disclosure of sensitivity of fiscal projections to macroeconomic shocks; consideration of explicit escape clause and natural disaster fund. ### Advancing structural reforms - Reform priorities: ambitious tax and pension reforms, advancing climate agenda, deepening capital markets, and boosting productivity. - Tax reform: - Unveiled in June; aims to raise revenues for social services expansion, increase progressivity, simplify and lower compliance costs, reduce aggressive tax planning incentives, and foster a green economy. - The personal income tax reform would reinforce a weak pillar but exemption threshold remains high and tax rates for low and middle brackets modest by international standards. - Cross-country experience suggests yields from tax administration and the wealth tax could be difficult to realize. - Recommendation: spending reforms should advance conditional on revenue performance and medium-term fiscal consolidation goals. - Pension reform: - Chile’s pension system has low replacement rates due to low contribution rates, low contribution density, declining returns, and rising life expectancy. - PGU introduced in March, financed with general tax revenues, virtually eliminated risks of old-age poverty at a sizable fiscal cost. - Draft reform (presented in November) proposes further expansion of PGU contingent on tax reform approval, overhaul of private capitalization pillar, and introduction of a new contributory social security pillar. - Concerns: retirement age (65/60 men/women) would continue to lag life expectancy; risks include increased redistribution spending needing sustainable finance, higher cost of formal labor, weaker incentives to save, and uneven playing field among public and private investment managers. - Recommendation: new pension withdrawals should be avoided. - Capital markets deepening: - Chile has deep and sophisticated capital markets among EMs; APFs play a critical role. - Pension withdrawals and uncertainty about AFPs have hurt depth and liquidity of domestic capital market. - Authorities plan to establish a repo market, develop a primary dealer system, promote fintech, and foster internalization of the Chilean peso. - Climate policy: - Framework Law on Climate Change published in June. - Chile committed to decommissioning coal-fired power plants by 2040 and achieving carbon neutrality by 2050. - Current carbon tax rate remains low at US$5/tCO2e. - CPAT simulations suggest: - a gradual increase in carbon price to US$60/tCO2e by 2030, coupled with higher excises for diesel, would be needed to reach NDC goals; - US$150/tCO2e would keep Chile on track to net-zero. - Proceeds from carbon pricing (of up to 2 percent of GDP) could be recycled for targeted transfers and public investment to offset impacts on vulnerable households and boost potential growth. ### Authorities’ views (summary) - Authorities affirmed commitment to flexible exchange rate, prudent use of FCL, and rebuilding reserves when feasible. - Emphasized proactiveness in adopting FSAP recommendations, keeping pace with fintech, and monitoring nascent pockets of vulnerability. - Stressed commitment to medium-term fiscal consolidation plan, conservative revenue projections in 2023 Budget, and cautious approach to spending until permanent revenues are secured. - See structural reforms as central to fostering inclusion, tackling inequality, and countering climate change; agreed to proceed cautiously with spending commitments until permanent revenues are secured. *Source: IMF staff report chapter on Chile (as provided).* ### 38. The flexible exchange rate continues to play its role as a shock absorber, while a ### 38. The flexible exchange rate continues to play its role as a shock absorber, while a ### Exchange rate policy and external buffers - Findings: - The FX intervention program reduced FX volatility, restored price formation signals, and prevented spillovers from disorderly market conditions. - Exchange rate flexibility remains instrumental to absorb shocks as monetary policy rates in major economies continue to rise and global financial conditions tighten. - Gross international reserves declined in 2022. - The net IIP has deteriorated since end-2021, reaching -15.8 percent of annualized GDP in 2022Q3. - External demand grew 2.2 percent in 2022Q3. - Policy recommendations: - Use FX interventions only in exceptional circumstances. - When market conditions are conducive, implement a substantial reserve accumulation program to replenish buffers. ### Financial sector resilience and supervision - Findings: - The financial sector remains resilient; the banking sector is sound, with adequate funding and profitability, and low impairments. - Adoption of Basel III standards and consolidated supervision, progress on FSAP recommendations, and efforts to strengthen the AML/CFT framework support resilience. - Policy recommendations: - Closely monitor emerging pockets of vulnerability amid tightening financial conditions to identify early signs of stress and prevent disorderly consequences. ### Fiscal performance and consolidation - Findings: - The 2022 headline fiscal balance is projected to reach the first surplus in over a decade, a significant overperformance compared to the authorities’ pre-announced plan. - The 2023 Budget, amid a negative output gap, is consistent with the authorities’ path and debt sustainability but results in an expansionary fiscal stance. - The authorities committed to fiscal consolidation of about 3 percent of GDP over the next five years. - The authorities aim to achieve a broadly balanced structural fiscal position and keep gross public debt below a prudent ceiling of 45 percent of GDP. - Policy recommendations: - Save any revenue overperformance and wait to disburse unallocated funds to support inflation and external convergence. - Continue to target support to the most vulnerable. - Maintain commitment to the multi-year consolidation path to preserve sustainability. ### Fiscal framework refinements - Findings: - Recent enhancements include parameters in the structural balance rule, adoption of a medium-term fiscal path, introduction of a prudent debt ceiling, and disclosure of sensitivity of fiscal projections to macroeconomic shocks. - An explicit escape clause and a natural disaster fund are under consideration by congress. - Policy recommendations: - Enhance analysis and management of assets and liabilities and of fiscal risks. - Strengthen the supervisory and advisory role of the Autonomous Fiscal Council. ### Tax reform and social spending - Findings: - The tax reform plan is ambitious and comprehensive. - The reform to the personal income tax would reinforce a weak pillar of the system, but the exemption threshold would remain high and tax rates for low and middle brackets modest by international standards. - Expected yields from tax administration measures and the wealth tax could be difficult to realize. - Policy recommendations: - Advance higher social spending only conditional on revenue performance and consistent with medium-term fiscal consolidation goals. ### Pensions and capital markets - Findings: - Tackling inadequate pensions is a priority; the PGU protects vulnerable retirees, but many Chileans still face inadequate pensions. - The reform proposal aims to improve pensions, foster redistribution, and enhance competition, but the retirement age would remain low compared to life expectancy. - Sizable pension withdrawals have hurt the depth and liquidity of the domestic capital market; pension withdrawals reduce aggregate savings and affect long-term financing. - Policy recommendations: - Design and implement pension reform carefully to ensure sustainability, strengthen incentives for labor formalization and savings, and ensure a level playing field among investment managers. - Avoid new pension withdrawals as they would undermine pensions, fiscal sustainability, and capital markets. - Pursue measures to deepen capital markets, including plans to establish a repo market, develop a primary dealer system, promote fintech, and foster the internalization of the Chilean peso. ### Climate policy - Findings: - Chile implemented a carbon tax and is a global leader in issuance of ESG bonds. - Chile committed to decommissioning coal-fired power plants by 2040 and achieve carbon neutrality by 2050. - Policy recommendations: - Gradually increase the carbon price, coupled with higher excises for diesel, to reach NDC goals and stay on track to net-zero. - Recycle proceeds from carbon pricing for targeted transfers and public investment to offset impacts on vulnerable households and boost potential growth. ### Institutional recommendation - Finding: - Staff recommends that the next Article IV consultation take place on the standard 12-month cycle. *International Monetary Fund — Chile: chapter highlights* ### 13.6 percent of GDP in the third quarter of 2022... ### 13.6 percent of GDP in the third quarter of 2022... ### External sector and current account - Current account (percent of GDP): -5.2 (2019), -1.7 (2020), -6.3 (2021), -8.7 (2022), projected -4.9 (2023), -4.1 (2024), -3.5 (2025), -3.3 (2026), -3.1 (2027), -3.0 (2028). - Current account (in billions of U.S. dollars): -14.4 (2019), -4.3 (2020), -20.1 (2021), -26.5 (2022), projected -16.3 (2023), -14.5 (2024), -12.6 (2025), -12.5 (2026), -12.2 (2027), -12.7 (2028). - Trade balance (in billions of USD): 2.9 (2019), 19.0 (2020), 10.7 (2021), 1.9 (2022), projected 7.9 (2023), 10.7 (2024), 13.7 (2025), 15.0 (2026), 16.1 (2027), 17.1 (2028). - Exports (in billions of USD): 68.8 (2019), 74.0 (2020), 94.7 (2021), 97.7 (2022), projected 96.5 (2023), 100.2 (2024), 103.8 (2025), 108.0 (2026), 112.4 (2027), 116.7 (2028). - Copper exports (in billions of USD): 32.7 (2019), 38.3 (2020), 53.3 (2021), 43.3 (2022), projected 41.5 (2023), 43.2 (2024), 44.3 (2025), 45.7 (2026), 47.2 (2027), 48.7 (2028). - Gross international reserves (in billions of USD): 40.7 (2019), 39.2 (2020), 51.3 (2021), 39.6 (2022), projected 39.6 (2023) and thereafter 39.6 (2024–2028). - Financial account balance (percent of GDP): -3.8 (2019), -1.2 (2020), -10.9 (2021), -4.8 (2022), projected -4.9 (2023), -4.1 (2024), -3.5 (2025), -3.3 (2026), -3.1 (2027), -3.0 (2028). - Foreign direct investment (net, percent of GDP): -1.2 (2019), -1.0 (2020), -0.3 (2021), -3.1 (2022), projected -2.2 (2023), -2.1 (2024), -2.2 (2025), -1.9 (2026), -2.2 (2027), -2.1 (2028). ### Financial markets and exchange rate - Domestic equity index: Chile's equity index exceeds its pre-pandemic levels and regional peers (chart note). - Exchange rate behavior: following a large depreciation between June and mid-July the peso has stabilized (chart note). - EMBI and CDS spreads: EMBI spreads and CDS spreads have stabilized at levels somewhat above pre-pandemic levels (chart note). - Domestic currency sovereign bond yields: domestic currency bond yields are consistently below regional peers (chart note). - Selected market indices and spreads use Jan 03, 2020 = 100 and Feb 10, 2020 references in charts (chart note). - Sources for financial market charts: Haver Analytics and Bloomberg LLP. ### Monetary policy, inflation, and wages - Monetary policy rate: the BCCh has quickly raised the policy rate (chart note showing policy rate increases through Nov-22). - Inflation (end of period, percent): 2.9 (2019), 2.9 (2020), 7.1 (2021), 12.5 (2022), projected 5.0 (2023), 3.0 (2024), 3.0 (2025), 3.0 (2026), 3.0 (2027), 3.0 (2028). - Inflation (average, percent): 2.3 (2019), 3.0 (2020), 4.5 (2021), 11.6 (2022), projected 8.2 (2023), 3.7 (2024), 3.0 (2025), 3.0 (2026), 3.0 (2027), 3.0 (2028). - Headline and core inflation: headline and core inflation have edged down from a peak in August (chart note). - Inflation expectations: 1-year and 2-year ahead inflation expectations remain slightly above the inflation target (chart note). - Wages: nominal general wage index and real general wage index show real wages are deteriorating (chart note). ### Financial sector performance and stability - Banking sector profitability: banks' profitability rose to 20.4 percent in December 2021 (text note). - Non-performing loans: non-performing loans have edged up (chart note). - Tier 1 capital ratio: lower than peer countries but above regulatory requirements (chart note). Latest available Tier 1 Capital Ratio shows Chile below Advanced Economies and Emerging Market and Developing Economies median in chart context (chart note). - Credit growth and interest rates: interest rates have risen with monetary tightening; credit growth has moderated, with cited growth rate of 12.6 (text fragment). - Mutual funds: total mutual funds assets fell in 2021, led by medium- and long-term fixed income funds (chart note). - Financial soundness indicators (selected): - Total assets (billions of Chilean pesos): 203,609 (2015), 211,687 (2016), 220,365 (2017), 246,266 (2018), 290,500 (2019), 323,127 (2020), 351,920 (2021). - Regulatory Capital to Risk-Weighted Assets (percent): 12.6 (2015), 13.8 (2016), 13.8 (2017), 13.3 (2018), 12.8 (2019), 14.7 (2020), 14.9 (2021). - Return on Equity (percent): 14.7 (2015), 11.5 (2016), 12.4 (2017), 12.5 (2018), 12.4 (2019), 5.6 (2020), 16.6 (2021). - NPLs to Gross Loans (percent): 1.7 (2015), 1.8 (2016), 1.9 (2017), 1.9 (2018), 2.1 (2019), 1.6 (2020), 1.2 (2021). - FX loans to total loans (percent): 20.0 (2015), 18.2 (2016), 16.6 (2017), 18.4 (2018), 18.9 (2019), 16.1 (2020), 18.3 (2021). ### Fiscal policy and public finances - Central government revenues (percent of GDP): 21.7 (2019), 20.1 (2020), 24.1 (2021), 25.6 (2022), projected 22.2 (2023), 23.0 (2024), 23.1 (2025), 23.2 (2026), 23.2 (2027), 22.9 (2028). - Central government expenditures (percent of GDP): 24.6 (2019), 27.4 (2020), 31.8 (2021), 24.0 (2022), projected 24.6 (2023), 24.9 (2024), 24.0 (2025), 23.1 (2026), 22.9 (2027), 22.6 (2028). - Central government fiscal balance (percent of GDP): -2.9 (2019), -7.3 (2020), -7.7 (2021), 1.6 (2022), projected -2.4 (2023), -1.9 (2024), -0.9 (2025), 0.1 (2026), 0.3 (2027), 0.3 (2028). - Structural fiscal balance (percent of GDP): -1.7 (2019), -1.7 (2020), -11.7 (2021), -0.7 (2022), projected -2.6 (2023), -2.2 (2024), -1.0 (2025), 0.2 (2026), 0.4 (2027), 0.3 (2028). - Gross public debt (general government, percent of GDP): 28.3 (2019), 32.6 (2020), 36.3 (2021), 37.3 (2022), projected 37.7 (2023), 39.9 (2024), 40.9 (2025), 40.9 (2026), 40.8 (2027), 39.5 (2028). - Notes on fiscal stance: the large fiscal stimulus of 2021 has been withdrawn in 2022; government started to replenish buffers; gross-debt-to-GDP remains relatively low by international standards; government continues to borrow at favorable rates (chart and text notes). ### Macro outlook and medium-term framework - Real GDP growth (annual percent): 0.9 (2019), -6.1 (2020), 11.7 (2021), 2.7 (2022), projected -1.5 (2023), 1.9 (2024), 2.1 (2025), 2.2 (2026), 2.5 (2027), 2.5 (2028). - Total domestic demand (annual percent): 0.9 (2019), -9.5 (2020), 21.7 (2021), 2.2 (2022), projected -4.5 (2023), 0.9 (2024), 1.1 (2025), 1.8 (2026), 2.1 (2027), 2.5 (2028). - Potential growth (percent): 2.1 (2019), -0.6 (2020), 1.5 (2021), 2.7 (2022), projected 2.7 (2023), 1.7 (2024), 2.0 (2025), 2.2 (2026), 2.5 (2027), 2.5 (2028). - Output gap (percent): 0.0 (2019), -5.5 (2020), 4.0 (2021), 4.0 (2022), projected -0.3 (2023), -0.1 (2024), 0.0 (2025–2028). ### Indicators of external vulnerabilities and reserves adequacy - Gross international reserves (in billions of USD): 38.6 (2015), 40.5 (2016), 39.0 (2017), 39.9 (2018), 40.7 (2019), 39.2 (2020), 51.3 (2021). - Gross official reserves (percent of GDP): 15.9 (2015), 16.2 (2016), 14.1 (2017), 13.5 (2018), 14.6 (2019), 15.5 (2020), 16.2 (2021). - Total external debt (percent of GDP): 65.4 (2015), 65.7 (2016), 62.5 (2017), 59.4 (2018), 66.7 (2019), 77.9 (2020), 72.4 (2021). - Total external debt to exports of goods and services (percent): 224.6 (2015), 235.9 (2016), 221.1 (2017), 208.7 (2018), 240.4 (2019), 246.8 (2020), 228.0 (2021). ### Selected social and macroeconomic indicators (high-level) - GDP (2021), in billions of pesos: 240. - GDP (2021), in billions of U.S. dollars: 316.8. - Per capita (2021), U.S. dollars: 16,096. - Population (2020), in millions: 19.7. - Poverty rate (2020): 10.80. - Gini coefficient (2017): 44.40. - Main export: Copper. - Key export markets: China, Euro area, U.S. - Labor market: unemployment rate (annual average) 7.2 (2019), 10.7 (2020), 8.8 (2021), 8.1 (2022), projected 8.4 (2023), 8.2 (2024), 7.8 (2025), 7.3 (2026), 7.2 (2027), 7.2 (2028). *Source: 1chlea2023002* ### Annex I. Recommendations of the 2021 Article IV Consultation ### Annex I. Recommendations of the 2021 Article IV Consultation and Authorities’ Actions ### Monetary Policy - Fund recommendation: - Monetary stimulus should remain guided by the inflation targeting framework, contingent on development and risks. - Authorities’ action: - The central bank pro-actively reacted to the buildup of inflationary pressures and raised the policy rate from a low of 0.5 percent in July 2021 to 11.25 percent in October. ### Financial Sector - Fund recommendation: - Financial vulnerabilities should continue to be closely monitored. After the pandemic recedes, the authorities should shift focus towards accelerating needed regulatory reforms. - Authorities’ action: - The authorities are closely monitoring financial sector vulnerabilities, while reinforcing an already sound regulatory framework, including by: - placing under the same umbrella the supervision of insurance, securities, and banks; - advancing the implementation of Basel III standards; - addressing other FSAP recommendations. ### Fiscal Policy - Fund recommendation: - Fiscal policy should progressively shift from supporting an inclusive recovery in the near term to strengthening medium-term sustainability. - Medium-term revenue and expenditure measures will be needed to address rising social demands and rebuild buffers. - Further pension withdrawals should be avoided. Pension reform remains critical. - The credibility of the fiscal framework would benefit from an explicit medium-term anchor with a buffer and a formal escape clause. - Authorities’ action: - The authorities’ structural fiscal consolidation is advancing much faster than planned, while reallocating spending to support the most vulnerable. - An ambitious tax reform aims to finance additional social spending, improve tax progressivity, and foster a green economy. - The authorities also replenished the sovereign wealth fund to pre-pandemic levels. - A proposal for a fourth pension withdrawal was rejected in congress. A draft pension reform proposal was submitted to congress in November. - The authorities introduced a medium-term prudent level of public debt of 45 percent of GDP and a structural fiscal consolidation path consistent with debt below the prudent threshold. They also refined the output gap estimates. ### Structural Reforms - Fund recommendation: - Structural and social reforms should help stimulate investment, confidence, and social convergence in support of inclusive growth. - Authorities’ action: - Following the tax reform proposal, planned reforms of social protection systems aim to complement the PGU approved in 2022, enhance the role of public service provision, and improve quality and access. - The government is also advancing the climate and productivity agenda. *Italic: Annex I. Recommendations of the 2021 Article IV Consultation — content as provided.* ### Annex II. External Sector Assessment ### Overall assessment and context - Overall Assessment: - The external position of Chile in 2021 was moderately weaker than the level implied by fundamentals and desirable policies, driven by exceptional pension withdrawals and fiscal support in the context of the pandemic, which contributed to a large current account (CA) deficit on a temporary basis. - Given the depreciation related to higher domestic uncertainty after 2019, the 2021 REER gap was assessed to be 0- 5 percent. - Potential Policy Responses: - Authorities responded appropriately to the Covid-19 outbreak with effective and multi-pronged fiscal, monetary, and financial support, resulting in a very fast recovery. - Amid a positive output gap, inflationary pressures, and an elevated CA deficit, the authorities adequately tightened macroeconomic policies. - Structural fiscal consolidation advanced significantly faster than planned in 2022. - BCCh began a monetary tightening cycle in July of 2021. - These policies, alongside exchange rate flexibility, are projected to help maintain a sustainable external position. ### Foreign assets and liabilities: position and trajectory - Background: - Chile’s net international investment position (NIIP) improved from -12.0 percent of GDP in 2020 to -4.9 percent of GDP in 2021, as exchange rate depreciation and valuation effects more than offset the large negative financial account balance. - Sectoral NIIP movements in 2021: - Government NIIP deterioration: 5 percent of GDP. - Pension funds NIIP deterioration: 9 percent of GDP. - Non-financial corporations (NFCs) NIIP improvement: about 18 pp of GDP. - External debt stood at 75 percent of GDP at end-2021, of which: - 31 percent of GDP was owed by NFCs, - 18 percent of GDP was in the form of FDI, - 14 percent of GDP was owed by the general government. - The NIIP stood at -14.6 percent of GDP at the end of 2022Q3, as foreign assets fell more than foreign liabilities. - Assessment: - Chile has large gross external liabilities largely offset by gross foreign assets. - FDI and equities represent a significant weight in gross liabilities. - Most sectors have positive net positions: the public sector, pension funds, and other non-bank financial institutions. - Banks and NFCs have negative net positions of about 8.7 and 36.3 percent of GDP, respectively. - About 66 percent of NFC’s liabilities are FDI. - FDI represents 54 percent of gross liabilities. - Regulatory limit: banks’ short FX positions due in thirty days cannot exceed long positions by more than the banks’ capital. - Conclusion: external vulnerability due to the negative NIIP remains limited. - Key 2021 figures (% GDP): - NIIP: -4.9 - Gross Assets: 142.6 - Reserve Assets: 16.2 - Gross Liab.: 147.4 - Debt Liab.: 75.4 ### Current Account - Background: - The CA deficit widened to 6.3 percent of GDP in 2021 (from 1.7 percent of GDP in 2020), driven by a strong rebound in domestic demand supported by sizable fiscal support measures and the exceptional pension fund withdrawals (about 19 percent of 2020 GDP). - The cyclically adjusted CA deficit stood also at 6.3 percent of GDP. - IMF staff projects that the CA deficit will narrow to about 3 percent of GDP over the medium term, supported by continued structural fiscal consolidation and the flexible exchange rate. - Assessment and model adjustments: - EBA model estimates a CA norm of -1.4 percent of GDP, compared to a cyclically adjusted CA of -6.3 percent of GDP. - IMF staff estimates CA adjustments related to COVID-19 at 2.4 percent of GDP, driven by: - higher transportation costs: 1.1 percent of GDP, - changes in household consumption composition: 0.8 percent of GDP, - imports of medical goods: 0.3 percent of GDP, - increased remittances: 0.2 percent of GDP. - CA is also adjusted by -1.5 percent of GDP to account for measurement biases due to inflation and portfolio equity retained earnings. - The resulting adjusted EBA model CA gap is -1.0 percent of GDP. - Methodological revisions to historical data launched in 2021 increased the historical CA deficit by one percent of GDP on average during 2013-20. - Key 2021 CA figures (% of GDP): - Actual CA: -6.3 - Cycl. Adj. CA: -6.3 - EBA CA Norm: -1.4 - EBA CA GAP: -4.9 - COVID-19 Adj.: 2.4 - Other Adj.: 1.5 - Adj. CA gap: -1.0 ### Real Exchange Rate (REER) - Background: - The REER (CPI-based) remained constant in 2021 relative to its 2020 average but 11 percent below its 2010-19 average. - The peso/USD exchange rate depreciated almost 30 percent in 2021 relative to its 2010-19 average. - In July 2022, the REER was at its weakest level in four decades. - Assessment: - The EBA REER index and level models suggest a REER undervaluation of 14.7 and 24.5 percent, respectively. - The EBA CA model implies an overvaluation of 4.5 percent (applying an estimated elasticity of 0.22). - Staff assessed the 2021 REER gap to be between 0-5 percent. - Considering the sharp depreciation of the REER in 2022 (first three quarters on average 8 percent more depreciated than in 2021), staff estimates the REER to be currently undervalued by 0-10 percent. ### Capital and Financial Accounts: flows and policy measures - Background: - Portfolio flows accounted for the bulk of net inflows in 2021 (10 percent of GDP), with general government net debt issuance representing the largest share (80 percent). - Non-residents were net buyers of Chilean assets (gross inflows totaled US$47 billion). - Residents were net buyers of foreign assets (gross outflows totaled US$24 billion), driven by: - FDI investment by NFCs: US$14 billion, - accumulation of reserve assets by the central bank: US$12 billion, - liquidation of foreign assets by pension funds: US$7 billion (offsetting some flows). - Between January and September 2022, net inflows totaled US$24 billion, led by: - decline of international reserves: US$10 billion, - net inflows to NFCs: US$9 billion. - Assessment: - Chile has demonstrated ample capacity to absorb short-term capital flow volatility. - The government has a large stock of liquid assets that limit financial markets risks. ### FX intervention and reserves level - Background: - The peso is floating; FX interventions have been limited to preventing disorderly market conditions. - January 2021: central bank announced a reserve accumulation program of US$12 billion over 15 months to reach 18 percent of GDP; program ended early in October after purchases of US$7.4 billion (about 62 percent of the target). - Stock of gross international reserves: US$51.3 billion at end-2021. - July 2022: BCCh launched an FX intervention program (auctions up to US$10 billion spot, US$10 billion forwards, up to US$5 billion liquidity swaps); by end-September BCCh had sold US$6.2 billion in the spot market and US$10 billion in the forwards’ market. - As of November 2022, reserves stood at US$39.6 billion (decline driven by FX sales, lower banks’ deposits at the BCCh, and valuation effects). - The July FX intervention program was successful in stabilizing FX markets and preventing broader spillovers. - Assessment: - Gross international reserves were 91 and 72 percent of the IMF’s EMs adequacy metric at end-2021 and November 2022, respectively. - Reserve adequacy metrics based on imports, short-term debt, and monetary base vastly exceed thresholds. - Mitigating factors supporting reserve adequacy: - In mature market economies reserves act as a second line of defense; Chile’s reserves more than amply cover estimated potential short-term banks’ needs. In September, banks’ foreign assets amounted to US$32.4 billion, compared with banks’ external debt of US$29.4 billion. - Central government’s usable liquid FX assets (about US$17.0 billion in October, including US$7.1 billion in the sovereign wealth fund and US$6.5 billion in the pension reserve fund) would correspond to approximately 30 percent of the ARA metric if counted as reserves. - Reserves are complemented with several FX liquidity lines totaling US$9.5 billion. - The BCCh is a subscriber of the FED’s FIMA repo facility. - Authorities remain strongly committed to a flexible exchange rate; BCCh is open to considering reserve accumulation programs to replenish buffers when conditions permit. *Italic: Annex II. External Sector Assessment — content as provided.* ### Annex III. Risk Assessment Matrix (RAM) — Selected risks, likelihood, impact, and policy advice - Notes on RAM: - “Low” = probability below 10 percent; “medium” = 10–30 percent; “high” = 30 percent or more. - RAM lists events that could materially alter the outlook and staff’s subjective assessment as of discussions with the authorities. - External Risks - Abrupt global slowdown or recession - Likelihood: High - Impact: High - Policy advice: - In a global recession scenario, use existing policy space to support the economy and protect the most vulnerable, consistent with the inflation targeting framework and fiscal sustainability. - Strength and mix of monetary and fiscal response would depend on Chile's cyclical position and the impact of shocks. - Allow the exchange rate to play its role as shock absorber. - Commodity price shocks - Likelihood: High - Impact: High - Policy advice: - Allow the exchange rate to play its role as shock absorber. - If inflationary pressures build up, extend the tightening cycle within the inflation-targeting framework. - Provide targeted fiscal support to vulnerable groups. - Advance reforms to address social demands. - Intensifying spillovers from Russia’s war on Ukraine - Likelihood: High - Impact: Medium - Policy advice: - If inflationary pressures build up, extend the tightening cycle within the inflation-targeting framework. - Allow the exchange rate to play its role as shock absorber. - Provide targeted fiscal support to vulnerable groups. - Improve diversification on export destination and products, enhance productivity growth. - De-anchoring of inflation expectations and stagflation - Likelihood: Medium - Impact: High - Policy advice: - Extend the tightening cycle and continue communicating a strong commitment to the inflation target. - Allow the exchange rate to play its role as shock absorber. - Use existing fiscal space to provide targeted support to vulnerable groups. - Domestic Risks - Social unrest - Likelihood: Medium - Impact: Medium - Policy advice: - Advance reforms to tackle social demands, anchored on broad political support. - Continue with policies to achieve the inflation target and maintain fiscal sustainability, while providing targeted support to the most vulnerable. - Allow the exchange rate to play its role as shock absorber. *Italic: Annex III. Risk Assessment Matrix — content as provided.* ### Annex IV. Passthrough from Inflation to Inflation Expectations - Context: - Since the second half of 2021, global inflation has persistently surprised on the upside. The distribution of inflation surprises (measured as the difference between monthly realized CPI inflation and analysts’ forecasts) shifted markedly to the left in 2021-2022 in advanced economies (AEs) and emerging market economies (EMs). - Higher inflation also pushed inflation expectations above target in many countries. - Purpose and data: - The annex presents estimates of passthrough from inflation to inflation expectations at different horizons. - Data: quarterly and monthly inflation expectations from the Continuous Consensus Survey and CPI inflation during 2000-2022 for a sample of AEs and EMs. - Estimation approach: - The following equation is estimated with a standard OLS regression: - Δπ̂t(πτ+j) = α + βj Δπt + εt - where Δπ̂t(πτ+j) are changes in inflation expectations at horizon j and Δπt are changes in CPI inflation. - The passthrough, βj, is estimated for each time horizon separately. *Italic: Annex IV. Passthrough from Inflation to Inflation Expectations — content as provided.* ### 3. Short-term passthrough increased recently. The passthrough to short-term inflation ### 3. Short-term passthrough increased recently. The passthrough to short-term inflation expectations increased in 2022, particularly at one year horizon and for EMs. On the other hand, the passthrough to medium-term inflation expectations (three years or more) remained unaffected and close to zero. ### Short-term versus medium-term passthrough: key findings - The passthrough to short-term inflation expectations increased in 2022, particularly at the one-year horizon and for EMs. - Passthrough to medium-term inflation expectations (three years or more) remained unaffected and close to zero. - During 2000-2019 for both AEs and EMs, short-term passthrough was larger in periods of high inflation. - For AEs, passthrough appeared proportional to changes in inflation. - For EMs, large positive changes in inflation were associated with more-than-proportional positive increases in inflation expectations. - In Chile in 2022: - The short-term passthrough was significantly larger than in the past and larger than in other countries. - Likely drivers: inflation surprises impacting an economy with a very strong cyclical position, alongside an increase in inflation persistence. - Chilean medium-term inflation expectations remain tightly centered around the target: - The 75 percent confidence interval for Chile’s medium-term inflation expectations is significantly tighter than in most countries, reflecting a very strong and highly credible institutional policy framework. ### FX intervention programs: objectives and outcomes - Since 1999 (inflation targeting and floating exchange rate), the BCCh intervened in FX markets in four exceptional circumstances. - FX interventions aimed to address disorderly market conditions without targeting any specific exchange rate level; interventions were fully sterilized to ensure consistency with the monetary policy rate. - Interventions were transparently communicated (maximum amounts, periods, auction plans and results). - July-22 intervention program outcomes: - On announcement day (July 14), before FX sales started, FX volatility declined and the peso recovered about half of the 30 percent depreciation between June and mid-July. - After announcement, FX volatility further subsided and bid-ask FX spreads normalized. - Historical episodic outturns (selected): - Aug-01: Up to US$2 billion spot / US$2 billion forward over four months. Outturn: US$803 million spot and US$2 billion forward. - Oct-02: Up to US$2 billion spot / US$2 billion forward until Feb 2003. Outturn: US$1.5 billion, without spot sales. - Nov-19: Up to US$20 billion (split spot/forward). Outturn: US$2.5 billion spot and US$4.5 billion forward over six weeks. - Jul-22: Up to US$20 billion (split spot/forward over three months). Outturn: US$6.2 billion spot and US$10 billion forward. ### Annex VI — 2021 FSAP Key Recommendations (selection with timing) - Bank Solvency and Liquidity - Ensure banks transition to Basel III-compliant capital structures and complete announced capital raises in a timely manner. Near-term (NT) - Improve collateral valuation and reporting framework. NT - Define and communicate clear criteria for unwinding extraordinary liquidity support measures (FCIC and LCL). Immediate (I) - Introduce liquidity stress tests for prudential and stability monitoring. NT - Banking Supervision - Ensure sufficient budget resources to attract and retain specialized talent. I - Strengthen credit risk management and asset classification, including provisioning and treatment of restructured loans. I, NT - Establish an integrated risk management framework and enhance corporate governance standards and supervision. NT - Strengthen legal framework for licensing to ensure banks’ shareholders are fit, proper and financially strong. NT - Improve corrective actions framework. NT - Improve consolidated supervision by enhancing legal framework, practices and organizational arrangements. NT - Pension Funds - Avoid further pension withdrawals and ensure the pension system supports deep and liquid long-term capital markets. I - Improve pension fund regulation and investment options to promote long-term investment and minimize excessive switching. NT - Insurance - Halt any further liquidations of life annuities. I - Implement a modern risk-based capital framework in insurance with due regard to IFRS 17 and IFRS 9. NT - Mutual Funds - Strengthen mutual fund liquidity management framework. NT - Crisis Management and Bank Resolution - Establish a statutory bank resolution authority with a comprehensive range of crisis management and resolution tools. I - Establish and implement recovery and resolution planning and set loss-absorbing capacity requirement for systemically important banks. I - Establish a new industry funded deposit protection scheme. NT - Systemic Liquidity - Facilitate development of the interbank repo market. NT - Enhance the risk management function of the BCCh through higher haircuts and a stricter approach to unsecured bank bonds. I - Finalize the Emergency Liquidity Assistance (ELA) framework. NT - Macro-prudential Framework and Tools - Increase CEF secretariat resources and through annual publication of official CEF views on macroprudential risks. NT - Enhance interagency coordination on the use of the macroprudential toolkit. NT - Establish a consolidated and comprehensive public credit registry. NT - AML/CFT - Ensure a swift implementation of the 2021 AML/CFT MER recommendations. NT (Note: I = Immediate is within one year; NT = Near Term is 1–3 years.) ### Fintech developments and CBDC: implications and policy actions - Fintech contributions to capital markets and financial services: - Alternative funding platforms: crowdfunding, P2P lending, pre-loaded payment platform investments, securitized products collaboration. - Enhancing efficiency: use of alternative data (utility payments, insurance claims, social media) and AI/ML for faster, lower-cost services and innovative investment products. - Facilitating innovation with CBDC: CBDC as a platform (programmable functions) can promote tokenized assets and automated trading via smart contracts. - Chilean regulatory and institutional steps: - Fintech Law (approved in October) brings fintech activities into regulatory perimeter; expected effects: promote competition, enhance financial inclusion and innovation, improve consumer data protection. - CMF to issue regulations on licensing requirements, risk management, data protection, and open finance; CMF to supervise new firms and the open finance ecosystem. - Key elements of the law: - New Financial Activities regulated: crowdfunding, alternative trading systems, custody of financial instruments, credit and investment advice, trading of financial instruments, transaction routing. Fintechs must be authorized and registered by the CMF. - Open Finance: customers can share information with new providers with greater control; information exchange with express consent via remote and automated access interfaces; CMF to regulate operation and implementation. - Cryptoassets and Stablecoins: crypto-assets considered financial instruments subject to CMF regulation; stablecoins considered a payment method subject to BCCh regulation. - BCCh’s CBDC work: - BCCh published an initial report on issuance of a retail CBDC; the report provides a preliminary assessment and calls for careful evaluation of costs and benefits compared to alternative payment systems; BCCh will advance broader discussions with public and private stakeholders. - Benefits cited: - CBDC as a form of retail digital money and a platform for innovative payment services. - Lower barriers to entry into payment markets, promoting competition and innovation. - A CBDC in Chilean pesos could mitigate risks from widespread use of other digital currencies denominated in different units of account. - Challenges cited: - CBDC could weaken banks’ intermediation and increase financial stability risks (e.g., runs to CBDC during stress). - BCCh could face technological and institutional challenges from a closer relationship with the public. - No established international standards or models that have proven to achieve desired objectives. ### Public debt outlook and fiscal projections (selected figures from baseline scenario) - Public debt (percent of GDP), actual and projections: - Actual 2021: 36.3 - 2022: 37.3 - 2023: 37.7 - 2024: 39.9 - 2025: 40.9 - 2026: 40.9 - 2027: 40.9 - 2028: 40.8 - Change in public debt (percent of GDP): - 2021: 3.7 - 2022: 1.0 - 2023: 0.3 - 2024: 2.2 - 2025: 1.0 - 2026: 0.0 - 2027: -0.1 - Contribution of identified flows (percent of GDP): - 2021: 1.9 - 2022: -0.6 - 2023: 0.7 - 2024: 2.0 - 2025: 0.7 - 2026: -0.3 - 2027: -0.4 - Primary deficit (percent of GDP): - 2021: 7.1 - 2022: -1.0 - 2023: 2.0 - 2024: 1.4 - 2025: 0.4 - 2026: -0.6 - 2027: -0.8 - 2028: -0.7 - Noninterest revenues (percent of GDP): - 2021: 23.8 - 2022: 24.1 - 2023: 21.5 - 2024: 22.2 - 2025: 22.4 - 2026: 22.4 - 2027: 22.4 - 2028: 22.1 - Noninterest expenditures (percent of GDP): - 2021: 30.9 - 2022: 23.1 - 2023: 23.5 - 2024: 23.7 - 2025: 22.8 - 2026: 21.8 - 2027: 21.6 - 2028: 21.4 - Automatic debt dynamics (percent of GDP): - 2021: -4.8 - 2022: -2.0 - 2023: -0.7 - 2024: -0.5 - 2025: -0.5 - 2026: -0.5 - 2027: -0.7 - Real interest rate and relative inflation (percent): - 2021: -1.0 - 2022: -1.1 - 2023: -1.3 - 2024: 0.2 - 2025: 0.3 - 2026: 0.3 - 2027: 0.3 - Real GDP growth (percent) (memo): - 2021: 11.7 - 2022: 2.7 - 2023: -1.5 - 2024: 1.9 - 2025: 2.1 - 2026: 2.2 - 2027: 2.5 - Inflation (GDP deflator; percent) (memo): - 2021: 7.5 - 2022: 8.0 - 2023: 9.7 - 2024: 3.4 - 2025: 2.7 - 2026: 2.7 - 2027: 2.8 - 2028: 3.0 - Commentary on baseline: Public debt will rise a bit but then stabilize, reflecting expectations of a narrowing of primary deficits and stable economic conditions. ### Medium-term risk analysis (selected indicators) - Debt fanchart width: 46.3 - Probability of debt not stabilizing (pct): 5.4 - Terminal debt level x institutions index: 15.5 0.3 - Average GFN in baseline: 2.4 0.8 - Bank claims on government (pct bank assets): 6.8 2.2 - Change in claims on government in stress (pct bank assets): 7.0 2.4 - GFN financeability index: 5.4 - Commentary: Debt Fanchart Module points to a moderate level of risk, while the GFN Financeability Module suggests low levels of risk. - Prob. of missed crisis, 2022-2027 (if stress not predicted): 9.1 pct. - Prob. of false alarm, 2022-2027 (if stress predicted): 61.4 pct. *Prepared by Chiara Fratto, based on Adler, Caruso Bloeck, and Fratto (forthcoming).* ### Annex IX. Tax Reform Proposal ### Annex IX. Tax Reform Proposal ### Overview - Following discussions in congress, the government amended some aspects of the tax reform and revised down the estimated net gains to 3.5 percent of GDP by 2026, from 4.1 percent of GDP originally. - The pillars of the reform are broadly unchanged, but new incentives will lower the overall net gains. Key amendments are highlighted in italics in the original text. ### Proposed tax-policy measures - PIT (Personal Income Tax) - Move from semi-integrated income taxation to a dual system, with a new tax on capital income. - Number of tax brackets would increase from 8 to 10, with higher marginal tax rates at higher incomes. - A new tax on retained earnings from firms with a majority of revenues from passive sources would be introduced. - New treatment of deferred accumulated earnings. - New wealth tax - A rate of one percent would apply to global net wealth in excess of US$5 million, increasing to 1.8 percent for net wealth in excess of US$15 million. - The total tax burden, considering both PIT and the wealth tax, will be capped at a level still to be determined. - Corporate income tax (CIT) - Top rate would decline from 27 to 25 percent. - A new 2 percent “development tax” on earnings could be paid with investments in R&D or productivity enhancing measures. - Immediate depreciation and the loss carryforward are expanded. - Adjustments to mining royalties for large-scale copper producers - An additional ad valorem tax at a fixed rate and higher rates on the current profits-based tax would apply. - Carbon and corrective taxes - A higher carbon tax and other green taxes will be introduced. - Tax administration measures - New anti-avoidance rule, a fiscal whistleblower program, more relaxed banking-secret restrictions vis-à-vis the tax authority, and more stringent transfer pricing regulations, among others. - Other measures - More favorable tax treatment for small and medium-sized enterprises, and tax credits for productive and green investments (registered as tax expenditures). ### Estimated revenue impacts (percent of GDP) - Income taxes: 2023: 0.2; 2024: 0.6; 2025: 0.7; 2026: 0.8 - Wealth: 2023: 0.0; 2024: 0.3; 2025: 0.4; 2026: 0.4 - Reduction of exemptions: 2023: 0.0; 2024: 0.0; 2025: 0.0; 2026: 0.2 - Tax administration: 2023: 0.4; 2024: 0.8; 2025: 1.2; 2026: 1.6 - Royalty: 2023: 0.0; 2024: 0.1; 2025: 0.5; 2026: 0.5 - Corrective taxes: 2023: 0.0; 2024: 0.0; 2025: 0.1; 2026: 0.3 - Total increase in revenues: 2023: 0.6; 2024: 1.8; 2025: 3.0; 2026: 3.8 - Tax expenditures: 2023: 0.0; 2024: -0.4; 2025: -0.3; 2026: -0.3 - Net increase in revenues: 2023: 0.6; 2024: 1.4; 2025: 2.7; 2026: 3.5 - Differences with original proposal: 2023: 0.0; 2024: -0.5; 2025: -0.5; 2026: -0.6 ### Cross-country assessment and feasibility - Staff view: the expected gross medium-term yield of 3.8 percent of GDP (before tax expenditures) is ambitious. - Benchmarking: staff looked at the tax to GDP ratio for OECD countries during 1990 – 2019 (pre-pandemic). - There have been 24 country episodes of similar (or larger) increases in tax ratios over a similar period, with the tax ratio increasing substantially (over 1.5 percent of GDP) and in a sustainable manner (lasting at least 4 years). - Out of this sample, only 6 episodes (about one quarter of all cases) had revenue yields above 3 percent point of GDP in four years (or less) from the start of the episode. ### Key findings and policy implications - Net fiscal gain - Revised net increase in revenues is estimated at 3.5 percent of GDP by 2026 (net of tax expenditures). - Ambition and implementation risks - The gross target of 3.8 percent of GDP is ambitious relative to historical OECD experiences; high yields above 3 percentage points of GDP within four years are uncommon. - New incentives, tax expenditures, and caps on total tax burden (PIT plus wealth tax) reduce projected net gains. - Administration and compliance - Strengthening tax administration (anti-avoidance, whistleblower program, relaxed banking secrecy for tax authority, transfer pricing rules) is a core element to realize projected yields. - Distributional and behavioral considerations - Wealth tax design (thresholds and rates) and the cap on total tax burden will affect high-net-wealth taxpayers’ responses. - CIT changes (lower headline rate, development tax paid via investment) and expanded immediate depreciation and loss carryforwards may alter firm investment and profit reporting behavior. - Complementary measures - Effective implementation requires careful calibration of tax expenditures (e.g., credits for productive and green investments) and close monitoring of revenue performance against the ambitious targets. *Sources: Ministry of Finance and IMF staff estimates.* ### 5. Congress advanced discussions on the fiscal reform agenda. The tax reform (presented ### 5. Congress advanced discussions on the fiscal reform agenda. The tax reform (presented in July 2022) made progress in the Finance Committee of the Lower House. The draft mining royalty bill was approved by the Senate’s Mining Committee and will next be discussed by the Senate’s Finance Committee. Proposed refinements to the fiscal framework have been approved by the Lower House and are now under discussion in the Finance Committee of the Senate. ### Statement by Mr. Herrera and Ms. Mostajo Soto on Chile (January 12, 2023) - Authorities thanked staff for open and constructive discussions during the Article IV consultation and welcomed the Staff Report’s assessment and policy advice. - Key policy stance: - Continue advancing structural reforms to achieve a more inclusive, dynamic, and greener economy while maintaining macroeconomic stability and fiscal responsibility. - Remain alert to implement necessary adjustments to policies if needed. ### Economic outlook and near-term dynamics - Post-pandemic recovery and imbalances: - Extraordinary pension fund withdrawals boosted private consumption, creating a sizable positive output gap, inflationary pressures, and an elevated current account deficit. - Growth projections and recent performance: - CBC projects real output to grow around 2.5 percent in 2022. - CBC projects output to contract between -1.75 and -0.75 percent in 2023 reflecting a negative carryover. - CBC projects return to positive growth in 2024, between 2 and 3 percent. - Demand and sectoral developments: - Domestic demand weakened since end-2021; private consumption slowed for almost a year. - Fixed investment remained resilient due to completion of large projects in renewable energy and other sectors but expected to weaken, notably in housing construction. - New home sales saw a sharp decline throughout 2022 amid tighter credit conditions. - Current account and external factors: - Current account deficit expected to decline in the near term in line with adjustments in consumption and investment, reduction in transport costs, and weak real exchange rate. - Risk assessment: - External risks elevated and tilted to the downside; domestic risks assessed as broadly balanced. - Domestic economic uncertainty index (DEPUC) has been declining markedly. - Chilean stock market gained about 20 percent in 2022 while the world's main stock markets experienced heavy losses. ### Monetary policy, exchange rate, and external buffers - Monetary policy actions and stance: - Since mid-2021, CBC increased MPR from 0.5 to 11.25 percent. - CBC stated intention to maintain the MPR at 11.25 percent until convergence process consolidated. - Monetary authority considers current stance tight enough to ensure convergence of inflation to target in the next two years. - Inflation outlook: - Inflation remains high and above the 3 percent target but has moderated recently. - Monetary authority expects headline inflation to continue to decline, converging to 3 percent in the second half of 2024. - Core inflation expected to reach 3 percent at the end of 2024. - Foreign exchange intervention and exchange rate policy: - Temporary, transparent, and fully sterilized FXI program conducted through the third quarter; FXI program ended last September as planned. - Authorities concur with staff that the FXI program successfully stabilized the currency market. - Authorities remain firmly committed to a flexible exchange rate as a key shock absorber. - CBC will assess replenishing external buffers when conditions become appropriate. - Precautionary liquidity: - New FCL arrangement expanded access to precautionary international liquidity; to be treated as precautionary and temporary. ### Fiscal policy, consolidation, and targets - Fiscal framework and objectives: - Multi-year consolidation plan to achieve a structural equilibrium position by 2026 (-0.3 percent of GDP) and keep public debt below 45 percent of GDP. - 2022 fiscal performance: - Government projects overall fiscal position improved to a surplus of 1.6 percent of GDP in 2022 from a deficit of 7.7 percent in 2021. - Structural fiscal balance projected to recover to a surplus of 0.9 percent of GDP from a deficit above 11 percent of GDP. - Both headline and structural balances were significantly stronger than the path established in the Fiscal Responsibility Law. - 2023 budget and public debt path: - 2023 budget establishes a structural fiscal deficit of 2.1 percent of GDP, with expenditures increasing 4.2 percent from 2022 in real terms. - Gross public debt expected to rise to 36 percent of GDP by the end of 2022 and to stabilize around 41 percent of GDP by 2026. - Fiscal rule reforms: - Methodological changes introduced to improve estimates of the output gap and government's structural revenues. - Government sent reforms to the Fiscal Responsibility Law including introduction of an explicit escape clause, a pre-established convergence route for public debt, and a special fund to deal with natural disasters. ### Financial sector policies and regulation - Banking sector soundness: - Banking sector remains liquid, solvent, and well capitalized. - CBC assessment did not reveal systemic vulnerabilities but highlighted high indebtedness of low-income households and financial weakness of certain companies in real estate and construction. - Regulatory reforms and Basel III: - Progress on regulatory reforms aligned with 2021 FSAP recommendations and gradual phase-in of Basel III. - Government submitted bills to Congress to strengthen system resilience, improve consolidated credit registry of personal debt, and grant CMF powers to regulate liquidity buffers of mutual funds. - CBC unwound extraordinary collateral policies from the pandemic, returning to usual framework. - Fintech and digital payments: - Fintech law expands regulatory perimeter; CBC advancing medium-term strategy for digital payments and exploring pros and cons of a CBDC in Chile. ### Structural policies: tax, pension, and climate agendas - Tax reform (presented July 2022): - Includes increases in taxes on personal income and personal wealth, reduction of tax exemptions, administrative measures to deter aggressive tax planning, evasion, and avoidance, and a review of the tax on mining royalties. - Expected to gradually raise revenues by about 3.5 percent of GDP by 2026. - Additional revenues to be allocated to health, education, pensions and caregiving, productive diversification, R&D and innovation, balanced regional development, and ensuring fiscal sustainability under the Fiscal Responsibility Law. - Government estimates tax reform will have net positive effects on real GDP mainly through impact on R&D expenditures. - Authorities acknowledge implementation will be protracted and agree with staff on need to proceed cautiously on new spending commitments until permanent revenues are obtained. - Government expects to submit a new bill in 2023 introducing corrective taxes and other measures to address environmental externalities, including those related to climate change and biodiversity. - Pension reform under discussion in Congress: - Gradually increase retirement contributions from 10 to 16.5 percent of workers' income. - Boost publicly guaranteed minimum pension. - Introduce changes in industrial organization of pension system to increase competition and reduce administrative costs. - Government estimates pension reform will help recover long-term savings base and depth of capital markets diminished by extraordinary pension withdrawals. - Workers' contribution to social security (10.5 percent) and most of the gradual increase in employers' social security contribution (6 percent) will be capitalized and contribute to national savings in the medium term. - Private sector to continue providing investment management services to savings in workers’ individual accounts. ### Climate change policy and constitutional process - Climate and energy transition: - Strong commitment to climate action with significant changes in energy matrix toward hydro, solar, and wind; development of national green hydrogen strategy. - Chile expected to stop depending on imported fossil fuels entirely in a decade. - Published Framework Law on Climate Change and Energy Efficiency Law to reduce emissions by 2 percent per year focused on industrial, mining, and transport sectors. - Updated NDC, committed to reducing methane emissions by 2025, and expanding ecosystem protection by 2030. - Authorities welcome staff’s assessment on carbon pricing and concur that a higher carbon price would contribute to climate goals; calibration should consider complementary tools. - Constitutional process: - After rejection of draft constitution in September referendum, a broad political agreement reached in December to start a new process. - Political agreement includes a new constitutional body with a mix of experts and elected members to draft a new proposal within an agreed framework of basic principles. *Statement by Mr. Herrera and Ms. Mostajo Soto on Chile (January 12, 2023), extracted from the source document.* --- _Source: https://www.imf.org/-/media/files/publications/cr/2023/english/1chlea2023002.pdf_