## _cr04291

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### Executive summary — outlook and key developments
- Real GDP is projected to grow by about 5 percent a year in 2004 and 2005.
- Private investment is gradually increasing.
- Unemployment remains relatively high, at about 9 percent in May.
- Copper accounts for 10 percent of Chile’s GDP and about 40 percent of its exports of goods.
- Copper prices: surged from US$0.72 a pound in December 2002 to US$1.30–1.40 a pound in March-April 2004; in early July copper prices stood at about US$1.25 a pound.
- External current account: projected surplus of 1 percent of GDP in 2004.
- Inflation: fell below the target band in early 2004; 12–month inflation projected at about 2 percent by end–2004; inflation expectations well anchored.
- Natural gas import disruption risks from Argentina deemed manageable; authorities promoting a gradual shift from gas to other electricity sources.

### Policy discussions — fiscal and monetary stance
- Fiscal rule: central government required to maintain a cyclically-adjusted surplus of 1 percent of GDP (structural fiscal balance rule); government firmly committed.
- Fiscal pressures: full adherence challenging in 2004 given calls to increase spending with high copper prices; government resisted.
- Copper Stabilization Fund (CSF): surpluses used largely to repay expensive debt.
- Monetary policy: staff and authorities concurred monetary policy can continue to support domestic demand given the output gap; readiness to tighten if inflation moves above the mid-range.
- Policy rate: central bank cut its policy rate twice, by 50 basis points in December 2003 and January 2004; policy rate had been unchanged at 2¾ percent during most of 2003 and has since remained unchanged; policy rate is well below most estimates of the neutral rate.

### Structural and financial sector issues
- Financial system: strong, with room for greater competition; FSAP/FSSA highlighted soundness and resilience.
- Authorities plan to follow up on FSAP recommendations.
- Income convergence: per capita income rose from about 20 percent of U.S. per capita income in early 1980s to close to 30 percent in 2002.
- Per capita growth: average annual per capita income growth 3¼ percent over 1980–2003; slowed to 1¼ percent during 1998–2003.
- Inequality: Chile’s income inequality is high—second only to Brazil per a recent World Bank report on Latin America.

### Recent developments — external environment and domestic demand
- Activity pickup since early 2004 amid favorable external environment, including strong demand in China.
- China trade: during 1998–2003, exports to China grew by 41 percent a year and imports from China by 13 percent a year; in 2003 China absorbed 9 percent of Chile’s exports—copper represented 70 percent of that total.
- China copper demand: equivalent to 20 percent of total world demand; Chile supplies about half of China’s external copper needs.
- World inventories: at low levels; copper prices expected to remain above current production costs for some time.
- 2003 trade: Chile had a trade surplus with China of over 1 percent of GDP.
- Q1 2004 real GDP: grew by 6½ percent (q/q, seasonally adjusted).
- Sovereign spreads: about 90 basis points, well below regional average of just over 600 basis points.
- Argentina gas cuts forced switch to more costly coal- and diesel-generated power, dampening disposable income growth.
- Growth concentrated in financial services, manufacturing, retail trade; output gap negative at 3¾ percent.
- Private sector nominal wage increase over 12 months ending April 2004: 3 percent.
- Retail sales and consumer lending strengthened by lower interest rates; business investment (capital goods imports) recovered recently.
- Real effective exchange rate: rose by close to 15 percent in H2 2003, retreated around 5 percent in first five months of 2004.
- Twelve-month CPI inflation: fell below 2–4 percent target range in late 2003/early 2004; returned to positive range—1 percent in June.
- Central government actual deficit reduced from 1¼ percent of GDP in 2002 to ½ percent in 2003, mainly via expenditure restraint.

### External position and vulnerability indicators (selected, 2000–2004)
- Terms of trade (2003): improved by 4¾ percent.
- Current account (percent of GDP): -1.2, -1.6, -1.3, -0.8, 1.0
- Short-term external debt (percent of GDP): 13.6, 14.5, 17.2, 18.2, 16.2
- International reserves (% of GDP): 20.1, 21.1, 22.8, 22.0, 18.8
- International reserves (months of imports): 8.5, 8.3, 7.8, 6.9, 6.8
- International reserves (% of short-term external debt): 147.6, 144.8, 132.4, 120.7, 116.2
- Bank indicators: Foreign currency deposits / total deposits: 11.6, 9.2, 10.1, 9.8, ...
- Net short-term foreign assets of commercial banks, US$ billion: 2.9, 1.3, 0.1, -1.0, -0.9
- Nonperforming loans / total loans: 1.7, 1.6, 1.8, 1.6, ...
- Risk-based capital-assets ratio: 13.3, 12.7, 14.0, 14.1, ...

### Macroeconomic outlook and projections (authorities and staff)
- 2004 growth: expected to pick up to about 5 percent.
- Drivers: supportive external environment, monetary stimulus, high copper prices.
- Expected near-term developments:
  - Strong rise in investment in H2 2004.
  - Slow closing of the output gap, growth moderately above trend.
  - Inflation gradually returning to target band, about 2 percent by end–2004.
- Trend GDP growth estimates: 4 percent in 2004 and 4¼ percent over the medium term, down from 6½ percent in the 1990s.
- Current account: surplus of 1 percent of GDP in 2004 largely reflecting higher copper prices.

### Medium-Term Baseline Scenario (2003–2009) — key projections (selected)
- Real GDP: 3.3 (2003); 4.9 (2004); 4½-5½ (2005); 5.3 (2006); 5.1 (2007); 4.8 (2008); 4.3 (2009)
- Output gap: -4.2 (2003); -3.3 (2004); -2.4 (2005); -1.3 (2006); -0.5 (2007); 0.0 (2008); 0.0 (2009)
- Total domestic demand: 3.5 (2003); 5.1 (2004); 6.7 (2005); 5.9 (2006); 5.3 (2007); 5.0 (2008); 4.4 (2009)
- Private consumption: 3.7 (2003); 4.1 (2004); 6.6 (2005); 5.8 (2006); 5.5 (2007); 4.6 (2008); 3.8 (2009)
- Fixed investment: 4.8 (2003); 8.5 (2004); 9.0 (2005); 8.5 (2006); 8.0 (2007); 8.0 (2008); 8.0 (2009)
- Unemployment rate (percent): 8.5 (2003); 8.3 (2004); 8.0 (2005); 7.8 (2006); 7.8 (2007); 7.7 (2008); 7.7 (2009)
- CPI (end of period): 1.1 (2003); 2.1 (2004); 2.9 (2005); 3.0 (2006); 3.0 (2007); 3.0 (2008); 3.0 (2009)
- Terms of trade: 4.8 (2003); 11.1 (2004); -3.9 (2005); -3.7 (2006); -1.5 (2007); 1.5 (2008); 0.2 (2009)
- Copper prices (US¢/lb): 80.7 (2003); 122.5 (2004); 104.3 (2005); 90.7 (2006); 86.2 (2007); 88.5 (2008); 89.6 (2009)
- Central government balance: -0.5 (2003); 1.5 (2004); 1.2 (2005); 1.1 (2006); 1.1 (2007); 0.8 (2008); 0.8 (2009)
- Central government gross debt: 13.3 (2003); 12.0 (2004); 11.9 (2005); 11.1 (2006); 10.6 (2007); 9.5 (2008); 8.8 (2009)
- Current account: -0.8 (2003); 1.0 (2004); -0.9 (2005); -1.9 (2006); -2.4 (2007); -2.6 (2008); -2.8 (2009)
- Gross external debt: 60.1 (2003); 51.0 (2004); 48.2 (2005); 48.5 (2006); 49.3 (2007); 50.1 (2008); 51.1 (2009)
  - Public: 12.9 (2003); 10.5 (2004); 9.5 (2005); 8.7 (2006); 7.5 (2007); 6.4 (2008); 5.6 (2009)
  - Private: 47.3 (2003); 40.5 (2004); 38.8 (2005); 39.8 (2006); 41.8 (2007); 43.7 (2008); 45.6 (2009)
- Sources: Central Bank of Chile; Ministry of Finance; and Fund staff projections.

### Risks and scenario notes
- Major short-term risks largely external, considered manageable:
  - Sharp increase in world interest rates and oil prices could weigh on growth and external financing.
  - Risk of lower copper prices if global activity weakens; assessed as modest given low world inventories.
  - Disruption of natural gas supplies from Argentina: authorities estimated worst case impact of about 0.1 percent reduction in output growth in 2004.
- Sensitivity: a 10 percent increase in oil prices would reduce the 2004 external current account surplus by about ½ percent of GDP.
- External debt: public external debt low; private corporations restructured debt benefiting from low interest rates; short-term debt residual maturity equals 22 percent of private external debt; average duration of medium-term private external debt above five years; more than half of private external debt owed by foreign-owned firms, one third representing parent-company claims.

### Energy sector vulnerability and policy response
- By 2003: gas-fired plants supplied about 40 percent of total electricity demand; gas imports from Argentina accounted for 98 percent of gas supply; in northern Chile gas-fired plants provided more than 60 percent of power generation.
- Argentina export cuts (2004): initial 15 percent in early April; raised to 40 percent in May; reduced to 15-20 percent in mid-June.
- Short-run responses: bring coal and diesel plants online; use newly installed hydroelectric capacity.
- New electricity law (Ley Corta) approved early 2004:
  - Promotes interconnection of networks; changes transmission fee arrangements; stabilizes node prices by allowing fluctuation up to 5 percent from market price (down from 10 percent); establishes panel of experts to mediate disputes.
  - Expected to boost investment in electricity generation by reducing regulatory uncertainty.

### Fiscal policy, structural balance rule, and public finances
- Structural balance rule: cyclically-adjusted surplus of 1 percent of GDP; designed to offset quasi-fiscal losses of the central bank of ½-1 percent a year.
- Policy actions 2003–2004: spending trimmed; VAT raised from 18 percent to 19 percent; budget cautious in 2004; military special funds included in structural balance.
- Ley Reservada 13.196: military transfers from CODELCO equal to 10 percent of copper sales; 2004 revenue from this estimated at ½ percent of GDP (spendable only with prior authorization).
- Institutionalization: rule not embodied in law; authorities plan legislation to require future budgets to include indicator of structural balance; staff encouraged further institutional steps.
- Copper Stabilization Fund: assuming average copper price of US$1.20 a pound, CSF expected to accumulate US$1–1½ billion in 2004; government plans to prepay expensive debt; January–April 2004 pre-payments: US$335 million to World Bank and Inter-American Development Bank.
- Mining company fee proposal: proposed 0–3 percent fee on mining profits; annual proceeds ~¼ percent of GDP; authorities preparing modified plan with three-year transition binding only on new investments; staff advised imposing fee only on new investments to avoid retroactivity concerns.
- PPPs: infrastructure investments under PPPs close to US$6 billion over past ten years; contingent liabilities ≈ US$1 billion.
- Fiscal statistics: FY2004 budget uses most GFSM methodology; full migration pending central bank recapitalization; discrepancies related to inflation and dollar-indexed debt persist; authorities agreed to publish explanatory chapter in FY2005 budget.

### Debt sustainability and monetary policy framework
- DSA: with structural fiscal rule, net public debt-to-GDP projected to decline to about 10 percent of GDP by 2009; Chile’s debt resilient to shocks.
- Monetary policy: inflation targeting since May 2000 to keep CPI within 2-4 percent range; central bank adjusts policy rate when inflation projected to deviate persistently from mid-range; central bank guided by (i) output gap; (ii) trade margins and costs including exchange rate; (iii) price expectations.
- Communication and transparency:
  - Central bank publishes Monetary Policy Report three times a year.
  - Monthly Board meeting communiqué; minutes released within 3 weeks; annual and committee testimonies; monthly Analysts’ Forecast Survey; quarterly survey on credit conditions; presentations and papers posted on central bank web page.

### Policy recommendations (summary)
- Fiscal:
  - Consolidate accomplishments and enrich structural balance rule.
  - Use panel of experts for forecasting copper reference prices and the output gap.
  - Continue improving transparency and statistical alignment with Fund standards.
- Monetary:
  - Staff supported authorities’ approach; provide technical assistance on interest rate transmission and monetary policy issues.
- Structural reform:
  - Increase labor market flexibility; build on trade openness.
  - Phase out price bands on certain agricultural products where possible.
- Financial sector:
  - Implement FSAP recommendations to deepen financial markets and enhance competition.
  - Strengthen AML/CFT framework; extend application to foreign exchange operators, securities firms, insurance companies.
- Central bank recapitalization:
  - Continue work; first stage: reduce stock of government debt held by central bank while pursuing recapitalization.

### Debt Sustainability Analysis — public sector (selected figures and scenarios)
- Public sector net debt (percent of GDP): 5.5 (2000); 9.6 (2001); 13.4 (2002); 13.0 (2003); 12.5 (2004); 12.3 (2005); 11.8 (2006); 11.6 (2007); 11.1 (2008); 10.8 (2009).
- Key macro-fiscal assumptions:
  - Real GDP growth (percent): 4.5 (2000); 3.4 (2001); 2.2 (2002); 3.3 (2003); 4.6 (2004); 3.0 (2005); 4.9 (2006); 5.0 (2007); 5.3 (2008); 5.1 (2009).
  - Average nominal interest rate on public debt (percent): 9.0 (2000); 8.1 (2001); 5.1 (2002); 4.4 (2003); 7.9 (2004); 1.8 (2005); 3.6 (2006); 6.3 (2007); 6.6 (2008); 6.9 (2009).
  - Inflation (GDP deflator, percent): 4.6 (2000); 3.6 (2001); 4.5 (2002); 3.9 (2003); 5.2 (2004); 3.8 (2005); 3.8 (2006); 3.1 (2007); 3.2 (2008); 3.5 (2009).
- Scenario outcomes (selected):
  - B2 (real GDP growth at historical average minus two standard deviations in 2005 and 2006): net debt rises from 12.5 (2004) to 31.6 by 2009.
  - B5 (one time 30 percent real depreciation in 2005): net debt jumps from 12.5 (2004) to 19.1 by 2009.

### External sustainability — gross external debt (selected)
- Gross external debt (percent of GDP): 49.4 (2000); 56.4 (2001); 60.8 (2002); 60.1 (2003); 51.0 (2004); 48.2 (2005); 48.5 (2006); 49.3 (2007); 50.1 (2008); 51.1 (2009).
- Vulnerabilities: high private-sector external debt but mitigants include natural hedges, hedging instruments, average medium-term debt duration above five years, and significant portion owed by foreign-owned firms (one third are parent-company claims).
- Stress scenarios:
  - B6 (one time 30 percent nominal depreciation in 2005): gross external debt rises from 51.0 (2004) to 73.0 by 2009.

### Pro-Growth Agenda and structural reforms (selected items and status)
- Product market and competition reforms:
  - Electricity Law: published — expected to increase generation capacity and improve transmission.
  - Fishing Law: first part published late-2002; second part being discussed by Senate.
  - Anti-Trust Court: law published.
  - Investment Platform Law: published.
  - Bankruptcy law, Telecommunications Regulation, Tax Courts, Economic Courts: under study or being discussed.
- Capital Market Reform II: being discussed in Congress; includes incentives for venture capital, corporate governance improvements, electronic trading, immaterialization.
- Modernization of the State: multiple laws published (Civil Service Regime, Campaign Finance, Public Procurement Law, Administrative Procedures Law, Military supplies tax changes); Budget Commission approved by Congress.
- Labor market reforms:
  - Bilateral agreements on work schedules (draft law under preparation).
  - Certification of Labor Competencies (sent to Congress).
  - Voluntary savings for unemployment (draft law under preparation).
  - Temporary workers regulation (being discussed in Senate).
- Social reforms:
  - AUGE (health) Plan: part approved by Congress; guarantee regime and private health reform in Senate.
  - Student loans for private universities: proposal under Senate review.
  - Chile Solidario: approved by Congress.

### Exchange rate, central bank debt management, and recapitalization
- Peso volatility: appreciated about 23 percent from mid-March 2003 to mid-January 2004; since depreciated close to 11 percent.
- Evidence of deeper hedging markets; pension funds hold about 27 percent of assets abroad.
- Central bank debt management: move to standardize issuance, promote liquidity, and develop longer-term peso bonds (ten-year).
- Policy to gradually reduce dollar-indexed debt while lowering gross reserves; advised prudence to avoid adverse market perceptions.
- Recapitalization: authorities reaffirmed willingness; plan includes advancing repayment of government debt held by central bank to reduce quasi-fiscal losses.

### Financial sector, pensions, AML/CFT, and capital markets
- FSAP/FSSA findings:
  - Banking system: sound, well-capitalized, profitable, internationally integrated, low nonperforming loans; stress tests show resilience.
  - Pension funds: dominant institutional investors; room to relax overly restrictive investment regime and increase competition.
  - Insurance sector: under-provisioning and weaknesses in resolution framework; increases in provisions and supervisory reforms should be phased in.
  - Market infrastructure gaps: clearance/settlement law concepts, securities lending, multilateral netting, market makers, valuation methods, OTC disclosure, IFRS, taxation review.
  - Supervision: segmented oversight has functioned but needs to adapt; short-term cooperation and systemic surveillance improvements; medium-term legal changes for consolidated supervision of conglomerates; move to risk-based supervision.
  - AML/CFT: limited sanctioning powers of FIU and inadequate access to information; need to extend AML/CFT to FX operators, securities firms, insurance companies.
- Pensions:
  - Number of funds reduced from 21 (mid–1990s) to six funds in 2004.
  - Issues: less than half of affiliated workers contribute regularly and are eligible for a minimum pension (minimum requires 20 years of contributions); operational costs high; restrictive investment regime limits competition.
  - Staff encouraged voluntary pension system competition, outsourcing operational management, and rationalizing investment rules.
- Capital Markets II: seen as promoting bank competition and broadening domestic capital markets; incentives for venture capital; standardizing pledges; national registry of pledges; aligning corporate law with OECD standards.

### Labor market, education, inequality, and poverty
- Labor market flexibility: less flexible than Canada, New Zealand, Korea; more flexible than some European countries; constraints include hours limits, contract lengths, high dismissal costs, limits on part-time employment.
- Minimum wage: any increase should preserve competitiveness and employment.
- Education:
  - Average years of schooling: 8¾ years in 1990 to 10½ years in 2002.
  - OECD proficiency for 15-year olds in reading, mathematics, sciences: low by international standards.
  - Only 30 percent of high school graduates attend college.
  - R&D spending: equivalent to ½ percent of GDP versus OECD average of 2½ percent of GDP.
  - Authorities plan to improve teacher qualifications/salaries, broaden merit pay, expand tertiary access via loans/subsidies, expand and rationalize R&D spending.
- Poverty and social programs:
  - Poverty cut in half since 1990.
  - Chile Solidario: program for the extremely poor (maximum duration two years) using trained counselors and transfers tied to self-help; identified as promising.
  - Progress on Millennium Development Goals noted.

### Article IV consultation recommendation and selected indicators
- Recommendation: next Article IV consultation with Chile on standard 12–month cycle.
- Selected macro indicators (annual/period figures highlighted in report):
  - Real GDP (annual percent change): 2000: 4.5; 2001: 3.4; 2002: 2.2; 2003: 3.3; 2004: 4.9; 2005 (projection): 4½-5½.
  - CPI (end of period): 2000: 4.6; 2001: 3.0; 2002: 2.9; 2003: 1.1; 2004: 2.1; 2005 (projection): 2.9.
  - Unemployment rate (annual average): 2000: 9.2; 2001: 9.2; 2002: 8.9; 2003: 8.5; 2004: 8.3; 2005 (projection): 8.0.
  - Current account (percent of GDP): 2000: -1.2; 2001: -1.6; 2002: -1.3; 2003: -0.8; 2004: 1.0; 2005 (projection): -0.9.
  - Gross official reserves (US$ billion): 2000: 15.1; 2001: 14.4; 2002: 15.4; 2003: 15.9; 2004 (projection): 16.5.
  - Gross external debt (percent of GDP): 2000: 49.4; 2001: 56.4; 2002: 60.8; 2003: 60.1; 2004 (projection): 51.0; 2005 (projection): 48.2.
  - Central government overall balance (percent of GDP): 2000: -0.9; 2001: -0.9; 2002: -1.4; 2003: -0.5; 2004 (projection): 1.5; 2005 (projection): 1.2.
  - Structural balance (percent of GDP): 2000: 0.3; 2001: 1.0; 2002: 0.7; 2003: 0.7; 2004 (projection): 0.8; 2005 (projection): 0.9.

### Authorities’ statement — policy priorities and views (selected)
- Authorities consented to publication of Staff Report, FSSA, and Special Issues Papers.
- GDP growth Q2 2004: about 5 percent; consensus forecast raised to similar rate from 4.5 percent previous year.
- Exports H1 2004: expansion 39 percent in value terms vs H1 2003; non-copper exports growing close to 15 percent in volume terms.
- Copper: accounts for 36 percent of total exports of goods per authorities’ statement; extraordinarily high copper prices a key factor in recovery.
- Labor market: employment growth sluggish despite output expansion; unemployment just over 9 percent in mid 2004; expected to decline as investment recovers.
- Capital markets: introduction of 10-year Central Bank peso bonds (yield 6.5 percent; indexed instruments of same maturity yield 3.7 percent).
- Energy: effects of Argentina gas disruption contained; industry exploring alternative energy sources and advancing hydroelectric projects.
- Corporate external debt: significant part corresponds to foreign-owned companies and parent-company claims; liquid external assets and hedging mitigate risks.
- FSAP: viewed as useful; central bank and SBIF advancing regulatory reforms; BCCH to publish Financial Stability Report periodically.
- Growth and reforms: under supportive external environment and strong policy framework, Chile well positioned to return to higher growth; potential output growth estimate 4.1 percent; average growth over next 4 years projected at 5.2 percent including gap absorption.
- Social policy: Chile Solidario highlighted as well-targeted program to reduce extreme poverty.

*Source: IMF staff report content as provided in the supplied PDF text.*

### Executive Summary  .....................................................................................................

### Executive Summary

### Economic outlook
- Real GDP is projected to grow by about 5 percent a year in 2004 and 2005.
- Private investment is gradually increasing.
- Unemployment remains relatively high, at about 9 percent in May.
- Copper accounts for 10 percent of Chile’s GDP and about 40 percent of its exports of goods.
- The price of copper surged from US$0.72 a pound in December 2002 to US$1.30–1.40 a pound in March-April 2004 (in early July, copper prices stood at about US$1.25 a pound).
- The external current account is projected to register a surplus of 1 percent of GDP in 2004.
- Inflation fell below the target band in early 2004, and 12–month inflation is projected at about 2 percent by end–2004.
- Inflation expectations are well anchored.
- The risks of disruption of natural gas imports from Argentina appear manageable; authorities are promoting a gradual shift from gas to other sources of electricity generation.

### Policy discussions — fiscal and monetary stance
- The government is firmly committed to the structural fiscal balance rule (requires the central government to maintain a cyclically-adjusted surplus of 1 percent of GDP).
- Full adherence to the rule is a challenge in 2004 given calls to increase spending in the context of high copper prices; the government has resisted such pressure.
- The government prudently used most of the surpluses accumulated by the Copper Stabilization Fund in recent months to repay expensive debt.
- Staff shared the authorities’ view that monetary policy can continue to support domestic demand for some time, particularly given the output gap.
- The authorities reaffirmed commitment to tighten policies when estimates show that, on a sustained basis, inflation would move above the mid-range of the target band.
- The central bank cut its policy rate twice, by 50 basis points on each occasion, in December 2003 and January 2004; the policy rate had been unchanged at 2¾ percent during most of 2003 and has since remained unchanged.
- The policy rate is well below most estimates of the neutral rate.

### Structural and financial sector issues
- The Chilean financial system is strong, with room for greater competition (as highlighted in the companion Financial System Stability Assessment (FSSA) report).
- The authorities plan to follow up on FSAP recommendations.
- Over 1980–2003, Chile narrowed the relative income gap with advanced economies (per capita income rose from about 20 percent of the U.S. per capita income in the early 1980s to close to 30 percent in 2002).
- Over 1980–2003 Chile’s average annual per capita income growth was 3¼ percent; 1980s–2003 outperformance relative to Latin America, whose average was ½ percent.
- Chile’s GDP per capita growth slowed to 1¼ percent during 1998–2003.
- Chile’s income inequality is high—second only to Brazil according to a recent World Bank report on Latin America.

### Recent developments — external environment and domestic demand
- Economic activity picked up since the beginning of 2004 amid a favorable external environment, including strong demand in China.
- During 1998–2003, Chile’s exports to, and imports from, China grew by 41 percent and 13 percent a year, respectively; in 2003 China absorbed 9 percent of Chile’s exports—copper represented 70 percent of the total.
- China’s copper demand is equivalent to 20 percent of total world demand; Chile supplies about half of China’s external copper needs.
- World inventories are at low levels; copper prices are expected to remain above current production costs for some time.
- In 2003, Chile had a trade surplus with China of over 1 percent of GDP.
- Real GDP grew by 6½ percent (q/q, seasonally adjusted) during the first quarter of 2004.
- Sovereign spreads have hovered at about 90 basis points, well below the regional average of just over 600 basis points.
- Argentina’s reduction in natural gas exports to Chile has forced a switch from gas to more costly coal- and diesel-generated power and dampened disposable income growth.
- Growth has been concentrated in financial services, manufacturing, and retail trade; unemployment remains at about 9 percent and the output gap is negative at 3¾ percent.
- Over the 12–month period ending in April 2004, the increase in nominal wages in the private sector was 3 percent.
- Consumer spending has driven the recent pickup in activity, with retail sales strengthened by lower interest rates and real consumer lending growth.
- Business investment (proxied by capital goods imports) rose strongly in the first half of 2003, lost momentum in the second half, and has been recovering in recent months.
- Businesses have been refinancing debt, locking in low interest rates and extending maturities.
- During the second half of 2003, Chile’s real effective exchange rate rose by close to 15 percent, before retreating by around 5 percent in the first five months of 2004.
- Twelve-month CPI inflation fell below the 2–4 percent central bank target range in late 2003 and early 2004; since February 2004 the peso has weakened somewhat and 12–month inflation returned to a positive range—at 1 percent in June.
- The central government actual deficit was reduced from 1¼ percent of GDP in 2002 to ½ percent in 2003, primarily reflecting expenditure restraint.

### External position and vulnerability indicators
- In 2003, Chile’s terms of trade improved by 4¾ percent.
- The external current account deficit narrowed by ½ percentage points, to ¾ percent of GDP in 2003.
- International reserves remain high—about seven months of goods and services imports and nearly 20 percent of GDP—and comfortably exceed the stock of short-term external debt.
- The appreciation of the peso contributed to a significant reduction in the external debt-to-GDP ratio, although external corporate debt remains high.
- Selected vulnerability indicators (2000–2004) include:
  - Foreign currency deposits / total deposits: 11.6, 9.2, 10.1, 9.8, ...
  - Net short-term foreign assets of commercial banks, US$ billion: 2.9, 1.3, 0.1, -1.0, -0.9
  - Nonperforming loans / total loans: 1.7, 1.6, 1.8, 1.6, ...
  - Risk-based capital-assets ratio: 13.3, 12.7, 14.0, 14.1, ...
  - Current account (in percent of GDP): -1.2, -1.6, -1.3, -0.8, 1.0
  - Short-term external debt (in percent of GDP): 13.6, 14.5, 17.2, 18.2, 16.2
  - International reserves in percent of GDP: 20.1, 21.1, 22.8, 22.0, 18.8
  - International reserves in months of imports: 8.5, 8.3, 7.8, 6.9, 6.8
  - International reserves in percent of short-term external debt: 147.6, 144.8, 132.4, 120.7, 116.2

### Report on the discussions — broad assessment and medium-term agenda
- Consensus that Chile is well-placed to benefit from the world economic recovery and to undertake structural reforms needed for sustained medium-term growth.
- Authorities noted solid pillars: (i) a strong fiscal position with counter-cyclical capacity; (ii) a well-tested inflation targeting monetary policy with a flexible exchange rate; (iii) a robust financial system; and (iv) a competitive, open economy.
- Short-term risks are largely external but considered manageable.
- With Presidential and congressional elections in late 2005, public debate is focusing on education reform, labor productivity, income distribution, promoting competition, and sustaining high economic growth.

*Source: Executive Summary.*

### 13.      The authorities and staff concurred that economic growth was expected to pick up to

### _cr04291 - 13.      The authorities and staff concurred that economic growth was expected to pick up to

### Macroeconomic outlook and projections
- Economic growth was expected to pick up to about 5 percent in 2004.
- Drivers cited: supportive external environment, monetary stimulus, and high copper prices.
- Expected developments:
  - A strong rise in investment in the second half of 2004 due to the rebound in the global economy and improvement in profit outlook.
  - The output gap would close slowly, with economic growth moderately above trend.
  - Inflation would gradually return to the central bank’s target band, at about 2 percent by end–2004.
- Trend GDP growth estimates:
  - Trend GDP growth is estimated at 4 percent in 2004 and 4¼ percent over the medium term, down from 6½ percent in the 1990s, reflecting slower total factor productivity and employment growth.
- Current account:
  - Largely reflecting higher copper prices, the current account would register a surplus of 1 percent of GDP in 2004.

### Medium-Term Baseline Scenario (2003–2009) — key projections and indicators
- Real GDP: 3.3 (2003); 4.9 (2004); 4½-5½ (2005); 5.3 (2006); 5.1 (2007); 4.8 (2008); 4.3 (2009)
- Output gap: -4.2 (2003); -3.3 (2004); -2.4 (2005); -1.3 (2006); -0.5 (2007); 0.0 (2008); 0.0 (2009)
- Total domestic demand: 3.5 (2003); 5.1 (2004); 6.7 (2005); 5.9 (2006); 5.3 (2007); 5.0 (2008); 4.4 (2009)
- Private consumption: 3.7 (2003); 4.1 (2004); 6.6 (2005); 5.8 (2006); 5.5 (2007); 4.6 (2008); 3.8 (2009)
- Fixed investment: 4.8 (2003); 8.5 (2004); 9.0 (2005); 8.5 (2006); 8.0 (2007); 8.0 (2008); 8.0 (2009)
- Unemployment rate (percent): 8.5 (2003); 8.3 (2004); 8.0 (2005); 7.8 (2006); 7.8 (2007); 7.7 (2008); 7.7 (2009)
- Consumer price index (end of period): 1.1 (2003); 2.1 (2004); 2.9 (2005); 3.0 (2006); 3.0 (2007); 3.0 (2008); 3.0 (2009)
- Terms of trade: 4.8 (2003); 11.1 (2004); -3.9 (2005); -3.7 (2006); -1.5 (2007); 1.5 (2008); 0.2 (2009)
- Copper prices (US¢/lb): 80.7 (2003); 122.5 (2004); 104.3 (2005); 90.7 (2006); 86.2 (2007); 88.5 (2008); 89.6 (2009)
- Central government balance: -0.5 (2003); 1.5 (2004); 1.2 (2005); 1.1 (2006); 1.1 (2007); 0.8 (2008); 0.8 (2009)
- Central government gross debt: 13.3 (2003); 12.0 (2004); 11.9 (2005); 11.1 (2006); 10.6 (2007); 9.5 (2008); 8.8 (2009)
- Current account: -0.8 (2003); 1.0 (2004); -0.9 (2005); -1.9 (2006); -2.4 (2007); -2.6 (2008); -2.8 (2009)
- Gross external debt: 60.1 (2003); 51.0 (2004); 48.2 (2005); 48.5 (2006); 49.3 (2007); 50.1 (2008); 51.1 (2009)
  - Public: 12.9 (2003); 10.5 (2004); 9.5 (2005); 8.7 (2006); 7.5 (2007); 6.4 (2008); 5.6 (2009)
  - Private: 47.3 (2003); 40.5 (2004); 38.8 (2005); 39.8 (2006); 41.8 (2007); 43.7 (2008); 45.6 (2009)
- Sources: Central Bank of Chile; Ministry of Finance; and Fund staff projections.

### Risks to the outlook and scenario notes
- Major short-term risks largely external and considered manageable by authorities:
  - Sharp increase in world interest rates and oil prices could weigh on growth and external financing conditions.
  - Risk of lower copper prices, particularly if global activity weakens; assessed as modest given low world copper inventories.
  - Disruption of natural gas supplies from Argentina: authorities estimated a worst case impact of about 0.1 percent reduction in output growth in 2004.
- Sensitivity analyses:
  - A 10 percent increase in oil prices would reduce the 2004 external current account surplus by about ½ percent of GDP.
- External debt considerations:
  - External public debt is low; private corporations have restructured debt benefiting from low interest rates.
  - Short-term debt on a residual maturity basis represents only 22 percent of private sector external debt.
  - Average duration of medium-term private external debt is above five years.
  - More than half of private external debt is owed by foreign-owned firms, with one third of this debt representing claims of parent companies.

### Energy sector vulnerability and policy response (Box 3)
- By 2003:
  - Gas-fired plants supplied about 40 percent of total electricity demand.
  - Gas imports from Argentina accounted for 98 percent of the gas supply.
  - In northern Chile, gas-fired plants provided more than 60 percent of power generation.
- Argentina’s export cuts to Chile in 2004:
  - Initial cut of 15 percent in early April; raised to 40 percent in May; reduced to 15-20 percent in mid-June.
  - Cuts expected to be temporary; short-run responses include bringing coal and diesel-fired plants back online and use of newly installed hydroelectric capacity.
- Risks:
  - Deeper and prolonged cuts could become a significant source of risk, especially with rapidly expanding power consumption in the central region and strain during dry years or harsh winters.
- Policy/legal response:
  - New electricity law (Ley Corta) approved in early 2004 to increase electricity generating capacity and improve transmission:
    - Promotes interconnection of networks; changes fees paid by generation and distribution companies to transmission companies.
    - Transmission fees no longer negotiated bilaterally in individual contracts.
    - Stabilizes node prices by allowing a fluctuation of up to 5 percent from the market price negotiated in private contracts (down from 10 percent).
    - Establishes a panel of experts to mediate disputes.
    - Expected to boost investment in electricity generation by reducing regulatory uncertainty.

### Fiscal policy, structural balance rule, and public finances
- Structural balance rule:
  - Targets a cyclically-adjusted surplus of 1 percent of GDP in central government accounts, designed to offset quasi-fiscal losses of the central bank of ½-1 percent a year.
  - Trend: structural balance has successfully anchored fiscal policy.
- Policy actions in 2003 and 2004:
  - Authorities trimmed spending and raised the value-added tax rate from 18 percent to 19 percent.
  - Fiscal expenditure stance to remain cautious in 2004; budget includes special funds for the military as part of the structural balance.
  - Under Ley Reservada 13.196, military receives transfers from CODELCO equal to 10 percent of its copper sales. In 2004, revenue from this (estimated at ½ percent of GDP) can be spent only with prior authorization of defense ministry and the budget office.
- Institutionalization and transparency:
  - The rule is not embodied in law; authorities plan to introduce legislation to require future budgets to include an indicator of the structural balance.
  - Staff encouraged further steps toward institutionalizing the rule.
- Copper Stabilization Fund (CSF):
  - Assuming an average copper price of US$1.20 a pound, CSF expected to accumulate resources of US$1–1½ billion in 2004.
  - Government plans to use a significant part to prepay expensive debt; during January–April 2004 the government pre-paid US$335 million in debts to the World Bank and the Inter-American Development Bank.
- Mining company fee proposal:
  - Proposed imposition of a 0–3 percent fee on profits of mining companies; annual proceeds expected to be about ¼ percent of GDP.
  - Authorities preparing a modified plan with a three-year transition period, under which the fee would only be binding for new investments.
  - Staff advised imposing the fee only on new investments to avoid perceptions of retroactive rule changes.
- Public-Private Partnerships (PPPs):
  - Infrastructure investments under PPPs amounted to close to US$6 billion over the past ten years, with contingent liabilities for the government of about US$1 billion.
- Fiscal statistics and standards:
  - Starting with FY2004, the authorities published the budget using most of the methodology in the Fund’s Government Financial Statistics Manual (GFSM); full migration pending central bank recapitalization.
  - Discrepancies persist related to inflation and dollar-indexed debt; authorities agreed to publish a chapter in the FY2005 budget to outline the issues and welcomed further STA technical assistance.

### Debt sustainability and monetary policy framework
- Debt Sustainability Analysis (DSA) findings:
  - With the structural fiscal rule, net public debt-to-GDP ratio projected to gradually decline to about 10 percent of GDP by 2009.
  - Chile’s debt is resilient to shocks.
- Monetary policy:
  - Inflation targeting objective since May 2000: keep CPI inflation within the 2-4 percent range.
  - Central bank adjusts policy rate when inflation is projected to deviate persistently from the mid-range of the target band.
  - Central bank sees price developments guided by: (i) the output gap; (ii) trade margins and costs, including exchange rate developments; and (iii) price expectations.
  - Authorities reaffirmed commitment to maintaining inflation close to the mid-point of the 2–4 percent target range and readiness to tighten policy decisively if needed.
- Communication and transparency (Box 5):
  - Central bank publishes a Monetary Policy Report three times a year.
  - Communication outlets and practices include:
    - A communiqué at the conclusion of monthly Board policy meetings (meetings announced six months in advance).
    - Minutes of monthly policy meetings released within 3 weeks.
    - Annual testimony before the full Senate and twice before the Finance Committee.
    - Monthly Analysts’ Forecast Survey and quarterly survey on credit conditions.
    - Presentations by central bank authorities posted on the central bank’s web page; prompt publication of relevant economic and financial data.
    - Regular publication of economic policy and working papers; description of structural and auxiliary models used in inflation forecasting and policy research.

### Box: Policy Recommendations and Implementation (summary)
- Fiscal policy:
  - Fund advice concentrated on consolidating accomplishments and enriching the structural balance rule.
  - Recommended reliance on a panel of experts for forecasting copper reference prices and the output gap.
  - Emphasis on improving transparency; Chile has made considerable progress toward Fund standards.
- Monetary policy:
  - Staff generally supported the authorities’ approach and provided technical assistance on interest rate transmission mechanisms and monetary policy issues.
- Structural reform:
  - Discussions included need to increase labor market flexibility and build on trade openness.
  - Progress in labor reforms limited due to institutional constraints.
  - Past encouragement to phase out price bands on certain agricultural products; sugar and wheat remain with (WTO-compliant) price bands.
- Standards and codes:
  - A fiscal ROSC was completed in 2003, and an FSAP was completed recently.
- Technical assistance and cooperation:
  - Authorities welcomed further work with Fund staff on public investment, fiscal policies, and fiscal statistics compilation.

*Source: IMF staff report content as provided in the supplied PDF text.*

### 25.      The mission commended the authorities for their flexible exchange rate policy.

### _cr04291 - 25.      The mission commended the authorities for their flexible exchange rate policy.

### Exchange rate developments and external competitiveness
- Since the beginning of 2003, the peso has displayed significant volatility, largely reflecting changes in the external environment.
- From mid-March 2003 through mid-January 2004, the peso appreciated by about 23 percent against the U.S. dollar, but it has since then depreciated by close to 11 percent.
- There is growing evidence that the market for foreign exchange hedging has deepened, with sectors long in foreign currency (including pension funds, which hold about 27 percent of their assets abroad) offering hedges to other sectors.
- Chile’s external competitiveness remains sound, as evidenced by the strong growth in nontraditional exports; nonmining exports rose by 17 percent in the year through June 2004.
- Figure references in the source: Figure 10 (Real and nominal effective exchange rate, January 1995=100) and Figure 11 (Stock of central bank paper in trillions of Chilean pesos).

### Central bank debt management and recapitalization
- The mission supported the central bank’s debt management strategy and its recent dollar-debt redemption program.
- The central bank moved to standardize and modernize the issuance of its debt instruments, promoting liquidity of central bank debt and development of a fixed-income corporate bond market.
- The central bank announced steps to promote longer-term (ten-year) nominal peso bonds.
- In November 2003, the central bank announced that it would aim at gradually reducing the stock of its dollar-indexed debt, while concomitantly lowering its gross reserves level (Figure 11).
  - This policy would help reduce the central bank’s quasi-fiscal losses and does not entail intervention in the foreign exchange market—given that the net foreign exchange position would remain unchanged.
- Staff concurred there was some scope for a reduction in the stock of dollar-indexed debt, given the comfortable level of gross official reserves.
- The mission advised prudence and avoidance of too large a decline in gross reserves, as this could adversely affect market perceptions and confidence; the authorities concurred and said they would keep plans under review based on financial market developments.
- On recapitalization:
  - The authorities reaffirmed willingness to recapitalize the central bank and noted finance ministry and central bank had made good progress toward the technical work.
  - They noted recapitalization would impact central government accounts, forcing a redefinition of the structural balance rule.
  - As a first step, they planned to advance the repayment of government debt held by the central bank to help reduce its quasi-fiscal losses.

### Financial sector strength, supervision, and reform
- The authorities welcomed the conclusions of the recent FSAP and expressed strong confidence in the soundness of the banking system.
- FSAP findings (Box 6 summary):
  - The Chilean banking system was found to be sound, generally resilient to shocks, and well-supervised. Banks are well capitalized, profitable, internationally integrated, and have relatively low nonperforming loans. Stress tests indicate they would absorb sizable macroeconomic shocks with only a moderate impact on solvency. Although bank competition remains limited, it has increased significantly in recent years.
  - Private pension funds are the dominant institutional investors. There is room to enhance their impact by judicious relaxation of their overly restrictive investment regime, intensifying competition, and considering a more radical reform to unbundle pension-related services.
  - The insurance sector faces some under-provisioning of risks, increased competition, and weaknesses in its resolution framework. Needed increases in provisions and supervisory reforms should be carefully planned and phased in.
  - Important gaps in market infrastructure limit market liquidity and investment and need to be filled (securities clearance and settlement law concepts, securities lending market, multilateral netting, market makers, valuation methods, contract standardization, OTC disclosure, international financial reporting standards, and financial sector taxation review).
  - Segmented financial oversight has functioned adequately but should adapt to an increasingly integrated and complex financial system: short-term reforms to enhance cooperation and systemic market surveillance; medium-term legal changes to support fully consolidated supervision of financial conglomerates; move from rule-based to risk-based supervision; strengthen financial and legal autonomy of supervisory agencies and accountability.
  - The AML/CFT framework needs strengthening: (i) address limited sanctioning powers of the Financial Intelligence Unit and its inadequate access to information; and (ii) extend AML/CFT application to foreign exchange operators, securities firms, and insurance companies.
- The mission commended authorities for moving toward risk-based regulation and supervision, while noting the transition requires improved disclosure standards and bank management attention to securitization and derivatives.
- The mission proposed easing bank restrictions on options markets to boost derivatives development and allow more efficient risk allocation.
- Declining credit risk (lower delinquency rates) reduced nonoperational costs and boosted bank net income; increased competition and efficiency are narrowing margins and pushing banks to diversify into commission-based activities.
- Officials viewed the proposed Capital Market II reform as promoting bank competition and broadening domestic capital markets, with incentives for venture capital, standardizing pledges on collateral, creating a national registry of pledges, strengthening regulation and supervision, and aligning corporate law with OECD standards.

### Pensions, AML/CFT, and related reforms
- The mission welcomed authorities’ consideration of proposals to foster worker participation and asset management competition in the private pension system.
  - The number of funds was reduced from 21 in the mid–1990s to six funds in 2004.
  - Key challenges identified:
    - Increasing coverage of individual accounts, as less than half of affiliated workers contribute on a regular basis and are eligible for a minimum pension (minimum pensions require a total of 20 years of contributions).
    - Reducing operational costs, which remain high by international standards.
    - Increasing asset management competition, as the current regulatory regime is somewhat restrictive and cumbersome.
  - Staff agreed the voluntary pension system, in which all financial intermediaries can compete, should enhance competition. The mission encouraged outsourcing operational management services and rationalizing the investment regime to allow greater diversification of funds.
- On AML/CFT:
  - Chile is a member of GAFISUD. GAFISUD’s 2003 report commended Chile for creating a Financial Intelligence Unit and stepping up financial institution disclosure requirements.
  - Subsequent Constitutional Court rulings reduced the FIU’s sanctioning powers and denied it access to information protected by bank secrecy; authorities recognized shortcomings and are considering steps to address them.
  - Authorities agreed to allow publication of the AML/CFT ROSC on the Fund’s website.

### Sustaining medium-term growth, trade, and external openness
- The authorities are implementing the Pro-Growth Agenda to rekindle Chile’s economic growth, which has slowed to 2½ percent a year on average since 1998.
- Recent congressional approvals of reforms are part of this agenda; further reforms cited as needed include continued trade liberalization, labor reform, and improvements in health and education.
- External markets and trade liberalization:
  - In 2003, Chile’s external tariff rate averaged only 2½ percent.
  - More than 90 percent of Chilean export products benefited from preferential treatment in export markets due to bilateral FTAs; recently implemented FTAs with the European Union and the United States are expected to have significant positive effects on growth over the medium term.
  - Authorities plan additional bilateral agreements after completing negotiations with South Korea, including: (i) closer cooperation with New Zealand and Singapore to improve competitiveness in third markets; (ii) a broad FTA with China; and (iii) a trade liberalization agreement with India for a limited list of products.
  - Chile’s foreign investment platform is among the world’s most open regimes, with no financial account restrictions except a one-year residency requirement for the equity portion under Decree Law 600.
  - Staff noted market participant concerns about excessive complexity of domestic taxation rules for foreign portfolio investors.

### Labor market, education, inequality, and poverty
- Labor market:
  - Studies indicate Chile’s labor market is less flexible than Canada, New Zealand, and Korea, but somewhat more flexible than some European countries.
  - Unemployment rate continues a downward trend but remains relatively high.
  - Authorities agreed more labor flexibility is desirable; constraints include limits on hours worked, length of standard labor contracts, high dismissal costs, and limits on part-time employment. Labor union opposition makes short-term passage of flexibility legislation unlikely.
  - Any increases in the minimum wage should be consistent with preserving competitiveness and employment.
- Education and productivity:
  - The education voucher system (1980) has led to some quality improvement but is seen as costly, poorly supervised, and lacking efficiency.
  - Average years of schooling increased from 8¾ years in 1990 to 10½ years in 2002.
  - OECD measurement of average proficiency for 15-year old students in reading, mathematics, and sciences is low by international standards.
  - Only 30 percent of high school graduates attend college.
  - Authorities plan to improve teacher qualification requirements and salaries, broaden merit pay, introduce a new accountability and incentives system, promote broader access to tertiary education through loans and subsidies, and expand and rationalize research and development spending.
    - Note: total research and development spending is equivalent to only ½ percent of GDP, versus an OECD average of 2½ percent of GDP.
- Poverty and social programs:
  - Poverty has been cut in half since 1990.
  - Authorities introduced Chile Solidario, a program aimed at lifting the extremely poor into the mainstream without generating dependency (maximum duration two years), using trained counselors and transfers tied to step-by-step self-help programs.
  - Progress is being made in meeting Chile’s Millennium Development Goals (Table 9).
- Labor market chart reference: Figure 12 (Unemployment rate in percent of the labor force).
- Poverty chart reference: Figure 13 (Poverty rates, 1990-2000, in percent of total population).

*Source: _cr04291 - 25.      The mission commended the authorities for their flexible exchange rate policy.*

### 40.      The Chilean authorities are to be commended for the continued implementation of

### The Chilean authorities are to be commended for the continued implementation of well-designed policies.

### Fiscal policy and fiscal rule
- Findings:
  - The authorities adhere to prudent fiscal policies.
  - The fiscal rule has gained considerable credibility, reflecting the authorities’ firm commitment to prudent fiscal policy.
  - Public debt ratios are low.
  - The sustained implementation of the fiscal rule is consistent with a further decline in the public debt to GDP ratio over the medium term.
- Staff recommendations:
  - Take further steps toward institutionalizing the fiscal rule and secure the necessary consensus to ensure it is preserved over the medium term.
  - Staff welcomes Chile’s decision to participate in a pilot program on public investment and fiscal policies.

### Inflation targeting and monetary policy
- Findings:
  - The inflation targeting framework is working well.
  - Low levels of 12–month CPI inflation registered in early 2004 largely reflected the earlier appreciation of the peso.
  - Surveys show that the core CPI is gradually returning to the center of the inflation target band.
  - The central bank has effectively communicated its policy and helped anchor inflation expectations.
- Policy stance and recommendation:
  - The current stance of monetary policy is appropriate.
  - Given the persistent output gap and inflation expectations anchored at the middle of the target range, monetary policy could support domestic demand for some time.
  - The authorities’ readiness to raise interest rates as soon as required by domestic and external conditions is appropriate.
  - The staff supports the central bank policy of nonintervention in the foreign exchange market.

### Growth, external sector, and commodities
- Findings and projections:
  - The prudent macroeconomic stance and strong economic institutions have led to sustained economic growth and a sharp reduction in poverty.
  - In 2004, real GDP growth is projected to gather further momentum, while inflation would gradually return within the inflation target band.
  - Reflecting the global recovery, copper prices have remained high and are expected to help generate a surplus in the current account balance in 2004.
  - The long-delayed recovery in investment now seems well under way and conditions are in place to sustain strong output growth into 2005.
- Risks noted:
  - Expected increase in global interest rates, high prevailing oil prices, and issues associated with the supply of gas constitute risks, but they appear manageable.
  - External competitiveness is appropriate, as evidenced by the strong growth of nontraditional exports.

### Financial system and FSAP
- Findings:
  - The FSAP team concluded that the financial system is strong.
- Recommendations:
  - Implement FSAP recommendations to further improve the depth of the financial system and the competitiveness of the banking system.
  - Staff appreciates the authorities’ intention to follow the FSAP recommendations closely.

### Mining taxation proposal
- Findings:
  - A proposal to introduce a fee on mining companies has gathered broad popular support.
- Staff recommendation:
  - Encourage caution: any change in the taxation of mining companies would have to be prepared carefully to ensure that it does not interfere with investment guarantees and increase investor uncertainty.

### Central bank recapitalization
- Recommendation:
  - Continue work toward the recapitalization of the central bank.
  - In a first stage, steps are expected to be taken to reduce the stock of government debt held by the central bank, while actively pursuing the objective of recapitalizing the central bank.

### Trade policy and agricultural pricing
- Findings:
  - Chile’s emphasis on free trade is commendable.
  - Recent free trade agreements with the EU and the United States, as well as current bilateral initiatives, are welcome.
- Recommendation:
  - Encourage the authorities to eliminate the price-band scheme that remains in place for a few agricultural goods.

### Social policy, education, and poverty reduction
- Findings and recommendations:
  - Staff is encouraged by the open debate on policies to promote strong economic growth and further reduce poverty over the medium term.
  - Enhancing education and labor flexibility are key to promoting strong and sustainable growth and reduce poverty.
  - One of the main challenges is to ensure that the children of the poor have access to education, where there is room for improvement.
  - Chile Solidario is identified as a promising approach to deal with poverty in a comprehensive manner.

### External and private sector debt
- Findings:
  - While the external debt of the private sector is relatively high, it does not give rise to concern because it is at relatively long terms, and part of the debt is held as claims of parent companies on their Chilean affiliates.

### Data quality and statistics
- Findings:
  - Chile’s data are of good quality, timely, and adequate for surveillance purposes.
  - With the introduction of the 2004 budget, the authorities have removed most of the differences that existed with Fund standards.
  - The authorities have sought technical assistance to produce high quality data.

*IMF staff report content.*

### 53.      It is recommended that the next Article IV consultation with Chile be held on the

### _cr04291 - 53.      It is recommended that the next Article IV consultation with Chile be held on the

### Recommendation
- It is recommended that the next Article IV consultation with Chile be held on the standard 12–month cycle.

### Macroeconomic outlook and key projections
- Real GDP (annual percentage change): 2000: 4.5; 2001: 3.4; 2002: 2.2; 2003: 3.3; 2004: 4.9; 2005 (projection): 4½-5½.
- Total domestic demand (annual percentage change): 2000: 5.9; 2001: 2.2; 2002: 2.5; 2003: 3.5; 2004: 5.1; 2005: 6.7.
- Consumer prices (end of period): 2000: 4.6; 2001: 3.0; 2002: 2.9; 2003: 1.1; 2004: 2.1; 2005 (projection): 2.9.
- Consumer prices (average): 2000: 3.8; 2001: 3.6; 2002: 2.5; 2003: 2.8; 2004: 0.9; 2005 (projection): 2.8.
- Unemployment rate (annual average): 2000: 9.2; 2001: 9.2; 2002: 8.9; 2003: 8.5; 2004: 8.3; 2005 (projection): 8.0.
- Current account (percent of GDP): 2000: -1.2; 2001: -1.6; 2002: -1.3; 2003: -0.8; 2004: 1.0; 2005 (projection): -0.9.
- Gross official reserves (in US$ billion): 2000: 15.1; 2001: 14.4; 2002: 15.4; 2003: 15.9; 2004 (projection): 16.5.
- Gross external debt (percent of GDP): 2000: 49.4; 2001: 56.4; 2002: 60.8; 2003: 60.1; 2004 (projection): 51.0; 2005 (projection): 48.2.

### Fiscal position and public finances
- Central government overall balance (percent of GDP): 2000: -0.9; 2001: -0.9; 2002: -1.4; 2003: -0.5; 2004 (projection): 1.5; 2005 (projection): 1.2.
- Central government gross debt (percent of GDP): 2000: 13.7; 2001: 15.0; 2002: 15.7; 2003: 13.3; 2004 (projection): 12.0; 2005 (projection): 11.9.
- Summary operations of the central government (Table 2, percent of GDP): Total revenue: 2000: 21.9; 2001: 21.8; 2002: 21.1; 2003: 21.2; 2004 (projection): 22.5; 2005 (projection): 21.9. Total expenditure: 2000: 22.8; 2001: 22.7; 2002: 22.4; 2003: 21.7; 2004 (projection): 21.0; 2005 (projection): 20.7.
- Structural balance (percent of GDP): 2000: 0.3; 2001: 1.0; 2002: 0.7; 2003: 0.7; 2004 (projection): 0.8; 2005 (projection): 0.9.

### External sector structure and vulnerabilities
- Exports (U.S. dollars, percent change): 2000: 11.9; 2001: -4.9; 2002: -0.5; 2003: 15.8; 2004: 31.1; 2005 (projection): -4.1.
- Imports (U.S. dollars, percent change): 2000: 16.0; 2001: -3.9; 2002: -3.1; 2003: 13.3; 2004: 18.7; 2005 (projection): 5.9.
- Terms of trade (percent change): 2000: 5.1; 2001: -7.4; 2002: 4.0; 2003: 4.8; 2004: 11.1; 2005 (projection): -3.9.
- Real effective exchange rate (end of period, percent change): 2000: -2.9; 2001: -8.2; 2002: -2.5; 2003: 4.6.
- Exchange rate (pesos per US$, period average): 2000: 539.6; 2001: 635.3; 2002: 689.5; 2003: 690.5.

### External financing, debt service, and reserves metrics
- Total external debt to exports of goods and services (percent): 2000: 159.6; 2001: 172.0; 2002: 182.0; 2003: 167.9; 2004 (projection): 135.7.
- External interest payments to exports of goods and services (percent): 2000: 8.9; 2001: 8.4; 2002: 7.2; 2003: 4.6; 2004 (projection): 4.0.
- Gross official reserves, months of imports of goods and services: 2000: 8.5; 2001: 8.3; 2002: 7.8; 2003: 6.9; 2004 (projection): 6.8.
- Total debt outstanding (percent of GDP, projections, Table 7): 2000: 37.2; 2001: 38.5; 2002: 41.0; 2003: 43.4; 2004 (projection): 44.6; 2005 (projection): 45.1. Total external debt (end of period, percent of GDP): 2000: 49.4; 2001: 56.4; 2002: 60.8; 2003: 60.1; 2004 (projection): 51.0; 2005 (projection): 48.2.

### Financial sector indicators
- M3 (percent change): 2000: 8.4; 2001: 7.0; 2002: 8.3; 2003: -1.8; 2004 (projection): 8.2.
- Bank credit to GDP: 2000: 72.4; 2001: 73.1; 2002: 74.9; 2003: 77.8; 2004 (projection): 77.9.
- Share of nonperforming loans in total loans (official measure): 2000: 1.7; 2001: 1.6; 2002: 1.8; 2003: 1.6.
- Risk-based capital-assets ratio, end of period: 2000: 13.3; 2001: 12.7; 2002: 14.0; 2003: 14.1.
- Gross official reserves to broad money: 2000: 41.8; 2001: 43.8; 2002: 46.8; 2003: 49.3; 2004 (projection): 42.6.

### Medium-term balance of payments and external sector projections (selected)
- Current account (percent of GDP), projections 2004–2009 (Table 6): 2004: 0.9; 2005: -0.8; 2006: -1.8; 2007: -2.5; 2008: -2.9; 2009: -3.4.
- Trade balance (percent of GDP), projections 2004–2009: 2004: 6.2; 2005: 3.8; 2006: 2.4; 2007: 2.0; 2008: 2.3; 2009: 2.4.
- Exports (percent of GDP) projections show increasing shares for non-copper exports: 2004: 14.7 (non-copper); 2009 projection: 18.5 (non-copper).
- Copper export prices (Chilean export price, annual change, percent): 2000: 14.8; 2001: -14.0; 2002: 0.4; 2003: 12.9; 2004: 51.7; 2005 (projection): -14.8.
- Copper price (LME; U.S. cents per pound, memorandum): 2000: 82.2; 2001: 71.7; 2002: 70.8; 2003: 80.7; 2004 (projection): 122.5; 2005 (projection): 104.3.

### Public finance accounting and statistical reforms (policy-relevant changes)
- With the introduction of the 2004 budget, authorities:
  - Rectified major discrepancies with international standards by displaying and including previously off-budget transactions.
  - Introduced accrual accounting for most transactions, including recording copper income on an accrual basis and using the Copper Stabilization Fund as a financing vehicle to meet accrued copper income.
  - Began presenting budget data in categories used by Government Financial Statistics Manual (GFSM 2001).
- Additional improvements anticipated during 2004:
  - Central government to record transactions in an integrated financial management system (SIGFE) allowing real-time reports on an accrual basis.
  - Expenditure data to be presented according to GFSM 2001 classifications.
  - Quarterly fiscal data back to 1987 to be made available, with detailed balance sheet data including an estimate of consumption of fixed capital.
  - Publication of information on the effects of inflation on the value of inflation-indexed bonds in the FY2005 budget.
- Remaining methodological differences with GFSM 2001 noted:
  - Interest payments on Treasury debt held by the central bank still recorded on a cash basis; part of interest payment may be deferred and not fully reflected as accrual interest expense.
  - Authorities plan to publish, but not include as an interest expense, valuation changes due to inflation on indexed bonds in the budget.
- Impact note: These two differences are not expected to be large in 2004; over the medium term they would increase expenditure by only ¼-½ percent of GDP.

### Fund relations and technical assistance (selected)
- Membership: Joined 12/31/45; Article VIII.
- Quota (SDR Million): Quota 856.10 (100.00 percent).
- Fund holdings of Chilean pesos: 562.85 (65.75 percent of quota); Reserve tranche position: 293.25 (34.25 percent of quota).
- SDR Department: Net cumulative allocation 121.92 (100.00 percent); Holdings 32.46 (26.63 percent).
- Outstanding Purchases and Loans: None.
- Financial arrangements (historical): SBA approved 11/08/89–11/07/90, amount approved SDR 64.00 and drawn 64.00; EFF approved 8/15/85–8/14/89, amount approved SDR 825.00 and drawn 650.00.
- Exchange arrangements: The exchange rate is permitted to float freely. On May 31, the interbank exchange rate was Ch$632.32 per U.S. dollar.
- Article IV consultation: The Executive Board concluded the 2003 Article IV consultation on August 18, 2003; staff report released as Country Report No. 03/303.
- Technical assistance: Multiple missions listed (FAD, STA, MAE, WHD, FSAP) covering accrual accounting, public expenditure management, money and banking statistics, national accounts, VAT administration, customs administration, nominalization and interest rate pass-through, fiscal statistics, and a financial system assessment (FSAP) in late 2003–early 2004.

### Multilateral and development partner engagement (selected)
- World Bank CAS covering FY2002-05 discussed February 2002, with focus on selective engagement and diversification of financing instruments.
- IFC support areas include private infrastructure, SMEs, specialized housing finance, and social sector; MIGA expected to facilitate foreign direct investment.
- As of May/June 2004, six investment loans in Chile’s operations portfolio totaling US$290.5 million in commitments; a Social Protection Adjustment Loan DDO of US$200 million (FY04) has been fully disbursed.
- IBRD portfolio and IFC transactions and disbursement data summarized (commitments, disbursements, undisbursed amounts as presented in the source).

*Source: IMF staff report content as provided in the supplied document.*

### 1. General government only (excluding municipal governments).    2/ Quarterly data at constant prices only.    3/ Extern

### Chile—Debt Sustainability Analysis (DSA)

### Fiscal sustainability: public (non-financial) sector (net debt)
- Analysis focuses on net debt of the non-financial public sector because the central government holds a large stock of assets (7 percent of GDP at end-2003).
- Baseline projection:
  - Primary balance remains in surplus over the forecast horizon, "well above 2 percent of GDP (Table 1)".
  - Net debt declines from 12½ percent of GDP in 2004 to 10¾ percent by 2009.
  - Computations at the time of the 2004 budget suggest the stock of net (central) government debt would be eliminated between 2012 and 2030.
- Identified caveats:
  - Three categories of debt excluded from the assessment:
    - Recognition bonds (16 percent of GDP by end-2003); amortization data unavailable in the Public Debt Report.
    - Central bank debt stock (around 30 percent of GDP by end-2003) offset by assets; net central bank debt low (½ percent of GDP by end-2003).
    - Contingent liabilities on investment guarantees (around 10 percent of GDP).
- Stress-test and bounds-test outcomes:
  - In most bound tests assuming significant shocks the debt stock would not decline, but the debt-to-GDP ratio would remain low by international standards and, in most cases, stabilize at or below 20 percent.
- Selected historical and projected public sector numbers (Table 1, in percent of GDP unless noted):
  - Public sector net debt 2000–2009: 5.5 (2000); 9.6 (2001); 13.4 (2002); 13.0 (2003); 12.5 (2004); 12.3 (2005); 11.8 (2006); 11.6 (2007); 11.1 (2008); 10.8 (2009).
  - o/w foreign-currency denominated: 11.4 (2000); 15.2 (2001); 19.3 (2002); 18.0 (2003); 16.9 (2004); 16.4 (2005); 15.7 (2006); 15.2 (2007); 14.5 (2008); 13.9 (2009).
  - Change in public sector debt: 2.6 (2000); 4.0 (2001); 3.8 (2002); -0.4 (2003); -0.5 (2004); -0.2 (2005); -0.4 (2006); -0.2 (2007); -0.5 (2008); -0.3 (2009).
  - Primary deficit (percent of GDP): -1.0 (2000); -0.4 (2001); 0.7 (2002); -1.0 (2003); -2.7 (2004); -3.0 (2005); -2.7 (2006); -2.9 (2007); -2.7 (2008); -2.9 (2009).
  - Revenue and grants (percent of GDP): 33.7 (2000); 33.5 (2001); 33.6 (2002); 32.7 (2003); 33.8 (2004); 33.0 (2005); 32.0 (2006); 30.7 (2007); 29.9 (2008); 29.3 (2009).
  - Primary (noninterest) expenditure (percent of GDP): 32.6 (2000); 33.1 (2001); 34.4 (2002); 31.7 (2003); 31.1 (2004); 29.9 (2005); 29.3 (2006); 27.8 (2007); 27.2 (2008); 26.4 (2009).
  - Residual, including asset changes (percent of GDP): 2.9 (2000); 2.7 (2001); 2.0 (2002); 3.9 (2003); 2.9 (2004); 3.0 (2005); 2.5 (2006); 2.9 (2007); 2.4 (2008); 2.6 (2009).
  - Public sector debt-to-revenue ratio: 16.4 (2000); 28.6 (2001); 39.9 (2002); 39.7 (2003); 37.0 (2004); 37.2 (2005); 37.0 (2006); 37.8 (2007); 37.1 (2008); 36.9 (2009).
- Key macro-fiscal assumptions (selected):
  - Real GDP growth (in percent): 4.5 (2000); 3.4 (2001); 2.2 (2002); 3.3 (2003); 4.6 (2004); 3.0 (2005); 4.9 (2006); 5.0 (2007); 5.3 (2008); 5.1 (2009).
  - Average nominal interest rate on public debt (in percent) 7/: 9.0 (2000); 8.1 (2001); 5.1 (2002); 4.4 (2003); 7.9 (2004); 1.8 (2005); 3.6 (2006); 6.3 (2007); 6.6 (2008); 6.9 (2009).
  - Inflation rate (GDP deflator, in percent): 4.6 (2000); 3.6 (2001); 4.5 (2002); 3.9 (2003); 5.2 (2004); 3.8 (2005); 3.8 (2006); 3.1 (2007); 3.2 (2008); 3.5 (2009).
- Scenario highlights (selected outcomes from Table 1):
  - A1 (key variables at historical averages in 2005-09): net debt stabilizes around 12.5 (2004) rising to 17.5 by 2009 (debt-stabilizing primary balance 11/ reported as 0.0).
  - A2 (no policy change, constant primary balance in 2005-09): net debt moves from 12.5 (2004) to 11.3 by 2009 (debt-stabilizing primary balance 10/ reported as 0.9).
  - B2 (real GDP growth at historical average minus two standard deviations in 2005 and 2006): net debt rises from 12.5 (2004) to 31.6 by 2009.
  - B5 (one time 30 percent real depreciation in 2005): net debt jumps from 12.5 (2004) to 19.1 by 2009.

### External sustainability: gross external debt
- Baseline assessment:
  - External debt remains well-contained over the medium term.
  - High gross external debt to GDP ratio reflects corporate-sector borrowing; at end-2003 external public debt was equivalent to only 9¼ percent of GDP.
  - Gross external debt to GDP improved sharply in recent years due to appreciation of the Chilean peso.
  - Over the medium term, the gross external debt ratio projected to remain broadly stable, at around 50 percent of GDP.
- Vulnerabilities and mitigating factors:
  - Private sector external debt is relatively high, but mitigants include natural hedges for the export sector and access to financial hedges.
  - Short-term debt on a residual maturity basis represents only 22 percent of private sector external debt.
  - Average duration of medium-term debt is above five years.
  - More than half of private external debt is owed by foreign-owned firms, with one third representing claims of parent companies.
- Sensitivity to shocks:
  - External debt is sensitive to price and exchange rate shocks; the share of external debt rose to above 60 percent of GDP in 2002 because of a sharp depreciation.
  - Shocks to real GDP growth or the current account have a limited impact relative to price/exchange rate shocks.
- Selected external sector figures (Table 2, in percent of GDP unless noted):
  - External debt (percent of GDP) 2000–2009: 49.4 (2000); 56.4 (2001); 60.8 (2002); 60.1 (2003); 51.0 (2004); 48.2 (2005); 48.5 (2006); 49.3 (2007); 50.1 (2008); 51.1 (2009).
  - Change in external debt: 1.8 (2000); 6.9 (2001); 4.5 (2002); -0.7 (2003); -9.2 (2004); -2.7 (2005); 0.3 (2006); 0.8 (2007); 0.8 (2008); 1.0 (2009).
  - Identified external debt-creating flows (4+8+9): -1.8 (2000); 5.1 (2001); 4.9 (2002); 1.5 (2003); -1.7 (2004); -0.1 (2005); 0.8 (2006); 1.1 (2007); 1.2 (2008); 1.4 (2009).
  - Current account deficit, excluding interest payments (percent of GDP): -1.6 (2000); -1.1 (2001); -1.1 (2002); -0.8 (2003); -2.4 (2004); -1.2 (2005); -0.5 (2006); -0.1 (2007); -0.1 (2008); -0.1 (2009).
  - Exports (percent of GDP): 31.0 (2000); 32.8 (2001); 33.4 (2002); 35.8 (2003); 37.6 (2004); 34.1 (2005); 31.5 (2006); 30.1 (2007); 30.0 (2008); 30.0 (2009).
  - Imports (percent of GDP): 29.1 (2000); 31.3 (2001); 31.1 (2002); 32.7 (2003); 31.3 (2004); 31.2 (2005); 30.1 (2006); 29.2 (2007); 29.0 (2008); 28.9 (2009).
  - Net non-debt creating capital inflows (negative = net inflows) (percent of GDP): -1.6 (2000); -1.4 (2001); 2.7 (2002); 4.8 (2003); 1.7 (2004); 1.3 (2005); 1.3 (2006); 1.1 (2007); 0.8 (2008); 0.6 (2009).
  - Automatic debt dynamics contribution (percent of GDP): 1.3 (2000); 7.7 (2001); 3.3 (2002); -2.4 (2003); -1.0 (2004); -0.3 (2005); 0.0 (2006); 0.2 (2007); 0.5 (2008); 0.9 (2009).
  - External debt-to-exports ratio (in percent): 159.6 (2000); 172.0 (2001); 182.0 (2002); 167.9 (2003); 135.7 (2004); 141.3 (2005); 154.0 (2006); 163.6 (2007); 166.9 (2008); 170.5 (2009).
  - Gross external financing need (in billions of U.S. dollars): 9.4 (2000); 11.6 (2001); 12.3 (2002); 12.1 (2003); 13.2 (2004); 14.3 (2005); 14.8 (2006); 16.3 (2007); 16.3 (2008); 16.9 (2009).
- Stress-test scenarios (Table 2, selected):
  - B3 (change in US dollar GDP deflator at historical average minus two standard deviations in 2005 and 2006): gross external debt rises from 51.0 (2004) to 80.9 by 2009.
  - B6 (one time 30 percent nominal depreciation in 2005): gross external debt rises from 51.0 (2004) to 73.0 by 2009.

### International investment position (Table inset, stocks at end-year, in percent of GDP, 2002)
- Assets / Liabilities / Net position (stocks at end-year, in percent of GDP):
  - Public sector: 24 / 11 / 13.
  - Reserves: 23 (single entry).
  - Private sector: 60 / 114 / -55.
  - Financial: 12 / 7 / 6.
  - Non-financial: 47 / 108 / -60.
  - FDI: 19 / 66 / -47.
  - Equity: 0 / 3 / -3.
  - Debt: 20 / 38 / -19.
  - Commercial: 11 / 7 / 4.
  - Short-term: 7 / 1 / 7.
  - Medium/long-term: 1 / 30 / -29.
- Interpretation:
  - Reflecting large FDI, Chile’s net international investment position is negative, but both the public and the financial sector have positive net positions.
  - Financial system assets abroad largely reflect holdings of pension funds and, to a lesser extent, banks abroad.
  - Private nonfinancial sector negative net position (-55 percent of GDP) largely reflects FDI.
  - Private nonfinancial sector holds debt abroad equivalent to 38 percent of GDP, mostly medium- and long-term (close to 5 years), partly offset by holdings of assets equivalent to close to 20 percent of GDP (predominantly short-term).

### Pro-Growth Agenda: Description and Update (as of June 11, 2004) — Selected reforms and status
- I. Regulation of Product Markets and Competition (selected items):
  - Electricity Law: expected to lead to increased electricity generating capacity and improvements in transmission systems. Status: Law already published.
  - Fishing Law: first part extended fishing rights for 10 years and eliminated link to specific vessels; second part (extend rights for an additional 15 years and quotas for small fisheries) being discussed by the Senate. Status: First law published in late-2002; second part being discussed by the Senate.
  - Telecommunications Regulation: setting uniform and transparent access fees between all telecommunication companies. Status: Under Study.
  - Tax Courts: creation of 16 independent and specialized tax courts, free from hierarchical and administrative control of SII; specialized tribunals at Court of Appeals level. Status: Being discussed in Congress.
  - Anti-Trust Court: replaces Anti-monopoly Resolution Commission; law already published. Status: Law already published.
  - Economic Courts: establishment under study. Status: Under Study.
  - Investment Platform Law: establishes regime to avoid double taxation on foreign enterprises based in Chile to invest abroad. Status: Law already published.
  - Bankruptcy law: aimed at modernizing bankruptcy framework; status: Under study.
- II. Capital Markets Reform (selected):
  - Capital Market Reform II: package includes incentives for venture capital, reduction of transaction costs for small companies, corporate governance improvements, financial incentives for voluntary private pension savings, regulatory/coordination changes in financial supervision, immaterialization and electronic trading of assets. Status: Being discussed in Congress.
- III. Modernization of the State (selected):
  - Civil Service Regime: changes remuneration and career development for non-managerial civil servants; reduce political appointments from around 3,500 to 400; create senior executive service (alta dirección pública); create National Direction of Civil Service under Ministry of Finance. Status: Law already published.
  - Campaign Finance: sets limits on electoral spending and increases transparency; Status: Law already published.
  - Public Procurement Law: increases transparency, requires annual contracting plans, establishes electronic procurement system and Procurement Directorate, creates Public Procurement Court. Status: Law already published.
  - Administrative Procedures Law: sets maximum terms for issuance of permits and certificates (“silencio administrativo”). Status: Law already published.
  - Military supplies: elimination of tax exemptions on imports by the armed forces excluding munitions, parts and fuel. Status: Law already published.
  - Budget Commission: special bicameral budget commission approved by congress. Status: Approved by congress.
- IV. Labor Market:
  - Bilateral agreements to make work schedules more flexible (adaptabilidad pactada). Status: (item listed; status not shown in supplied excerpt).

*Source: Chile—Debt Sustainability Analysis (DSA), APPENDIX IV and Pro-Growth Agenda (Appendix V), IMF staff report content provided.*

### Introduction of the possibility of bilateral agreements between employers and employees to reduce restrictions on work s

### _cr04291 - Introduction of the possibility of bilateral agreements between employers and employees to reduce restrictions on work s

### Labor-market reforms and status
- Introduction of the possibility of bilateral agreements between employers and employees to reduce restrictions on work schedules, which should also facilitate the use of the part-time and labor-training contracts introduced in the 2001 labor reform.
  - Status: Draft law under preparation.
- Certification of Labor Competencies
  - Creation of a national system of labor competencies’ certification to reduce information asymmetries by standardizing information on labor competencies.
  - Status: Sent to Congress.
- Voluntary Savings for Unemployment
  - A complement to the unemployment insurance system for middle- and high-wage earners.
  - Status: Draft law under preparation.
- Temporary workers
  - Regulation of firms providing temporary workers and the relationship between subcontracted workers and hiring companies.
  - Status: Being discussed in Senate.

### Social-sector reforms and status
- AUGE (health) Plan
  - Comprehensive reform to the health system aimed at improving the use of resources by the public health system, explicitly guaranteeing access to health services for the most common and costly pathologies, and overhaul of the financing mechanisms of public and private health care.
  - Expected effect: Health-service providers would adapt better to the demand structure through a reallocation of resources among health units.
  - Status: Part of the reform has been approved by congress. The guarantee regime and the private health system reform continue to be discussed in the Senate.
- Student Loans System for Private Universities
  - Aims at establishing student loans with government guarantees in private universities, accompanied by a system to secure the quality of higher education through better qualification processes.
  - Status: Proposal under review by the Senate.
- Chile Solidario
  - Targeting of social policies toward the indigent.
  - Status: Approved by congress.

### Background and macroeconomic outlook (high-level findings)
- Policy framework and recent history
  - Over the past two decades, Chile has adhered to a policy mix based on open trade, exchange rate flexibility, inflation targeting, and achievement of a fiscal structural balance rule—requiring a cyclically-adjusted, central government fiscal surplus of 1 percent of GDP.
  - During 2000-03, the actual overall balance of the central government registered a deficit of just below 1 percent of GDP and, in 2004, the accounts of the central government are expected to register a surplus of 1.5 percent of GDP.
- Growth and labor market
  - Real GDP growth averaged 3½ percent a year during 2000-03.
  - Real GDP grew by 6½ percent in seasonally-adjusted terms during the first quarter of 2004.
  - The World Economic Outlook projects a rate of growth of 5 percent for 2004.
  - Unemployment rate has remained relatively high, at about 8½ percent.
- Inflation and monetary policy
  - Twelve-month inflation temporarily fell below the 2-4 percent inflation target range.
  - The central bank cut its policy interest rates twice, by 50 basis points on each occasion, in December 2003 and January 2004.
- External conditions and terms of trade
  - Copper price nearly doubled since end-2002.
  - High copper prices expected to help the external current account to register a surplus of about 1 percent of GDP in 2004.
- Near-term projection
  - Economy expected to grow by about 5 percent a year in 2004 and 2005.
  - Output gap would close slowly; inflation expected to gradually return within the central bank’s target band.

### Executive Board assessment — main conclusions and recommendations
- Commendations and overall assessment
  - Directors commended the Chilean authorities for continued implementation of sound policies: prudent fiscal policy, successful inflation targeting, and trade integration.
  - These policies, together with a robust financial system, led to sustained economic growth and contributed to a sharp reduction in poverty.
- Fiscal policy
  - Praised commitment to a prudent fiscal policy reinforced by adherence to a structural balance rule calling for a surplus of 1 percent of GDP in central government fiscal accounts.
  - Directors welcomed use of surpluses in the Copper Stabilization Fund to selectively prepay government debt.
  - Several Directors recommended formalizing the structural balance rule into a law; several other Directors thought formalizing would unnecessarily constrain countercyclical fiscal policy.
- Monetary and exchange-rate policy
  - Recognized success of inflation targeting in anchoring expectations.
  - Viewed current monetary stance as appropriate and supportive; advised gradual removal of monetary stimulus given the large output gap and still high unemployment.
  - Observed floating exchange rate regime has allowed smooth adjustment to external shocks; commended policy of nonintervention despite sharp appreciation in late 2003.
- Debt management and central bank
  - Agreed with central bank’s debt management strategy and plans to introduce long-term peso-denominated bonds.
  - Supported plans to gradually redeem part of dollar-indexed debt with foreign exchange reserves.
  - Encouraged recapitalization of the central bank to help resolve ongoing quasi-fiscal deficits; some Directors saw need to link structural balance rule to the bank’s quasi-fiscal deficit.
- Financial sector oversight and reforms
  - Welcomed authorities’ intention to follow Financial System Stability Assessment recommendations.
  - Financial system viewed as sound but Directors noted need to reduce risks in the insurance industry and strengthen securities industry regulation and supervision.
  - Noted need to improve Anti-Money Laundering/Combating the Financing of Terrorism legislation.
  - Suggested liberalizing investment restrictions on pension funds and moving to a high-quality risk-based regulatory system reflecting interconnections in financial markets.
  - Welcomed reforms in the new Capital Markets II draft law.
- Growth, inequality, and structural reforms
  - Praised on-going public debate on sustaining higher growth while reducing income inequality.
  - Supported recent laws to implement the Pro-Growth Agenda.
  - Noted importance of liberalizing labor market laws and strengthening education to improve employment opportunities.
  - Praised social policies such as Chile Solidario as well-targeted to reduce extreme poverty.
- Data and transparency
  - Recognized data received by the Fund as good quality, timely, and adequate for surveillance; commended strides in fiscal statistics alignment with international standards.
  - Welcomed Chile’s participation in pilot project to evaluate public investment and Public-Private Partnerships.

### Key selected economic indicators (as reported)
- Real GDP growth (annual percentage change)
  - 1998: 3.2
  - 1999: -0.8
  - 2000: 4.5
  - 2001: 3.4
  - 2002: 2.2
  - 2003: 3.3
- Real GDP growth average 2000-03: 3½ percent a year
- Real GDP growth (Q1 2004, seasonally-adjusted): 6½ percent
- Projected growth: 5 percent for 2004
- Unemployment rate (annual average)
  - 1998: 6.2 percent
  - 1999: 9.7 percent
  - 2000: 9.2 percent
  - 2001: 9.2 percent
  - 2002: 8.9 percent
  - 2003: 8.5 percent
- Consumer prices (end of period)
  - 1998: 4.4
  - 1999: 2.5
  - 2000: 4.6
  - 2001: 3.0
  - 2002: 2.9
  - 2003: 1.1
- Central government fiscal balance
  - 2003: -0.5 (percent of GDP)
  - Expected 2004 surplus: 1.5 percent of GDP
- Gross domestic investment (percent of GDP)
  - 1998: 26.9
  - 1999: 20.9
  - 2000: 21.9
  - 2001: 22.0
  - 2002: 22.0
  - 2003: 21.8
- Current account
  - 1998: -4.9
  - 1999: 0.1
  - 2000: -1.2
  - 2001: -1.6
  - 2002: -1.3
  - 2003: -0.8
- Gross external debt (percent of GDP)
  - 1998: 41.1
  - 1999: 47.6
  - 2000: 49.4
  - 2001: 56.4
  - 2002: 60.8
  - 2003: 60.1
- Central government gross debt (percent of GDP)
  - 1998: 12.5
  - 1999: 13.7
  - 2000: 13.7
  - 2001: 15.0
  - 2002: 15.7
  - 2003: 13.3

*Source: Public Information Notice (PIN) No. 04/83 — IMF Concludes 2004 Article IV Consultation with Chile (August 5, 2004).*

### 1. The Chilean authorities once again express their appreciation to the staff for the valuable

### 1. The Chilean authorities once again express their appreciation to the staff for the valuable

### Publication and policy dialogue
- Authorities consent to the publication of the Staff Report, the FSSA, and the Special Issues Papers.
- Chile’s home-grown economic strategy has been strengthened by a close policy dialogue with the Fund, despite sometimes different views on specific issues.
- The consultation process has helped refine some policies and better convey to the international community and financial markets the foundations of Chile’s strategy.

### Recent growth performance and external sector
- GDP growth in the second quarter will be about 5 percent.
- The consensus growth forecast for this year has been raised to a similar rate, up from 4.5 percent at the time of last year’s consultation.
- Export expansion during the first half of this year: 39 percent in value terms, compared to the first half of last year’s.
- Non-copper exports are growing close to 15 percent in volume terms this year.
- Copper accounts for 36 percent of total exports of goods.
- Sectoral growth during the first quarter this year:
  - Manufacturing, Agriculture, Construction, Commerce, and Transport and Communications: growing between 4.5 and 6.5 percent.
  - Fisheries: expanded at two-digit rates.
  - Mining: suffered a temporary delay in the expansion of new projects.
- Drivers: strengthening external demand, improvement of the terms of trade, supportive monetary policy, faster domestic demand growth (private consumption and private investment, particularly in machinery and equipment).

### Commodities, diversification, and resilience
- Copper remains very important; extraordinarily high copper prices this year have been a key factor favoring the recovery.
- Export diversification: open-trade strategy has permitted sustained diversification of the export base, with copper falling to 36 percent of total exports of goods.
- Diversification plus consistent macroeconomic policy and effective financial sector regulation and supervision have helped increase resilience to external shocks.
- The natural resource content of the export basket does not represent a barrier to long-term growth (as recognized by the staff in last year’s Article IV Consultation).

### Labor market and productivity
- Employment growth has remained somewhat sluggish despite output and sectoral expansion.
- Positive implication: significant expansion in productivity is taking place.
- Unemployment history and recent levels:
  - Peaked at 11.5 percent in mid 1999 after a short-lived recession.
  - Gradually came down reaching just over 9 percent in mid 2004.
- Reasons unemployment has not fallen more rapidly: movements within employment towards better and more formal jobs, return to the labor force of previously discouraged workers.
- Outlook: recovery in investment expansion should translate into more dynamic employment creation and lower unemployment rate.

### Monetary policy, inflation, and capital markets
- Credibility of the independent Central Bank of Chile (BCCH) has allowed countercyclical monetary policy contributing to domestic demand recovery.
- Inflation has in general remained within the target band and is currently converging towards it from below after a short period of negative inflation due to supply shocks.
- Development of the capital market aided by consolidation of low inflation.
- Recently introduced 10-year Central Bank bonds denominated in Chilean pesos are the longest non-indexed domestic currency instrument ever issued by the Chilean public sector.
  - Their yield: 6.5%.
  - Yield of indexed instruments of the same maturity: 3.7%.
  - The sum of implicit inflationary expectations and a risk premium or discount are slightly below 3 percent.
- Alignment of inflationary expectations with the center of the inflation target range is confirmed by surveys.

### Exchange rate regime, fiscal policy, and transparency
- Monetary stimulus possible because of floating exchange rate system, rules-based fiscal policy, and overall credibility of the policy framework.
- Foreign currency intervention has not been used since early 2003.
- Fiscal policy targets:
  - Structural surplus equivalent to 1 percent of GDP for the central government balance also during the upswing.
  - A nominal fiscal surplus above 1 percent of GDP is expected for this year.
- The structural fiscal target aims to allow automatic stabilizers to operate throughout the cycle and avoid past pro-cyclical bias.
- Both fiscal and monetary policies display high and increasing levels of transparency, as recognized in last year’s Fiscal ROSC and this year’s Monetary ROSC.

### Energy supply risks and response
- Effects of the disruption of natural gas supplies from Argentina have been contained; recent news have been favorable, reducing the moderate impact on output growth and energy costs mentioned in the report.
- Increased use of natural gas added diversification to an energy matrix historically concentrated in hydroelectric power.
- Industry is searching for alternative energy sources given unreliability of the new supply source and demand pressures, including:
  - Importing natural gas from outside the region.
  - Geo-thermal energy.
  - Bringing forward future hydroelectric projects.

### Corporate external debt and private sector financial position
- Concerns about “relatively high” Chilean corporate external debt reflect a partial view:
  - A substantial part corresponds to companies owned by non-financial multinationals, much of it due to parent companies.
  - Chile’s indicators of gross private external debt are below those of advanced economies.
  - Large accumulation of assets held abroad by Chilean corporations and institutional investors should be considered.
- For financial risk analysis, gross debt should be complemented with a comprehensive analysis of asset-liability mismatches.
- Development of derivatives markets for exchange-rate risk provides hedging access.
- Liquid external assets of the private sector cover a significant portion of short-term external liabilities.
- International capital markets have improved risk evaluation of Chilean corporations:
  - Bond spreads for a representative sample of corporations: from an average of 280 basis points last year, to around 200 basis points on average throughout this year.

### Financial sector assessment (FSAP / FSSA) and reforms
- FSAP exercise judged extremely useful.
- Core message of the FSSA: Chilean financial system is relatively large, sound, well diversified, and resilient to shocks.
- Strengths underscored: banking system, supervisory and regulatory institutions, role of pension funds and their substantial accumulation of domestic and external financial assets.
- FSSA identified areas requiring strengthening to improve efficiency of resource allocation; recommendations have been welcomed and work has begun.
  - Central Bank and SBIF published a proposal for reforming regulations on market risk at banks along the lines of the 1996 amendment to the Basle capital accord, and are considering the scope of derivative intermediation open to banks.
  - Central Bank has revamped payment systems and continues to improve clearance and settlement infrastructure for securities.
  - Capital Markets II initiative and a bill to introduce additional flexibility to ceilings on lending interest rates (making them more product-specific) have been submitted to Congress.
  - Other initiatives requiring legislative work or more sophisticated technical treatment will follow.
  - BCCH will soon start periodically publishing a Financial Stability Report to enhance surveillance.

### Growth prospects, potential output, and reforms
- Outstanding performance during the nineties explained by reforms, institution building, and strengthening of the macroeconomic policy framework.
- Recent slow growth due to contagion from crisis episodes in emerging markets and weak global conditions at the turn of the century.
- Under supportive external environment and strong policy/institutional framework, Chile is well positioned to return to a higher growth path.
- Independent experts estimating parameters for fiscal structural balance:
  - Growth rate of potential output: 4.1 percent.
  - Including absorption of existing output gap, average growth over the next 4 years is projected at 5.2 percent.
- Room for greater optimism due to recent advances: free trade agreements, structural reforms (capital markets, civil service, education, health, sanitation), infrastructure building, and prospects for a more robust return of capital inflows and foreign investment.

### Human capital and social policy priorities
- Improving the efficiency of the education system is necessary to sustain higher economic growth.
  - Many observed weaknesses in quality of education attributed to rapid expansion of coverage.
  - Several projects aimed at increasing education quality are already underway.
- Well-focalized social policies remain a priority despite impressive poverty reduction over the last decade; significant pockets of poverty still remain.
- Authorities have developed a special, well-focalized program, Chile-Solidario, to increase access to social services by marginalized segments of the population, mostly in rural areas.
- A more balanced wealth and income distribution is likely to result from sustained implementation of policies aimed at ensuring equal opportunities.

*Source: Chilean authorities' statement contained in the IMF consultation materials.*

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