## _cr06335 ## Source details **Canonical URL:** [_cr06335](https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2006/_cr06335.pdf) ## Other formats - [Markdown version](/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2006/_cr06335.pdf.md) - [Structured JSON version](/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2006/_cr06335.pdf.json) --- ### Executive summary — background and performance - Structural reforms and prudent policies over the past fifteen years anchored Chile’s performance: fiscal restraint, independent monetary policy, a sound and deep financial system, and an outward-looking trade policy. - Over the 15–year period through 2005: - Rate of economic growth averaged 5½ percent a year. - Per capita income tripled in U. S. dollar terms. - Poverty rate was cut in half, to about 18 percent. - Income inequality remains high. - Copper sector and prices: - Copper sector accounts for 15 percent of Chile’s GDP and over 40 percent of its total exports. - Copper prices rose from US$0.8 a pound on average in 2003 to US$3.7 in May 2006, easing to US$3.5 in mid‑July 2006. - Political/institutional: - President Bachelet’s administration reaffirmed support for macro framework and confirmed adherence to the structural fiscal surplus rule of 1 percent of GDP; announced plans to strengthen social services and comprehensively reform the private pension system. ### Recent macroeconomic developments - Growth and demand: - Annualized quarterly GDP growth slowed to about 4 percent since mid–2005. - Year‑on‑year real GDP growth was 5.1 percent in the first quarter of 2006. - Domestic demand main driver; investment growth decelerated sharply after a surge in 2004–05 while consumption remains strong. - Labor market: - Employment increased cumulatively by 8½ percent through end‑May 2006 (since end–2003). - Unemployment hovered around 8 percent (seasonally‑adjusted); youth unemployment close to 20 percent. - 12–month nominal wage increase close to 5¾ percent since mid‑2005. - Inflation and exchange rate: - Since the beginning of 2003, the peso appreciated by 25 percent in nominal terms against the U.S. dollar and by 22 percent in real effective terms. - Headline inflation rose to the top of central bank’s 2–4 percent target range in Q1 2006; headline inflation was 3.9 percent in June 2006. - Narrowly‑defined 12‑month core inflation was 2.7 percent (up from 1.7 percent a year earlier). - External sector and public finances: - 2005 external current account surplus narrowed from 1½ percent of GDP in 2004 to ½ percent of GDP. - Terms of trade improved by 12½ percent in 2005 (on top of a 21 percent increase in 2004). - Non‑mining export volume rose 10 percent in 2005; mining export volume fell 3 percent from 2004. - Imports rose 21 percent in volume terms in 2005. - Net public sector debt (including central bank debt) fell from about 13 percent of GDP in 2003 to 7½ percent in 2005. - Gross public sector debt declined from 44½ percent of GDP to 31½ percent of GDP (2003–2005). - Private sector indebtedness abroad fell by 15 percentage points, to close to 31 percent of GDP at end‑2005. - Gross official international reserves were US$17 billion (15 percent of 2005 GDP), ~110 percent of short‑term external debt and covering close to five months of imports. - Fiscal and monetary stance: - Central government overall surplus of 4¾ percent of GDP in 2005 (up from 2¼ percent in 2004); surplus used roughly equally to prepay debt and increase liquid asset holdings. - Central bank raised policy rate by 325 basis points since September 2004 to 5 percent; policy rate unchanged since April 2006 (later noted as 5.25 percent after July meeting). - Authorities view monetary conditions as somewhat expansionary, policy rate about 1 percent in real terms. - Market resilience: - June correction: peso depreciated almost 3 percent vs. U.S. dollar; stock market fell about 1½ percent; sovereign spreads tightened slightly to around 80 basis points. ### Outlook and projections - Growth and inflation: - Real GDP projected to grow by 5-6 percent in 2006–07. - Inflation projected to gradually return to the middle of the inflation target range ("3 percent ± 1 percent"). - Fiscal and external: - Central government expected to register an overall surplus close to 6 percent of GDP in 2006 (reflecting higher copper prices). - External current account surplus projected to widen to about 2 percent of GDP in 2006. - Policy intentions: - Government bill to congress to establish rules for investing and managing fiscal surpluses: envisages investing part in a pension fund, gradually recapitalizing the central bank, and lodging remaining surpluses in Fund for Economic and Social Stabilization (FESS) permitted to invest abroad. - Central bank intends to continue gradually removing monetary stimulus; further interest rate hikes data‑dependent—particularly core inflation, non‑mining output growth, and possible additional fiscal stimulus in 2007. - Pension reform process: - Commission appointed to report by early‑July to an interministerial committee; congressional process expected in 2007. ### Risks, scenarios, and quantitative sensitivities - Risks broadly balanced; key examples: - Global/regional risks: disorderly adjustment in global imbalances or increased U.S. interest‑rate uncertainty could trigger asset sell‑offs, drops in commodity prices and financing, affecting growth; regional political developments could reduce investor appetite for Latin American risks. - Energy risks: - Disruptions in Argentine gas supplies and oil price increases could raise production costs and weigh on growth. - Since 2004 Argentina reduced gas exports; gas cuts in Q2 2006 averaged close to 40 percent (up from 30 percent during same period last year). - Three‑fourths of Chilean firms using gas have converted plants to alternative energy sources. - Staff estimate: a 10 percent increase in oil prices above the baseline could reduce GDP growth by a ¼ of a percentage point. - Copper price risks: low stocks, limited capacity expansion, rising demand (especially from China), and speculative capital raise volatility and risk of a sudden price correction. ### Fiscal policy design and tax recommendations - Structural fiscal rule: - Structural surplus rule guides fiscal policy; amended beginning with 2006 budget to smooth higher copper price impacts. - Molybdenum receipts from CODELCO included in structural revenue computation based on average prices observed in previous years. - Use of surpluses (bill to congress): - Pension fund: at least 0.2 percent (and up to 0.5 percent if cash surplus allows) of previous-year’s GDP invested each year; amounts locked for 10 years; investment rules aligned with private pension funds (currently allowed up to 30 percent abroad). - Central bank recapitalization: up to 0.5 percent of GDP assigned each year for next five years, covering about half of recapitalization need; to be used to build foreign reserves. - FESS: remaining surpluses lodged in FESS; transparent, quarterly reporting; allowed to invest abroad initially in government and high-grade corporate bonds; future diversification could include equities. - Tax reform proposals: - Reduce distortionary taxes using buoyant revenues. - Stamp tax generated 0.6 percent of GDP in 2005; staff recommended equating incidence across maturities and eliminating the stamp tax for some operations, including on‑lent bank borrowing from abroad. - Authorities planned to eliminate the tax for refinancing of loans (already removed for mortgage loans since 2003) and consider further changes later. - Suggested eliminating the small tax on electronic transactions and checks and simplifying tax regime for SMEs. ### Monetary policy stance and guidance - Central bank policy rate developments: - Policy rate set at 5 percent since April 2006; later increased by 25 basis points in July meeting to 5.25 percent. - Since September 2004 central bank raised policy rate by total of 325 basis points (noting elsewhere as 350 basis points up to 5.25 percent). - CBC considers policy rate below neutral rate; plans gradual removal of stimulus with data‑dependence on core inflation, nonmining output growth, industrial production, and capital good imports. - Exchange rate and intervention policy: - Peso appreciated 22 percent in real effective terms since 2003. - Central bank will only intervene if three conditions met: (i) evidence of misalignment; (ii) misalignment impacts economic activity; (iii) intervention likely to succeed—conditions not met; plan to let peso float freely. - Staff supported free float, noting hedging market development and continued nonmining export growth. ### Pension system reform options and recommendations - System scale and challenges: - Private pension funds manage around US$68 billion (about three‑fifths of GDP). - Issues: low density of contributions; coverage of social pillar; lack of competition; investment rules; low participation of women and self-employed (self-employed participation currently 5 percent). - Minimum pension guarantee tied to years of contribution (20 years) rather than need; welfare pension eligibility broad. - Commission recommendations (presented July 6, 2006): - Create solidarity pillar guaranteeing basic universal pension for the poor. - Require self‑employed to contribute. - Streamline and liberalize pension fund investment regime. - Separate account and investment management functions. - Staff recommendations: - Make participation compulsory for self-employed. - Rationalize investment restrictions and consider raising foreign investment limits. - Specific reform options under consideration: - Change minimum pension eligibility from time basis to financial threshold. - Reduce costs and increase competition by separating investment management from account administration, auctioning accounts of worker groups, allocating new workers to lowest‑cost funds, or restricting movement into higher‑cost funds. - Streamline more than ninety limits and sub-limits on portfolio risk, foreign investment, and asset allocation. - Address gender disparities: delay retirement age (average retirement age women 54 years and 57 for men), make early retirement less attractive, or subsidize pension contributions of mothers. ### Financial sector soundness, markets, and regulatory priorities - Prudential indicators: - Banking system sound with high capital, low impaired assets, and high provisioning. - Consumer credit: 12–month real increase 22 percent at end‑March; consumer credit accounts for 15 percent of total bank credit; department store credit card lending at least 20 percent of total consumer credit. - Need to improve consolidated information on credit risks; support creation of a central credit database covering banks, cooperatives, and department store card lending. - Capital market and legal reforms: - Capital Market Law II draft stalled in congress; proposals include incentives for risk capital, new national registry for pledges to improve SME financing, and strengthened corporate governance to OECD standards. - Financial Intelligence Unit (FIU) draft law expected to restore FIU powers; passage critical to combat money laundering. - Domestic bond market and public debt management: - Domestic bond market grown but low activity; staff recommended improving liquidity by relaxing some investment restrictions on private pension funds, reviewing taxation of foreign investors, removing stamp tax distortions, and possibly introducing specialists in public debt. - Need coordinated medium‑term debt management strategy between Finance Ministry and Central Bank; Finance Ministry to focus on long end (including inflation‑indexed issues) while Central Bank issues medium/short tenors. - Central Bank made public key aspects of reserve management, including currency composition. - Regulatory/tax measures announced by Minister of Finance (July 20): - Legislative priority for draft fiscal responsibility law. - Rekindle Capital Market II reform bill and send revised bill to congress. - Proposal to gradually reduce stamp tax from 1.6 percent to 1.2 percent by 2009 and exempt all refinancing operations. - Issue regulations to simplify capital gains tax and clarify exemptions. - Facilitate issuance of peso bonds by foreign investors and align settlement/netting for derivatives to international standards. - Unify taxes on imported software, patents, and technological services at 15 percent. - Subsidies and tax exemptions for R&D spending by private companies. ### Labor market, social policy, and human capital - Labor market impediments: - Unemployment high and labor market rigidities persist; labor force participation low by international standards for youth and women. - Severance payments equivalent to one month’s wages per year of service (up to 11 months). - About one fourth of formal sector workers under temporary work arrangements; fixed‑term contracts limited to one year by law. - Policy measures and recommendations: - Government plans to subsidize 50 percent of minimum wage for some 1,500 first‑time young workers and extend benefit to workers up to 25 years old (from 21 years). - Bonuses for firms that employ youths at social risk. - Staff recommended more use of short‑term and part‑time contracts for youth, broaden childcare coverage, restraint in future minimum wage increases, introduce more flexibility in working hours and allow longer fixed‑term contracts. - Human capital and innovation: - Potential growth estimated around 5 percent a year; trend productivity growth estimated at ½–1 percent (slower than 2 percent in 1990s). - Education priorities: universal pre‑school coverage over four‑year term; broaden preferential subsidy vouchers; increase scholarships and loan guarantees for tertiary access; grants to study abroad. - R&D: current spending around 0.7 percent of GDP; Fund for Innovation (financed by special tax on mining) awaiting congressional approval; spending on‑budget and covered by structural surplus rule. - Staff: improving human capital and boosting innovation key to long‑term development. ### Data, statistics, and identified weaknesses - Overall quality generally good; improvements needed in CPI and labor cost components. - Specific recommendations: - Expand CPI survey sample outside Santiago and update weights to 2006-2007 HBS; undertake new household expenditure survey and use hedonic price analysis. - Review recent establishment survey for compensation and hours worked quality. - Improve Central Bank inventory data to distinguish persistent consumption shifts from transitory stockpiling. - GFSM 2001 implementation progressing; further improvements needed in disaggregating subsidies/grants and reconciling interest recording. - Central Bank publishes quarterly BOP and IIP consistent with BPM5; coverage of military sector in external statistics incomplete. - Chile in observance with SDDS. ### Key macroeconomic aggregates (selected values and projections) - Real GDP (annual % change): 2001: 3.4; 2002: 2.2; 2003: 3.9; 2004: 6.2; 2005: 6.3; 2006: 5-6; 2007: 5-6. - Consumer prices (end of period): 2005: 3.7; 2006: 3.4; 2007: 3.0. - Unemployment rate (annual average): 2005: 8.0; 2006: 7.7; 2007: 7.5. - Current account (percent of GDP): 2005: 0.6; 2006: 2.0; 2007: 1.1. - Exports of goods (millions US$): 2005: 40,574; 2006: 52,235; 2007: 48,612. - Copper exports (millions US$): 2005: 18,306; 2006: 28,134; 2007: 23,899. - Copper as percent of total exports: 2005: 45.1; 2006: 53.9; 2007: 49.2. - Gross official reserves (US$ billion): 2005: 16.0; 2006: 17.0; 2007: 16.6. - Net public sector debt (percent of GDP): 2005: 7.7; 2006: 3.4; 2007: 1.3. - Central government overall balance (percent of GDP): 2005: 5.9; 2006: 3.5 (projected in table context). ### Staff appraisal and priority recommendations - Strengths and resilience: - Favorable external environment, strong policy framework (structural surplus rule, inflation targeting, floating exchange rate), and deepening financial system enhance resilience. - Markets differentiated Chile favorably during emerging‑market sell‑off. - Priorities and recommendations: - Maintain fiscal discipline and adhere to structural surplus rule while prioritizing non‑recurrent and tradable‑goods outlays in 2007 budget. - Accumulate and invest copper windfalls abroad (pension reserve, central bank recapitalization, FESS) to limit upward currency pressure. - Central bank to continue gradual, data‑dependent removal of monetary stimulus; readiness to adjust if fiscal stance becomes more expansionary in 2007. - Create central credit database covering banks, cooperatives, and department store card lenders; proceed with simplified FecuPymes for SMEs. - Reduce scope and rate of stamp tax; consider eliminating small tax on electronic transactions and checks. - Develop medium‑term public debt strategy coordinated with Central Bank; clarify capital gains tax exemptions for foreign institutional investors to enhance liquidity and internationalize the peso. - Build social consensus for labor market reforms but take bold action to address high youth unemployment and low female participation. - Improve CPI, labor, and inventory statistics despite required investments of time and labor. ### Timing and consultations - It is recommended that the next consultation occur on the usual 12‑month cycle. *Prepared by IMF staff; Staff Report for the 2006 Article IV Consultation — Supplementary Information (content unit _cr06335).* ### Executive Summary ...................................................................................................... ### Executive Summary ### Background - Structural reforms and prudent economic policies over the past fifteen years have anchored Chile’s performance: fiscal restraint, independent monetary policy, a sound and deep financial system, and an outward-looking trade policy. - Over the 15–year period through 2005: - Rate of economic growth averaged 5½ percent a year. - Per capita income tripled in U. S. dollar terms. - Poverty rate was cut in half, to about 18 percent. - Income inequality remains high. - Since 2003, copper prices have surged and are central to Chile’s outlook: - Copper sector accounts for 15 percent of Chile’s GDP and over 40 percent of its total exports. - Copper prices rose from US$0.8 a pound on average in 2003 to US$3.7 in May 2006, easing to US$3.5 in mid‑July 2006. - President Bachelet’s administration (assumed office in early March) reaffirmed support for the macroeconomic framework and confirmed adherence to the structural fiscal surplus rule of 1 percent of GDP, while announcing plans to strengthen social services and comprehensively reform the private pension system. - 2006 consultation discussions focused on: - Appropriate policy mix given the economic cycle and social spending plans. - Managing the copper boom. - Ensuring long-term sustained growth. ### Recent Developments - Growth and demand: - Annualized quarterly GDP growth slowed to about 4 percent since mid–2005. - Year‑on‑year real GDP growth was 5.1 percent in the first quarter of 2006. - Domestic demand remains the main driver; investment growth decelerated sharply after a surge in 2004–05 while consumption remains strong. - Labor market: - Employment increased cumulatively by 8½ percent through end‑May 2006 (since end–2003). - Unemployment has hovered around 8 percent in seasonally‑adjusted terms (near the top of the central bank’s estimate of the NAIRU), with youth unemployment close to 20 percent. - Since mid‑2005, the 12–month rate of wage increase has been close to 5¾ percent in nominal terms. - Inflation and exchange rate: - Since the beginning of 2003, the Chilean peso appreciated by 25 percent in nominal terms against the U.S. dollar and by 22 percent in real effective terms. - Headline inflation rose to the top of the central bank’s 2–4 percent target range in the first quarter of 2006. - Headline inflation was 3.9 percent in June 2006. - Narrowly‑defined 12‑month core inflation (excluding perishables, energy, and regulated prices) was 2.7 percent (up from 1.7 percent a year earlier). - External sector and vulnerabilities: - In 2005, external current account surplus narrowed from 1½ percent of GDP in 2004 to ½ percent of GDP. - Terms of trade improved by 12½ percent in 2005, on top of a 21 percent increase in 2004. - Non‑mining export volume rose by 10 percent in 2005; mining export volume fell by 3 percent from 2004. - Imports rose sharply, 21 percent in volume terms in 2005. - Net public sector debt (including central bank debt) fell from about 13 percent of GDP in 2003 to 7½ percent in 2005. - Gross public sector debt declined from 44½ percent of GDP to 31½ percent of GDP (2003–2005). - Private sector indebtedness abroad fell by 15 percentage points, to close to 31 percent of GDP at end–2005. - Gross official international reserves were US$17 billion (15 percent of 2005 GDP), equivalent to close to 110 percent of Chile’s short‑term external debt and covering close to five months of imports of goods and services. - Fiscal and monetary stance: - Central government recorded an overall surplus of 4¾ percent of GDP in 2005 (up from 2¼ percent in 2004); the surplus was used roughly equally to prepay debt and increase liquid asset holdings. - The central bank raised its policy rate by 325 basis points since September 2004 to 5 percent, responding to recovery and closing output gap; policy rate has been unchanged since April 2006. - Authorities view current monetary conditions as somewhat expansionary, with the policy rate about 1 percent in real terms. - Market resilience: - June correction: peso depreciated almost 3 percent vs. U.S. dollar and stock market fell about 1½ percent from elevated levels; sovereign spreads tightened slightly to around 80 basis points. ### Outlook - Growth and inflation projections: - Real GDP projected to grow by 5-6 percent in 2006–07. - Inflation projected to gradually return to the middle of the inflation target range. - Fiscal and external projections: - Central government expected to register an overall surplus close to 6 percent of GDP in 2006 (reflecting higher copper prices). - External current account surplus projected to widen to about 2 percent of GDP in 2006. - Policy intentions and institutional measures: - Government sent a bill to congress to establish rules for investing and managing fiscal surpluses: draft envisages investing part of surpluses in a pension fund, gradually recapitalizing the central bank, and lodging remaining surpluses in a newly‑created Fund for Economic and Social Stabilization (FESS); FESS permitted to invest assets abroad to help alleviate upward pressure on the currency. - Central bank plans to continue gradually removing monetary stimulus; with policy rate at 5 percent since April 2006, it considers this below the neutral rate and projects the output gap to close in 2007. - Further interest rate hikes would be largely data‑dependent—particularly core inflation, non‑mining output growth, and possible additional fiscal stimulus in 2007. - Pension reform process: - Government appointed a commission to propose reforms addressing: low density of contributions; coverage of the social pillar; lack of competition; rules governing investments of the funds; and increasing participation of women. - Commission expected to report by early‑July to an interministerial committee which will draft reform legislation; congressional process expected in 2007. ### Risks and Scenarios - Risks broadly balanced, examples include: - Global and regional risks: - A disorderly adjustment in global imbalances or increased U.S. interest‑rate uncertainty could trigger sharper emerging‑market asset sell‑offs, pronounced drops in commodity prices and available financing, and negatively affect growth. - Regional political developments could reduce investor appetite for Latin American risks and affect capital flows; Chile’s investment grade rating provides some shelter, but asset prices correlate with regional movements, especially Brazil. - Energy risks: - Disruptions in Argentine gas supplies and further oil price increases could raise production costs and weigh on growth. - Since 2004 Argentina reduced gas exports to Chile; gas cuts in Q2 2006 averaged close to 40 percent (up from 30 percent during the same period last year). - Three‑fourths of Chilean firms using gas have converted plants to alternative energy sources, mitigating some risks. - Staff estimate: a 10 percent increase in oil prices above the baseline could reduce GDP growth by a ¼ of a percentage point. - Copper price risks: - Low stocks, limited recent capacity expansion, rising demand (especially from China), and speculative capital have raised prices and volatility, increasing the risk of a sudden price correction, although analysts expect supportive market conditions in the near‑to‑medium term. *IMF Executive Summary* ### 15. Discussions took place against the backdrop of the surge in world copper prices. ### _cr06335 - 15. Discussions took place against the backdrop of the surge in world copper prices. ### Context and main policy challenge - Discussions occurred with the economy "close to full potential" amid a surge in world copper prices. - Authorities viewed the copper boom as temporary and highlighted the challenge of managing increased government revenue that could boost spending pressures while the output gap was closing. - To limit aggregate demand growth and alleviate upward pressure on the currency (and avoid Dutch disease), the authorities intended to lodge part of government financial assets abroad. - As of April 2006, the government had accumulated US$6 billion in assets, of which US$3.8 billion were invested abroad. - Chile’s sovereign spreads remain the lowest in the region; in July Moody’s upgraded Chile's foreign currency sovereign rating from Baa1 to A2. ### Macroeconomic policy mix — monetary and fiscal stance - Monetary policy - The central bank set the policy rate at 5 percent since April 2006. - The central bank considered the policy rate remained below the neutral rate and planned to continue gradually removing monetary stimulus. - Further moves would be largely data-dependent: core inflation, nonmining output growth, industrial production, and capital good imports. - The slowdown in activity was judged to reflect supply weaknesses (e.g., poor weather in agriculture) that macroeconomic policy could do little to offset. - The staff considered that the increase in headline inflation mostly reflected the pass-through from oil price increases, and that the upward trend in core inflation signaled a mean-reversion to its well-anchored level of 3 percent. - Fiscal policy - Fiscal policy remains guided by the structural surplus rule (amended beginning with the 2006 budget to smooth higher copper price impacts on revenues from CODELCO and private mining companies). - Molybdenum receipts from CODELCO are included in computation of structural revenue based on average prices observed in previous years. - In the year to April, central government spending rose by 5.5 percent in real terms over the same period in 2005, below the budgeted increase of 6.3 percent. - Higher copper revenues boosted the surplus to 3.8 percent of annual GDP. - Authorities reaffirmed commitment to a fiscal surplus rule of 1 percent of GDP and emphasized moderation in expenditure growth. - The Copper Committee’s long-term copper reference price (to be announced in July) would be critical to the 2007 fiscal stance. - Authorities intended to prioritize non–recurrent outlays and the purchase of tradable goods in the 2007 budget to avoid recurrent spending rigidities. ### Fiscal revenues and tax policy recommendations - Findings and proposals - Buoyant fiscal revenues provide opportunity to reduce distortionary taxes. - The stamp tax generated revenue of 0.6 percent of GDP in 2005 and was identified as an impediment to financial system efficiency. - Staff recommended equating incidence across maturities and eliminating the stamp tax for some operations, including on-lent bank borrowing from abroad. - Authorities planned to eliminate the tax for refinancing of loans (already removed for mortgage loans since 2003) and might consider other changes later. - Plans included sending a bill to congress to simplify the tax regime for small and medium enterprises. - The mission suggested eliminating the small tax on electronic transactions and checks to widen access to banking services. ### Managing the copper boom — exchange rate and reserves policy - Exchange rate - Since 2003, the peso appreciated by 22 percent in real effective terms. - The central bank reaffirmed it would only intervene in FX markets if three conditions were met: (i) evidence of misalignment; (ii) misalignment impacts economic activity; and (iii) intervention likely to succeed. The authorities judged these conditions were not met and plan to let the peso float freely. - Staff supported free float, noting it enhanced development of hedging markets and that peso levels did not appear out of line with long-term trends; nonmining exports continued to grow. - Use of fiscal surpluses (policy announced in bill to congress) - Pension fund - Each year, at least 0.2 percent (and, should the cash surplus allow, up to 0.5 percent) of previous-year’s GDP would be invested in a pension fund aimed at covering future pension liabilities. - Amounts in the fund would remain locked for a 10–year period. - Investment policies guided by the same regulations as private pension funds, currently allowed to invest up to 30 percent of their assets abroad. - Central bank recapitalization - Up to 0.5 percent of GDP would be assigned to gradual recapitalization of the central bank for each of the next five years, covering about half of its total recapitalization need. - Central bank plans to use the funds to build up foreign reserves. - Fund for Economic and Social Stabilization (FESS) - All remaining surpluses would be lodged in the FESS. - The FESS would operate transparently with quarterly public reporting of asset composition and be allowed to invest abroad (initially in government and high-grade corporate bonds), helping alleviate upward pressure on the currency. - Authorities and staff agreed future diversification could include equities. ### Data and statistics: identified weaknesses and proposed improvements - General assessment - Chile’s economic data are generally of good quality, but improvements needed in CPI and labor cost components. - Specific recommendations - Expand CPI survey sample outside Santiago. - Undertake a new household expenditure survey and use hedonic price analysis to account for quality changes. - Review the recently overhauled establishment survey to ensure data quality for compensation and hours worked. - Improve inventory data collected by the Central Bank to better distinguish persistent consumption shifts from transitory stockpiling increases. - These changes would require significant investments in time and labor but offer considerable dividends. ### Boosting long-term growth and competitiveness - Potential growth and productivity - Potential growth estimated at around 5 percent a year. - Trend productivity growth estimated at ½–1 percent, significantly slower than 2 percent annual growth observed during the 1990s. - Policy priorities to increase long-term productivity - Structural reforms to improve competitiveness, skills, and microeconomic efficiency. - Labor market reform to reduce still-high unemployment (particularly among the young) and improve female labor force participation, which remains low by international standards. - Strengthen competition policy: reduce conflicts of interest in corporate governance, increase fines for antitrust violations while tying them to damages, and protect whistleblowers. - Efficiency improvements in financial and labor markets. ### Pension system reform - System characteristics and challenges - Private pension funds manage around US$68 billion in assets, equivalent to three-fifths of Chile’s GDP. - Key issues: low density of contributions; coverage of the social pillar; competition; rules governing investments; and increasing participation of women. - Low participation among the self-employed (currently only 5 percent participate in the pension system). - The minimum pension guarantee is tied to years of contribution (20 years) rather than need; welfare pension eligibility is broad and not strictly income-based. - Commission process and timeline - A commission was appointed to hear views and develop proposals; it will report by early-July to an interministerial committee drafting reform legislation expected to be sent to congress by late 2006. - Staff recommendations and authorities’ view - Staff recommended making participation compulsory for the self-employed and rationalizing investment restrictions on pension funds, including raising the limit on investments abroad. - Authorities saw merit in these recommendations and awaited the commission’s report to formulate specific policies. - Specific reform options under consideration (as described by the commission) - Change minimum pension eligibility from a time basis to a financial threshold to benefit self-employed and temporary workers. - Reduce costs and increase competition by separating investment management from account administration, auctioning accounts of worker groups, allocating new workers to lowest-cost funds, or restricting movement into higher-cost funds. - Streamline more than ninety limits and sub-limits on portfolio risk, foreign investment, and asset allocation to improve returns and flexibility. - Address gender disparities: consider delaying retirement age (currently about 60 percent of workers retire early; the average retirement age for women is 54 years and 57 for men), make early retirement less attractive, or subsidize pension contributions of mothers; President Bachelet announced measures to encourage higher female workforce participation. ### Financial sector competition and developments - Financial market developments noted - Financial system is solid and has deepened, including bond and derivatives markets, improving shock-absorption capacity. - Bank lending has grown steadily since the 2003 recovery. - Sovereign spreads remain well below regional levels. - Staff emphasized the need for greater efficiency and competition in the financial sector as part of the strategy to boost long-term productivity. *Source: IMF country document _cr06335 (excerpt).* ### 28. Prudential indicators continue to show that the banking system is sound, with high ### _cr06335 - 28. Prudential indicators continue to show that the banking system is sound, with high ### Financial sector prudential indicators and consumer credit - Prudential indicators show the banking system is sound, with high capital, a low level of impaired assets, and high provisioning. - Consumer credit developments: - 12–month increase in real terms was 22 percent at end-March. - Consumer credit accounts for 15 percent of total bank credit. - Department store credit card lending is estimated to account for at least 20 percent of total consumer credit. - Data and reporting gaps: - Staff emphasized the need to improve consolidated information on credit risks across the financial sector. - Supported creation of a central credit database covering banks, cooperatives, and department store credit card lending. - For small and medium-sized enterprises (SMEs), mission advised introducing mechanisms to ensure collection of data under a simplified version of the FecuPymes reporting system. ### Capital market and regulatory reforms - Capital Market Law II: - Draft law has not made headway in congress, partly due to broad coverage and technical complexity. - Authorities consider narrowing scope to ensure earlier passage. - Draft law would: - Bring wide-ranging improvements to several existing laws. - Introduce incentives for risk capital and entrepreneurship. - Create a new national registry for pledges to improve SMEs’ access to financing. - Strengthen corporate governance legislation to bring it to OECD standards. - Increase powers for superintendents to share information. - Financial Intelligence Unit (FIU): - Separate draft law aiming to restore some FIU powers is expected to be approved by congress in the near future. - Passage of this law is described as critical to ensure the FIU can effectively combat money laundering. ### Domestic bond market, liquidity, and public debt management - Market characteristics and staff recommendations: - Domestic bond market has grown steadily but remains characterized by a relatively low level of activity. - Staff recommended improving liquidity by: - Relaxing some investment restrictions on private pension funds. - Reviewing procedures surrounding taxation of foreign investors. - Removing distortions caused by the stamp tax. - Considering introducing a system of specialists in public debt with tailored obligations. - Public debt management strategy: - Central Bank has set an explicit objective for its debt management and communicated it to the market; government should do likewise. - Sporadic bond issuance by the Finance Ministry has created market uncertainty. - Need for a coordinated medium-term debt management strategy with the Central Bank. - Asset-liability management approach suggestion: - Finance Ministry concentrate on the long end of the curve, including through inflation-indexed issues, to provide benchmarks at longer tenors and complement Central Bank issuance at medium- and shorter-tenors. - Authorities indicated they needed more time to specify policy in this area. - Reserve management: - Central Bank made public key aspects of its reserve management policy, including with respect to currency composition. ### Human capital, education, and innovation - Education priorities of the new government: - Make pre-school care coverage universal over its four-year term. - Broaden system of preferential subsidy vouchers. - Increase number of scholarships and government loan guarantees to improve tertiary education access for the poor. - Provide grants for Chileans to study abroad. - R&D and innovation: - Law establishing a Fund for Innovation financed with proceeds of the special tax on mining is awaiting approval by congress. - Transitional commission preparing guidelines for projects and financing. - Fund will provide resources for seed and venture capital, partly through CORFO and CONICYT. - Spending from the fund will be on-budget and covered by the structural surplus rule. - Staff view: - Improving quality of human capital and boosting innovation is key to long-term development. - Performance will be closely monitored to ensure results. ### Labor market impediments and reform priorities - Structural issues: - Unemployment remains high and labor market plagued with rigidities. - Labor force participation rates are low by international standards, particularly for the young and for women. - Severance payments are high; about one fourth of Chile’s workforce is under temporary work arrangements. - Specific measures and statistics: - Government plans to subsidize 50 percent of the minimum wage for some 1,500 first-time young workers and extend this benefit to workers up to 25 years old (from 21years old at present). - Bonuses will be offered to firms that employ youths at social risk. - Severance payments: equivalent to one month’s wages for each year of service (up to a maximum of 11 months’ wages). - Minimum wage adjustments under the previous government: - In July 2005, minimum wage increased by 6¼ percent. - Announced it would be raised again by close to 6 percent in July 2006. - About one fourth of formal sector workers are under temporary work arrangements; Chile does not allow fixed-term contracts longer than one year in law. - Staff recommendations: - Make more intensive use of short-term and part-time contracts for youth. - Broaden childcare coverage to improve female participation. - Exercise restraint in determining future minimum wage increases, given its level relative to the median wage. - Reform objectives: introduce more flexibility in working hours, allow longer fixed-term contracts, and avoid too rapid increases in minimum wages rather than subsidizing them. - Authorities advised to seek social consensus but urged to take bold action to address high youth unemployment and improve labor force participation. ### Energy, trade liberalization, and external sector - Energy sector: - 2005 regulatory changes led to strong increase in investment in electricity generation, including hydroelectric capacity. - Efforts to reduce reliance on natural gas from Argentina; northern mining companies investing in coal and diesel plants. - Government initiated construction of a liquid natural gas terminal near Santiago to mitigate central supply concerns. - Trade: - Trade liberalization credited with serving Chile well; Chile has one of the lowest tariff rates in the world. - Almost four-fifths of all trade is undertaken under some level of tariff preference. - Non-mining exports grew at an annual rate of 13 percent during 2001-05. - FTA with China and a trans-Pacific pact with Singapore, New Zealand, and Brunei to become operational by end–2006. - Partial trade agreement signed with India in March; negotiations under way with Japan. - Authorities reiterated strong commitment to multilateral trade liberalization. ### Staff appraisal, macroeconomic policy, and risks - Outlook and macro resilience: - With a very favorable external environment, prospects remain strong despite recent slowdown in activity. - Growth slowed since mid–2005 partly because investment returned to a more sustainable rate after a spurt. - Private consumption growing at a sustainable rate; economy expected to expand steadily in 2006 and 2007. - Policy framework strengths: - Fiscal surplus rule, inflation targeting with a floating exchange rate, and trade openness have improved resilience. - Financial system is solid and has deepened with bond and futures markets. - Markets differentiated Chile favorably during recent emerging-market sell-off. - Monetary and fiscal stance: - Authorities treating sharp increase in copper price as temporary. - Fiscal policy managed prudently; expenditure growth tied to structural surplus rule. - Central bank appropriately gradually removing monetary stimulus; monetary stance should be data driven. - Inflation expectations anchored near mid-point of inflation target range. - Given policy rate remains below neutral rate, room exists for further removal of stimulus, particularly if fiscal policy becomes more expansionary in 2007. - 2007 budget guidance: - 2007 budget should keep growth in central government expenditure at a moderate level. - Under the structural surplus rule, revenue in 2007 could be boosted by an increase in the reference price for copper, creating pressure to expand spending. - Authorities reaffirmed intention to limit expenditure increases in 2007 and give prominence to nonrecurrent spending. - Central Bank recapitalization: - Government intends to gradually recapitalize the central bank by providing about half of its capital need over a five-year period. - Gradual recapitalization will help strengthen institutional independence and foreign reserves position but will not allow the central bank to cover all its losses. - Key risks and data needs: - Uncertainty around output gap measures poses a challenge; central bank estimates point to a closing of the gap in early 2007 but some computations suggest persistence. - Recent pickup in inflation in early 2006 largely reflects higher energy prices; no conclusive data on resource and labor cost pressures. - Rapid increase in consumer credit growth requires vigilance and better information sharing between banks and non-bank credit card issuers. ### Policy recommendations and priorities highlighted by staff - Financial sector and markets: - Create a central credit database covering banks, cooperatives, and department store credit card lending. - Proceed with a simplified FecuPymes reporting system for SMEs. - Reduce scope and rate of the stamp tax; consider eliminating small tax on electronic transactions and checks. - Develop a medium-term public debt strategy beyond the political cycle and decide on government presence in bond issuance. - Clarify exemptions from capital gains tax for foreign institutional investors to enhance liquidity and internationalize the peso. - Labor market: - Build social consensus for labor market reforms but take bold action to address unemployment and participation gaps. - Introduce more flexibility in working hours, allow longer fixed-term contracts, and avoid too rapid minimum wage increases. - Data and statistics: - Improve data quality and coverage for the consumer price index, labor indicators, and inventories; recognize these improvements require significant investment in time and labor. *Source: IMF staff report chapter provided in content unit _cr06335.* ### 48. It is recommended that the next consultation occur on the usual 12-month cycle. ### _cr06335 - 48. It is recommended that the next consultation occur on the usual 12-month cycle. ### Article IV consultation timing - It is recommended that the next consultation occur on the usual 12-month cycle. ### Macroeconomic performance and projections (selected indicators) - Real GDP (annual percentage change): 2001: 3.4; 2002: 2.2; 2003: 3.9; 2004: 6.2; 2005: 6.3; 2006: 5-6; 2007: 5-6. - Total domestic demand (annual percentage change): 2001: 2.4; 2002: 2.4; 2003: 4.9; 2004: 8.1; 2005: 11.4; 2006: 6.8; 2007: 6.1. - Consumer prices (end of period): 2001: 2.7; 2002: 2.9; 2003: 1.1; 2004: 2.5; 2005: 3.7; 2006: 3.4; 2007: 3.0. - Consumer prices (average): 2001: 3.6; 2002: 2.5; 2003: 2.8; 2004: 1.1; 2005: 3.1; 2006: 3.5; 2007: 3.1. - Unemployment rate (annual average): 2001: 9.2; 2002: 9.0; 2003: 8.5; 2004: 8.8; 2005: 8.0; 2006: 7.7; 2007: 7.5. ### Demand composition (selected) - Consumption (annual percentage change): 2001: 2.9; 2002: 2.5; 2003: 4.0; 2004: 6.1; 2005: 7.6; 2006: 6.6; 2007: 6.6. - Investment (annual percentage change): 2001: 0.8; 2002: 2.2; 2003: 7.8; 2004: 14.3; 2005: 22.2; 2006: 7.4; 2007: 5.2. - Fixed investment: 2001: 4.3; 2002: 1.5; 2003: 5.7; 2004: 11.7; 2005: 24.7; 2006: 8.1; 2007: 5.0. - Inventories contribution: 2001: 1/-0.8; 2002: 0.2; 2003: 0.5; 2004: 0.8; 2005: -0.3; 2006: -0.1; 2007: 0.1. - Net exports contribution: 2001: 1/1.0; 2002: -0.2; 2003: -0.9; 2004: -1.9; 2005: -5.2; 2006: -2.0; 2007: -1.1. ### External sector and balance of payments - Current account (millions of US$): 2001: -1,100; 2002: -580; 2003: -964; 2004: 1,586; 2005: 703; 2006: 2,780; 2007: 1,581. - Current account (percent of GDP): 2001: -1.6; 2002: -0.9; 2003: -1.3; 2004: 1.7; 2005: 0.6; 2006: 2.0; 2007: 1.1. - Trade balance (millions of US$): 2001: 1,844; 2002: 2,385; 2003: 3,685; 2004: 9,196; 2005: 10,180; 2006: 17,436; 2007: 11,020. - Exports of goods (millions of US$): 2001: 18,272; 2002: 18,180; 2003: 21,664; 2004: 32,215; 2005: 40,574; 2006: 52,235; 2007: 48,612. - Copper exports (millions of US$): 2001: 6,537; 2002: 6,323; 2003: 7,815; 2004: 14,483; 2005: 18,306; 2006: 28,134; 2007: 23,899. - Copper as percent of total exports: 2001: 35.8; 2002: 34.8; 2003: 36.1; 2004: 45.0; 2005: 45.1; 2006: 53.9; 2007: 49.2. - Imports of goods (millions of US$): 2001: -16,428; 2002: -15,794; 2003: -17,979; 2004: -23,020; 2005: -30,394; 2006: -34,799; 2007: -37,591. - Exports (annual percentage change, U.S. dollars): 2001: -4.9; 2002: -0.5; 2003: 19.2; 2004: 48.7; 2005: 25.9; 2006: 28.7. - Imports (annual percentage change, U.S. dollars): 2001: -3.9; 2002: -3.9; 2003: 13.8; 2004: 28.0; 2005: 32.0; 2006: 14.5. - Terms of trade (annual percentage change): 2001: -7.2; 2002: 3.7; 2003: 9.7; 2004: 20.7; 2005: 12.5; 2006: 17.6; 2007: -12.0. - Real effective exchange rate (INS definition, end of period): 2001: -10.1; 2002: -6.9; 2003: 13.4; 2004: -3.7; 2005: 11.9; 2006: 13.8; 2007: ... ### External vulnerability indicators (selected) - Gross official reserves (US$ billion): 2001: 15.1; 2002: 14.4; 2003: 15.4; 2004: 15.9; 2005: 16.0; 2006: 17.0; 2007: 16.6. - Gross official reserves, months of imports of goods and services: 2001: 8.5; 2002: 8.3; 2003: 7.8; 2004: 6.4; 2005: 5.0; 2006: 4.7; 2007: 4.3. - Gross official reserves to broad money: 2001: 41.9; 2002: 44.0; 2003: 47.0; 2004: 49.6; 2005: 37.1; 2006: 29.7; 2007: ... - Total external debt (percent of GDP): 2001: 49.4; 2002: 56.2; 2003: 60.2; 2004: 58.4; 2005: 45.8; 2006: 39.0; 2007: 33.8. - External debt to exports of goods and services: 2001: 159.6; 2002: 171.9; 2003: 179.5; 2004: 161.6; 2005: 113.7; 2006: 94.3; 2007: 78.7. - Exchange rate (pesos per US$, period average): 2001: 539; 2002: 635; 2003: 689; 2004: 691; 2005: 610; 2006: 560; 2007: ... ### Public sector finances and projections - Central government overall balance (percent of GDP): 1997: -0.6; 1998: -0.5; 1999: -1.2; 2000: -0.4; 2001: 2.1; 2002: 4.7; 2003: 5.9; 2004: 3.5. - Total revenue (percent of GDP): 1997: 21.7; 1998: 21.8; 1999: 21.1; 2000: 20.8; 2001: 22.2; 2002: 24.5; 2003: 24.8; 2004: 23.8. - Taxes (percent of GDP): 1997: 16.5; 1998: 16.6; 1999: 16.7; 2000: 15.9; 2001: 15.7; 2002: 17.3; 2003: 16.8; 2004: 16.6. - Central government balance components (selected): interest payments (percent of GDP) around 1.2 in earlier years declining to 0.7 by 2007; gross investment (percent of GDP) about 2.2 historically and projected 2.4 in 2007. - Net debt (public sector, percent of GDP): 2001: 10.9; 2002: 11.0; 2003: 13.1; 2004: 10.8; 2005: 7.7; 2006: 3.4; 2007: 1.3. - Gross consolidated debt (public sector, percent of GDP): 2001: 41.9; 2002: 42.8; 2003: 44.6; 2004: 39.4; 2005: 31.7; 2006: 28.0; 2007: 28.0. - Central government debt (percent of GDP): 2001: 15.0; 2002: 15.7; 2003: 13.1; 2004: 10.8; 2005: 7.5; 2006: 5.6; 2007: 4.7. - Central government balance (percent of GDP): 1998-2005 series show improvement culminating in surplus: 2005: 5.9; projected 2006: 3.5. ### Public saving and investment - Gross domestic investment (percent of GDP): 2001: 22.1; 2002: 21.7; 2003: 21.9; 2004: 21.4; 2005: 23.0; 2006: 22.3; 2007: 22.1. - Public investment (percent of GDP): 2001: 2.6; 2002: 2.6; 2003: 2.3; 2004: 2.1; 2005: 2.1; 2006: 2.2; 2007: 2.7. - Private investment (percent of GDP): 2001: 19.5; 2002: 19.1; 2003: 19.6; 2004: 19.2; 2005: 20.9; 2006: 20.1; 2007: 19.4. - Gross national savings (percent of GDP): 2001: 20.5; 2002: 20.8; 2003: 20.6; 2004: 23.0; 2005: 23.6; 2006: 24.3; 2007: 23.2. - Public savings (percent of GDP): 2001: 2.4; 2002: 1.6; 2003: 2.5; 2004: 4.9; 2005: 7.7; 2006: 9.6; 2007: 7.7. - Private savings (percent of GDP): 2001: 18.2; 2002: 19.1; 2003: 18.2; 2004: 18.1; 2005: 15.9; 2006: 14.7; 2007: 15.5. ### Debt sustainability and stress tests (public and external) - Public sector gross debt (percent of GDP): 2001: 15.0; 2002: 15.7; 2003: 13.1; 2004: 10.8; 2005: 7.5; 2006: 5.6; 2007: 4.7; 2008: 6.1; 2009: 6.9; 2010: 7.4; 2011: 7.4. - Debt-stabilizing primary balance (public sector) shown in scenarios and stress tests; baseline primary deficit and automatic debt dynamics detailed in Table (selected lines): - Primary deficit (percent of GDP): 2001: -2.1; 2002: -1.4; 2003: -2.2; 2004: -4.5; 2005: -7.3; 2006: -8.6; projections include -6.2 in 2007 and continuing negative primary balances in later years. - Automatic debt dynamics (percent of GDP contribution): 2001: 1.3; 2002: 0.7; 2003: -3.1; 2004: -1.8; 2005: -1.4; 2006: -0.6; 2007: 0.2; 2008: 0.3. - External debt (percent of GDP baseline): 2001: 56.2; 2002: 60.2; 2003: 58.4; 2004: 45.6; 2005: 38.9; 2006: 33.8; 2007: 35.1; 2008: 35.7; 2009: 34.8; 2010: 33.8; 2011: 32.3. - External debt service and amortization indicators provided (e.g., total debt service percent of exports and interest component series). ### Financial sector indicators - Broad money (M3, percent change): 2000: 11.7; 2001: 10.3; 2002: 6.3; 2003: 3.7; 2004: 10.6; 2005: 11.9; 2006: ... - Credit to the private sector (annual percentage change): 2000: 72.4 (ratio to GDP reported elsewhere); 2001: 72.9; 2002: 75.1; 2003: 76.1; 2004: 76.8; 2005: 79.5. - 90-day central bank promissory note (nominal, avg): 2000: 10.8; 2001: 7.2; 2002: 3.9; 2003: 2.8; 2004: 1.8; 2005: 3.5. - Share of foreign currency deposits in total deposits: 2000: 11.3; 2001: 14.0; 2002: 12.9; 2003: 13.2; 2004: 11.5; 2005: 10.1. - Share of nonperforming loans in total loans (official measure): 2000: 1.7; 2001: 1.6; 2002: 1.8; 2003: 1.6; 2004: 1.2; 2005: 0.9; 2006: 0.9. - Risk-based capital-assets ratio, end of period: 2000: 13.3; 2001: 12.7; 2002: 14.0; 2003: 14.1; 2004: 13.6; 2005: 13.0; 2006: 13.9. - Return on bank capital: 2000: 12.7; 2001: 17.7; 2002: 14.4; 2003: 16.6; 2004: 16.7; 2005: 16.4; 2006: 18.8. ### Social and demographic indicators (selected) - GDP (2005) in Chilean pesos (billions): 64,549. - GDP (2005) in U.S. dollars (billions): 115.3. - Per capita (U.S. dollars): 7,124. - Population total (in millions, 2005): 16.2. - Urban population (percent of total): 87.3. - Poverty rate (2003): 18.8. - Indigent: 4.7. - Poor, not indigent: 14.1. - Life expectancy at birth (years): 78.0. - Infant mortality rate (per thousand births): 7.6 (year indicated in table). - Access to electricity (percent of population, 2003): 98.9. - Access to safe water (percent of population, 2003): 93. - Income distribution (2000): percent of total income received by richest 10 percent: 47.0; by poorest 20 percent: 3.3; Gini coefficient: 57.1. - Education indicators (2003): adult literacy rate (2004): 95.7; gross enrollment rates: primary 100; secondary 88; tertiary 42. ### Millennium Development Goals (selected series) - Population below $1 a day (percent): 1990: 6.2; 2015 Target: 1.0. - Net primary enrollment ratio (percent of relevant age group): 1990: 87.7; 2004: 86.4; 2015 Target: 100.0. - Under 5 mortality rate (per 1,000): 1990: 19.0; 2004: 9.0; 2015 Target: 8.4. - Immunization, measles (percent of children under 12 months): rising to 99 in several years shown. ### Fund relations, membership, and technical assistance - Membership status: Joined 12/31/45; Article VIII. - Quota (SDR Million, percent): Quota 856.10 100.00. - Fund holdings of Chilean pesos: 759.61 88.73. - Reserve tranche position: 96.49 11.27. - SDR Department net cumulative allocation (SDR Million, percent): 121.92 100.00; holdings 36.90 30.26. - Outstanding Purchases and Loans: None. - Historical financial arrangements listed (SBA, EFF) with amounts approved and drawn in SDR Million (details in source). - Projected obligations to the Fund (SDR Million): Charges/Interest: 2006: 2.21; 2007: 2.99; 2008: 3.00; 2009-2010: 2.99 each. - Exchange arrangements: The exchange rate is permitted to float freely. On June 26, 2006 the interbank exchange rate was Ch$549.6 per U.S. dollar. - Article IV Consultation: Executive Board concluded the 2005 Article IV consultation on July 29, 2005; staff report released as IMF Country Report No. 05/315. - Technical assistance: Missions and advice summarized (MFD, WHD, FAD, STA, FSAP) with topics including nominalization and interest rate pass-through, fiscal statistics, financial system assessment, AML/CFT training, coverage and quality of short-term economic indicators, and strengthening liquidity in fixed-income markets. ### Statistical issues and data quality - Chile is in observance with the Special Data Dissemination Standards (SDDS). - Monetary and financial statistics broadly in line with the Fund’s MFSM; deviations include inclusion of nonbank financial intermediaries in the private sector and some accounting valuation criteria. - Real sector: change to 2003 benchmark and base year planned for 2007; annual and quarterly GDP series for 1986–2003 scheduled to be compiled in 2007. BCCH compiles national accounts with 1996 base currently; new GDP series published March 2005. - CPI: recommendations include expanding survey sample outside Santiago and updating weights to the 2006-2007 HBS. - Labor market statistics: INE introduced a new household survey in 2006 modeled on U.S. BLS and ILO standards. - Government finance statistics: substantial progress implementing GFSM 2001, new functional classification disseminated, separate accounts for municipalities and public corporations; further improvements needed including disaggregating subsidies and grants by level of government and reconciling interest recording across liabilities. - Balance of payments and external debt: central bank publishes quarterly BOP and IIP consistent with BPM5; coverage of the military sector in external statistics is incomplete and accuracy of military import estimates should be verified. ### Financial relations with the World Bank (summary) - Most recent Country Assistance Strategy (CAS) covered Fiscal Years 2002-06; new CAS planned for second quarter of FY07. - CAS focuses on human capital, inclusion of rural populations, and social safety net. Projects cited include Science for Knowledge Economy (FY03), Lifelong Learning and Training (FY02), Infrastructure for Rural Development (FY05), Social Protection Adjustment Loan DDO (FY04), and others. - IFC and MIGA roles noted; seven investment loans in operations portfolio totaling US$215.1 million (commitments) as of the CAS coverage. *Prepared by IMF staff; Staff Report for the 2006 Article IV Consultation — Supplementary Information (July 26, 2006).* ### 1. In its July meeting, the central bank increased its policy rate by 25 basis points (to ### _cr06335 - 1. In its July meeting, the central bank increased its policy rate by 25 basis points (to ### Monetary policy and interest rates - Central bank increased its policy rate by 25 basis points (to 5.25 percent). - Further monetary tightening would be "data-dependent and more gradual." - Since September 2004, the central bank raised its policy rate by a total of 350 basis points, to 5.25 percent, in response to recovery and gradual closing of the output gap. - Directors supported the gradual tightening of monetary policy and concurred that any further tightening should be largely data driven. - Three-month interest rate: 10.8 (2000), 7.2 (2001), 3.9 (2002), 2.8 (2003), 1.8 (2004), 3.5 (2005). ### Pension system reform proposals - Presidential commission findings (presented July 6, 2006) recommend: - Creation of a solidarity pillar guaranteeing a basic universal pension for the poor. - Introducing a requirement for the self-employed to contribute. - Streamlining and liberalizing the pension fund investment regime. - Separating account and investment management functions. - Government expected in coming months to decide which proposals to retain and to send a draft bill to congress. ### Fiscal policy, structural surplus rule, and public finances - Central government registered an overall surplus of 4¾ percent of GDP in 2005, up from 2¼ percent in 2004. - Consistent with the structural surplus rule and projected copper prices, the central government would register an overall surplus of close to 6 percent of GDP in 2006. - Directors commended strict adherence to the structural fiscal surplus rule, which calls for a structural surplus of 1 percent of GDP in the overall balance of the central government. - Fiscal measures announced July 20 by the Minister of Finance include: - Legislative priority for the draft fiscal responsibility law. - Rekindling process on draft Capital Market II reform bill and sending a revised bill to congress. - Proposal to gradually reduce the stamp tax rate from 1.6 percent at present to 1.2 percent by 2009 and to exempt all refinancing operations from the tax. - Issue regulations to simplify the capital gains tax and clarify conditions for exemptions. - Facilitate issuance of peso bonds by foreign investors and bring settlement and netting arrangements for derivative instruments to international standards. - Unify taxes on imported software, patents, and other technological services at a reduced rate of 15 percent. - Provide subsidies and tax exemptions for research and development spending by private companies. - Net public sector debt (including central bank and public enterprises) fell from about 13 percent of GDP in 2003 to 7½ percent in 2005. - Central government net debt / related public sector figures: - Central government balance: -0.7 (2000), -0.5 (2001), -1.2 (2002), -0.5 (2003), 2.2 (2004), 4.7 (2005). - Central government (gross debt as percent of GDP): 13.7 (2000), 15.0 (2001), 15.7 (2002), 13.1 (2003), 10.8 (2004), 7.5 (2005). - Gross debt 5/: 40.9 (2000), 41.9 (2001), 42.8 (2002), 44.6 (2003), 39.4 (2004), 31.7 (2005). - Net debt ... 10.9 (2001), 11.0 (2002), 13.1 (2003), 10.8 (2004), 7.7 (2005). - Excluding public enterprises ... 6.4 (2001), 5.5 (2002), 7.2 (2003), 5.5 (2004), 2.6 (2005). ### Financial sector, capital markets, and AML/CFT - Directors welcomed plans to restart legislative process toward early approval of the Capital Markets II draft law. - Supported plans to streamline financial taxation (stamp tax, capital gains tax) and to reform the private pension system to extend coverage, strengthen social safety net, improve competition, and liberalize investment regime. - Recent revision to AML/CFT legislation welcomed; it will enhance the ability of the Financial Intelligence Unit (FIU) to obtain information and combat money laundering. - Directors saw room for further efficiency improvements in the financial sector while maintaining sound oversight; encouraged close scrutiny of consumer lending growth and enhanced consolidation of risk information. ### Growth, inflation, and external sector outlook - Growth and demand: - During the 15–year period through 2005, growth averaged 5½ percent a year. - Following growth of 6.3 percent in 2005, real GDP is projected to rise by 5-6 percent in 2006. - The Chilean economy is widely expected to grow in the range of 5 to 6 percent in 2006-2007. - Inflation: - Headline inflation expected to move gradually to the middle of the 2-4 percent target range. - Headline inflation is currently at the top of the target range; core inflation measures and expectations are well-anchored around the middle of the range. - Average consumer prices: 3.8 (2000), 3.6 (2001), 2.5 (2002), 2.8 (2003), 1.1 (2004), 3.1 (2005). - End of period consumer prices: 4.6 (2000), 2.7 (2001), 2.9 (2002), 1.1 (2003), 2.5 (2004), 3.7 (2005). - External balances and trade: - Current account surplus projected at close to 2 percent of GDP in 2006. - Current account (billions US$): -0.9 (2000), -1.1 (2001), -0.6 (2002), -1.0 (2003), 1.6 (2004), 0.7 (2005). - Current account in percent of GDP: -1.2 (2000), -1.6 (2001), -0.9 (2002), -1.3 (2003), 1.7 (2004), 0.6 (2005). - Trade Balance (billions US$): 2.1 (2000), 1.8 (2001), 2.4 (2002), 3.7 (2003), 9.2 (2004), 10.2 (2005). - Exports of Goods (billions US$): 19.2 (2000), 18.3 (2001), 18.2 (2002), 21.7 (2003), 32.2 (2004), 40.6 (2005). - Copper exports (billions US$): 7.3 (2000), 6.5 (2001), 6.3 (2002), 7.8 (2003), 14.5 (2004), 18.3 (2005). - Copper in percent of total exports: 37.9 (2000), 35.8 (2001), 34.8 (2002), 36.1 (2003), 45.0 (2004), 45.1 (2005). - Imports of Goods (billions US$): 17.1 (2000), 16.4 (2001), 15.8 (2002), 18.0 (2003), 23.0 (2004), 30.4 (2005). - Exports (annual percent change): 11.9 (2000), -4.9 (2001), -0.5 (2002), 19.2 (2003), 48.7 (2004), 25.9 (2005). - Imports (annual percent change): 16.0 (2000), -3.9 (2001), -3.9 (2002), 13.8 (2003), 28.0 (2004), 32.0 (2005). - Terms of trade (annual percent change): 4.5 (2000), -7.2 (2001), 3.7 (2002), 9.7 (2003), 20.7 (2004), 12.5 (2005). - Real effective exchange rate 3/: -2.9 (2000), -10.1 (2001), -6.9 (2002), 13.4 (2003), -3.7 (2004), 11.9 (2005). - Net Foreign Direct Investment (billions US$): -85.9 (2000), 196.5 (2001), -14.8 (2002), 22.4 (2003), 109.0 (2004), -19.9 (2005). - Net FDI in percent of GDP: 1.2 (2000), 3.8 (2001), 3.3 (2002), 3.7 (2003), 5.9 (2004), 3.9 (2005). ### Labor market and social outcomes - Wage-based employment continues to increase relatively vigorously. - Unemployment rate (annual average): 9.2 (2000), 9.2 (2001), 9.0 (2002), 8.5 (2003), 8.8 (2004), 8.0 (2005). - Despite strong employment growth, unemployment remains relatively high at about 8 percent. - Over the 15–year period through 2005, per capita income tripled in U.S. dollar terms and the poverty rate was cut in half, to about 18 percent. Income inequality remains high. - Directors encouraged improving labor market flexibility to increase employment opportunities and address high unemployment, especially among the young. - Directors welcomed reforms to improve pre-school coverage for low-income groups, enhance funding for tertiary education, and promote research and development. ### Risks, vulnerabilities, and policy recommendations - Main risks to outlook described as broadly balanced: - Downside risks: uncertainty in commodity prices (especially further oil price increases), abrupt increases in international interest rates and negative effects on emerging market investor sentiment, uncertainty regarding the evolution of house prices in some important industrial economies. - Upside risk: more favorable global growth and continuation of high copper prices. - Specific risk: disruptions in gas supply from Argentina could raise production costs, negatively affecting domestic demand and growth; authorities consider the impact moderated by conversion to alternative energy sources and recent negotiations with Argentine authorities. - Directors recommended: - Continued commitment to fiscal discipline while recognizing priorities to increase social spending in health and education. - Use copper windfalls prudently: accumulate resources to cover future contingent liabilities, recapitalize the central bank, and invest the surpluses (a few Directors suggested a faster pace of recapitalization). - Continued adherence to inflation targeting and readiness to adjust monetary policy if fiscal stance evolves differently than expected in 2007. - Continued fiscal restraint and investing fiscal surpluses abroad to help limit upward pressures on the currency. - Keep growth in consumer lending under close scrutiny and continue enhancing consolidation of risk information. ### Key macroeconomic aggregates (selected annual values) - Real GDP (annual percent change): 4.5 (2000), 3.4 (2001), 2.2 (2002), 3.9 (2003), 6.2 (2004), 6.3 (2005). - Total domestic demand (annual percent change): 6.0 (2000), 2.4 (2001), 2.4 (2002), 4.9 (2003), 8.1 (2004), 11.4 (2005). - Consumption (annual percent change): 3.6 (2000), 2.9 (2001), 2.5 (2002), 4.0 (2003), 6.1 (2004), 7.6 (2005). - Investment (annual percent change): 14.0 (2000), 0.8 (2001), 2.2 (2002), 7.8 (2003), 14.3 (2004), 22.2 (2005). - Fixed investment (annual percent change): 8.9 (2000), 4.3 (2001), 1.5 (2002), 5.7 (2003), 11.7 (2004), 24.7 (2005). - Broad money (annual percent change): 5.3 (2000), 4.9 (2001), 3.3 (2002), 2.3 (2003), 11.7 (2004), 22.1 (2005). - Credit to the private sector (annual percent change): 12.1 (2000), 8.1 (2001), 9.6 (2002), 11.4 (2003), 14.8 (2004), 15.4 (2005). - Gross domestic investment (percent of GDP): 21.9 (2000), 22.1 (2001), 21.7 (2002), 21.9 (2003), 21.4 (2004), 23.0 (2005). - National savings (percent of GDP): 20.7 (2000), 20.5 (2001), 20.8 (2002), 20.6 (2003), 23.0 (2004), 23.6 (2005). - External savings (percent of GDP): 1.2 (2000), 1.6 (2001), 0.9 (2002), 1.3 (2003), -1.7 (2004), -0.6 (2005). - Gross external debt (billions US$): 49.4 (2000), 56.2 (2001), 60.2 (2002), 58.4 (2003), 45.8 (2004), 39.0 (2005). - Public external debt (billions US$): 8.0 (2000), 8.9 (2001), 10.7 (2002), 12.6 (2003), 10.3 (2004), 8.3 (2005). - Private external debt (billions US$): 41.4 (2000), 47.3 (2001), 49.5 (2002), 45.8 (2003), 35.5 (2004), 30.7 (2005). *IMF Public Information Notice (PIN) No. 06/97 — IMF Executive Board Concludes 2006 Article IV Consultation with Chile (August 11, 2006).* ### 5. Against the backdrop of domestic financial conditions still expansionary, our ### _cr06335 - 5. Against the backdrop of domestic financial conditions still expansionary, our ### Financial stability assessment - Authorities assess that risks for financial stability are reduced given expansionary domestic financial conditions. - Key supportive factors: - Financial system described as profitable, well-capitalized, with historically low levels of non performing loans, and effectively supervised and regulated. - Corporate sector and households’ balance sheets are in solid position. - Risks of accessing external funding are low because Chile’s economy has no external financing needs in 2006-07. - External debt ratio has continued its improvement in the first half of 2006. - Corporate and banking sectors have appropriately hedged their currency risks. - Central Bank of Chile’s foreign reserve adequacy ratios and external assets accumulated by the government due to high copper prices provide an additional buffer against external shocks. ### Macroeconomic policy stance and monetary policy - Monetary framework: - Target inflation: "3 percent ± 1 percent". - Exchange rate regime: floating exchange rate. - Policy horizon: 12 to 24 months. - Policy actions and stance: - Since September 2004, the CBC has raised its policy rate by 350 basis points to 5¼ percent. - CBC views the economy as operating with little or almost no slack and considers further gradual rate hikes likely to bring inflation closer to the target; new policy rate changes will be data-dependent and probably less frequent than in previous quarters. - Inflation expectations are well anchored around 3 percent. - Market views are divided on frequency and extent of further interest rate adjustments; some participants argue the monetary tightening cycle might be coming close to an end. ### Fiscal position, copper windfall, and structural surplus rule - Copper price windfall and rule of structural surplus: - Fiscal policy expected to reach a significant increase in the surplus in 2006 to around 6 percent of the GDP. - This will allow further reduction of both government’s gross and net debt ratios to levels compared favorably with economies of similar sovereign risk grade. - Policy implications: - Strong public finances provide flexibility to adjust quickly to deterioration of external environment. - Authorities mindful of expansive effect on spending of high copper prices in 2007 and committed to manage revenue windfall prudently. - To avoid Dutch-disease like effects, authorities plan to prioritize in the 2007 budget a recomposition of spending towards outlays with high tradable content. ### Government’s structural goals and social outcomes - Long-term growth and poverty indicators: - GDP per capita averaged around 4.1 percent per year during 1991-2005 to reach about US$ 7 thousand per person. - Poverty incidence reduced from 45 percent in 1987 to 19 percent in 2003. - Government challenges and objectives: - Ensure conditions for sustained growth in an increasingly flexible economy while guaranteeing a wide network of social protection. ### Boosting productivity and growth — SME, innovation, and competition - SME-focused initiatives: - Tax debt relief for SMEs reaching up to 80 percent of interest and penalties. - Gradual reduction of the stamp tax on debt reschedulings that take into account revenue collection. - Establishment of a simplified tax system for SMEs. - Strengthening of Fondo de Garantia para Pequeñas Empresas (FOGAPE) by adding US$ 10 million to allow 46 percent more government-guaranteed loans to SMEs. - Enlargement of SME base of BancoEstado to reach 300 thousand customers by 2008. - Specific measures to strengthen SME liquidity. - Development of risk and venture capital industry through congressional approval of the Capital Market Reform (MKII) package. - Innovation policy: - Current R&D spending around 0.7 percent of GDP; innovation activities driven and funded by public sector through a fragmented National Innovation System. - Authorities intend to implement recommendations of the National Innovation Council financed with mining royalty resources estimated to reach US$ 150 million a year in steady state. - Policy measures proposed include a 15 percent flat tax on software and technology imports and a draft bill establishing a 35 percent subsidy on R&D spending carried out by companies together with universities and research centers. - Competition policy: - Further steps planned to promote market competition: strengthen governance framework for free competition, allocate more resources to the Office of the National Economic Attorney and the Court of Free Competition, and set up a new merger policy with penalties to discourage market collusion. ### Building a social safety net — macro and social policies - Two-pillar approach: - Pillar 1: Macroeconomic policy framework oriented to strengthen resilience against shocks (monetary, exchange rate including exceptional interventions, and fiscal policy). - Pillar 2: Social policy focused on creation of a social safety net. - Fiscal rule and institutional measures: - Target for central government structural surplus: 1 percent of GDP. - Law of Fiscal Responsibility expected to be approved by Congress during the second half of 2006; includes: - Legal obligation for future governments to set forth basis for fiscal policy during first 90 days of administration. - Creation of a new Economic and Social Stabilization Fund as described in the staff report. - Creation and regulation of the Pension Reserve Fund to accumulate resources guaranteeing future payments of minimum and assistance pensions due to rise as of 2016. - Establishment of rules for management and reporting of resources from both Funds. - Authorization for the government to make capital contributions to the Central Bank on account of actual surplus. - Social policy measures: - Childhood protection: increased preschool education coverage for 20 thousand children by opening 800 childcare centers; Advisory Committee for Childhood recommendations to inform a new childhood protection policy to be brought to Congress. - Elderly protection: bills approved in Congress raised pensions for those over 65 years-old and guarantee gratuity in public hospitals for all citizens 60 years-old or more. - Pension system reform: President’s Advisory Committee issued a report covering 70 reform proposals in 11 areas; draft bill expected to be sent to Congress late this year with Congressional discussion during 2007. - Housing and urban policy: housing deficit halved since 1991 with almost 2 million units constructed; government aims to reduce deficit further by 20 percent over the next four years via a new social housing policy to raise construction and design standards and subsidize housing localization to avoid urban segregation. - Urban security: measures include increased spending on police force and creation of a Ministry of Homeland Security. ### Conclusion — outlook for development - In summary, measures described, within a sound and responsible fiscal and monetary policy framework, are intended to: - Create conditions for stronger productivity growth. - Support sustained economic growth and rising living standards. *IMF staff report excerpt* --- _Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2006/_cr06335.pdf_