## _cr10298

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---

### Context and recent shocks
- Since 2008 Chile experienced two large adverse shocks: the global financial crisis and the February 2010 earthquake.
- Underpinning strengths:
  - A strong policy framework: a fiscal rule, inflation targeting, and exchange rate flexibility.
  - A well-capitalized banking system and absence of private-sector imbalances.
- Policy responses:
  - Fiscal stimulus announced January 2009.
  - Credit-facilitating measures in March and May 2009.
  - Central bank liquidity provision and policy rate cuts: policy rate from 8.25 percent to 0.5 percent by July 2009.
  - New administration (since March 2010) implemented an earthquake reconstruction program financed by temporary tax increases, reprioritization of spending, and some borrowing.

### Outlook for 2010 — Key projections and indicators
- Real GDP growth:
  - Projected to grow by 5 percent in 2010.
  - Real GDP grew at an annualized rate of 7 percent in the second half of 2009.
- Inflation and output gap:
  - Inflation expected to rise to 3.7 percent by end-2010.
  - Consumer prices increased by 2.2 percent y/y in July (after falling by 1.4 percent during 2009).
  - Staff estimates output gap would average about 2 percent of GDP in 2010 and close in 2011.
- Fiscal outcomes and public finances:
  - Central government deficit projected to decline to 1¾ percent of GDP in 2010 (from 4.4 percent of GDP in 2009).
  - Staff estimates reconstruction spending would raise the structural deficit to about4.1 percent of GDP in 2010 (from 3.1 percent of GDP in 2009).
  - Net financial asset position of the central government projected to decline to 14 percent of GDP by end-2010 (from a peak of 20 percent of GDP in 2008).
- Financial conditions:
  - Annual bank credit growth to the private sector recovered to 7.5 percent in mid-2010.
  - Non-performing loans at 3 percent of all loans.
  - Central bank policy rate raised to 2 percent in August 2010 after three consecutive monthly increases.
- External sector:
  - Net international investment position improved by about US$30 billion since mid-2009.
  - Current account projected to shift from a surplus of 2½ percent of GDP in 2009 to a deficit of about 1 percent of GDP in 2010.
  - Real effective exchange rate broadly in line with long-term fundamentals as of June 2010.

### Medium-term outlook and risks
- Growth path:
  - Real GDP growth expected to accelerate to about 6 percent in 2011 and thereafter converge to potential output growth of about 4½ percent.
- Fiscal baseline:
  - Staff baseline assumes overall central government position returns to virtual balance by 2014 and net financial assets remain close to 15 percent of GDP.
- External and reserves:
  - Current account deficit expected to stabilize at around 2¼ percent of GDP, financed mainly by net FDI.
  - Net international reserves projected to remain stable under exchange rate flexibility.
- Risks:
  - Near-term risks broadly balanced; vulnerabilities to global commodity price volatility, global growth, and capital markets given dependence on copper and oil.

### Fiscal policy — plans, scenarios, and staff views
- Authorities’ objectives and measures:
  - Emphasis on expenditure restraint to anchor fiscal policy over the medium term.
  - Aim to reduce the structural deficit to 1 percent of GDP by 2014.
  - Government estimated its share of total reconstruction costs of about US$30 billion would be on the order of US$8.4 billion (4 percent of GDP) over 2010–13.
  - Financing: insurance reimbursements, improved efficiency and reallocation of spending, temporary tax increases, and debt issuance.
  - Market placements in July: a US$1 billion 10-year bond at a spread of 90 basis points; a US$500 million peso-linked bond to international investors at an interest rate of 5.5 percent.
- Staff-supported scenario and recommendations:
  - Staff supported narrowing the structural deficit to 1 percent of GDP by 2014 but noted this requires keeping government spending growth below output growth (assuming unchanged tax burden and stable long-term copper prices).
  - Scenario discussed: headline central government deficit declines from 1.7 percent of GDP in 2010 to 0.5 percent of GDP in 2011, with real government expenditure growth of 9 percent in 2010 and 5 percent in 2011.
  - Under this scenario: central government headline position moves to virtual balance by 2014; expenditure declines to about 22 percent of GDP; structural deficit about 3 percent of GDP in 2011 and falls to 1 percent of GDP by 2014.
  - Staff advised prudence and suggested returning the structural position to balance over a longer horizon (for example by 2016) to preserve net financial position.
  - Staff recommended using any upward revisions in long-term copper price to reduce the structural deficit faster.

### Fiscal rule review — commission findings and staff recommendations
- Commission established to review the fiscal rule; interim report published in late August 2010; final report due by November 2010.
- Staff observations and recommendations:
  - Make the calculation of the structural balance more transparent and easy to replicate.
  - Introduce an explicit escape clause to allow discretionary countercyclical policy for large shocks.
  - Complement the rule with a medium-term policy framework extending beyond the 4-year presidential term to provide a clear path for returning to the fiscal target after deviations.
  - Minimize unintended procyclicality; an expenditure growth ceiling could help prevent procyclical increases in public spending in the event of a significant increase in the long-term copper price.
  - Expand role of expert committees to include ex-post assessment and consider adopting a full “fiscal council” to increase transparency and accountability.
  - Complement the rule with an indicative target for government long-term net financial assets, taking into account contingent liabilities.
- Authorities agreed with interim recommendations but would review final report before offering views; staff recommended a clear timetable for adopting any revisions after the final report.

### Central bank recapitalization and monetary policy stance
- Central bank recapitalization:
  - Between 2006 and 2008 the estimated capital shortfall of the central bank was reduced to ½ percent of GDP; transfers suspended in 2009.
  - Staff encourages completing recapitalization to strengthen credibility.
- Monetary policy and risks:
  - Monetary policy moved to a tightening stance since June 2010.
  - Market expectations: policy rate will increase to 5.5 percent by early 2012.
  - First line of defense against surge in capital inflows: allow nominal exchange rate appreciation, possibly with macroprudential policies.
  - Possible macroprudential measures: higher bank reserve requirements; countercyclical provisioning or capital requirements; limits on loan-to-value and loan-to-deposit ratios; limits and/or higher capital requirements on banks’ forward foreign exchange positions.
  - Staff agreed with central bank that foreign exchange intervention warranted only for extreme exchange rate misalignments risking domestic financial market disruptions; central bank has intervened only on three occasions since 2000.

### Financial sector soundness, reforms, and staff suggestions
- System resilience:
  - Central bank stress tests: banks’ capital ratios expected to remain above minima even under deteriorations.
  - As of April 2010 external funding was 9 percent of total liabilities; most of it long-term.
- Network and TCTF analysis:
  - Direct-exposure worst-case average capital loss for some banks: 6-10 percent of capital.
  - A sudden withdrawal of funding from foreign banks could induce an average capital loss of 17 percent, up to 22 percent if combined with a credit shock.
  - Withdrawal of funding by domestic non-bank financial institutions could produce average capital loss exceeding 40 percent (likelihood very small).
- Authorities’ reforms:
  - MKIII (approved May 2010): broadens authorized financial instruments (including exchange-traded funds and mortgage bonds), facilitates securitization, extends tax exemptions on selected fixed income instruments to foreign institutional investors.
  - MKB (Bicentennial Capital Markets Reform): develop liquidity, update institutional framework, consolidated supervision, and corporate governance of financial supervisors.
  - Pilot exercise on consolidated supervision of financial conglomerates and expanded data collection underway by SBIF, SVS, and SP.
- Staff recommendations:
  - Adopt a functional approach to regulation and supervision to limit regulatory arbitrage.
  - Formalize cooperative supervisory arrangements, including a systemic risk council.
  - Strengthen cross-border coordination and address information gaps.
  - Use a regulatory benchmark model and common assumptions to assess dynamic loan loss provisions.
  - Complement dynamic provisioning with countercyclical capital buffers.

### Enhancing productivity and labor market reforms
- Staff supported initiatives to increase competition, ease entry of new firms, improve credit access for SMEs, and reform bankruptcy procedures.
- Government plans to establish a specialized stock market for start-ups and increase venture capital availability.
- Labor market:
  - Staff agreed replacing high severance payments with a comprehensive unemployment insurance scheme could increase labor mobility and investment in education and training.
  - Chile’s 2010 rank: 49th in World Bank’s Doing Business Indicators.
  - Minimum wages: 45 percent of the average wage in Chile compared to OECD average of 40 percent.
  - High minimum wages could increase youth unemployment and informal sector growth.
- Potential gains: Pro-investment policies and reforms expected to yield an additional 1 percentage point to potential GDP growth; administration’s goal is a 6 percent potential growth rate.

### Staff appraisal and Fund Board assessment — key judgments and recommendations
- Recovery underway; fiscal policy played a critical countercyclical role; earthquake delayed withdrawal of stimulus.
- Staff supports authorities’ goal of reducing structural deficit of the central government to 1 percent of GDP by 2014 but notes the target is challenging.
- Over the longer horizon staff advised returning the structural position to balance to preserve net financial assets; use any permanent copper price increases to reduce structural deficit faster.
- Staff supports shift to a tightening monetary stance to bring inflation to target within a 24-month horizon, and endorses exchange rate flexibility as first defense against capital inflows with macroprudential backstops.
- Recommended further strengthening of prudential framework: consolidated supervision, functional regulation, formal cooperation among supervisors, cross-border coordination, information enhancements, and consumer protection agency inclusion once operational.
- Fund Board commended authorities’ responses, supported reconstruction financing measures, and agreed with recommendations on fiscal rule transparency, escape clause, medium-term framework, and timetable for revisions.

### External and public debt sustainability — selected baseline figures and scenarios
- External debt (percent of GDP): 32.4 (2006), 33.9 (2007), 37.6 (2008), 45.8 (2009), 38.6 (2010), 35.1 (2011), 35.1 (2011), 32.6 (2012), 30.9 (2013), 29.1 (2014), 27.4 (2015).
- External debt change (percent of GDP): -5.5 (2006), 1.5 (2007), 3.7 (2008), 8.2 (2009), -7.2 (2010), -3.5 (2011).
- Gross external financing need (billions of US dollars): 15.2 (2006), 22.6 (2007), 38.6 (2008), 34.9 (2009), 41.9 (2010), 46.6 (2011), 53.5 (2012), 57.6 (2013), 59.0 (2014), 59.4 (2015).
- Public (central government) baseline debt (percent of GDP): 7.3 (2005), 5.3 (2006), 4.1 (2007), 5.2 (2008), 6.2 (2009), 7.6 (2010), 6.9 (2011), 6.4 (2012), 6.0 (2013), 5.6 (2014), 5.3 (2015).
- Central government primary deficit (percent of GDP): -5.4 (2005), -8.4 (2006), -9.4 (2007), -5.7 (2008), 3.9 (2009), 1.3 (2010), 0.3 (2011).
- Key macro assumptions (selected):
  - Real GDP growth (percent): 4.6 (2005), 4.6 (2006), 3.7 (2007), -1.5 (2008), 5.0 (2009), 6.0 (2010), 4.6 (2011), 4.5 (2012–2015).
  - GDP deflator in US dollars (change in percent): 18.7 (2005), 7.0 (2006), 0.3 (2007), -3.9 (2008), 17.3 (2009), 5.5 (2010), 4.9 (2011).
  - Current account balance, excluding interest payments (percent of GDP): 5.9 (2005), 5.5 (2006), -0.6 (2007), 3.6 (2008), 0.1 (2009), -1.3 (2010), -1.6 (2011).
- Stress-test scenarios include one-time real depreciation of 30 percent in 2010 for external debt tests and contingent liability shocks of 10 percent of GDP combined with real depreciation for public debt tests.

### Box: Bicentennial Capital Markets Reform (MKB) — seven pillars
- Updating the institutional framework, including consolidated supervision and corporate governance strengthening, increased autonomy of banking supervisor, and bankruptcy law updates.
- Reducing credit procyclicality and upgrading solvency and liquidity requirements.
- Enhancing information and transparency: integrating securities exchanges, improved price information, minimum professional certification, and “Chinese walls.”
- Reforming taxation framework for investment funds, fixed income instruments, and derivatives.
- Creating a financial consumer protection agency.
- Improving market access for middle class households and SMEs: increased banking services, reduction of IPO costs, incentives for venture capital.
- Developing new markets and financial products: high yield bond market, better FX hedging access for small firms, and legal framework for microfinance institutions.

### Key quantitative and dated observations (selected)
- Rule in place since 2001.
- Commission interim report published in late August 2010; final report due by November 2010.
- Central bank capital shortfall reduced to ½ percent of GDP between 2006 and 2008; transfers suspended in 2009.
- Market expectation: policy rate to increase to 5.5 percent by early 2012.
- As of April 2010, external funding was 9 percent of total liabilities.
- Central bank interventions in foreign exchange market: only on three occasions since 2000.
- Chile ranked 49th in the World Bank’s Doing Business Indicators in 2010.
- Minimum wages: 45 percent of the average wage in Chile versus OECD average of 40 percent.
- Staff supports reducing structural deficit to 1 percent of GDP by 2014.
- Output gap estimates: about 2–3 percent as of end-2009; recovery should close the output gap by mid-2011; linear-filter estimate about 2–3 percent in Q1-2010.
- Worst-case average capital losses noted in network analysis: 6-10 percent (direct exposures), 17 percent (withdrawal by foreign banks), up to 22 percent if combined with credit shock, and exceeding 40 percent if domestic non-bank financial institutions withdraw funding (likelihood very small).

*IMF staff report — Executive Summary (Article IV consultation, July 19–30, 2010).*

*Source: Staff Report for the 2010 Article IV Consultation — sections and annexes as provided in the source content.*

### Executive Summary

### Executive Summary

### Context
- Since 2008, Chile’s economy has withstood two large adverse shocks—the global financial crisis and a devastating earthquake in February 2010—underpinned by:
  - a strong policy framework (a fiscal rule, inflation targeting and exchange rate flexibility),
  - a well-capitalized banking system,
  - absence of imbalances in the private sector.
- Policy responses included a sizable fiscal stimulus (announced January 2009), measures to facilitate credit (March and May 2009), and central bank liquidity provision and policy rate cuts (policy rate from 8.25 percent to 0.5 percent by July 2009).
- After taking office in March 2010, the new administration implemented an ambitious earthquake reconstruction program financed by temporary tax increases, reprioritization of spending, and some borrowing.

### Outlook for 2010 — Key Projections and Indicators
- Real GDP growth: projected to grow by 5 percent in 2010.
- Recent performance: real GDP grew at an annualized rate of 7 percent in the second half of 2009.
- Inflation and output gap:
  - Inflation expected to rise to 3.7 percent by end-2010.
  - Consumer prices increased by 2.2 percent y/y in July (after falling by 1.4 percent during 2009).
  - Staff estimates output gap would average about 2 percent of GDP in 2010 and close in 2011.
- Fiscal outcomes:
  - Central government deficit projected to decline to 1¾ percent of GDP in 2010 (from 4.4 percent of GDP in 2009).
  - Staff estimates reconstruction spending would raise the structural deficit to about4.1 percent of GDP in 2010 (from 3.1 percent of GDP in 2009).
  - Net financial asset position of the central government projected to decline to 14 percent of GDP by end-2010 (from a peak of 20 percent of GDP in 2008).
- Financial conditions:
  - Credit growth resumed; annual bank credit growth to the private sector recovered to 7.5 percent in mid-2010.
  - Non-performing loans at 3 percent of all loans.
  - Central bank policy rate raised to 2 percent in August 2010 after three consecutive monthly increases.
- External sector:
  - Net international investment position improved by about US$30 billion since mid-2009.
  - Current account projected to shift from a surplus of 2½ percent of GDP in 2009 to a deficit of about 1 percent of GDP in 2010.
  - Real effective exchange rate broadly in line with long-term fundamentals as of June 2010.

### Medium-Term Outlook and Risks
- Growth path:
  - Real GDP growth expected to accelerate to about 6 percent in 2011 and thereafter converge to potential output growth of about 4½ percent.
- Fiscal baseline:
  - Staff baseline assumes overall central government position returns to virtual balance by 2014 and net financial assets remain close to 15 percent of GDP.
- External and reserve projections:
  - Current account deficit expected to stabilize at around 2¼ percent of GDP, financed mainly by net FDI.
  - Net international reserves projected to remain stable, given central bank commitment to exchange rate flexibility.
- Risks:
  - Near-term risks broadly balanced, but vulnerabilities persist to global commodity price volatility, global growth, and capital markets due to Chile’s openness and dependence on copper and oil.

### Policy Discussions — General
- Authorities committed to preserving macroeconomic stability, strengthening the policy framework, and boosting productivity through public sector efficiency improvements and comprehensive capital markets reform.
- Government convened a high-level commission to recommend reforms to the fiscal rule.

### Fiscal Policy — Plans, Scenarios, and Staff Views
- Authorities’ objectives and measures:
  - Emphasis on expenditure restraint to anchor fiscal policy over the medium term.
  - Aim to reduce the structural deficit to 1 percent of GDP by 2014, requiring cautious expenditure policy despite reconstruction spending in 2010–12.
  - Government estimated its share of total reconstruction costs of about US$30 billion would be on the order of US$8.4 billion (4 percent of GDP) over 2010–13, to be financed through insurance reimbursements, improved efficiency and reallocation of spending, temporary tax increases, and debt issuance.
  - Temporary tax increases intended to avoid near-term spending compression and combined with reforms including extension of the reduction in the stamp tax on financial transactions and tax breaks for small and medium sized enterprises.
  - Market financing: in July the government placed a US$1 billion 10-year bond at a spread of 90 basis points, and sold a US$500 million peso-linked bond to international investors at an interest rate of 5.5 percent.
- Staff-supported scenario and recommendations:
  - Staff supported narrowing structural deficit to 1 percent of GDP by 2014 but noted this requires keeping government spending growth below output growth (assuming unchanged tax burden and stable long-term copper prices).
  - Scenario discussed: headline central government deficit declines from 1.7 percent of GDP in 2010 to 0.5 percent of GDP in 2011, with real government expenditure growth of 9 percent in 2010 and 5 percent in 2011.
  - Under this scenario: central government headline position moves to virtual balance by 2014; expenditure declines to about 22 percent of GDP; structural deficit remains about 3 percent of GDP in 2011 and falls to 1 percent of GDP by 2014.
  - Staff advised prudence and suggested returning the structural position to balance over a longer horizon, say by 2016, to signal longer-term neutrality and preserve the government’s net financial position.
  - Staff recommended using any upward revisions in long-term copper price (structural revenue gains) to reduce the structural deficit faster.

### Analytical Work and Other Notes
- Background studies prepared include:
  - Options for strengthening Chile’s fiscal framework.
  - Assessment of “too-connected-to-fail” risk through network analysis.
  - Estimates of potential output.
  - Measurement of effects of terms of trade shocks on income distribution.
- Exchange rate system: Chile has accepted the obligations of Article VIII, Sections 2, 3, and 4 and maintains an exchange rate system free of restrictions on current international transactions, and a floating exchange rate.
- OECD membership: Chile joined the OECD in May 2010.

_Italic: IMF staff report — Executive Summary (Article IV consultation, July 19–30, 2010)._

### 14.      Staff welcomed the government’s decision to establish a commission to review

### _cr10298 - 14.      Staff welcomed the government’s decision to establish a commission to review

### Fiscal rule review — findings and recommendations
- The government established a commission to review the fiscal rule; the commission published an interim report in late August 2010 and a final report was due by November 2010.
- Staff noted the rule in place since 2001 helped stabilize spending growth and accumulate sizable net financial assets during the copper price boom, but could be improved in several aspects.
- Staff analysis, drawing on best international practices (Annex 1), suggested the following points to consider:
  - Make the calculation of the structural balance more transparent and easy to replicate.
  - Introduce an explicit escape clause to allow for discretionary countercyclical policy in the case of large shocks.
  - Complement the rule with a medium-term policy framework that would extend beyond the 4-year presidential term to provide a clear path for returning to the fiscal target after temporary deviations.
  - Minimize unintended procyclicality. An expenditure growth ceiling could help prevent procyclical increases in public spending in the event of a significant increase in the long-term copper price.
  - Expand the role of the expert committees to include an ex-post assessment of the implementation of the rule and consider the adoption of a full “fiscal council” system to increase further fiscal transparency and accountability.
  - Complement the rule with an indicative target for the government’s long-term net financial assets, taking into account contingent liabilities.
- The authorities agreed with the recommendations in the interim report but wanted to carefully review the final report before offering any views on possible reforms to the rule.
- Staff recommended that once the commission issues its final report, the government could limit uncertainty by outlining a clear timetable for adopting any revisions to the rule.

### Central bank recapitalization
- Between 2006 and 2008, the government reduced the estimated capital shortfall of the central bank to ½ percent of GDP, but transfers were suspended in 2009.
- Completing the recapitalization of the central bank would help strengthen its credibility, without affecting the overall asset position of the general government.
- The authorities replied that they would review a report on the capital position of the central bank before deciding on next steps.
- Staff encourages the government to renew its commitment to fully recapitalize the central bank.

### Monetary policy stance and risks
- Monetary policy moved to a tightening stance since June (2010 context).
- Market expectations suggest that the policy rate will increase to 5.5 percent by early 2012.
- Staff noted widening interest rate and growth differentials with major advanced economies could trigger capital inflows.
- Agreed first line of defense in case of surge in capital inflows: allow nominal exchange rate appreciation, possibly accompanied by macroprudential policies to limit excessive growth in credit.
- Possible macroprudential measures suggested:
  - Higher bank reserve requirements.
  - Countercyclical provisioning or capital requirements.
  - Limits on loan-to-value and loan-to-deposit ratios.
  - Limits and/or higher capital requirements on banks’ forward foreign exchange positions in case of excessive exchange rate volatility.
- The authorities noted macroprudential choices would be tailored to specific situations and coordinated with supervisory agencies; some measures could require legislative approval.
- Staff agreed with central bank that foreign exchange intervention would be warranted only in case of extreme exchange rate misalignments with risk of domestic financial market disruptions, in line with the framework for sterilized interventions in place since 2000.
- The central bank has intervened only on three occasions since 2000.

### Strengthening the financial system — risks, reforms, and staff suggestions
- Domestic credit risks expected to diminish as the recovery firms up; the earthquake could have a limited temporary impact in affected zones but overall banking system effects expected to be offset by rebound and lower unemployment.
- Central bank stress tests suggest banks’ capital ratios will remain above minima even if economic conditions deteriorate and cost of financing increases relative to baseline projections.
- As of April 2010, external funding was only 9 percent of total liabilities and most of it was long-term debt.
- Balance sheet network analysis: TCTF (Too-Connected-to-Fail) risk from direct exposures is small; interbank exposure relative to banks’ capital is relatively small.
  - In the worst case, some banks would experience an average loss of 6-10 percent of their capital from direct exposures.
  - A sudden withdrawal of funding from foreign banks could induce an average capital loss of 17 percent, and up to 22 percent if combined with a credit shock.
  - If domestic non-bank financial institutions were to withdraw their funding, the average capital loss would exceed 40 percent of the capital of the banking system, though the likelihood of such an event is very small.
- Authorities remain committed to financial sector reforms:
  - The third capital market reforms law (MKIII), approved by Congress in May 2010, broadens authorized financial instruments (including exchange-traded funds and mortgage bonds), facilitates securitization, and extends tax exemptions on selected fixed income instruments to foreign institutional investors.
  - The government is developing the bicentennial capital market reform (MKB) to improve liquidity and update institutional framework, especially consolidated supervision and corporate governance of financial supervisors.
- Staff fully supported initiatives and suggested additional measures:
  - Adopt a functional approach to regulation and supervision to limit regulatory arbitrage and facilitate systemic risk assessment.
  - Formalize cooperative supervisory arrangements among the three supervisory agencies, including by setting up a systemic risk council.
  - Strengthen cross-border coordination with international counterparts.
  - Address information gaps to help identify vulnerabilities and price misalignments.
  - Use a regulatory benchmark model and common assumptions to assess adequacy of dynamic loan loss provisions.
  - Complement dynamic provisioning with countercyclical capital buffers to reduce macroprudential risks associated with procyclical credit expansion.
- Authorities reported the three main supervisory agencies (SBIF, SVS, and SP) are implementing a pilot exercise on consolidated supervision of financial conglomerates and are expanding data collection from financial conglomerates.

### Enhancing productivity growth
- Staff supported government initiatives to increase competition, facilitate entry of new firms, make credit more accessible to small and medium-enterprises, and improve bankruptcy regulations.
- The government plans to establish a specialized stock market to facilitate initial public offerings for start-ups and increase availability of venture capital.
- Staff agreed that replacing the current high severance payment system with a more comprehensive unemployment insurance scheme could increase labor mobility and encourage greater investment in education and on-the-job training.
- Chile’s 2010 rank and labor market indicators:
  - In 2010, Chile ranked 49th in the World Bank’s Doing Business Indicators.
  - Relatively high costs for starting a business, inefficient bankruptcy procedures, and labor market regulations that favor short-term subcontracting were noted.
  - Relatively high minimum wages in Chile—45 percent of the average wage compared to the OECD average of 40 percent—could increase youth unemployment and contribute to growth of the informal sector.
- Increasing the share of skilled workers could help reduce income inequality.

### Staff appraisal — key judgments and targets
- Chile’s economy showed remarkable resilience; the economic recovery is fully underway.
- Fiscal policy played a critical countercyclical role; the 2009 fiscal stimulus supported an early recovery; withdrawal delayed by the February 2010 earthquake.
- Government financed emergency spending through reprioritization, temporary tax increases, efficiency gains, and some debt issuance.
- The government committed to firm expenditure restraint starting in 2011 to reduce risk of overheating and limit exchange rate appreciation pressures.
- Staff supports authorities’ goal of reducing the structural deficit of the central government to 1 percent of GDP by 2014, while noting the target is challenging and implies firm expenditure restraint over a number of years.
- Over a longer horizon, staff advised returning the structural position of the central government to balance to keep discretionary fiscal policy neutral while preserving net financial assets; any increase in the long-term copper price could be used to reduce the structural deficit faster.
- Staff supports the recent shift of monetary policy to a tightening stance to bring inflation in line with the target by the end of the 24-month policy horizon.
- Implementation of monetary policy could become challenging if widening interest rate and growth differentials lead to a surge in capital inflows; staff supports exchange rate flexibility as first line of defense and possible macroprudential measures.
- Further strengthening the prudential framework is beneficial: adopt consolidated supervision, functional regulation, formalize cooperation among supervisory agencies, strengthen cross-border coordination, address information gaps, and include consumer protection agency once operational.
- Staff supports authorities’ focus on faster productivity growth and labor market efficiency reforms.
- Staff proposed that the next Article IV consultation be held on the standard 12-month cycle.

### Key quantitative and dated observations
- Rule in place since 2001.
- Commission interim report published in late August 2010; final report due by November 2010.
- Estimated central bank capital shortfall reduced to ½ percent of GDP between 2006 and 2008; transfers suspended in 2009.
- Market expectation: policy rate to increase to 5.5 percent by early 2012.
- As of April 2010, external funding was 9 percent of total liabilities.
- Central bank interventions in foreign exchange market: only on three occasions since 2000.
- Chile ranked 49th in the World Bank’s Doing Business Indicators in 2010.
- Minimum wages: 45 percent of the average wage in Chile versus OECD average of 40 percent.
- Staff supports reducing structural deficit to 1 percent of GDP by 2014.
- Output gap estimates: about 2–3 percent as of end-2009; recovery should close the output gap by mid-2011; using linear filters output gap about 2–3 percent in Q1-2010.
- Worst-case average capital losses noted: 6-10 percent (direct exposures), 17 percent (withdrawal by foreign banks), up to 22 percent if combined with credit shock, and exceeding 40 percent if domestic non-bank financial institutions withdraw funding (though likelihood very small).

*IMF staff report section as provided in the source content.*

### Box 3. Bicentennial Capital Markets Reform (MKB)

### Box 3. Bicentennial Capital Markets Reform (MKB)

### Overview
- The new financial markets reform initiative, announced on May 5, 2010, rests on the following seven pillars:

### Seven pillars
- Updating the institutional framework, including implementing consolidated supervision of financial conglomerates; strengthening of the corporate governance of the securities and insurance supervisory agency; increasing the autonomy of the banking supervisory agency, and updating the bankruptcy law for non-financial corporations.
- Reducing credit procyclicality and upgrading the solvency and liquidity requirements for financial institutions.
- Enhancing information and transparency in the financial system through further integration of securities exchanges, improved price information in exchange markets, minimum professional certification requirements for financial sector employees, and the use of “Chinese walls” to prevent the misuse of inside information.
- Reforming the taxation framework to simply the value added tax on investment funds and the tax treatment of fixed income instruments and derivatives products.
- Creating a financial consumer protection agency.
- Improving market access for middle class households and small and medium enterprises through increased banking services to households, reduction of initial public offering costs, and further incentives for venture capital.
- Developing new markets and financial products to reduce financing costs, including the development of a high yield bond market, better access to foreign exchange hedging by small firms, and the provision of a sound legal framework governing microfinance institutions.

*Source: Box 3, Bicentennial Capital Markets Reform (MKB).*

### ANNEX 1. CHILE’S FISCAL RULE FROM AN OECD PERSPECTIVE

### ANNEX 1. CHILE’S FISCAL RULE FROM AN OECD PERSPECTIVE

### Clear statutory basis
- OECD practice: fiscal rules supported by special legislation (e.g. national law, guidelines or supranational agreements) that usually includes stringent procedural rules on accountability, transparency and fiscal stability, as well as key budget principles.
- Chile’s situation:
  - Chile’s Fiscal Responsibility Law (FRL) of 2006 does not provide much guidance on the design and practical implementation of the fiscal rule.
  - The FRL only mandates:
    - that the President of the Republic enacts, within the 90 days of entering office, a decree indicating how the fiscal policy planned for his/her administration will affect the structural balance; and
    - that the Budget Directorate calculates the structural balance.
  - The nature, rationale, and methodology for the calculation of the structural balance rule have been usually explained in policy papers issued by the Budget Directorate.

### Clear targets
- OECD practice: legislation typically includes clear methodological principles and definitions for the fiscal rule; targets often on gross or net public debt, several definitions of deficit (overall, structural balance, primary balance, non-oil primary balance), tax ratios, and growth rate of government expenditure.
- Chile’s situation:
  - The FRL defines the structural balance as the difference between the central government revenues and expenditures that would have been obtained if, in any given year, the economy was operating at potential and the copper price was at its (estimated) long-term level.
  - The initial methodology outlined by the Budget Directorate to calculate the structural balance was easy to understand and replicate.
  - The computation of the structural balance has become increasingly complex and difficult to replicate owing to:
    - the expansion of the private mining sector,
    - the introduction of new taxes on mining,
    - the coming into stream of output of non-copper minerals (e.g. molybdenum),
    - and non-transparent changes in the elasticities of tax collections with respect to the output gap.

### Clear objectives
- OECD practice: rationale for fiscal rules usually spelled out in legislation or guidelines; objectives typically include ensuring public debt sustainability, addressing common pool problems in decentralized countries or within international arrangements, avoiding domestic demand pressures, and tackling ageing-related issues.
- Chile’s situation:
  - A 2001 policy paper of the Budget Directorate spelled out the objectives of Chile’s fiscal rule.
  - The paper noted that the structural surplus targeted with the rule (1 percent of GDP at the time) was to be used to:
    - recapitalize the central bank,
    - pre-finance contingent liabilities,
    - and create a buffer of net financial assets to allow the central government to absorb external shocks.
  - The 2006 FRL did not refer to these objectives, and only stipulated the creation of two separate sovereign funds for the allocation of overall surpluses.

### Clear link between targets and objectives
- OECD practice: fiscal rules usually set targets/benchmarks on several fiscal indicators covering sustainability and cyclicality; common features include upper limits on gross or net public debt, ceilings on deficit definitions, and ceilings for overall balance and expenditure growth.
- Chile’s situation:
  - Chile’s structural balance rule does not establish a clear link with medium-term fiscal goals.
  - The rule is not formulated within a full-fledged medium-term framework nor is it used to assess how current policies would affect the government’s net financial wealth.
  - The upward revision of the long-term copper price in recent years has imparted an unintended procyclicality to government expenditures.

### Flexibility
- OECD practice: rules include provisions to deal with unexpected shocks, allowing temporary deviations and guidance for gradual adjustment; common tools include “exceptional circumstances clauses,” “notional accounts,” and procedures for periodic/rolling adjustments.
- Chile’s situation:
  - Chile’s rule is, in principle, quite flexible: it does not constrain the government’s capacity to modify the structural balance target.
  - The target has been changed over time for several reasons, and changes have usually been justified by analytical work.
  - However, Chile’s fiscal framework does not provide much guidance on how to introduce changes to the target or how to implement a discretionary response to a shock.
  - In terms of ex-post compliance, Chile’s FRL does not contain mechanisms to assess small ex-post deviations or eliminate them over time.

### Transparency provisions
- OECD practice: legislation usually contains provisions to promote full transparency of fiscal policy plans and ex-post fiscal performance, informing the public of deviations and plans to correct them.
- Chile’s situation:
  - Chile’s FRL does not include provisions to promote full transparency (either of the ex-ante calculation of the structural balance or ex-post performance).
  - The only legal requirement is that the Budget Directorate computes the structural balance every year.
  - The government monitors fiscal performance on an ongoing basis and has shown a strong responsiveness to new informational demands, even though not required by law.
  - Because of those actions, understanding of Chile’s rule by the public is quite high, in spite of its complexity.

### Accountability
- OECD practice: many countries have independent fiscal councils providing objective analysis, independent projections and forecasts, and assessment of rule application; councils typically advisory and accountable to the legislature.
- Chile’s situation:
  - Chile’s framework delegates to two independent panels of experts the determination of critical inputs for the calculation of the structural balance:
    - the long-term copper price, and
    - the rates of growth of the labor force, capital accumulation, and total factor productivity.
  - The composition of the panels and their main recommendations are published by the Budget Directorate regularly.
  - The recommendations of the panels are not binding, and the law does not assign to any third party the task of assessing compliance with the rule.

*Source: ANNEX 1. CHILE’S FISCAL RULE FROM AN OECD PERSPECTIVE (text supplied).*

### 11.2 percent of GDP in 2009, and gross central government debt remained low at 9 percent

### _cr10298 - 11.2 percent of GDP in 2009, and gross central government debt remained low at 9 percent

### External debt sustainability: baseline and stress-test findings
- External debt (baseline, percent of GDP): 32.4 (2006), 33.9 (2007), 37.6 (2008), 45.8 (2009), 38.6 (2010), 35.1 (2011), 32.6 (2012), 30.9 (2013), 29.1 (2014), 27.4 (2015).
- Change in external debt (percent of GDP): -5.5 (2006), 1.5 (2007), 3.7 (2008), 8.2 (2009), -7.2 (2010), -3.5 (2011), -2.4 (2012), -1.7 (2013), -1.9 (2014), -1.7 (2015).
- Identified external debt-creating flows (percent of GDP): -17.1 (2006), -15.8 (2007), -9.9 (2008), -8.4 (2009), -11.6 (2010), -10.0 (2011), -7.1 (2012), -6.8 (2013), -5.1 (2014), -4.0 (2015).
- Current account deficit, excluding interest payments (percent of GDP): -5.9 (2006), -5.5 (2007), 0.6 (2008), -3.6 (2009), -0.1 (2010), 1.3 (2011), 1.6 (2012), 0.8 (2013), 0.9 (2014), 1.0 (2015).
- Deficit in balance of goods and services (percent of exports): -75.6 (2006), -79.6 (2007), -85.8 (2008), -69.0 (2009), -72.3 (2010), -73.2 (2011), -76.5 (2012), -76.2 (2013), -74.4 (2014), -72.3 (2015).
- Net non-debt creating capital inflows (negative, percent of GDP): -4.9 (2006), -7.9 (2007), -10.0 (2008), -7.9 (2009), -10.4 (2010), -9.9 (2011), -7.8 (2012), -7.7 (2013), -6.1 (2014), -5.1 (2015).
- Automatic debt dynamics contributions (percent of GDP): -6.3 (2006), -2.5 (2007), -0.5 (2008), 3.2 (2009), -1.1 (2010), -1.4 (2011), -0.9 (2012), 0.1 (2013), 0.1 (2014), 0.1 (2015).
  - Contribution from nominal interest rate (percent of GDP): 1.1 (2006), 1.0 (2007), 0.8 (2008), 1.0 (2009), 0.8 (2010), 0.7 (2011), 0.5 (2012), 1.5 (2013), 1.4 (2014), 1.3 (2015).
  - Contribution from real GDP growth (percent of GDP): -1.4 (2006), -1.3 (2007), -1.2 (2008), 0.6 (2009), -1.9 (2010), -2.1 (2011), -1.5 (2012), -1.4 (2013), -1.3 (2014), -1.2 (2015).
  - Contribution from price and exchange rate changes (percent of GDP): -6.0 (2006), -2.1 (2007), -0.1 (2008), 1.5 (2009), … (table continues in source).
- Residual, including change in gross foreign assets (percent of GDP): 11.7 (2006), 17.3 (2007), 13.6 (2008), 16.6 (2009), 4.4 (2010), 6.4 (2011), 4.7 (2012), 5.1 (2013), 3.2 (2014), 2.3 (2015).
- External debt-to-exports ratio (in percent): 71.6 (2006), 72.4 (2007), 83.3 (2008), 119.0 (2009), 98.4 (2010), 87.9 (2011), 78.9 (2012), 76.2 (2013), 74.3 (2014), 73.0 (2015).
- Gross external financing need (in billions of US dollars): 15.2 (2006), 22.6 (2007), 38.6 (2008), 34.9 (2009), 41.9 (2010), 46.6 (2011), 53.5 (2012), 57.6 (2013), 59.0 (2014), 59.4 (2015).
- Gross external financing need (in percent of GDP): 10.4 (2006), 13.7 (2007), 22.6 (2008), 21.6 (2009), 21.1 (2010), 20.9 (2011), 21.9 (2012), 22.2 (2013), 21.4 (2014), 20.2 (2015).
- Scenario with key variables at their historical averages (external debt, percent of GDP): 38.6 (2006), 36.2 (2007), 31.7 (2008), 26.7 (2009), 19.9 (2010), 12.5 (2011), -7.4 (2012) — table continues in source.

### Public (central government) debt sustainability: baseline and stress-test findings
- Baseline central government debt (percent of GDP): 7.3 (2005), 5.3 (2006), 4.1 (2007), 5.2 (2008), 6.2 (2009), 7.6 (2010), 6.9 (2011), 6.4 (2012), 6.0 (2013), 5.6 (2014), 5.3 (2015).
- o/w foreign-currency denominated (percent of GDP): 5.2 (2005), 3.6 (2006), 2.1 (2007), 2.1 (2008), 1.5 (2009), 2.8 (2010), 2.5 (2011), 2.3 (2012), 2.2 (2013), 2.0 (2014), 1.9 (2015).
- Change in central government debt (percent of GDP): -3.4 (2005), -2.0 (2006), -1.2 (2007), 1.1 (2008), 1.0 (2009), 1.4 (2010), -0.7 (2011), -0.5 (2012), -0.4 (2013), -0.4 (2014), -0.3 (2015).
- Identified debt-creating flows (percent of GDP): -6.1 (2005), -8.0 (2006), -9.5 (2007), -5.1 (2008), 4.0 (2009), 1.3 (2010), 0.0 (2011), -0.4 (2012), -0.9 (2013), -1.5 (2014), -2.0 (2015).
- Primary deficit (percent of GDP): -5.4 (2005), -8.4 (2006), -9.4 (2007), -5.7 (2008), 3.9 (2009), 1.3 (2010), 0.3 (2011), -0.2 (2012), -0.7 (2013), -1.4 (2014), -1.9 (2015).
- Revenue and grants (percent of GDP): 23.8 (2005), 25.8 (2006), 27.4 (2007), 26.2 (2008), 20.1 (2009), 21.9 (2010), 22.5 (2011), 22.1 (2012), 22.2 (2013), 22.3 (2014), 22.4 (2015).
- Primary (noninterest) expenditure (percent of GDP): 18.4 (2005), 17.4 (2006), 18.0 (2007), 20.5 (2008), 24.0 (2009), 23.2 (2010), 22.8 (2011), 21.9 (2012), 21.5 (2013), 21.0 (2014), 20.5 (2015).
- Automatic debt dynamics (percent of GDP): -0.7 (2005), 0.4 (2006), -0.1 (2007), 0.6 (2008), 0.1 (2009), 0.0 (2010), -0.3 (2011), -0.2 (2012), -0.2 (2013), -0.1 (2014), -0.1 (2015).
  - Contribution from interest rate/growth differential (percent of GDP): 0.0 (2005), 0.2 (2006), 0.2 (2007), 0.0 (2008), 0.5 (2009), 0.0 (2010), -0.3 (2011), -0.2 (2012), -0.2 (2013), -0.1 (2014), -0.1 (2015).
  - Of which contribution from real interest rate (percent of GDP): 0.6 (2005), 0.5 (2006), 0.4 (2007), 0.1 (2008), 0.4 (2009), 0.3 (2010), 0.1 (2011), 0.1 (2012), 0.1 (2013), 0.1 (2014), 0.1 (2015).
  - Of which contribution from real GDP growth (percent of GDP): -0.5 (2005), -0.3 (2006), -0.2 (2007), -0.1 (2008), 0.1 (2009), -0.3 (2010), -0.4 (2011), -0.3 (2012), -0.3 (2013), -0.3 (2014), -0.2 (2015).
- Contribution from exchange rate depreciation (percent of GDP): -0.7 (2005), 0.2 (2006), -0.3 (2007), 0.6 (2008), -0.4 (2009), … (table continues in source).
- Residual, including asset changes (percent of GDP): 2.7 (2005), 5.9 (2006), 8.4 (2007), 6.2 (2008), -3.0 (2009), 0.1 (2010), -0.7 (2011), -0.1 (2012), 0.5 (2013), 1.1 (2014), 1.7 (2015).
- Central Government debt-to-revenue ratio (percent): 30.6 (2005), 20.4 (2006), 14.9 (2007), 19.7 (2008), 30.9 (2009), 34.7 (2010), 30.7 (2011), 28.8 (2012), 27.0 (2013), 25.2 (2014), 23.6 (2015).
- Gross financing need (percent of GDP): -1.3 (2005), -5.6 (2006), -6.9 (2007), -3.2 (2008), 6.1 (2009), 3.1 (2010), 0.7 (2011), 0.5 (2012), -0.1 (2013), -1.0 (2014), -1.6 (2015).
- Gross financing need (in billions of U.S. dollars): -1.6 (2005), -8.3 (2006), -11.4 (2007), -5.4 (2008), 9.9 (2009), 6.2 (2010), 1.5 (2011), 1.2 (2012), -0.2 (2013), -2.9 (2014), -4.6 (2015).
- Scenario with no policy change (constant primary balance) in 2010-2015: 7.6, 7.9, 9.0, 10.6, 13.0, 15.8 (table-format continuation in source).

### Key macroeconomic assumptions underlying baseline projections
- Real GDP growth (percent): 4.6 (2005), 4.6 (2006), 3.7 (2007), -1.5 (2008), 5.0 (2009), 6.0 (2010), 4.6 (2011), 4.5 (2012), 4.5 (2013), 4.5 (2014), 4.5 (2015).
- GDP deflator in US dollars (change in percent): 18.7 (2005), 7.0 (2006), 0.3 (2007), -3.9 (2008), 17.3 (2009), 5.5 (2010), 4.9 (2011), 1.6 (2012), 1.8 (2013), 1.8 (2014), 1.8 (2015).
- Nominal external interest rate (in percent): 3.4 (2005), 3.3 (2006), 2.6 (2007), 2.5 (2008), 2.1 (2009), 2.0 (2010), 1.7 (2011), 5.0 (2012), 4.9 (2013), 4.9 (2014), 4.9 (2015).
- Growth of exports (US dollar terms, in percent): 37.4 (2005), 15.7 (2006), 0.4 (2007), -19.4 (2008), 25.5 (2009), 13.8 (2010), 13.8 (2011), 4.1 (2012), 2.7 (2013), 2.0 (2014), 2.0 (2015).
- Growth of imports (US dollar terms, in percent): 16.0 (2005), 21.7 (2006), 28.3 (2007), -28.8 (2008), 33.6 (2009), 12.4 (2010), 15.9 (2011), 7.5 (2012), 5.5 (2013), 4.9 (2014), 4.9 (2015).
- Current account balance, excluding interest payments (percent of GDP): 5.9 (2005), 5.5 (2006), -0.6 (2007), 3.6 (2008), 0.1 (2009), -1.3 (2010), -1.6 (2011), -0.8 (2012), -0.9 (2013), -1.0 (2014), -1.0 (2015).
- Net non-debt creating capital inflows (percent of GDP): 4.9 (2005), 7.9 (2006), 10.0 (2007), 7.9 (2008), 10.4 (2009), 9.9 (2010), 7.8 (2011), 7.7 (2012), 6.1 (2013), 5.1 (2014), 5.1 (2015).

### Stress tests and scenario notes (from figures and footnotes)
- Individual shocks for the bound tests are permanent one-half standard deviation shocks.
- Permanent 1/4 standard deviation shocks applied to real interest rate, growth rate, and current account balance in some combined-scenario calculations.
- One-time real depreciation of 30 percent occurs in 2010 in one scenario for external debt tests.
- For public debt tests, one scenario includes a one-time real depreciation of 30 percent and a 10 percent of GDP shock to contingent liabilities in 2010; real depreciation is defined as nominal depreciation (measured by percentage fall in dollar value of local currency) minus domestic inflation (based on GDP deflator).
- Primary balance shock scenarios include a "no policy change" (constant primary balance) scenario; baseline and scenario averages are reported in figure boxes (e.g., Baseline: 0.8; Scenario: -1.6; Historical: 2.0 for a primary-balance related box in the public debt figure).

### Selected historical fiscal and financial context (from appendixes)
- Staff Report for the 2010 Article IV Consultation—Informational Annex prepared by the Western Hemisphere Department, August 25, 2010.
- Fund relations and membership: Joined December 31, 1945; Article VIII. Quota: 856.10 (SDR Million) 100.00 percent quota; Fund holdings of currency: 672.99 (SDR Million) 78.61 percent.
- Data adequacy: "Data provision is adequate for surveillance." National Institute of Statistics (INE), Central Bank of Chile, and Ministry of Finance publish comprehensive data; Chile is a subscriber to the Fund’s Special Data Dissemination Standard (SDDS) since May 17, 1996. A data ROSC was published September 17, 2007.

*Source: Staff Report for the 2010 Article IV Consultation—Informational Annex (International Monetary Fund), tables and figures as provided in the source PDF.*

### 2.  Fund  work

### 2.  Fund  work

### Program and Delivery Timeline
- 2011 Article IV Consultation: Staff visit March 2011; Staff report August 2011; Board discussion June 2011.  
- FSAP Update: Delivery dates March 2011 and June 2011.  
- Delivery date refers to the Board date in lending projects and to delivery to client in case of AAA.

### Background and Recent Shocks
- Chile faced two large negative shocks: the global financial crisis and the February 2010 earthquake.  
- The earthquake was estimated by the Banco Central de Chile (BCC) to have destroyed 3 percent of the country’s capital stock.  
- The government’s share of the estimated US$30 billion reconstruction cost is anticipated to be US$8.4 billion (4 percent of GDP), to be implemented between 2010 and 2013.  
- GDP returned to growth in the second half of 2009; recovery strengthened in 2010 with first-quarter output growth of 1.5 percent (1.4, SA) and second-quarter growth of 6.5 percent (6.5, SA).  
- Market expectations and the BCC forecast for output growth in 2010 were in the range of 5.0 to 5.5 percent.

### Executive Board Assessment — Key Findings and Recommendations
- Commended authorities’ responses to the global financial crisis and the earthquake; Chile’s robust policy framework supported a sustainable recovery.  
- Supported the authorities’ decision to accommodate relief and reconstruction spending through a combination of tax and expenditure measures and some debt issuance.  
- Supported government target of lowering the structural deficit of the central government to 1 percent of GDP by 2014; noted that returning to a zero structural balance over a longer horizon would be desirable.  
- Encouraged the government to renew its commitment to fully recapitalize the central bank.  
- Welcomed decision to review the fiscal rule and recommended making it more transparent; introducing an explicit escape clause and features to limit spending procyclicality; complementing it with an explicit medium-term policy framework that extends beyond the government’s term; and outlining a clear timetable for adopting revisions once the fiscal rule commission issues its final report.  
- Supported gradual tightening of monetary policy; agreed with central bank approach to let exchange rate flexibility be the first line of defense against potential surges in capital inflows.  
- Recommended macroprudential measures to protect domestic balance sheets and prevent excessive growth in credit.  
- Noted financial sector soundness and supported planned move towards consolidated supervision of financial conglomerates; recommended adopting a functional approach to regulation and supervision; formalizing cooperation arrangements among supervisory agencies; and strengthening cross-border coordination.  
- Supported government initiatives to reduce the cost of doing business, facilitate entry of new firms, increase credit access for small and medium enterprises, reform corporate bankruptcy procedures, and increase labor market efficiency.

### Fiscal Policy and Public Finances
- Overall fiscal balance shifted to a deficit of 4.4 percent of GDP in 2009.  
- Structural fiscal deficit expected to remain high in 2010 due to reconstruction spending.  
- Fiscal credibility remained strong; Moody’s raised Chile’s government debt rating to Aa3 in June (2010).  
- Reconstruction financing measures include temporary rise in taxes, improved expenditure efficiency, and debt issuance (two bonds placed in international markets at end of July).

### Monetary Policy and Financial Conditions
- BCC reduced policy rate by 775 basis points to 0.5 percent in July 2009; 0.5 percent was treated as the lower bound.  
- Term funding facility phased out by May 2010; policy rate unchanged at 0.5 percent until May 2010.  
- Since June 2010 the policy rate has been hiked by 50 basis points each time, reaching 2.0 percent by August 2010.  
- BCC expected to continue withdrawing monetary stimulus at a pace dependent on internal and external macroeconomic conditions.  
- Financial system: Non-performing loans at 3 percent of all loans; banks well capitalized with relatively stable domestic funding base; temporary short-term bank liquidity facility terminated in mid-June 2010.

### Macroeconomic Outlook and Risks
- Real GDP growth: expected 5 percent in 2010, accelerating to 6 percent in 2011.  
- CPI inflation: annual CPI inflation increased to 2.2 percent in July (2010); CPI expected to exceed the 3-percent target by the end of 2010 and converge to 3 percent in 2011. BCC revised its y-o-y inflation forecast to 3.9 percent for December 2010.  
- Net exports likely to weaken in 2010–2011 as strong domestic demand spills over to imports.  
- Recognition of risk that widening interest rate and growth differentials with major advanced economies could result in a surge in capital inflows.

### Social and Economic Indicators — Selected Key Statistics
- GDP (2009): 91,518 (U.S. dollars, billions) and 9,809 per capita (U.S. dollars).  
- Population (2008): Total 16.7 million; Urban population 87.9 percent; Life expectancy at birth 78.3 years.  
- Poverty rate (2009): 15.1 percent; Indigent 3.7 percent; Poor, not indigent 11.4 percent.  
- Income distribution (2009): Richest 10% of households 40.2 percent; Poorest 20% of households 3.6 percent; Gini coefficient 0.55.  

Macro aggregates (annual percentage change unless otherwise specified)
- Real GDP: 2005 5.5; 2006 4.6; 2007 4.6; 2008 3.7; 2009 -1.5; 2010 5.0 (Est.); 2011 6.0 (Staff Projections).  
- Total domestic demand: 2005 10.3; 2006 6.8; 2007 7.5; 2008 7.6; 2009 -5.9; 2010 13.4; 2011 6.9.  
- Consumption: 2005 7.1; 2006 7.0; 2007 7.0; 2008 4.0; 2009 1.7; 2010 6.4; 2011 4.7.  
- Investment: 2005 21.4; 2006 6.3; 2007 9.2; 2008 18.7; 2009 -25.9; 2010 38.9; 2011 13.0.  
- Exports: 2005 4.3; 2006 5.1; 2007 7.5; 2008 3.2; 2009 -5.6; 2010 6.3; 2011 6.4.  
- Imports: 2005 16.9; 2006 10.6; 2007 14.5; 2008 12.3; 2009 -14.3; 2010 26.3; 2011 8.2.  
- CPI end of period: 2005 3.7; 2006 2.6; 2007 7.8; 2008 7.1; 2009 -1.4; 2010 3.7; 2011 3.0.  
- CPI average: 2005 3.1; 2006 3.4; 2007 4.4; 2008 8.7; 2009 1.7; 2010 1.7; 2011 3.0.  
- Unemployment rate (annual average): 2005 9.3; 2006 8.0; 2007 7.0; 2008 7.7; 2009 9.6.  
- Current account (percent of GDP): 2005 1.2; 2006 4.9; 2007 4.5; 2008 -1.5; 2009 2.6; 2010 -0.7; 2011 -2.0.  
- Trade balance (in billions of U.S. dollars): 2005 10.8; 2006 22.8; 2007 23.9; 2008 8.8; 2009 14.0; 2010 14.5; 2011 18.6.  
- Exports of goods (in billions of U.S. dollars): 2005 41.3; 2006 58.7; 2007 68.0; 2008 66.5; 2009 53.7; 2010 68.6; 2011 78.5.  
- Imports of goods (in billions of U.S. dollars): 2005 30.5; 2006 35.9; 2007 44.0; 2008 57.6; 2009 39.8; 2010 54.0; 2011 59.8.  
- Gross external debt (percent of GDP): 2005 38.0; 2006 32.4; 2007 33.9; 2008 37.6; 2009 45.8; 2010 38.6; 2011 35.1.  
- Gross international reserves (in billions of U.S. dollars): 2005 17.0; 2006 19.4; 2007 16.9; 2008 23.2; 2009 25.4; 2010 25.4; 2011 25.4.  
- Terms of Trade (annual percentage change): 2005 10.8; 2006 31.1; 2007 4.3; 2008 -15.9; 2009 2.9; 2010 12.6; 2011 4.6.  
- Gross domestic investment (percent of GDP): 2005 22.1; 2006 20.0; 2007 20.4; 2008 25.0; 2009 19.1; 2010 23.2; 2011 24.3.  
- National saving (percent of GDP): 2005 23.4; 2006 24.9; 2007 25.0; 2008 23.5; 2009 21.7; 2010 22.5; 2011 22.3.  

Public sector finance (percent of GDP)
- Net Debt: 2005 11.8; 2006 -1.5; 2007 -10.4; 2008 -17.5; 2009 -11.3; 2010 -9.9; 2011 -9.7.  
- Public sector gross debt: 2005 34.9; 2006 25.7; 2007 28.8; 2008 27.3; 2009 27.7; 2010 26.2; 2011 24.5.  
- Central government gross debt: 2005 7.3; 2006 5.3; 2007 4.1; 2008 5.2; 2009 6.2; 2010 7.6; 2011 6.9.  
- Central government balance: 2005 4.6; 2006 7.7; 2007 8.2; 2008 4.3; 2009 -4.4; 2010 -1.7; 2011 -0.6.

*International Monetary Fund — Public Information Notice No. 10/136, September 29, 2010.*

### 9.       While the nominal exchange rate has fluctuated due to market developments, the real

### 9.       While the nominal exchange rate has fluctuated due to market developments, the real

### Exchange rate framework
- The real exchange rate broadly remains aligned with its long-term fundamentals.
- Authorities are committed to maintaining the flexible exchange rate regime in place since late 1999.
- The framework does not preclude intervention during extraordinary circumstances.

### Fiscal policy and productivity-oriented reforms
- Fiscal deterioration occurred as the country faced the global crisis and the earthquake; the new administration is committed to improving fiscal accounts and increasing government efficiency to enhance potential growth over the next four years.
- Sovereign Wealth Funds and countercyclical response:
  - Pension Reserve Fund and Economic and Social Stabilization Fund (ESSF) accumulated US$ 20.2 billion as of December 2008.
  - The ESSF financed countercyclical responses including: a Fiscal Stimulus Plan, a Pro-Credit Plan, and the Pro-employment Employment Accord.
  - Fiscal Stimulus Plan announced in early January 2009 with a size equivalent to 2.4 percent of GDP (US$4 billion).
  - Withdrawals from the ESSF totaled US$9.3 billion in 2009.
  - By the end of 2009, public expenditure had grown 18.2 percent in real terms, surpassing initial estimates.
- 2010 financing and debt issuance:
  - Real growth rate of government expenditure in 2010 expected to decrease to 9 percent.
  - Authorities submitted a funding package including temporary tax increases, redirecting Codelco revenues, and a proposed increase in the mining royalty regime; all measures except the royalty were approved by Congress.
  - Late July issuances: a US$1 billion bond and a US$500 million peso-linked bond issued in international markets.
    - The US$1 billion bond paid a 90 basis points premium.
    - The peso-linked bond of US$500 million was issued at a 5.5 percent interest rate.
- Structural budget rule adjustments and targets:
  - The fiscal rule applied between 2001 and 2008 was a fundamental pillar but did not allow for the magnitude of counter-cyclical policies used in 2009.
  - Authorities originally contemplated reducing the structural surplus target from 0.5 to 0 percent of GDP on a temporary basis; this finally became a 1.2 structural deficit as conditions warranted a larger fiscal stimulus.
  - A Committee of Advisors on the Structural Balance Rule was assembled to recommend improvements and legal framework changes.
  - The Committee’s preliminary report recommended:
    - Using the rule as it currently stands for next year's budget while suggesting: (1) reversing the correction for transitory tax measures; (2) reversing the cyclical adjustment of the "other income" account; (3) reversing the cyclical adjustment of the interest earned on the treasury's financial assets; and (4) re-estimating the elasticity of health insurance contributions.
  - Applying the revised methodology to historical data yields larger structural deficits as percentage of GDP for 2008 (-0.6 vs. 0.0) and 2009 (-3.1 vs. -1.2).
  - Authorities adopted the Committee's preliminary methodology for the 2011 budget and revised the outlook to:
    - a 3.2 percent deficit for 2010, and
    - a 1 percent structural deficit target (instead of structural balance) for 2014.
  - Authorities emphasize these modifications clarify expenditures and income under a neutral stance of GDP to improve transparency on structural balance.
- Efficiency, labor, and growth measures:
  - Government programs are being audited to identify social returns and reallocate resources to higher-benefit programs.
  - Labor legislation reforms aim to make the labor market more flexible, favoring indefinite versus fixed-term contracts and increasing labor force participation.
  - Plans include substituting large firing costs with a more comprehensive unemployment insurance scheme to favor training and human capital accumulation under indefinite contracts.
  - Pro-investment policies to favor small- and medium-size enterprises combined with reforms are expected to yield an additional 1 percentage point to potential GDP growth rate.
  - Administration's goal: attain a 6 percent potential growth rate for Chile.

### Financial sector
- Sound regulatory framework helped secure financial system stability and insulated the domestic market from global turmoil.
- Financial sector performance and conditions:
  - Banks’ capitalization remained well above minimum regulatory requirements during the crisis.
  - The sector proved resilient to the earthquake and recent financial turmoil triggered by events in Europe.
  - The most recent bank lending conditions survey shows banks are easing credit conditions, consistent with a recovery in credit growth.
- Regulatory and market reforms:
  - MKIII financial market reform broadens authorized financial instruments, facilitates securitization, improves conditions for foreign institutional investors, and expands long-term financing alternatives for banks.
  - The Bicentennial Capital Markets reform (MKB) is being pursued to further improve market liquidity, update corporate governance of supervisors, improve information sharing, and move towards comprehensive supervision reform.
  - Progress strengthening supervision of financial conglomerates:
    - A Memorandum of Understanding (MoU) signed in June 2009 by members of the Committee of Superintendents to formalize cooperation and coordination channels.
    - The Committee is conducting a pilot oversight project for conglomerates under a lead supervisor model.
  - Strengthening the consumer protection agency’s role in financial products is under discussion in Congress.
  - Concrete steps taken to strengthen securities clearing and settlement infrastructure.

### Conclusion and outlook
- The comprehensive stimulus package financed with resources saved during the commodity price boom minimized adverse effects from the global crisis.
- Recovery began but was interrupted by the February 27 earthquake; the administration framed reconstruction and reforms as opportunities to:
  - reconstruct lost infrastructure,
  - restore fiscal balance, and
  - attain higher potential output growth.
- Reconstruction funding sources include temporary tax increases and borrowing.
- Authorities seek to enhance the fiscal balance rule to cope with extreme situations like 2009 and to improve transparency of fiscal balance goals.
- Chile is on a solid recovery path with output growing at healthy rates and decreasing unemployment.
- Strong institutions and policy frameworks contributed to Chile’s accession as an official OECD member in May of 2010.

*Excerpt from the provided IMF country report content.*

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_Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2010/_cr10298.pdf_