## The Role of Domestic and External Factors in the Fall of Private Investment

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### Context and key drivers of the slowdown
- GDP growth was 1.9 percent in 2014, well below the last decade average of 4¾ percent.
- Main driver: sharp fall in private investment.
- Staff estimates the 20 percent decline in copper prices from their average level in 2006–14 may subtract about 3 percentage points (pps) from Chile’s GDP growth, cumulatively over the next 5 to 10 years.
- Structural reform agenda launched in 2014 (education, infrastructure, tax reform approved in September 2014 that gradually increases capital income taxation) could boost productivity and long-term growth if well implemented, but is likely to raise the short-term cost of capital and increase uncertainty for the private sector.

### Empirical findings on the investment fall
- Investment performance:
  - Investment fell by about 6 percent in 2014; staff estimates private fixed investment fell by about 7 percent in 2014.
- External drivers:
  - Copper prices: as of June 2015, down 35 percent from their 2011 peak.
  - Mining investment reached about 7 percent of GDP in 2012 (from about 2 percent in early 2000s).
  - In 2013, the value of capital goods imported was more than 60 percent of fixed investment in equipment and machinery.
  - Quantitative allocation: depreciation of the peso and lower copper prices together account for about two-thirds of the decline in overall private fixed investment in 2014.
- Domestic drivers:
  - Business confidence index fell by 17 percent in 2014, lowest since the great financial crisis.
  - Staff VAR analysis: 2014 fall in business confidence was much larger than could be explained by copper prices and activity alone; may reflect uncertainty associated with the reform agenda.
  - Among domestic drivers, higher labor costs important for mining investment; non-mining investment affected by drop in business confidence and fall in Tobin’s Q (proxied by price-to-book for listed companies), possibly reflecting higher cost of capital from the tax reform.

### Recent macroeconomic developments
- Fiscal and monetary stance:
  - Fiscal policy turned highly expansionary in 2014 and 2015 with a strong acceleration of infrastructure spending in late 2014.
  - Central Bank kept the policy rate at 3 percent after reducing it by 200 basis points between September 2013 and November 2014; staff estimates the neutral rate at 4½–5 percent.
- Labor market and activity:
  - Economic activity picked up somewhat towards end-2014 and early 2015 but lost momentum thereafter.
  - Unemployment about 6 percent in the six months prior to May 2015 and rose to 6.6 percent in May 2015 as labor force participation inched up.
  - Imports of capital goods continued to decline year-on-year.
- Inflation and exchange rate:
  - Headline inflation exceeded the central bank’s target band (2–4 percent) for 15 consecutive months.
  - Inflation peaked at 5.7 percent in October 2014 and hovered around 4 percent in recent months; inflation expectations at the 24-month horizon remained anchored at 3 percent.
  - Real effective exchange rate depreciated about 15 percent in 2014 relative to early 2013; REER averaged about 2½ percent above the 2014 average in January–May 2015.
- External position:
  - Current account deficit fell from 3.7 percent of GDP in 2013 to 1.2 percent of GDP in 2014, driven mainly by contraction in investment-related imports.
  - EBA-based estimates suggested the currency was modestly undervalued in 2014 in real effective terms.

### Financial sector soundness and indebtedness
- Financial sector indicators:
  - Banks’ profitability remained strong in 2014 but declined in 2015 due to smaller inflation impact; non-performing loans decreased slightly and capital ratios remained above regulatory thresholds.
  - Mutual funds grew by almost 40 percent in 2015 compared to end-2013, with fastest growth in funds investing in medium- and long-term fixed-income instruments.
  - Life insurance companies and pension funds shifted toward riskier or less liquid assets (real estate, lower rating domestic and foreign corporate bonds, foreign mutual funds and equity).
- Debt dynamics:
  - Non-financial corporate debt-to-GDP about 100 percent at end-2014.
  - Household debt-to-disposable income rose to about 60 percent in 2014, driven by higher mortgage debt.
  - Household debt service-to-income ratios remained at low levels due to low interest rates.

### Corporate sector vulnerabilities
- Currency and composition of corporate debt:
  - Foreign currency funding associated with FDI and external bond issuances accounted for about 90 percent of the increase in the corporate debt-to-GDP ratio in 2014 relative to 2013.
  - At end-2014, 52 percent of corporate debt was in foreign currency, compared to 40 percent as of 2010.
  - Staff estimates roughly half of the increase in external corporate debt-to-GDP in 2014 attributable to valuation effects from the peso depreciation.
- Leverage and sectoral distribution:
  - Average leverage of non-financial firms remained stable, but leverage (debt-to-equity) for firms in the top 25 percent rose.
  - 2014 leverage increase concentrated in retail, forestry, and energy sectors; some large firms financed expansion plans abroad.
- Mitigating factors and risks:
  - Average time to maturity of domestic corporate bonds increased from 10 to 14 years since 2011, moderating rollover risks.
  - 20 largest Chilean corporations had small net foreign currency exposure on average; about 40 percent of foreign currency debt is FDI-related.
  - Market measures of credit risk (Moody’s CreditEdge+ one-year ahead expected default frequencies) remained stable.
  - But high leverage reduces resilience to further economic slowdown and external shocks; retail and construction profitability well below historical averages—raising potential spillovers to banks given non-listed firms’ reliance on bank funding.

### Outlook and key assumptions
- Growth and inflation projections:
  - Staff expects GDP growth to average 2½ percent in 2015 and to accelerate to 3.1 percent in 2016.
  - Inflation projected to decline slowly towards 3 percent by mid-2016.
- Main assumptions for 2016 recovery:
  - Moderate pick-up in non-mining investment as monetary policy remains highly accommodative and business sentiment gradually improves, offsetting continued weakness in mining investment (copper prices expected to remain stable in 2016 after falling by another 10 percent in 2015).
  - Trading partners’ growth rises from 3.2 percent in 2015 to 3.4 percent in 2016 (World Economic Outlook July 2015 update).
  - Modest firming of private consumption reflecting gradual return of consumer confidence, easy access to credit, and some pick-up in real income as lower inflation partly offsets slower nominal wage growth.

### Risks and policy implications
- Balance of risks:
  - The balance of risks is mainly on the downside.
- Policy considerations:
  - Continue accommodative monetary policy to support domestic demand while inflation normalizes.
  - Expansionary fiscal impulse in 2014–15 supports activity, notably via infrastructure spending, but fiscal expansion and structural reforms imply trade-offs with private investment through higher cost of capital and uncertainty.
  - Monitor and address corporate vulnerabilities—high leverage, increased foreign currency debt, and sectoral heterogeneity in profitability—to limit financial stability spillovers.
  - Structural reform agenda could boost long-term productivity if implemented effectively; clear communication and phased implementation could help reduce short-term uncertainty.

### Annex II — Main risks, external spillovers, and medium-term outlook
- Main external risks and channels:
  - More persistent weakness of private sector confidence and investment amid uncertainty over reforms and the external outlook is the main risk to staff’s baseline scenario.
  - Further decline in copper prices (e.g., deeper-than-expected downturn in China) would depress mining activity.
  - Tighter and more volatile global financial conditions could reduce availability and increase the cost of funding for non-financial corporates and banks, potentially triggering sharp asset price adjustments and decompression of credit spreads.
- Vulnerabilities and exposures:
  - Copper exports to China represent 40 percent of mining exports and 25 percent of total exports.
  - Revenue from mining companies constitutes more than 10 percent of total revenues.
  - Banks have large exposure to non-financial corporate debt: 55 percent of total bank credit.
  - Direct bank exposure to natural resource sectors: 11 percent.
  - Financial firms and non-financial corporate rely on external sources for 36 and 38 percent of their funding, respectively.
  - More than half of banks' funding is wholesale.
  - Non-financial corporate debt stands at about 100 percent of GDP.
  - 45 percent of financial and non-financial corporate sector debt is in foreign currency.
- Medium-term growth outlook and scenarios (Staff estimates, 2020 — labeled "Growth Assumptions: Medium-Term Scenarios"):
  - Output: Average (1994-2013) 4.7 / No reforms 3.2 / With reforms 3.7
  - TFP: 0.9 / 0.2 / 0.4
  - Capital: 5.3 / 4.8 / 5.1
  - Hours: 1.5 / 0.6 / 0.6
  - Human capital: 0.8 / 0.8 / 0.9
  - Staff expects potential GDP growth at 3.7 percent in 2020.
- Infrastructure and energy improvements:
  - Increase electricity generation capacity by about 30 percent by 2020.

### Risk Assessment Matrix — selected shock–impact–policy responses
- Sharp slowdown in China:
  - Amplified real effects via copper linkages and value-added chain; fiscal impact via mining revenues.
  - Policy responses: reduce policy uncertainty through careful design and implementation of reforms; maintain accommodative monetary policy; allow fiscal balance to deteriorate for cyclical reasons in case of severe output drop.
- Surge in global financial volatility:
  - Mitigating factors: significant share of external debt is FDI-related (70 percent for financial corporate and 40 percent for non-financial corporate); increasing maturities; limited evidence of large currency mismatches.
  - Policy toolkit: floating exchange rate as first line of defense; FX intervention to counter temporary disorderly conditions; temporary capital flow management in crisis circumstances; contain liquidity pressure via repo operations, broaden collateral, dollar swap auctions.

### Policy mix recommended by staff
- Combine tighter fiscal policy with continued monetary policy accommodation.
- Fiscal guidance:
  - Strong fiscal impulse in 2015 appropriate given severity of slowdown and low debt; infrastructure and education account for about half of the 9 percent projected increase in public expenditure this year.
  - Steady fiscal consolidation warranted beginning from 2016 as economy recovers.
  - Structural deficit in 2015 about 2¾ percent of GDP (against 1.1 percent in the last Budget) under staff’s assumptions.
  - Achieving balanced structural fiscal position in 2018 would require an average growth of public spending of just below 3 percent in real terms over 2016–2018.
  - Given Chile’s fiscal framework credibility, authorities have room for a slower consolidation pace if tightening would excessively weigh on pro-growth expenditures.
  - If business confidence recovery is slower than expected, fiscal policy stance should not be relaxed; committing to eliminate structural fiscal deficit over time likely supports private sector demand more than fine-tuning public spending.
- Monetary guidance:
  - Monetary policy has room to remain accommodative until strong signs that recovery consolidates.
  - Central bank baseline (June 2015 Monetary Policy Report) projects no interest rate increase until early 2016; staff sees this stance as appropriate.
  - Fiscal consolidation would give the Bank more room to maintain accommodative policy and to cut rates if economy weakened further.
- Authorities’ position:
  - Broad concurrence with staff: pace of rate normalization conditional on strength of recovery; large fiscal impulse in 2015 not sustainable and needs consolidation; restating commitment to a structural budget over the medium run supports confidence.
  - Authorities noted staff’s long-term GDP growth and copper price assumptions appear relatively pessimistic.
  - Intentions: simplify implementation of the tax reform, provide more guidance to firms, and prepare a new fiscal responsibility law to strengthen the role and governance of the Fiscal Council.

### Structural reforms: labor, education, governance
- Labor reform objectives and measures:
  - Expand coverage and scope of collective bargaining by empowering trade unions; reduce fragmentation of bargaining; promote social cohesion; reduce income inequality.
  - Maintain collective bargaining at firm level; introduce flexibility within collective bargaining; protect right to strike while defining "minimum services".
  - Selected proposed changes: priority for unions in bargaining where they exist; intercompany unions allowed limited negotiation rights; adaptability pacts; restrictions and rules for temporary and apprenticeship workers.
- Education reform:
  - Legislation ends for-profit education, co-payment, and discrimination at primary and secondary levels.
  - Proposed national teaching policy could raise teacher entry wages and link teacher evaluation with professional development.
  - Authorities intend to extend free tertiary education to all students beyond current coverage; timing depends on growth outlook and public resources.
  - Staff cautions on implications of universal free university education on income distribution and fiscal costs.
- Governance and institutional measures:
  - "Transparency Agenda" to improve corporate governance, investor protection, and market transparency; tighten audits; enhance powers of the new Securities and Insurance Commission.
  - Strengthen PPP institutional framework via centralized unit within Minister of Public Works to assess, approve, and develop new concessions; improve transparency and renegotiation terms; introduce minimum service standards.

### Corporate and household debt: prudential responses and regulation
- Corporate debt and prudential policy:
  - Staff recommended considering prudential measures if corporate debt continues to grow: higher risk weights or higher provisioning for commercial credit.
  - Authorities view leverage (debt-to-equity) as best debt indicator; leverage relatively stable and comparable to other economies.
  - Authorities cautioned broad prudential measures may be inappropriate given weak economy and lack of systemic risks from corporate leverage.
- Household sector measures:
  - New provisioning regulation for mortgage loans starting 2016 increases provisions for high LTV ratios and delinquent mortgages.
  - Staff argued tighter LTVs and debt service-to-income ratios could be considered if mortgage credit growth accelerates.
  - Authorities expect mortgage credit growth to decelerate in 2016 after VAT on first homes is introduced.
- Banking regulation and liquidity:
  - Forthcoming General Banking Law to be sent to Congress in second half of 2015; will adapt Basel III capital standards on a transitional basis and introduce capital surcharge for domestic systemically important banks.
  - New liquidity regulation effective from August 2015; authorities plan to specify minimum requirements for LCR and NSFR.
  - Authorities plan legal framework for bank resolution broadly in line with 2011 FSAP recommendations and to strengthen SBIF operational independence.
- Insurance and pension funds:
  - New regulation (2015) requires insurance companies to define risk appetite and introduces own risk and solvency assessment.
  - Legislative proposal for risk-based supervision for insurance companies pending in Congress.
  - Pension funds’ exposure abroad increased; authorities note strict regulation on foreign investment and that expansion abroad partly reflects lack of domestic investment opportunities.
- Supervision of financial conglomerates:
  - Financial Stability Council (FSC) law removed barriers to information-sharing and expanded supervisory powers; gaps remain in group-wide supervision powers and crisis-management framework.

### Structural issues beyond macro: female labor participation, diversification, SME finance
- Female labor participation:
  - Women comprise 40 percent of labor force; female participation at 55 percent; male participation at 80 percent.
  - Women earn 30–40 percent less than men for the same level of education (Sánchez, 2014; INE, 2015).
  - Staff welcomed authorities’ measures: expand early childhood education, "Más Capaz" training program target 450,000 youth and women in 2015–18, planned transport and childcare measures, and labor reform adaptability provisions.
- Economic diversification and innovation:
  - R&D spending at 0.4 percent of GDP, lowest in the OECD (OECD average 2 percent of GDP).
  - Authorities’ initiatives: "Start-up Chile", Small Business Centers, new agency to attract foreign investment, improve infrastructure to boost non-mining exports.
- SME finance and credit access:
  - Productivity gap between SMEs and large firms relatively large.
  - Authorities plan a Public Credit Bureau, a registry of firms’ mobile assets, and a regulated crowd-funding framework.

### Staff appraisal: summary of outlook and recommendations
- Growth outlook:
  - Staff baseline: GDP growth picks up to 3.1 percent in 2016 from 2½ percent in 2015.
- Key recommendations:
  - Combine tighter fiscal policy with continued monetary accommodation.
  - Begin fiscal consolidation in 2016 as economy recovers; reaffirm medium-term commitment to a structural budget position to anchor expectations and boost private sector confidence.
  - Minimize short-term negative effects on growth and uncertainty when implementing structural reforms; clarify constitutional reform procedures; ensure labor market reform improves efficiency; pursue education reform to raise human capital quality.
  - Strengthen financial sector governance, supervision of conglomerates, and prudential measures if corporate leverage continues to rise.
  - Approve bill implementing risk-based supervision and new solvency requirements for insurance companies.

### Key statistics and selected tables (selected figures preserved exactly)
- Real GDP (annual % change): 5.7 (2010), 5.8 (2011), 5.5 (2012), 4.3 (2013), 1.9 (2014), 2.5 (2015), 3.1 (2016)
- Unemployment rate (annual average): 8.2 (2010), 6.4 (2014), 6.5 (2015), 6.6 (2016)
- Consumer prices, end of period: 3.0 (2010), 4.6 (2014), 3.3 (2015), 3.0 (2016)
- Central government fiscal balance (In percent of GDP): -0.5 (2010), -1.6 (2014), -3.2 (2015), -2.0 (2016)
- Structural fiscal balance 2/: -2.5 (2010), -1.5 (2014), -2.8 (2015), -1.7 (2016)
- Public sector gross debt: 25.9 (2010), 36.1 (2014), 38.8 (2015), 39.6 (2016)
- Current account (in percent of GDP): 1.7 (2010), -3.7 (2013), -1.2 (2014), -0.4 (2015), -1.2 (2016)
- Gross international reserves (in billions of U.S. dollars): 27.9 (2010), 40.4 (2014), 40.4 (2015), 40.4 (2016)
- Copper price, USD per pound (WEO): 3.42 (2010), 4.03 (2011), 3.61 (2012), 3.33 (2013), 3.11 (2014), 2.74 (2015), 2.77 (2016 projection)
- Non-financial corporate debt-to-GDP: about 100 percent at end-2014.
- Household debt-to-disposable income: about 60 percent in 2014.
- Banks’ exposure to non-financial corporate debt: 55 percent of total bank credit.
- Share of corporate debt in foreign currency: 52 percent at end-2014 (40 percent as of 2010).
- Mutual funds growth: almost 40 percent in 2015 vs end-2013.
- Female labor force participation: 55 percent; women comprise 40 percent of the labor force.
- R&D spending: 0.4 percent of GDP.

*Source: IMF staff report chapter titled "The Role of Domestic and External Factors in the Fall of Private Investment" and accompanying annexes (extracted content).*

### 1. The Role of Domestic and External Factors in the Fall of Private Investment _____________________ 5

### 1. The Role of Domestic and External Factors in the Fall of Private Investment

### Context and key drivers of the slowdown
- GDP growth was 1.9 percent in 2014, well below the last decade average of 4¾ percent.
- The main force behind the slowdown has been the sharp fall in private investment.
- Staff estimates that the 20 percent decline in copper prices from their average level in 2006–14 may subtract about 3 percentage points (pps) from Chile’s GDP growth, cumulatively over the next 5 to 10 years.
- The structural reform agenda launched in 2014 (including education, infrastructure, and a tax reform approved in September 2014 that gradually increases capital income taxation) could boost productivity and long-term growth if well implemented, but is likely to raise the short-term cost of capital and increase uncertainty for the private sector.

### Empirical findings on the investment fall (Box 1)
- Investment fell by about 6 percent in 2014; staff estimates private fixed investment fell by about 7 percent in 2014.
- External factors were the predominant drivers:
  - The strong fall of copper prices (as of June 2015, down 35 percent from their 2011 peak) ended the investment boom and led mining investment to reach about 7 percent of GDP in 2012 (from about 2 percent in early 2000s).
  - The strong real effective depreciation of the peso made imported capital goods more expensive (in 2013, the value of capital goods imported was more than 60 percent of fixed investment in equipment and machinery).
- Domestic factors also mattered:
  - The business confidence index fell by 17 percent in 2014, hitting its lowest level since the great financial crisis.
  - Staff VAR analysis suggests the 2014 fall in business confidence was much larger than could be explained by copper prices and activity alone and may reflect uncertainty associated with the reform agenda.
- Quantitative allocation of the 2014 investment decline:
  - Depreciation of the peso and lower copper prices together account for about two-thirds of the decline in overall private fixed investment in 2014.
  - Among domestic drivers, higher labor costs were important for mining investment; non-mining investment was affected by the drop in business confidence and the fall in Tobin’s Q (proxied by price-to-book for listed companies), possibly reflecting higher cost of capital from the tax reform.

### Recent macroeconomic developments
- Fiscal and monetary stance:
  - Fiscal policy turned highly expansionary in 2014 and 2015 with a strong acceleration of infrastructure spending in late 2014.
  - The Central Bank kept the policy rate at 3 percent after reducing it by 200 basis points between September 2013 and November 2014; staff estimates the neutral rate at 4½–5 percent.
- Labor market and activity:
  - Economic activity picked up somewhat towards end-2014 and early 2015 but lost momentum thereafter.
  - Unemployment was about 6 percent in the six months prior to May 2015 and rose to 6.6 percent in May 2015 as labor force participation inched up.
  - Imports of capital goods continued to decline year-on-year; non-mining export growth slowed (partly due to one-offs).
- Inflation and exchange rate:
  - Headline inflation exceeded the central bank’s target band (2–4 percent) for 15 consecutive months.
  - Inflation peaked at 5.7 percent in October 2014 and hovered around 4 percent in recent months; inflation expectations at the 24-month horizon remained anchored at 3 percent.
  - The real effective exchange rate depreciated about 15 percent in 2014 relative to early 2013; REER averaged about 2½ percent above the 2014 average in January–May 2015.
- External position:
  - The current account deficit fell from 3.7 percent of GDP in 2013 to 1.2 percent of GDP in 2014, driven mainly by contraction in investment-related imports.
  - EBA-based estimates suggested the currency was modestly undervalued in 2014 in real effective terms.

### Financial sector and indebtedness
- Financial sector soundness:
  - Banks’ profitability remained strong in 2014 but declined in 2015 due to smaller inflation impact; non-performing loans decreased slightly and capital ratios remained above regulatory thresholds.
  - Life insurance companies and pension funds have shifted toward riskier or less liquid assets (real estate, lower rating domestic and foreign corporate bonds, foreign mutual funds and equity).
  - Mutual funds grew by almost 40 percent in 2015 compared to end-2013, with fastest growth in funds investing in medium- and long-term fixed-income instruments.
- Debt dynamics:
  - Non-financial corporate debt-to-GDP was about 100 percent at end-2014.
  - Household debt-to-disposable income rose to about 60 percent in 2014, driven by higher mortgage debt; mortgage credit outpaced consumer and commercial credit growth.
  - Household debt service-to-income ratios remained at low levels due to low interest rates.

### Corporate sector vulnerabilities (Box 2)
- Currency and composition of corporate debt:
  - Foreign currency funding associated with FDI and external bond issuances accounted for about 90 percent of the increase in the corporate debt-to-GDP ratio in 2014 relative to 2013.
  - At end-2014, 52 percent of corporate debt was in foreign currency, compared to 40 percent as of 2010.
  - Staff estimates attribute roughly half of the increase in external corporate debt-to-GDP in 2014 to valuation effects from the peso depreciation.
- Leverage and sectoral distribution:
  - While average leverage of Chilean non-financial firms remained stable over the past two years, the share of firms with relatively high leverage increased; leverage (debt-to-equity) for firms in the top 25 percent rose.
  - The 2014 leverage increase concentrated in retail, forestry, and energy sectors; some large firms financed expansion plans abroad.
- Mitigating factors and risks:
  - Rollover risks on domestic corporate bonds appear moderate as average time to maturity increased from 10 to 14 years since 2011.
  - Increased foreign currency funding does not seem to imply greater currency mismatches on average: the 20 largest Chilean corporations had small net foreign currency exposure on average and about 40 percent of foreign currency debt is FDI-related.
  - Market measures of credit risk (Moody’s CreditEdge+ one-year ahead expected default frequencies) remained stable.
  - Nonetheless, high leverage reduces resilience to further economic slowdown and external shocks; profitability and liquidity indicators show heterogeneity, with retail and construction profitability well below historical averages—raising potential spillovers to banks given non-listed firms’ reliance on bank funding.

### Outlook and key assumptions
- Growth projections:
  - Staff expects GDP growth to average 2½ percent in 2015 and to accelerate to 3.1 percent in 2016.
- Inflation outlook:
  - Inflation is projected to decline slowly towards 3 percent by mid-2016, supported by a negative output gap and waning pass-through from the 2014 peso depreciation.
- Main assumptions underlying the 2016 recovery:
  - A moderate pick-up in non-mining investment as monetary policy remains highly accommodative and business sentiment gradually improves, offsetting continued weakness in mining investment (copper prices expected to remain stable in 2016 after falling by another 10 percent in 2015).
  - Stronger non-mining exports aided by a more competitive REER while trading partners’ growth rises from 3.2 percent in 2015 to 3.4 percent in 2016 (World Economic Outlook July 2015 update).
  - A modest firming of private consumption reflecting gradual return of consumer confidence, easy access to credit, and some pick-up in real income as lower inflation partly offsets slower nominal wage growth.

### Risks and policy implications
- Balance of risks:
  - The balance of risks is mainly on the downside.
- Policy considerations inferred from analysis:
  - Continued accommodative monetary policy is supporting domestic demand while inflation gradually normalizes toward target.
  - The expansionary fiscal impulse in 2014–15 supports activity, notably via infrastructure spending, but the interaction of fiscal expansion and structural reforms implies trade-offs with private investment through higher cost of capital and uncertainty.
  - Monitoring and addressing corporate sector vulnerabilities—particularly high leverage, increased foreign currency debt, and sectoral heterogeneity in profitability—are important to limit financial stability spillovers.
  - The authorities’ structural reform agenda could boost long-term productivity if implemented effectively, but clear communication and phased implementation could help reduce short-term uncertainty for the private sector.

*Source: IMF staff report chapter titled "The Role of Domestic and External Factors in the Fall of Private Investment" (extracted content).*

### Annex II on spillovers). The main risk to staff’s baseline scenario is a more persistent weakness of

### Annex II on spillovers

### Main risks and external spillovers
- Main risk to staff’s baseline scenario: a more persistent weakness of private sector confidence and investment amid continued uncertainty over the structural reform agenda and the external outlook.
- External shocks highlighted:
  - A further decline in copper prices (for example associated with a deeper-than-expected downturn in China) would imply more depressed activity in the mining sector.
  - Tighter and more volatile global financial conditions could reduce availability and increase the cost of funding for the non-financial corporate sector and banks, potentially triggering sharp asset price adjustments and decompression of credit spreads.
- Vulnerabilities and channels:
  - Copper exports to China represent 40 percent of mining exports and 25 percent of total exports.
  - Revenue from mining companies constitutes more than 10 percent of total revenues.
  - Financial exposure and leverage:
    - Banks have large exposure to non-financial corporate debt: 55 percent of total bank credit.
    - Direct bank exposure to natural resource sectors: 11 percent.
    - Financial firms and non-financial corporate rely on external sources for 36 and 38 percent of their funding, respectively.
    - More than half of banks' funding is wholesale.
    - Non-financial corporate debt stands at about 100 percent of GDP.
    - 45 percent of financial and non-financial corporate sector debt is in foreign currency.
  - Tail-risk downside scenario concerns: sharp increases in foreign interest rates, strong peso depreciation, and accentuated economic slowdown.

### Medium-term growth outlook and underlying factors
- Staff revised down its estimate of medium-term GDP growth; a successful completion of the reform agenda could boost long-run growth.
- Key drivers and projections:
  - Capital accumulation expected to slow from its historical average due to lower copper prices and higher taxes on capital income.
  - Population aging should reduce labor input growth from 2⅓ in the 2000s to about 1 percent in 2020, lowering total hours worked.
  - Total factor productivity (TFP) growth slowdown: from an average 2½ percent in the 1990s to around ¼ percent since the early 2000s, with an important trend component reflecting declining productivity in mining and infrastructure bottlenecks.
  - Infrastructure and energy improvements expected to boost TFP and capital accumulation:
    - Increase electricity generation capacity by about 30 percent by 2020.
    - Reduce electricity costs with spot marginal costs lowered by a more competitive tender process among distributing firms.
  - Staff expects potential GDP growth at 3.7 percent in 2020.
- Growth assumptions (Staff estimates, 2020 — labeled "Growth Assumptions: Medium-Term Scenarios"):
  - Average (1994-2013) / No reforms / With reforms (Staff estimates, 2020)
  - Output: 4.7 / 3.2 / 3.7
  - TFP: 0.9 / 0.2 / 0.4
  - Capital: 5.3 / 4.8 / 5.1
  - Hours: 1.5 / 0.6 / 0.6
  - Human capital: 0.8 / 0.8 / 0.9

### Risk Assessment Matrix — shocks, impacts, and policy responses
- Noted risk events and suggested policy responses:
  - Sharp slowdown in China economic growth (e.g., severe housing downturn or shadow banking shock):
    - Real effects amplified via copper linkages and value-added chain.
    - Fiscal impact via mining revenues.
    - Policy responses: encourage private sector investment by reducing policy uncertainty through careful design and implementation of reforms; maintain accommodative monetary policy stance; in case of severe output drop, fiscal balance allowed to deteriorate for cyclical reasons.
  - A surge in global financial volatility related to asymmetric monetary policies:
    - Possible sharp increase in interest rates, sudden reversal of capital inflows, and strong peso depreciation.
    - Mitigating factors: significant share of external debt is FDI-related (70 percent for financial corporate and 40 percent for non-financial corporate sector); increasing maturities reduce rollover risk; natural hedges and scarce evidence of large currency mismatches; institutional investors likely to act as stabilizers.
    - Policy toolkit outlined:
      - Floating exchange rate as first line of defense.
      - Foreign exchange intervention could be used if needed to counter temporary disorderly conditions.
      - Capital flow management measures could be envisaged on a temporary basis but only in crisis-type circumstances.
      - Authorities should be prepared to contain liquidity pressure: expand repo operations, broaden range of accepted collateral, and set up dollar swap auctions.

### Policy mix: fiscal and monetary recommendations
- Staff recommendation: combine tighter fiscal policy with continued monetary policy accommodation.
- Fiscal policy guidance:
  - The strong fiscal impulse in 2015 was appropriate given the severity of the slowdown, the need to cushion temporary effects of structural reforms, low debt, and emphasis on infrastructure and education (which account for about half of the 9 percent projected increase in public expenditure this year).
  - A steady process of fiscal consolidation warranted beginning from 2016 as the economy recovers gradually.
  - Reaffirming commitment to a structural balanced budget position in the medium term would help anchor expectations and boost private sector confidence.
  - Based on staff’s assumptions about long-term GDP growth and copper prices, the structural deficit in 2015 is about 2¾ percent of GDP (against 1.1 percent in the last Budget).
  - Achieving a balanced structural fiscal position in 2018 would require an average growth of public spending of just below 3 percent in real terms over 2016–2018.
  - Given Chile’s fiscal framework credibility and lack of debt sustainability issues, authorities have room to proceed with a slower pace of consolidation if tightening would excessively weigh on pro-growth expenditures (infrastructure and education).
  - If business confidence recovery is slower than expected, fiscal policy stance should not be relaxed; sticking to the commitment to eliminate the structural fiscal deficit over time would likely support private sector demand more than fine-tuning public spending.
- Monetary policy guidance:
  - Monetary policy has room to remain accommodative until strong signs that the recovery consolidates.
  - Central bank baseline (June 2015 Monetary Policy Report) projects no interest rate increase until early 2016; staff sees this stance as appropriate.
  - Room to adopt a wait-and-see attitude given well-anchored inflation expectations, projected decline in headline inflation, and downside risks to growth.
  - Fiscal consolidation would give the Bank more room to maintain an accommodative monetary policy and to cut rates if the economy weakened further or downside risks materialized.
- Authorities’ position:
  - Broad concurrence with staff: pace of rate normalization conditional on strength of recovery; large fiscal impulse in 2015 not sustainable and needs consolidation; restating commitment to a structural budget over the medium run supports confidence.
  - Authorities noted staff’s long-term GDP growth and copper price assumptions appear relatively pessimistic; the reduction in real public expenditure growth to reach balanced budget in 2018 may not be as pronounced as envisaged by staff.
  - Intentions: simplify implementation of the tax reform, provide more guidance to firms, and prepare a new fiscal responsibility law to strengthen the role and governance of the Fiscal Council.

### Structural reforms: labor, education, governance
- Labor market reform (under discussion):
  - Objectives: expand coverage and scope of collective bargaining by empowering trade unions; reduce fragmentation of bargaining; promote social cohesion; reduce income inequality.
  - Context: about one-third of employees have temporary jobs (against the 12 percent OECD average); nearly 15 percent do not have written contracts; relatively low coverage of collective bargaining agreements compared to other OECD economies.
  - Staff priorities and cautions:
    - Foster labor market efficiency and flexibility while pursuing higher unionization and more extensive collective bargaining to reduce wage inequality and promote social dialogue.
    - Maintain collective bargaining at the firm level and introduce more flexible work arrangements within collective bargaining processes.
    - Protect right to strike balanced by clearly defining "minimum services".
    - Recent changes in unemployment insurance increase amount and duration of benefits and link them to mandatory training.
    - Improve skill training programs for youth and women outside the labor force.
    - Lowering relatively high severance payments could help reduce labor market duality.
  - Selected proposed changes (summary of areas and proposed changes):
    - Right-to-bargain: unions will have priority for collective negotiation in companies where they exist; non-union groups may bargain in firms without unions.
    - Level of collective negotiation: remains at firm level; intercompany unions allowed to negotiate only at company level if sufficient membership and employer must negotiate.
    - Extension of benefits of collective agreements: both union and employer should agree to extend benefits; non-union workers must pay total union fee to benefit.
    - Coverage: workers on apprenticeship and temporary contracts allowed to negotiate with some restrictions (e.g., SMEs).
    - Adaptability pacts: allow negotiation of special work conditions if company has 30 percent affiliation in one or more unions.
    - Right-to-strike: employers cannot replace workers on strike; unions must provide necessary personnel to comply with indispensable operations ("minimum services").
- Education reform:
  - Legislation approved early this year ends for-profit education, co-payment, and discrimination practices at primary and secondary levels; could deliver higher quality and equity by reducing segregation.
  - Proposed national teaching policy could raise teacher entry wages and link teacher evaluation with professional development.
  - Authorities intend to extend free tertiary education to all students beyond current coverage but timing depends on growth outlook and public resources.
  - Staff notes reforms to higher education warranted given relatively high tuition fees and more difficult access to financing in public universities compared to many OECD economies.
  - Staff cautions careful consideration of implications of universal free university education on income distribution and fiscal costs.
- Governance and institutional measures:
  - Authorities announced a "Transparency Agenda" with legislative and regulatory measures to improve corporate governance, investor protection, and market transparency, including tightening audits and enhancing powers of the new Securities and Insurance Commission.
  - Measures to restore confidence in public institutions: regulate funding to political parties and campaigns; tighten norms over conflicts of interest, corruption, and lobbying.
  - Institutional framework for PPP arrangements to be strengthened by a law proposal establishing a centralized unit within the Minister of Public Works to assess, approve, and develop new concessions, improve transparency and renegotiation terms of old concessions, and introduce minimum service standards.
  - Staff welcomed these initiatives as potentially mobilizing private finance for infrastructure and promoting more efficient use of public funds if well implemented.

*Source: Annex II on spillovers (IMF staff content).*

### 19.      Staff discussed with the authorities the policy implications of high corporate and

### 19.      Staff discussed with the authorities the policy implications of high corporate and household debt

### Corporate and household debt: risks and prudential responses
- Staff concern: high corporate and household debt could increase Chile’s vulnerability to adverse shocks.
- Corporate sector:
  - Staff recommended considering prudential measures if corporate debt continues to grow to reduce banking-sector vulnerability.
  - Specific measures suggested: higher risk weights or higher provisioning for commercial credit to increase banking-sector resilience to shocks in the corporate sector.
  - Authorities’ view: the best indicator of debt is leverage (debt-to-equity ratio), which has been relatively stable over the past two years and comparable to other economies.
  - Authorities cautioned that broad prudential measures across the corporate sector may be inappropriate given the weak economy and lack of systemic risks from corporate leverage.
- Household sector:
  - Staff welcomed the new provisioning regulation for mortgage loans which, from 2016 onwards, will increase provisions for high loan to value (LTV) ratios and delinquent mortgages.
  - Staff argued that tighter LTVs and debt service-to-income ratios could be considered if mortgage credit growth were to accelerate.
  - Authorities’ response: the new provision regulation was sufficient to address the risks, particularly because mortgage credit growth should decelerate in 2016, after the VAT on first homes is introduced.

### Banking regulation, liquidity, and resolution
- Forthcoming General Banking Law:
  - Authorities expect to send the new Banking Law to Congress during the second half of 2015.
  - The new law will adapt Basel III capital standards to Chilean banks on a transitional basis and introduce a capital surcharge for domestic systemically important banks.
- Liquidity regulation:
  - New liquidity regulation effective from August 2015.
  - Authorities plan to specify minimum requirements for the liquidity coverage ratio (LCR) and net-stable funding ratio (NSFR).
  - Staff view: this will strengthen liquidity risk management and address risks from reliance on wholesale funding, particularly for medium and small banks.
- Bank resolution and supervisory resources:
  - Authorities plan to implement a legal framework for bank resolution, broadly in line with the 2011 FSAP recommendations.
  - Authorities willing to strengthen SBIF operational independence; staff emphasized ensuring SBIF is given sufficient financial resources to conduct effective implementation of new regulatory requirements.
- Staff assessment: banking sector generally well prepared to implement Basel III capital and liquidity requirements on a transitional basis.

### Insurance sector and pension funds: search for yield and cross-border exposure
- Staff concern: life insurance companies’ search for yield warrants close attention due to potential implications for financial stability from expansion into riskier investments.
- Authorities’ position: share the concerns; stress tests suggest the insurance sector is resilient to large shocks.
- Regulatory changes:
  - New regulation (2015) requires insurance companies to define their risk appetite and introduces the concept of own risk and solvency assessment.
  - Legislative proposal to introduce risk-based supervision for insurance companies is still in Congress.
- Pension funds:
  - Staff enquired about the rapid increase in Chilean pension funds’ exposure abroad as a potential signal of shifting appetite toward riskier assets.
  - Authorities: pension funds are subject to strict regulation regarding foreign investment; expansion abroad mainly in response to lack of domestic investment opportunities.

### Supervision of financial conglomerates
- Financial Stability Council (FSC) law achievements:
  - Removed barriers to information-sharing among supervisors.
  - Expanded supervisors’ power to request information from final owners of financial institutions within a conglomerate.
  - Established solvency requirements for controlling shareholders of banks and insurance companies.
- Remaining gaps:
  - Supervisors still lack powers and authority to conduct comprehensive group-wide supervision (including setting risk-based minimum prudential standards and monitoring compliance with limits on risk exposure).
  - 2011 FSAP recommended stronger coordination among supervisors and identification of a group-level supervisor with enhanced powers.
  - Authorities identified main challenges as designing a crisis management framework for conglomerates and supervising mixed conglomerates; awaiting final report from a recent IMF technical assistance mission.

### Other structural issues: female labor participation, diversification, SME finance
- Female labor force participation:
  - Staff welcomed authorities’ efforts to increase female labor force participation, which is one of the lowest in the OECD and Latin America (Annex III).
  - Authorities’ measures:
    - Increase coverage of early childhood education by building childcare institutions and replacing mandated employer-provided childcare with a universal system.
    - Launch “Más Capaz” training program with an objective to train 450,000 youth and women in 2015–18 and facilitate their entrance into the job market.
    - Proposed labor market reform’s “adaptability” provisions could foster female participation by allowing more flexible work arrangements.
    - Improving transportation infrastructure to reduce commuting time.
- Economic diversification and innovation:
  - Staff noted Chile’s economic structure is not as diversified as neighboring countries and diversification seems to have declined over time.
  - R&D spending: At 0.4 percent of GDP, Chile’s R&D spending is the lowest in the OECD (2 percent of GDP on average), particularly low in the private sector.
  - Authorities’ measures: initiatives such as “Start-up Chile”; room to expand and rationalize programs and strengthen firm–university collaboration; create Small Business Centers to develop managerial skills; reduce red tape for creating new companies; announced a new agency to attract foreign investment; emphasize better infrastructure to boost non-mining exports.
- Access to credit for SMEs:
  - Productivity gap between SMEs and large firms in Chile is relatively large (about twice as large as in Europe, for example); may reflect more difficult access to credit.
  - Authorities plan to accelerate approval of a bill introducing a Public Credit Bureau to reduce information gaps and improve financial institutions’ assessment of credit risks.
  - Plans to introduce a registry of firms’ mobile assets to facilitate assessment of collateral value.
  - Intend to implement a regulated crowd-funding framework to increase competition in the credit market and incentives for non-bank institutions to provide credit to SMEs.

### Staff appraisal: macro outlook and policy recommendations
- Recent economic context and outlook:
  - Growth has remained lackluster over the past year as the economy adjusts to the end of the mining boom; main force behind the slowdown: sharp fall in fixed investment.
  - External position has improved with a large decline in the current account deficit and a real exchange rate closer to fundamentals.
  - Structural reform agenda launched in 2014 has generated adjustment costs and increased uncertainty, contributing to weaker business confidence and lower investment.
- Growth forecast and risks:
  - Staff baseline: GDP growth picks up modestly to 3.1 percent in 2016 from 2½ percent in 2015.
  - Drivers: continued accommodative monetary policy and gradual recovery of business sentiment improving non-mining business investment, more than offsetting continued weakness in mining investment.
  - Main risks: more persistent weakness of private sector confidence and investment amid protracted uncertainty over the structural reform agenda and the external outlook; further decline in copper prices from a deeper than expected downturn in China; renewed global financial volatility tightening external financial conditions for Chile’s highly leveraged corporate sector.
- Recommended macroeconomic policy mix:
  - Combine tighter fiscal policy with continued monetary policy accommodation.
  - Start fiscal consolidation next year as the economy recovers gradually; reaffirm commitment to fiscal discipline after the fiscal impulse in 2015 to help boost business confidence.
  - Pace of consolidation should consider deterioration of long-term prospects for GDP growth and copper prices.
  - Monetary policy: room to remain accommodative given start of fiscal consolidation, well-anchored inflation expectations, and downside risks to growth until strong signs of recovery consolidation appear.
- Structural reform implementation:
  - Minimize short-term negative effects on growth and uncertainty when implementing reforms.
  - Actions to clarify constitutional reform procedures; ensure labor market reform improves efficiency; pursue education reform to raise human capital quality, increase productivity, and lower income inequalities.
- Financial sector governance and oversight:
  - Staff welcomed efforts to strengthen public and private governance, corporate governance, investor protection, and market transparency to bolster business confidence, increase market liquidity, and reduce cost of capital.
  - Improve institutional framework for PPPs to mobilize private finance for infrastructure and ensure efficient public fund use.
  - Financial sector notes:
    - While healthy overall, relatively high corporate and household debt may reduce resilience to shocks and needs close monitoring.
    - If corporate leverage increases, consider additional prudential measures to safeguard financial sector.
    - Staff welcomes adoption of minimum liquidity standards and plan to send new General Banking Law to Congress during second half of 2015 (introducing Basel III bank capital standards).
    - Authorities should continue strengthening supervision of financial conglomerates.
    - As insurance companies expand into riskier and less liquid investments, approve the bill implementing risk-based supervision and introducing new solvency requirements for insurance companies.

*Source: Excerpt from IMF staff report (text of content unit provided).*

### 33.      Staff proposes to hold the next Article IV consultation on the standard 12-month

### _cr15227 - 33.      Staff proposes to hold the next Article IV consultation on the standard 12-month cycle.

### Economic activity
- Growth bottomed out in Q3, 2014; recent monthly indicators suggest that the recovery is losing momentum.
- Contributions to Real GDP Growth (y/y, S.A.) shown for 2014Q1–2015Q1 include:
  - Consumption, Gross fixed capital formation, Change in inventories, Imports, Exports, GDP growth (charted).
- Output gap:
  - Output gap (In percent of potential GDP) swung into negative territory (series shown 2009–2015*; * Projection).
- Labor market:
  - Despite lower employment growth, the unemployment rate has remained relatively flat thanks to lower labor force participation.
  - Employment y/y change and Unemployment rate (RHS) series shown (Jan 10–May 15, 3mma).

### Fiscal policy and public finances
- Fiscal balances have weakened since 2012.
- Drivers:
  - Subdued mining revenue.
  - Higher spending on education, infrastructure and social programs (noted).
- Public sector position:
  - The public sector remains a net creditor.
  - Gross debt remains low, although it doubled as a share of GDP since the financial crisis.
- Central Government Balances (In percent of GDP):
  - Structural and Overall central government balances series shown for 2010–2015*.
- Central Government Revenues (In percent of GDP):
  - Non-mining tax and Mining revenue components shown 2010–2015*.
- Central Government Investment and Current Expenditure (In percent of GDP):
  - Current expenditure and Investment series for 2010–2015*.
- Public expenditure scenarios:
  - Fund staff baseline and "To achieve balance budget by 2018" paths shown.
  - Statement: "Complying with the 2018 target will require expenditure restraint."

### Monetary policy and inflation
- Inflation:
  - Inflation has been above the target band since Feb-2014.
  - Target (3%) shown; CPI excluding food and energy (core inflation) defined as excluding fuels, fresh fruits, and vegetables.
  - Inflation expectations remain anchored at 3 percent (In 11 months and In 23 months series).
- Policy rates and credit:
  - Policy rate cuts of -200 bps since Sep. 2013 have translated into lower lending and interbank rates.
  - Real credit growth (total, commercial, consumer, housing) series show support to credit growth, particularly in the housing sector.
- Exchange rate pass-through:
  - High inflation mainly reflects the pass-through of peso depreciation to prices.
- Labor costs and unit labor costs:
  - Nominal hourly compensation index, Labor productivity index, Nominal unit labor cost index (Index 2009Q1=100, S.A.) series shown; note: "as well as rising labor costs."

### External sector
- Current account and financing:
  - The current account deficit remains mostly financed by FDI, but with a growing debt component.
  - Current account (in percent of GDP; 4-quarter moving sum) and Net FDI series shown 2010Q1–2015Q1.
- External debt and reserves:
  - Gross External Debt (In percent of GDP) and components (External debt excluding FDI, Gross external financing needs) series for 2010–2014.
  - Gross international reserves and IMF reserve adequacy metric (In billions of U.S. dollars) shown; "gross international reserves are adequate."
- Recent trends:
  - The current account has improved markedly with a large decline in capital goods imports.
- International investment position:
  - Chile's international investment position remains strong (Total Assets, Of which: official reserves, Total Liabilities, 2014 comparison with peers).
- Change in trade balance (2013Q2–2015Q1):
  - Breakdown includes Trade balance, Exports (agriculture, mining, industrial products), Imports (consumer, intermediate, capital goods), presented in percent of GDP.

### Financial sector
- Banking sector profitability and asset quality:
  - Income statement series (In billions of Chilean pesos) for 2012–2015*; ROE before taxes (RHS).
  - Profitability remains high despite the fall in 2015Q1 due to lower inflation.
  - Non-performing loans have been falling, mainly for mortgages: NPLs to Gross Loans series show 2.1 percent in 2014 (Table 7).
- Capital and liquidity:
  - Tier 1 Capital Ratio (end 2014) vs peers shown; 60 percent of Tier 1 capital is common equity.
  - Capital adequacy: Regulatory Capital to Risk-Weighted Assets series 2009–2014 (e.g., 13.2 in 2014).
- Mutual funds and pensions:
  - Mutual funds investing in medium and long-term instruments have grown rapidly (structure series in billions of Chilean pesos).
  - Pension funds show positive real returns; Real Return on Investment of Insurance Sector and Real Return of Pension Funds (series).
  - Life insurance companies face low returns on their investments due to low interest rates.
- Financial soundness indicators (Table 7, selected figures):
  - Total assets (billions of Chilean pesos): 101,903.8 (2009) to 175,754.5 (2014 1/).
  - NPLs to Gross Loans: 2.9 (2009), 2.1 (2014 1/).
  - Return on Assets: 1.5 (2009), 1.6 (2014 1/).
  - Regulatory Capital to Risk-Weighted Assets: 14.3 (2009), 13.2 (2014 1/).
  - FX Loans to Total Loans: 10.8 (2009), 19.4 (2014 1/).

### Housing market
- House prices and sales:
  - House prices have grown at a relatively fast pace with a pick up since mid 2014, reflecting the impending higher VAT on houses.
  - Real Residential Price Indices (2008Q4=100) and Residential Price-to-Income Ratios (2008Q4=100) series shown for Chile and peers (CHL, MEX, COL, NZL, AUS).
  - Residential property sales in Greater Santiago have stabilized but at levels above the historical average (thousands of units).
- Household debt:
  - Household debt has increased, driven by mortgage loans.
  - Debt-to-income ratio in Chile remains low relative to advanced economies.
  - Loans to the Household Sector (Percentage change, y/y) series: Mortgage loans (bank), Mortgage loans (non-bank), Consumer loans (banks), Consumer loans (non-bank).
- Mortgage and household indicators:
  - Debt-to-income and household debt comparisons (Household Debt, 2014 /3, in percent of disposable income) presented across country groups.

### Selected social and economic indicators (Table 1, selected figures)
- GDP (2014), in billions of pesos: 147,166
- GDP (2014), in billions of U.S. dollars: 258.0
- Per capita (U.S. dollars): 14,480
- Population (2014), in millions: 17.8
- Poverty rate (2011): 14.40
- Main products and exports: Copper
- Key export markets: China, Euro area, U.S.
- Real GDP (annual % change): 5.7 (2010), 5.8 (2011), 5.5 (2012), 4.3 (2013), 1.9 (2014), 2.5 (2015), 3.1 (2016)
- Unemployment rate (annual average): 8.2 (2010), 6.4 (2014), 6.5 (2015), 6.6 (2016)
- Consumer prices, end of period: 3.0 (2010), 4.6 (2014), 3.3 (2015), 3.0 (2016)
- Central government fiscal balance (In percent of GDP): -0.5 (2010), -1.6 (2014), -3.2 (2015), -2.0 (2016)
- Structural fiscal balance 2/: -2.5 (2010), -1.5 (2014), -2.8 (2015), -1.7 (2016)
- Public sector gross debt: 25.9 (2010), 36.1 (2014), 38.8 (2015), 39.6 (2016)
- Current account (in percent of GDP): 1.7 (2010), -3.7 (2013), -1.2 (2014), -0.4 (2015), -1.2 (2016)
- Gross international reserves (in billions of U.S. dollars): 27.9 (2010), 40.4 (2014), 40.4 (2015), 40.4 (2016)

### Central government operations (Table 2, selected fiscal numbers, In percent of GDP)
- Revenues: 21.5 (2010), 22.7 (2011), 22.2 (2012), 20.9 (2013), 20.7 (2014), 20.3 (2015), 22.1 (2016 projection)
- Taxes: 15.9 (2010), 17.4 (2011), 17.7 (2012), 16.8 (2013), 16.6 (2014), 17.1 (2015), 18.5 (2016)
- Expenditures: 22.0 (2010), 21.4 (2011), 21.6 (2012), 21.5 (2013), 22.3 (2014), 23.5 (2015), 24.1 (2016)
- Net lending/borrowing: -0.5 (2010), 1.3 (2011), 0.6 (2012), -0.6 (2013), -1.6 (2014), -3.2 (2015), -2.0 (2016)
- Structural balance 2/: -2.5 (2010), -1.0 (2011), -0.1 (2012), -1.1 (2013), -1.5 (2014), -2.8 (2015), -1.7 (2016)
- Copper price, USD per pound (WEO): 3.42 (2010), 4.03 (2011), 3.61 (2012), 3.33 (2013), 3.11 (2014), 2.74 (2015), 2.77 (2016 projection)

### Balance of payments (Table 3, selected figures, In millions of U.S. dollars and percent of GDP)
- Current account (USD millions): 3,770 (2010), -3,089 (2011), -9,626 (2012), -10,127 (2013), -2,993 (2014), -1,135 (2015), -3,230 (2016)
- Trade balance (USD millions): 15,942 (2010), 11,039 (2011), 2,333 (2012), 1,820 (2013), 7,768 (2014), 7,593 (2015), 6,099 (2016)
- Exports (USD millions): 71,109 (2010), 81,438 (2011), 77,791 (2012), 76,477 (2013), 75,675 (2014), 71,260 (2015), 74,004 (2016)
  - Copper exports (USD millions): 41,361 (2010), 44,670 (2011), 41,955 (2012), 40,019 (2013), 37,872 (2014), 35,084 (2015), 36,202 (2016)
- Imports (USD millions): 55,167 (2010), 70,399 (2011), 75,458 (2012), 74,657 (2013), 67,907 (2014), 63,667 (2015), 67,905 (2016)
- Gross official international reserves (months of imports): 3.9 (2010), 5.6 (2011), 5.5 (2012), 6.0 (2013), 6.2 (2014), 5.9 (2015), 5.5 (2016)

### Monetary and financial aggregates (Table 4, selected figures)
- Central bank net international reserves (in millions of US$): 25,372 (2009), 27,865 (2010), 41,980 (2011), 42,231 (2012), 45,216 (2013), 51,288 (2014)
- Monetary base (levels and percent changes shown across series for 2009–2014).
- Credit to the private sector (banking system) levels and annual percentage change series shown (e.g., Credit to the private sector 69,783 in 2009 rising to 118,176 in 2014).

### Medium-term framework (Table 5, selected projections)
- Real GDP projections: 3.1 (2016), 3.3 (2017), 3.5 (2018), 3.6 (2019), 3.7 (2020)
- Consumer prices, end of period: 3.0 (2016–2020 projections)
- Output gap: -0.6 (2015), -0.7 (2016), -0.6 (2017), -0.3 (2018), -0.1 (2019), 0.0 (2020)
- Current account (percent of GDP): -0.4 (2015), -1.2 (2016), -1.7 (2017), -2.0 (2018), -2.2 (2019), -2.2 (2020)
- Gross external debt (percent of GDP): 60.1 (2015), 61.1 (2016), 61.5 (2017), 61.9 (2018), 62.2 (2019), 62.1 (2020)
- Gross international reserves (in billions of U.S. dollars): 40.4 (2015–2020 projections)

### Indicators of external vulnerability (Table 6, selected figures)
- Private sector credit to GDP: 66.6 (2010), 79.9 (2014)
- 90-day central bank promissory note (nominal) interest rate (avg.): 1.7 (2010), 4.0 (2014)
- Share of foreign currency deposits in total deposits: 15.4 (2010), 16.7 (2014)
- Current account balance (percent of GDP): 1.7 (2010), -1.2 (2014), -0.4 (2015)
- Gross official reserves (in billions of U.S. dollars): 27.9 (2010), 40.4 (2014), 40.4 (2015)
- Total external debt (percent of GDP): 39.1 (2010), 56.5 (2014), 60.1 (2015)
- Total external debt to exports of goods and services: 103.3 (2010), 168.1 (2014), 190.2 (2015)

### Financial soundness indicators (Table 7, selected figures)
- Total assets (billions of Chilean pesos): 101,903.8 (2009), 175,754.5 (2014 1/)
- Total assets as percent of GDP: 105.80 (2009), 119.43 (2014 1/)
- Regulatory Capital to Risk-Weighted Assets: 14.3 (2009), 13.2 (2014 1/)
- NPLs to Gross Loans: 2.9 (2009), 2.1 (2014 1/)
- Return on Equity: 21.4 (2009), 20.6 (2014 1/)
- FX Liabilities to Total Liabilities: 20.7 (2009), 27.2 (2014 1/)

*Source: IMF staff calculations and figures as presented in the cited content.*

### Annex I. Chile: External Sector Assessment Report

### Annex I. Chile: External Sector Assessment Report

### Overall assessment
- Chile’s net international investment position (NIIP) has hovered around -15 percent of GDP since 2008.
- The IIP is projected to remain largely unchanged in the next few years amid small current account deficits.
- The external position and the exchange rate are broadly consistent with medium-term fundamentals and desirable policy settings.
- The increase in FX private debt warrants close monitoring.

### Foreign asset and liability position
- Chile has a net negative FDI position reflecting large inflows in the mining sector, and a net positive equity position.
- The financial sector (pension funds, mutual funds, and insurance companies) is the main holder of foreign assets.
- Gross external debt grew rapidly in the last 4 years, from 39 to 56 percent of GDP (as of end 2014), with most of the increase concentrated in the nonfinancial corporate sector.
- Assessment: external debt remains sustainable under a range of adverse scenarios.

### Current account
- Background:
  - Chile’s current account (CA) has improved significantly since mid-2013, reflecting lower imports of capital goods and oil, as well as higher non-mining exports (boosted by the peso depreciation).
  - Over the last 2 years national savings has remained relatively stable as a percent of GDP, while the investment ratio has declined sharply reflecting lower copper prices and a fall in business confidence.
- Assessment:
  - Projected CA deficit is 0.4 percent of GDP in 2015, below the EBA norm of 2 percent.
  - The gap is mostly unexplained by the EBA regression (after correcting for the commodity and output cycles).
  - A possible reason is that the CA improvement is partly due to domestic factors not captured by the EBA equation, in particular the deterioration in business confidence.
  - Once confidence and investment recover, the CA deficit should rise and converge towards the norm.

### Real exchange rate and competitiveness
- Background:
  - Chile’s exchange rate is strongly correlated with copper prices, and, to a lesser extent, to the interest rate differential with the US.
  - Reflecting lower copper prices, rising market U.S. interest rates, and weaker portfolio inflows, Chile’s REER has depreciated by about 15 percent in 2014 relative to early 2013.
  - Since the fall of 2014 the REER has appreciated and its average between January and May 2015 was 2½ percent above its average in 2014.
- Assessment:
  - The peso was moderately undervalued in 2014 (between -4 and -11 percent according to EBA estimates).
  - The recent real appreciation is likely to have reduced the misalignment, bringing the currency closer to its equilibrium value.

### Capital and financial accounts
- Background:
  - The CA deficit is mainly financed from a relatively stable source of FDI inflows.
  - After declining in 2013, FDI inflows partly recovered in 2014.
  - The debt component of FDI has increased gradually in the last decade.
- Assessment:
  - Chile has a fully open capital account.
  - Vulnerabilities are limited by a credible commitment to a floating exchange rate and a strong fiscal position.

### FX intervention and reserves level
- Background:
  - Chile has a free floating exchange rate regime. The central bank generally does not intervene in the foreign exchange market.
  - Chile had two recent intervention programs in 2008 and 2011, both aimed at weakening the peso and both based on purchases of USD.
  - The Bank of Chile has 6 months of reserves, which is estimated as adequate according to standard reserve adequacy metrics.
- Assessment:
  - A flexible exchange rate is the first line of defense in a small economy exporting commodities like Chile, with a large exposure to international shocks.

---

### Annex II. Chile: Trade and Financial Linkages

### Trade openness and exposures
- Chile’s trade openness (sum of exports and imports) is 65 percent of GDP.
- Chile is an important recipient of FDI inflows to the region, receiving nearly 15 percent of total FDI to LA-5.
- Foreign claims on Chile by BIS-reporting banks amount to over 40 percent of GDP.
- About one-third of total funding of both financial and non-financial corporate sectors relies on foreign sources and has been on the rise in recent years.
- Chile’s export product concentration:
  - Copper comprises over half of Chile’s exports.
  - Fish and wine/grapes each about 5 percent.

### Inward spillovers: Trade channels
- More than two-thirds of Chile’s exports are directed to China, Europe, the United States, and Japan.
- China is Chile’s largest trading partner and accounts for 40 percent of mineral (almost exclusively copper) exports.
  - Staff estimate: a 1 percentage point decline in China’s growth over a four-year horizon will lower Chile’s GDP by 0.3 percentage point.
- Europe:
  - A one percent fall of GDP in Europe translates into a ¼ percent drop in Chile’s GDP in the medium run.
- United States:
  - Chile’s exports to the U.S. comprise mostly manufacturing goods, including processed food and agricultural products.
  - The direct (trade) impact of lower U.S. GDP growth would be relatively small and would affect mainly the agricultural sector (which directs one-third of its exports to the U.S. market).

### Inward spillovers: FDI and financial channels
- FDI:
  - FDI inflows are an important source of investment, particularly for the mining, financial and utilities sectors.
  - FDI inflows increased from an annual average of 6 percent of GDP in the early 2000s to 8½ percent in recent years.
  - The United States, the Netherlands, and Spain represent the main source markets.
- Banks:
  - Foreign banks (mainly from Spain and Canada) account for about 35 percent of Chile’s total banking sector assets (45 percent of GDP).
  - Chilean banks’ reliance on external sources is relatively moderate at 12¼ percent of their total funding needs (up from about 9½ in August 2012).
- Pension funds:
  - Total assets are above 70 percent of GDP.
  - Foreign investment amounts on average to 45 percent of total assets, up from 35 percent at end-2011.
  - Most foreign investment is in mutual funds and equities, mainly in the United States and Emerging Asia assets.
- Portfolio investment and sovereign exposure:
  - Portfolio investment in Chile amounted to 30 percent of GDP in 2014 (based on IIP data).
  - Chile has a positive net portfolio equity position (about 30 percent of GDP) that is more than offset by a large negative net FDI position.
  - U.S. residents hold nearly half of total portfolio investment assets vis-à-vis Chile, followed by Luxembourg and the United Kingdom (each 10 percent).
  - Non-residents hold about 5 percent of Chile’s sovereign bonds.
- Risk premium shock simulation:
  - If both corporate and sovereign risk premia rise by 100 basis points, Chile’s GDP would decline by ¼ percent in the medium term.

### Outward spillovers
- Trade outward spillovers:
  - Outward trade spillovers from Chile are very small.
  - About 60 percent of Chile’s imports are from the United States, Asia, and Europe.
  - Intermediate goods (mainly energy products and machine parts) comprise about two-thirds of Chile’s total imports, followed by capital goods (about 20 percent) and consumption goods and vehicles (each 10 percent).
  - In Latin America, Chile imports primarily from Brazil, Argentina, and Mexico, but exports to Chile represent only 1¾ percent of Brazil’s total exports.
  - Staff simulations show that a decline in GDP growth in Chile would have a negligible impact on the region’s GDP.
- Financial outward spillovers:
  - Chile is an important source of FDI for other countries in the region despite Chile’s GDP being less than 4 percent of total Latin America GDP.
  - The share of Chilean FDI in total FDI inflows in a given host country varies from 4 percent for Brazil to 12 percent for Colombia and Argentina.
  - Consolidated foreign assets of Chilean banks amount to about 7 percent of Chile’s GDP as of end-2014 (up from 5 percent at end-2013).
  - Chilean banks’ claims are generally a very small share of total bank credit to private sector in other Latin American countries (less than 1 percent in Colombia, Brazil, Mexico, and Peru).

*IMF staff: Annex I and Annex II, Chile: External Sector Assessment Report*

### Annex III. Women in Chile’s Labor Market: Addressing the Gender

### _cr15227 - Annex III. Women in Chile’s Labor Market: Addressing the Gender Gap

### Current situation and key statistics
- Women currently comprise 40 percent of Chile’s labor force, up from less than one-third in 1990.
- Female labor force participation rate: 55 percent (noted as “at 55 percent” in text).
- Male labor force participation rate: 80 percent.
- Participation is particularly low among low-income households.
- Women earn 30–40 percent less than men for the same level of education (text attribution: Sánchez, 2014; INE, 2015).
- Selected indicators (Gender Gaps and Childcare Support: Selected Indicators):
  - Female labor force participation rate 2/: Chile 55.3; OECD 62.6; LAT6 60.8
  - Labor force participation gap 3/: Chile 24.3; OECD 17.0; LAT6 23.5
  - Gender wage gap 4/: Chile 16.0; OECD 14.8; LAT6 ..
  - Coverage of early childhood education 5/: Chile 17.6; OECD 32.6; LAT6 ..
  - Public expenditure on childcare and pre-school 6/: Chile 0.4; OECD 0.8; LAT6 ..
  - (Sources: OECD, WDI, and Fund staff calculations. Notes: 1/ Includes Argentina, Brazil, Colombia, Mexico, Peru, and Uruguay; 2/ Percent of female population 15–64; 3/ Difference between male and female labor force participation rates; 4/ Difference between median earnings of men and women in percent of median earnings of men; 5/ Average enrolment rate of children under 3-years of age in formal childcare; 6/ Percent of GDP.)

### Factors explaining Chile’s gender gap
- Low coverage of childcare and early childhood education; family reasons cited as the main reason for inactivity by one-third of women.
- Mandated provision of childcare services by firms with more than 20 female employees increases the relative cost of employing women and is shown to reduce starting wages of women by 10–20 percent (Prada, Rucci, and Urzúa, 2015).
- Strict approach to flexible working hours and poor-quality part-time work: part-time work is common but mostly informal (leading to lower wages and greater risk of poverty) and involuntary (ILO, 2014; Sánchez, 2014).
- Long commuting hours and high transport costs: Chile lags 60 percent in terms of km of road behind the OECD average; transport costs represent almost 10 percent of the net wage of a part-time worker (6.5 percent for a full-time worker) in Santiago (Rau, 2010).
- Gender-based legal restrictions: laws still vest control over marital property in husband’s hands in many cases, limiting women’s economic independence.

### Economic consequences and potential gains
- Literature highlights that gender gaps in labor force participation, entrepreneurial activity, and education impede economic growth (IMF, 2013 and 2015).
- Cuberes and Teignier (2014) estimate GDP losses due to economic gender gaps amount to 17 percent of GDP for Chile (12 percent for LAT6 countries).
- Staff estimates: closing the current gap with LAT6 average (by increasing female participation by 1¼ percent per year over 2015–20) would result in a cumulative GDP gain of about 3 percent by 2020, relative to baseline.

### Recent reforms and their likely effects
- Reforms enacted:
  - Extension of early-childhood education and childcare services since 2006 (Chile Crece Contigo).
  - Introduction of employment bonuses for low-income women in 2012 (Ingreso Etico Familiar, to be expanded in 2015).
  - Extension of maternity leave with possibility to share leave with fathers in 2011.
  - Ongoing education reform discussed in the text.
- Empirical evidence on the impact of past policies—particularly greater childcare provision—on female participation is mixed; it is too early to fully evaluate most recent policies.

### Policy recommendations and areas for further reform
- Extend early-childhood education and childcare services, including through longer hours of care and out-of-school care services.
  - Administration plan: open 4,500 new childcare institutions for children under 3 years of age during the next four years.
- Remove mandated employer-provided childcare (as was being considered).
- Improve flexibility in hours of work and promote better transition to full-time, permanent jobs:
  - Strengthen workers’ rights to request changes in working hours and allow the possibility to “reverse” from part-time to full-time hours (examples: France, Germany, the Netherlands, and Poland).
  - More generally address labor market duality.
- Invest in transport infrastructure:
  - Authorities planning to nearly double the expenditure in transportation in 2015 relative to 2014 (noted that this still represents a small fraction of the entire investment plan for the year).
- Ensure desired take-up of policy measures:
  - Make paternal leave non-transferable “take-it or lose-it” (example: Norway).
  - Facilitate access to available subsidies for female workers.
- Reduce occupational segregation by gender through education and job training policies to improve gender equality in the labor market.

*Source: _cr15227 - Annex III. Women in Chile’s Labor Market: Addressing the Gender Gap*

### 1. Bank work program  A. Investment Loans

### 1. Bank work program  A. Investment Loans

### A. Investment Loans
- Tertiary Education Finance for Results Project III (P111661) — March 2012

### B. Technical Assistance
- 1. RAS Strengthening the legal framework for Institutional Water Resources Management — June 2015
- 2. RAS  Institutional Strengthening of the PPP unit — June 2015
- 3. RAS Chile Distributional Effects of the Tax Reform — September 2015
- 4. RAS CORFO SME finance — June 2015
- 5. RAS Determining the cost of public financing of higher education institutions — June 2015
- 6. RAS Higher Education Public Technical Education Network in Chile: Comparative Analysis of Models — September 2015
- 7. RAS Higher Education Quality Assurance: Definition, Design, and Institutional Arrangement — September 2015
- 8. RAS National System for Social Care — December 2015
- 9. RAS Redesigning Integrated Social Information System for the new model of selection of social protection beneficiaries — December 2015

### C. Recipient Executed Trust Fund
- 1. Sustainable Land Management – GEF (P085621) — September 2014
- 2. Market Instruments for climate change mitigation in Chile – PMR (P130378) — August 2014
- 3. Chile Quilleco Hydroelectric Project — May 2014
- 4. Securitization and Carbon Sinks Project — July 2010
- 5. Forest Carbon Partnership Facility - Chile Readiness Preparation Grant — January 2014
- 6. Strengthening Chile's Public Senior Executive Service System — July 2013
- 7. Chile- First Biennial Update Report, Report to Conventions. — August 2014

*cr15227 - 1. Bank work program  A. Investment Loans*

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_Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2015/_cr15227.pdf_