## _op231

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---

### Economic Performance
- From 1984 to 1997 economic activity in Chile grew at an annual rate exceeding 7 percent.
- Per capita income (PPP) evolution over two decades:
  - In 1980 Chile was significantly below Argentina’s, essentially the same as Mexico’s, and not much above Brazil’s.
  - Two decades later, Chilean income was twice that of Brazil and over one and a half times those of Argentina and Mexico.
- Crisis history:
  - Only Chile avoided a major episode of output contraction in the last 20 years (Chile’s last crisis episode was in 1982).
- Inflation trajectory:
  - From 20 percent in 1990, annual inflation declined steadily to 6 percent in 1997, and reached the low single digits a few years later.
- Fiscal outcomes:
  - Only in Chile were years of fiscal deficits roughly offset by years of surpluses over the last two decades.
  - Fiscal discipline resulted in lower government debt and lower real interest rates relative to peers.

### Policies Underpinning Success
- Fiscal discipline:
  - Strong fiscal discipline over the last two decades; Chile offset deficits with surpluses, yielding a lower debt-servicing burden.
- Financial regulation and market development:
  - Strengthened financial regulatory framework coupled with policies encouraging deepening of domestic capital markets.
  - Balance sought between market discipline and sound banking supervision amid financial liberalization.
- Trade integration and openness:
  - Chile’s export sector is among the most open and diversified in Latin America, acting as an important buffer against current account shocks.
  - High degree of trade integration likely enhanced growth potential; empirical studies suggest open trade regimes grow faster.
- Institutional arrangements:
  - Institutional design aimed to create a more certain macroeconomic environment, reducing incentives for short-term gains at the expense of long-term stability.
  - Key institutional features include budget process rules, tight constraints on subnational governments, and effective central bank independence.

### Macroeconomic and Institutional Framework
- Four thematic focus areas of the paper:
  1. The macroeconomic and institutional framework.
  2. Recent developments in financial markets.
  3. An assessment of the domestic position of the public sector and the country’s external position.
  4. The role of exports in economic growth.
- Exchange rate and monetary policy evolution:
  - Chile exited an exchange rate band without a crisis and adopted a floating exchange rate system.
  - Gradual move into a full-fledged inflation-targeting framework and a fiscal rule.
- Components of the inflation-targeting framework (current):
  - (1) a prespecified continuous inflation target band;
  - (2) a preannounced “policy horizon”;
  - (3) timely communication of the authorities’ inflation forecast, the rationale for policy decisions, and reasons for temporary deviations from the inflation target.
- Exchange rate policy principles:
  - Calls for zero exchange intervention except under exceptional circumstances.
  - When intervention occurs, authorities announce the event, reveal the amount, and do not target a specific exchange rate.
- Fiscal rule mechanics:
  - Defines a specific medium-term fiscal policy path that removes policy discretion while not suppressing automatic stabilizers.
  - Use of expert panels to determine cyclical adjustments enhances transparency and credibility.

### Recent Developments in Financial Markets
- Drivers of capital market development:
  - Privatization of pension funds’ management, capital market reforms, and macroeconomic stability deepened capital markets in the 1990s.
  - A well-developed and large institutional investor base provided a stable and growing source of domestic finance.
- Trends and composition:
  - Equity markets expanded rapidly in the early 1990s.
  - The domestic corporate bond market experienced a remarkable resurgence since 2000 as large corporate firms sought to time the market after a sharp drop in domestic interest rates.
- Remaining challenges:
  - Low liquidity in equity and corporate bond markets.
  - High degree of ownership and investor concentration.
- Policy responses:
  - Recent changes in financial regulation and legislation aim to improve depth of capital markets and corporate governance and to enhance capital market regulation.
  - Authorities focused on improving market infrastructure, bridging missing markets, promoting liquidity and transparency, and providing incentives for wider access to investment resources.
- Banking system role:
  - For the last twenty years, Chilean banks have had access to relatively strong consumer credit evaluation technology.
  - Since the mid-1980s the banking system has maintained a reputation for stability and strength while continuing to evolve.

### Banking System Update (Section V)
- System condition:
  - The Chilean banking system "continues to remain robust."
- Inverlink episode:
  - Documents the "Inverlink" case: a corrupt private financial company sold stolen government securities to the market; the case "originated outside of, but nevertheless had repercussions for, the banking system."
  - Authorities' responses included immediate actions to address liquidity needs and forward-looking measures to improve financial security.
- Role of banks:
  - Describes key factors behind the active role played by banks in the allocation of credit to the private sector.

### Domestic Financial Position of the Public Sector (Section VI)
- Overall assessment:
  - Public sector finances are favorable.
  - Risky balance sheet structures have been avoided; exposure to currency and interest rate risks is limited.
- Analysis focus:
  - Centers on central government finances using newly available balance sheet data on the debt and financial assets of the Chilean public sector.
- Main fiscal conclusion:
  - As long as the government’s fiscal structural balance target continues to be met, public finances will remain sustainable.
- Central bank observations:
  - Tendency to run a modest operational deficit.
  - Considerable strength in foreign exchange and liquidity positions.
  - The bank’s deficit has been fairly stable and has not interfered with its monetary policy objectives.
  - Suggested step to improve financial position: a capital injection from the government.
- Public enterprises:
  - Situation appears sound, given overall profitability and limited debt.

### Country’s External Financial Position and Vulnerabilities (Section VII)
- Analytical dimensions:
  - External debt dynamics.
  - Sensitivity of gross external financing requirements to specific shocks.
  - Implications of Chile’s international investment position for external vulnerability.
- Key findings:
  - The analysis underscores the strength of Chile’s aggregate external position.
  - In a standard debt sustainability framework, various hypothetical shocks would lead to a substantial, though temporary, increase in the external debt-to-GDP ratio.
  - The risks of these standardized shocks seem remote, given the strength of Chile’s current policy framework.
  - Liquidity problems are not expected given the country’s significant liquid foreign assets, held by both the public and private sectors.
  - Chile’s large foreign asset–liability structure is a source of strength.
  - Large foreign direct investment in Chile helps explain that foreign-owned Chilean resident firms hold more than half of Chile’s total external debt.
  - Sensitivity analysis using the net international investment position shows the dampening effects of large direct investment on the country’s aggregate net liability.

### Export Specialization and Economic Growth (Section VIII)
- Literature context:
  - Not all countries have benefited equally from globalization; literature suggests a negative relationship between natural resource exports and long-term growth.
- Chile’s experience:
  - Chile has benefited from increased integration with the global economy.
  - Chile’s export sector has promoted competitiveness, positive spillovers, and economic growth.
  - Export specialization in Chile often follows comparative advantage, meaning exports that are natural resource based.
  - The section offers a critical assessment of the notion that such exports are necessarily stagnant and have a negative impact on growth.
  - In Chile, these exports have been associated with positive spillovers leading to the creation of new products.
  - Emphasizes the need to promote human capital accumulation to take advantage of spillovers, increase productivity, and continue diversifying the Chilean export basket.

*Source: I. Overview (Preface and Sections I and V–VIII) of IMF Occasional Paper 231.*

### 1.  Chile—Economic  policy.  2.  Capital  market—Chile.  3.  Banks  and

### I. Overview

### Economic Performance
- From 1984 to 1997 economic activity in Chile grew at an annual rate exceeding 7 percent.
- In 1980, per capita income (PPP) in Chile was significantly below Argentina’s, essentially the same as Mexico’s, and not much above Brazil’s; two decades later, Chilean income was:
  - twice that of Brazil,
  - over one and a half times those of Argentina and Mexico.
- Only Chile avoided a major episode of output contraction in the last 20 years (Chile’s last crisis episode was in 1982).
- Inflation:
  - From 20 percent in 1990, annual inflation declined steadily to 6 percent in 1997, and reached the low single digits a few years later.
- Fiscal outcomes:
  - Only in Chile were years of fiscal deficits roughly offset by years of surpluses over the last two decades.
  - Fiscal discipline resulted in lower government debt and lower real interest rates relative to peers.

### Policies Underpinning Success
- Fiscal discipline:
  - Strong fiscal discipline over the last two decades; Chile offset deficits with surpluses, yielding a lower debt-servicing burden.
- Financial regulation and market development:
  - Strengthened financial regulatory framework coupled with policies encouraging deepening of domestic capital markets.
  - Chile sought a balance between market discipline and sound banking supervision amid financial liberalization.
- Trade integration and openness:
  - Chile’s export sector is among the most open and diversified in Latin America, acting as an important buffer against current account shocks.
  - High degree of trade integration likely enhanced growth potential; empirical studies suggest open trade regimes grow faster.
- Institutional arrangements:
  - Institutional design aimed to create a more certain macroeconomic environment, reducing incentives for short-term gains at the expense of long-term stability.
  - Key institutional features include budget process rules, tight constraints on subnational governments, and effective central bank independence.

### Four Thematic Areas of This Paper
- The paper is organized around four themes:
  1. The macroeconomic and institutional framework.
  2. Recent developments in financial markets.
  3. An assessment of the domestic position of the public sector and the country’s external position.
  4. The role of exports in economic growth.
- Purpose:
  - Provide a unified source of lessons for countries committed to sustainable improvements in economic policies and institutions.
  - Include forward-looking suggestions as the publication is intended as a reference.

### Macroeconomic and Institutional Framework
- Institutional role in sustaining policies:
  - Section II examines how institutional arrangements helped identify, implement, and maintain sound policies, focusing on:
    - Fiscal policy discipline,
    - Price stability arrangements,
    - Financial stability and banking supervision,
    - Open and stable trade policy regime.
  - Constitutional features and effective central bank independence are highlighted as especially important.
- Refinements to the macro policy framework:
  - Chile exited an exchange rate band without a crisis and adopted a floating exchange rate system.
  - Gradual move into a full-fledged inflation-targeting framework and a fiscal rule.
- Components of the inflation-targeting framework (current):
  - (1) a prespecified continuous inflation target band;
  - (2) a preannounced “policy horizon”;
  - (3) timely communication of the authorities’ inflation forecast, the rationale for policy decisions, and reasons for temporary deviations from the inflation target.
- Exchange rate policy:
  - Calls for zero exchange intervention except under exceptional circumstances.
  - When intervention occurs, authorities announce the event, reveal the amount, and do not target a specific exchange rate.
- Fiscal rule mechanics:
  - Defines a specific medium-term fiscal policy path that removes policy discretion while not suppressing automatic stabilizers.
  - Use of expert panels to determine cyclical adjustments enhances transparency and credibility.

### Recent Developments in Financial Markets
- Drivers of capital market development:
  - Privatization of pension funds’ management, capital market reforms, and macroeconomic stability deepened capital markets in the 1990s.
  - A well-developed and large institutional investor base provided a stable and growing source of domestic finance.
- Trends and composition:
  - Equity markets expanded rapidly in the early 1990s.
  - The domestic corporate bond market experienced a remarkable resurgence since 2000 as large corporate firms sought to time the market after a sharp drop in domestic interest rates.
- Remaining challenges for domestic capital markets:
  - Low liquidity in equity and corporate bond markets.
  - High degree of ownership and investor concentration.
- Policy responses and reforms:
  - Recent changes in financial regulation and legislation aim to improve depth of capital markets and corporate governance and to enhance capital market regulation.
  - Authorities have focused on improving market infrastructure, bridging missing markets, promoting liquidity and transparency, and providing incentives for wider access to investment resources.
- Banking system role:
  - For the last twenty years, Chilean banks have had access to relatively strong consumer credit evaluation technology.
  - Since the mid-1980s the banking system has maintained a reputation for stability and strength while continuing to evolve.

*Source: I. Overview (Preface and Section I) of the IMF Occasional Paper series, occasional paper 231.*

### Section  V  provides  an  update  on  the  Chilean

### I OVERVIEW

### Banking System Update (Section V)
- The Chilean banking system "continues to remain robust."
- Documents the "Inverlink" case: a corrupt private financial company sold stolen government securities to the market; the case "originated outside of, but nevertheless had repercussions for, the banking system."
- Authorities' responses:
  - Immediate actions to address liquidity needs following the episode.
  - Forward-looking measures to improve financial security.
- Describes key factors behind the active role played by banks in the allocation of credit to the private sector.

### Domestic Financial Position of the Public Sector (Section VI)
- Assessment of public sector finances is favorable.
- Risky balance sheet structures have been avoided; exposure to currency and interest rate risks is limited.
- Analysis centers on central government finances using newly available balance sheet data on the debt and financial assets of the Chilean public sector.
- Main conclusion: as long as the government’s fiscal structural balance target continues to be met, public finances will remain sustainable.
- Central bank balance sheet observations:
  - Tendency to run a modest operational deficit.
  - Considerable strength in foreign exchange and liquidity positions.
  - The bank’s deficit has been fairly stable and has not interfered with its monetary policy objectives.
  - Suggested step to improve financial position: a capital injection from the government.
- Public enterprises: situation appears sound, given overall profitability and limited debt.

### Country’s External Financial Position and Vulnerabilities (Section VII)
- Assessing external position requires close look at the external position of the corporate sector, including relationships with parent companies.
- Key dimensions of the analysis:
  - External debt dynamics.
  - Sensitivity of gross external financing requirements to specific shocks.
  - Implications of Chile’s international investment position for external vulnerability.
- Findings:
  - The analysis underscores the strength of Chile’s aggregate external position.
  - In a standard debt sustainability framework, various hypothetical shocks would lead to a substantial, though temporary, increase in the external debt-to-GDP ratio.
  - The risks of these standardized shocks seem remote, given the strength of Chile’s current policy framework.
  - Liquidity problems are not expected given the country’s significant liquid foreign assets, held by both the public and private sectors.
  - Chile’s large foreign asset–liability structure is a source of strength.
  - Large foreign direct investment in Chile helps explain that foreign-owned Chilean resident firms hold more than half of Chile’s total external debt.
  - Sensitivity analysis using the net international investment position shows the dampening effects of large direct investment on the country’s aggregate net liability.

### Export Specialization and Economic Growth (Section VIII)
- Not all countries have benefited equally from globalization; literature suggests a negative relationship between natural resource exports and long-term growth.
- Chile’s experience:
  - Chile has benefited from increased integration with the global economy.
  - Chile’s export sector has promoted competitiveness, positive spillovers, and economic growth.
  - Export specialization in Chile often follows comparative advantage, meaning exports that are natural resource based.
  - The section offers a critical assessment of the notion that such exports are necessarily stagnant and have a negative impact on growth.
  - In Chile, these exports have been associated with positive spillovers leading to the creation of new products.
  - Emphasizes the need to promote human capital accumulation to take advantage of spillovers, increase productivity, and continue diversifying the Chilean export basket.

*Overview (Sections V–VIII) of the document.*

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_Source: https://www.imf.org/-/media/websites/imf/imported-publications/external/pubs/nft/op/231/_op231.pdf_