IMF Survey: Chile: Strong Recovery After Devastating Earthquake

IMF News, September 29, 2010

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Seven months after the February 27, 2010 earthquake, the economy is expected to recover strongly in 2010–11, driven by reconstruction spending and a rebuilding of inventories.
Reconstruction costs were estimated to be close to US$30 billion.
The IMF projects growth of 5 percent in 2010 and 6 percent in 2011.
The recovery was supported by strong private consumption and large public and private investment, including on inventories.

Fiscal policy acted as a critical countercyclical tool, drawing on public savings accumulated prior to the global crisis.
The government aims to achieve a structural deficit of 1 percent by 2014 (with revenues measured at potential output and long-term copper prices), while allowing for earthquake reconstruction spending.
To meet the target the authorities plan to:
- drastically trim the growth of nonessential expenditure,
- reallocate spending,
- temporarily increase taxes,
- carry out some additional borrowing.
Recent market transactions signaling confidence:
- 10-year bonds worth $1 billion placed with a spread of only 90 basis points,
- peso-denominated debt worth $500 million at a 5.5 percent interest rate.
IMF recommendations on the fiscal rule include:
- review and improve transparency of the calculation of the structural balance,
- introduce an explicit escape clause to allow discretionary countercyclical policy in the case of large shocks,
- set fiscal policy in a medium-term context that extends beyond the current government’s term.

The central bank has begun tightening policy as the economy rebounds.
As of mid-September the policy interest rate had been increased to 2.5 percent.
The central bank stands ready to raise interest rates as necessary to keep inflation in line with the target of 3 percent.
Markets expect inflation to gradually decline to the target within the 24-month policy horizon of the central bank.
The IMF supports relying on exchange rate flexibility as the first line of defense to discourage excessive capital inflows that could result from higher domestic interest rates and the recovering economy.

IMF staff agreed domestic credit risks would diminish further as the recovery firms up; the earthquake is expected to have a limited temporary impact on credit risk in affected zones.
The rebound of economic activity and lower unemployment offset localized credit effects for the banking system as a whole.
Authorities remain committed to financial sector reforms to strengthen the prudential framework and deepen domestic capital markets.
Recent and planned reforms:
- Third capital market reforms law (approved by Congress in May 2010) broadens authorized financial instruments including exchange-traded funds and mortgage bonds; facilitates securitization; extends tax exemptions on selected fixed income instruments to foreign institutional investors.
- Additional reforms under development aim to improve market liquidity and update institutional framework, especially in consolidated supervision and corporate governance of financial supervisors.

Government plans to increase competition, facilitate entry of new firms, expand credit access to small and medium-enterprises, and improve bankruptcy regulations.
Plans include establishing a specialized stock market to facilitate initial public offerings for start-ups and increase availability of venture capital.
IMF staff support replacing the current high severance payment system with a more comprehensive unemployment insurance scheme to:
- increase labor market mobility,
- encourage greater investment in education and on-the-job training.
Increasing the share of skilled workers in the labor force is cited as a way to help reduce income inequality.

IMF Survey: Chile: Strong Recovery After Devastating Earthquake — Nicolás Magud, IMF Western Hemisphere Department, September 29, 2010.