Mission Concluding Statement 

Chile: Staff Concluding Statement of the 2018 Article IV Mission

September 20, 2018

Chile’s economic recovery is firmly on its way: while the external environment poses downside risks, the domestic reform agenda offers upside risks to the outlook. The envisaged fiscal adjustment is expected to stabilize debt by early 2020s, and inflation expectations are well anchored to the target. The authorities are deeply engaged in a broad reform agenda that should raise growth and living standards, though more needs to be done to set the country on an inclusive path to advanced-economy status.

Chile’s economic recovery gains momentum, while risks appear balanced.

1. The economy is recovering following several years of subdued growth. Supported by robust business and consumer confidence, and a considerable rebound in both mining and non-mining, economic growth in the first half of 2018 has been the strongest since 2012. Given solid fundamentals and limited bilateral trade exposure, the economy has been largely sheltered from the recent volatility in emerging markets, with the flexible exchange rate playing the role of shock absorber. GDP growth is expected to slow down in the second part of the year and to settle at about 4 percent in 2018.

2. The economic outlook is favorable with balanced risks. Output growth is projected to gradually converge to its medium-term potential of about 3 percent. Headline inflation is expected to reach the central bank’s target of 3 percent in early 2019. With the economic rebound and weaker terms of trade, the current account deficit is expected to widen to about 2½ percent of GDP, before declining to about 2 percent of GDP in the medium term, financed mainly through FDI inflows. Downside risks mainly stem from the uncertain external environment and are related to rising protectionism, sharp tightening of global financial conditions, and weaker-than-expected growth in key trading partners. Upside risks to the outlook are related to a rapid implementation of the structural reform agenda and stronger-than-expected rebound in investment.

3. The financial sector remains healthy and profitable, though macro-financial linkages need to be closely monitored. Bank profitability improved, while NPLs remained low as a share of total loans, notwithstanding the prolonged slowdown. Risks to financial stability are mostly related to high leverage of non-financial corporates, which could affect the wider economy through macro-financial linkages. Nonetheless, these risks are mitigated from the fact that such leverage is associated either with debt to parent companies or long maturity and exchange rate hedging. The ongoing pickup in economic activity is likely to be reflected in improving banking sector performance.

Macroeconomic policies provide macroeconomic stability and policy credibility

4. The announced gradual fiscal consolidation should enhance policy credibility, by striking a balance between stabilizing debt and addressing development and social spending needs. Staff projects central government gross debt to broadly stabilize in 2021. To further enhance credibility and market confidence, the authorities could consider deepening the fiscal consolidation or strengthening the fiscal framework.

5. The authorities presented a proposal to streamline the tax system to make it more efficient and pro-growth, and it will be essential to ensure that the final outcome is funded and equitable. Several measures, such as a return to a single and fully integrated tax system, accelerated depreciation, and faster reimbursement of VAT, should overall spur investment and growth. Staff welcomes the authorities’ commitment that the reform will be fully funded. To the extent there are concerns related to tax avoidance, the authorities should further strengthen the tax administration and explore additional measures. In a broader context, the authorities could also consider widening the tax base, for instance via a reduction of special tax regimes, an extension of VAT coverage, and adjustment of excise taxes.

6. With the aim to strengthen the institutional framework on fiscal responsibility, the authorities proposed a reform enhancing the fiscal council. The proposal will institutionalize a new council with more independence, own resources, and a broader mandate than the existing one.

7. The need to start normalization of monetary policy rates is approaching. Such a tightening cycle should start once evidence of a persistent convergence of inflation towards the target is supported by a broad set of indicators. Despite the pickup in economic activity and headline inflation in the first half of 2018, a subdued core inflation, the remaining slack in the labor market, weak earnings growth, and the evolution of domestic and external risks constitute key additional factors to determine the start and the pace of a tightening cycle.

8. The revamped communication framework by the central bank is welcome. The authorities aligned the release of the Monetary Policy Report (4 times a year) to the policy meetings, introduced regular press conferences, and reduced the number of meetings from twelve to eight—a frequency in line with many other central banks. These changes are expected to further enhance the central bank’s already strong communication framework.

9. The proposed general banking law will bolster the sector’s resilience. The current bill aims at closing the gap with Basel III minimum solvency requirements, providing new financial stabilization tools (counter-cyclical capital buffers), and improving the corporate governance of the supervisory and regulatory agencies. Staff encourages a swift approval of the reform.

10. Staff welcomes the ongoing agenda in financial sector regulation. The authorities are preparing draft laws enhancing transparency and tightening responsibilities for financial market agents, reinforcing data protection rights, and establishing the legal basis for risk-based supervision of insurance companies.

11. Once the banking law is passed, it will be important to devote attention to additional financial sector reforms . Staff encourages the authorities to: strengthen the early intervention regime and broaden the powers and tools available to the regulator for resolution of banks; establish a national deposit insurance scheme funded by member banks; strengthen the legal basis for inter-agency coordination and cooperation among supervisors (particularly on cooperatives and cajas de compensación). In this context, the authorities have requested a Financial Sector Assessment Program from the Fund, scheduled for early 2020.

Transitioning to advanced economy status

12. Implementation of the structural reform agenda would make the outlook more favorable. Among others, the authorities announced measures to substantially streamline business regulation and licensing, improve coordination among public institutions, and establish offices dedicated to identifying and solving bottlenecks in the business environment as well as enhancing and harmonizing the regulatory environment. They also aim to increase female labor participation and formal job creation through universal childcare access and more flexible employment contracts (on hours, timing, and workplace), including for young workers. Efforts to ensure smooth resolution of labor market uncertainties and enhance social protection for independent workers are being undertaken. The current education agenda aims at addressing skill mismatches. A pension reform aimed at increasing benefits through higher mandatory contributions and an enhanced solidarity pillar is being designed. Staff is supportive of this agenda which—depending on final legislation and implementation, and together with the agenda outlined in the five presidential acuerdos nacionales —should raise output and living standards, resulting in a higher growth scenario than presented in our baseline medium-term projections.

13. A broader set of reforms would speed up the transition to advanced economy status. Strengthening capacity for innovation and R&D, further improving the quality of education and human capital, as well as deepening labor market flexibility would further boost productivity, medium-term growth prospects, and diversification. Growth of small and medium firms would particularly benefit from improved access to working capital and tailored training programs. Together with the authorities’ reform agenda, the implementation of such measures could result in higher output by up to 6 percent after 5 years, and favor inclusiveness. In addition, following an initial fiscal cost due to direct policy outlays, the set of reforms is expected to have a positive net fiscal impact through higher output over the medium term.

14. Cybersecurity and FinTech regulation frameworks need to be strengthened. Recent cyberattacks point at private sector underinvestment in cybersecurity and regulatory gaps, which may affect market confidence if left unaddressed. Staff welcomes the authorities’ ongoing efforts to prepare new cybersecurity legislation aimed at enhancing information sharing, detection, and response. Rapidly growing FinTech activity requires adequate regulation, and the authorities are considering options based on international experience.

Overall, Chile’s economy remains grounded in strong fundamentals, solid institutional frameworks, and a sound track record of macroeconomic policies.

The mission thanks the authorities and other counterparts for the excellent discussions and warm hospitality.