Chile: Staff Concluding Statement of the 2022 Article IV Mission
IMF News, October 28, 2022
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- Published: October 28, 2022
Overview and main takeaways
- An IMF mission met with Chilean authorities during October 18–27 to discuss recent economic developments and policy priorities. This concluding statement summarizes the mission’s main takeaways.
- After an impressive recovery from the Covid-19 pandemic, the Chilean economy is undergoing a necessary transition towards sustainable growth.
- GDP growth is projected to decline from 11.7 percent in 2021 to 2.1 percent in 2022 and turn negative at -1.3 percent in 2023, before returning to an estimated potential rate of 2.5 percent over the medium term.
Balance of risks
- The balance of risks is tilted to the downside.
- External risks:
- Possibility of an abrupt global slowdown or recession, with an associated spike in global risk premia and commodity price volatility.
- Possible de-anchoring of inflation expectations in major economies alongside further tightening of global financial conditions.
- Commodity price shocks or an intensification of spillovers from Russia’s war in Ukraine.
- Domestic risks:
- High inflation persisting for longer than expected.
- Social discontent over high food and energy prices.
- Slow progress to meet social demands.
- Constitutional reform process is expected to continue but uncertainty over possible outcomes has narrowed.
Fundamentals and precautionary frameworks
- Very strong fundamentals and institutional policy frameworks underpin Chile’s resilience and capacity to respond to shocks.
- On August 29, the IMF Executive Board approved a two-year Flexible Credit Line (FCL) arrangement for Chile in the amount of SDR 13.954 billion (about US$18 billion).
- Strengths cited:
- Low public debt ratio.
- Ample liquidity buffers (international reserves, FX liquidity lines, and assets in sovereign wealth funds).
- Sustained track record of implementing very strong policies.
Monetary policy and inflation
- The Central Bank of Chile (BCCh) has appropriately tightened monetary policy to tame inflationary pressures and remains vigilant to risks.
- Inflationary outcomes and expectations:
- Headline (core) inflation reached 13.7 (11.1) percent in September.
- Two-year ahead inflation expectations stand above the 3 percent target.
- Policy rate:
- BCCh raised the policy rate to 11.25 percent in October (substantially above the neutral rate) and announced it will remain at that level for as long as necessary to ensure inflation converges to target.
- IMF staff assessment:
- Monetary stance is assessed to be adequate.
- Upside risks to inflation may require extending the tightening cycle if inflation pressures persist.
- Effective communication is key to preserving long-term gains of low inflation and well-anchored expectations.
FX interventions, exchange-rate policy, and external buffers
- The FX intervention program (mid-July to end-September) was successful in addressing risks of disorderly market conditions:
- Reduced FX volatility, restored price formation signals, and prevented broader spillovers to financial markets and the real economy.
- Interventions were fully sterilized, implemented with high transparency, and consistent with the monetary policy framework.
- Policy guidance:
- Exchange rate should continue to play its role as a shock absorber.
- FX interventions should be used only in exceptional circumstances to prevent disorderly market conditions.
- BCCh has ample FX liquidity buffers, including international reserves, FX liquidity lines, and the FCL.
- When market conditions are conducive, a substantial reserve accumulation program would be advisable to replenish buffers.
Financial sector soundness
- The financial sector remains resilient; banks have adequate profitability, capital, and liquidity.
- Observations:
- Banking sector is sound despite sluggish credit recovery.
- Capital adequacy and liquidity ratios are comfortably above regulatory requirements.
- Non-performing loan ratio remains below the historical average.
- Banks' profitability has returned to pre-pandemic levels.
- Adoption of Basel III standards and establishment of the Financial Market Commission strengthen supervision.
- Vulnerabilities:
- Pockets among low-income indebted households, smaller firms, and sectors more affected by the pandemic and cost increases (such as construction).
- Recommendation:
- Closely monitor vulnerabilities as financial conditions tighten and Covid-19 liquidity measures unwind.
Fiscal performance and policy
- The authorities’ fiscal overperformance in 2022 was remarkable.
- Fiscal outcomes:
- Headline fiscal balance is expected to reach a surplus of 1.6 percent of GDP in 2022 (the first surplus in a decade), compared with a deficit of -7.7 percent of GDP in 2021.
- Government replenished US$6 billion in the sovereign wealth fund.
- Policy emphasis:
- Reallocated spending to support the most vulnerable, including measures to mitigate high energy and food prices, employment subsidies in lagging sectors, and targeted transfers to households.
2023 Budget and medium-term fiscal strategy
- The 2023 draft Budget focuses on social spending and public investment consistent with the authorities’ pre-announced medium-term fiscal plan and debt sustainability.
- Assessment:
- Amid a negative output gap, the draft Budget envisions higher mandated spending on universal guaranteed pensions and other social areas, and aims to increase public investment and foster productivity within a sustainable medium-term path.
- IMF staff estimates the 2023 fiscal stance would be expansionary when both inflation and the current account deficit are elevated.
- Recommendations:
- Save any stronger than projected revenues and wait to disburse unallocated funds to support disinflationary process and current account convergence.
- Commitment to a multi-year fiscal consolidation plan to achieve a broadly balanced structural fiscal position and keep gross public debt below a prudent ceiling of 45 percent of GDP over the medium term is essential.
- This would require a fiscal consolidation of about 3 percent of GDP over the next five years, accompanied by targeted measures to protect the most vulnerable.
Fiscal framework enhancements
- Efforts to refine Chile’s very strong fiscal framework are welcome.
- Recent enhancements:
- Adjusted parameters in the structural balance rule.
- Adoption of medium-term fiscal targets.
- Introduction of a prudent debt ceiling.
- Disclosure of sensitivity of fiscal projections to macroeconomic shocks.
- Consideration of an explicit escape clause and a natural disaster fund by congress.
- Further desirable enhancements:
- Analysis and management of assets and liabilities and of fiscal risks.
- Strengthening the supervisory and advisory role of the Autonomous Fiscal Council.
Tax reform, social spending, and sequencing
- Social spending reforms should advance as yields from tax reform materialize in line with medium-term fiscal objectives.
- Tax reform objectives:
- Raise revenues for expansion of social services.
- Increase progressivity of the tax system.
- Simplify and lower compliance costs, reduce incentives for aggressive tax planning, and foster a green economy.
- Caveats:
- Exemption threshold in personal income tax reform would remain high; tax rates for low and middle brackets modest by international standards.
- Expected yields from tax administration and the wealth tax could be difficult to realize.
- Recommendation:
- Higher spending should advance conditional on revenue performance and medium-term fiscal consolidation goals.
Pensions and capital markets
- Pension reform remains critical to tackle inadequate pensions.
- Observations:
- Introduction of a guaranteed universal pension addressed challenges for the most vulnerable retirees.
- Many Chileans still face inadequate pensions, aggravated by pension withdrawals.
- Replacement rates for middle-income households compare unfavorably with international standards due to low contribution rates, low contribution density, and a retirement age that has not kept up with life expectancy.
- Critical pension reform aspects to consider:
- Scope to expand the universal pension in a sustainable manner.
- Increase in contribution rates and their destination (individual accounts versus a redistributive pillar).
- Measures to improve contribution density, particularly for younger cohorts, and reduce informality.
- Increases in the retirement age.
- The role of Pension Funds (AFPs).
- New pension withdrawals should be avoided.
- Capital markets:
- Pension funds have deepened capital markets but withdrawals and uncertainty about the future of AFPs have hurt depth and liquidity.
- Authorities’ plans to establish a repo market, develop a primary dealer system, promote fintech (supported by the new Fintech Law), and foster internalization of the Chilean peso could deepen capital markets.
- Increasing aggregate savings and financing long-term investment are important complements.
Climate policy and green taxation
- A broader use of green taxes should support Chile’s ambitious climate agenda.
- Commitments and measures:
- Framework Law on Climate Change; pioneer carbon tax; commitment to decommission coal-fired power plants by 2040 and achieve carbon neutrality by 2050.
- IMF simulations suggest:
- A gradual increase in the carbon tax to at least US$60/tCO2e by 2030, coupled with higher excises for diesel, would be needed to reach Nationally Defined Contribution goals.
- A carbon tax of US$150/tCO2e would allow Chile to stay on track to net-zero.
- Estimates would need re-calibration if combined with complementary measures to curb CO2 emissions.
- Proceeds from carbon pricing (of up to 2 percent of GDP) could be recycled for targeted transfers and public investment to offset impacts on vulnerable households and boost potential growth.
Key social and economic indicators (selected)
- Output
- Real GDP: 2021 = 11.7; 2022 = 2.1; 2023 = -1.3; 2024 = 2.3
- Employment
- Unemployment rate (annual average): 2021 = 8.8; 2022 = 7.9; 2023 = 8.5; 2024 = 8.0
- Consumer prices
- Inflation (End of period): 2021 = 7.2; 2022 = 12.1; 2023 = 5.0; 2024 = 3.0
- Public sector finances (In percent of GDP)
- Central government fiscal balance: 2021 = -7.7; 2022 = 1.6; 2023 = -2.4; 2024 = -1.9
- Central government gross debt: 2021 = 36.3; 2022 = 38.0; 2023 = 38.2; 2024 = 40.4
- Balance of payments (In percent of GDP)
- Current account: 2021 = -6.7; 2022 = -6.9; 2023 = -4.5; 2024 = -3.7
- Gross external debt: 2021 = 72.4; 2022 = 79.3; 2023 = 74.8; 2024 = 73.6
IMF Staff Concluding Statement of the 2022 Article IV Mission to Chile (October 28, 2022).