Press Release No. 15/373

Press Release: IMF Executive Board Concludes 2015 Article IV Consultation with Chile

August 6, 2015

On August 4, 2015, the Executive Board of the International Monetary Fund (IMF) concluded the Article IV consultation¹ with Chile, and considered and endorsed the staff appraisal without a meeting².

GDP growth has remained lackluster over the past year. The main force behind the economic slowdown in 2014 has been the sharp fall in private investment, mainly the consequence of the end of the mining boom but also reflecting the uncertainty and adjustment costs associated with the structural reform agenda. The external position has improved markedly, with a large decline in the current account deficit and a real exchange rate now close to equilibrium.

The economic recovery that started towards the end of 2014 is still fragile and recent economic indicators suggest that private domestic demand is relatively weak. Staff expects growth to increase modestly to 2.5 percent in 2015, mainly thanks to strong fiscal support. Private domestic demand should strengthen somewhat in 2016, primarily as very simulative monetary conditions and a gradual recovery of business confidence sustain private investment.

The balance of risks is on the downside. The main risk is a persistent weakness of private sector confidence and investment, amid continued uncertainty over the structural reform agenda and the external outlook. On the external front, a further decline in copper prices or greater global financial volatility could also derail the recovery. High leverage and heavy reliance on foreign currency debt make Chile’s corporate sector vulnerable to a tail-risk downside scenario, where foreign interest rates increase sharply, the availability of foreign funding dries out, the peso depreciates strongly, and the economic slowdown accentuates.

The financial sector appears generally healthy, with banks showing solid profitability and adequate capital buffers. On the other hand, life insurance companies and pension funds continue to be pressured by the low yield environment and have kept on restructuring their portfolios towards riskier or less liquid assets.

The macroeconomic policy mix has remained highly accommodative. Staff estimates that the cumulative fiscal impulse in 2014–15 was equivalent to 1.7 percent of GDP, mainly reflecting an increase in spending (in infrastructure, education and current transfers). The Central Bank has kept the policy rate at 3 percent after reducing it by 200 basis points between September 2013 and November 2014. The authorities have continued to advance their structural reform agenda. Legislation approved early this year reforms the primary and secondary education systems by ending for-profit education, co-payments and discrimination practices. A labor market reform that aims at expanding the coverage and scope of collective bargaining by empowering trade unions is currently under discussion at Congress.

Executive Board Assessment

In concluding the 2015 Article IV consultation with Chile, Executive Directors endorsed the staff’s appraisal as follows:

Growth has remained lackluster over the past year, as the economy continues to adjust to the end of the mining boom. The main force behind the slowdown has been the sharp fall in fixed investment. To a large extent, this reflects the inevitable adjustment of the Chilean economy to the end of the commodity boom, which had pushed investment and GDP growth to above potential rates over the past few years. The external position has improved markedly, with a large decline in the current account deficit and a real exchange rate now closer to a level consistent with macroeconomic and policy fundamentals.

But the economy has also been negatively affected by the adjustment costs from the structural reform agenda launched in 2014. The decline in fixed investment partly reflects the fall in business confidence which cannot be fully reconciled with the external shocks, and likely results from the uncertainty generated by the structural reform agenda and its short-term costs. If well implemented, the reforms have the potential to boost productivity and long-term growth, but the higher cost of capital and the complexity of the new tax regime are likely to have a negative effect on economic activity in the short-term. Moreover, the announced constitutional and labor market reforms appear to have increased private sector’s uncertainty over Chile’s future economic environment.

GDP growth is expected to increase modestly in 2015 and 2016, but the balance of risks is tilted to the downside. In the baseline scenario, GDP growth picks up modestly to 3.1 percent in 2016 from 2½ percent in 2015. Continued accommodative monetary policy conditions and a gradual recovery of business sentiment will improve non-mining business investment, more than offsetting continued weakness in mining investment. The main risk to the baseline scenario is a more persistent weakness of private sector confidence and investment, amid protracted uncertainty over the structural reform agenda and the external outlook. On the external front, a further decline in copper prices from a deeper than expected downturn in China’s economy would imply more depressed activity in the mining sector, while renewed bouts of global financial volatility and disruptive asset price shifts may tighten external financial conditions for Chile’s highly leveraged corporate sector.

Against this background, the macroeconomic policy mix should combine tighter fiscal policy with continued monetary policy accommodation. As the economy is expected to recover gradually, starting a process of fiscal consolidation next year is warranted. Reaffirming the commitment to fiscal discipline after the fiscal impulse in 2015 would also help boost business confidence. The pace of fiscal consolidation would need to take into account the deterioration of the long-term prospects for GDP growth and copper prices. On the other hand, the beginning of fiscal consolidation, the well-anchored inflation expectations, and the downside risks to growth all give room for monetary policy to remain accommodative until there are strong signs that the economic recovery consolidates.

Nurturing the return of business confidence also requires a careful design and implementation of the structural reform agenda. It is important to minimize the potential for short-term negative effects on growth, including those related to higher uncertainty. In this regard, effective action could be taken to clarify the procedures of the constitutional reform; ensure that the reform of the labor market improves its efficiency; and pursue the education reform with a view to raising the quality of Chile’s human capital, increasing productivity, and lowering income inequalities.

The authorities’ efforts to strengthen public and private sectors’ governance and institutions are commendable. The measures that aims at improving corporate governance, investor protection, and market transparency, could bolster business confidence, increase market liquidity and reduce the cost of capital. Improvements in the institutional framework for PPP arrangements could contribute to mobilizing private financial resources needed to fill Chile’s infrastructure gap, as well as promoting the efficient use of public funds. The recent efforts to restore confidence in public institutions are also needed and timely.

While Chile’s financial sector is healthy, there are a few areas where financial oversight could be strengthened further. The relatively high level of corporate and household debt does not appear to pose risks to economic and financial stability per se, but it may reduce Chile’s resilience to negative shocks and needs to be monitored closely. If the increase in corporate leverage were to accelerate in the future, the authorities could consider adopting additional prudential measures to safeguard Chile’s financial sector against these shocks. The adoption of minimum liquidity standards and the authorities’ plan to send the new General Banking Law to Congress during the second half of 2015 (which will introduce Basel III bank capital standards) are welcomed. While the Financial Stability Council law represents an important step forward, the authorities should keep strengthening the supervision of financial conglomerates. As the insurance companies’ expansion into riskier and less liquid investments continues, it is essential to approve the bill proposal that implements risk-based supervision and introduces new solvency requirements for insurance companies.