Mission Concluding Statement 

Chile: IMF Staff Concluding Statement of the 2023 Article IV Mission

November 21, 2023

Washington, DC:

Chile’s macroeconomic imbalances built during the pandemic have been largely resolved, while the external environment remains challenging. Policy priorities are shifting toward making the economy more inclusive, dynamic, and greener. This will require pension and tax reforms to fund social needs as well as efforts to promote investment particularly for the green transition, including a clear long-term strategy to develop the lithium industry. Moreover, continuously adapting Chile’s very strong institutional policy frameworks to new developments, including for fiscal, monetary, and financial sector policies, will strengthen resilience in a more shock-prone world.

The economy is transitioning to trend growth and targeted inflation

Tighter macroeconomic policies have supported the normalization of domestic demand after the imbalances built during the pandemic. Economic activity has started to show signs of stabilization in the second half of 2023. Staff projects quarterly growth to return to its potential pace in 2024, yielding about 1.5–2 percent real GDP growth next year and 2–2.5 percent over the medium term. Inflation is expected to decelerate to 4–4.5 percent by end-2023 and converge to the 3 percent target in the second half of 2024. The current account deficit is projected to narrow to 3¼ percent of GDP in 2023 and to around 3 percent of GDP in the medium term.

Risks remain elevated

The main external risks comprise uncertainties around potentially higher-for-longer interest rates, commodity price volatility due to the slowdown in China, and the intensification of regional conflicts in the world. These risks could cause abrupt changes in global financial conditions, raise long-term borrowing costs, reduce capital inflows, and lead to lower commodity exports and higher oil prices. As regards domestic risks, political polarization and fragmentation could lead to more reform gridlock. Moreover, social discontent over inequality and the security situation remains prevalent. Also, uncertainty related to the solvency of private health insurance companies is a concern. On the upside, as the world transitions to greener technologies, the expected increase in the global demand for copper, lithium, and renewable energy represents new economic opportunities, given Chile’s rich endowment in these resources.

Monetary policy is on track to bring inflation back to the 3 percent target

The pace of further monetary easing should continue to be data-dependent. Real rates will likely need to remain above their neutral levels for the near future considering the still high core and food inflation, and the pass-through from the rise in oil prices and exchange rate depreciation since July. The pace of policy easing could be faster, however, if projected disinflation accelerates as a consequence of, for example, further intensification of labor market slack, persistently lower oil prices, or a strong exchange rate appreciation. 

Rebuilding foreign reserve buffers is important to enhance resilience

While the flexible exchange rate plays its role as a shock absorber, foreign reserves can provide a shield against potential risks in a shock-prone global economy that could result in disorderly market conditions. Therefore, resuming the Central Bank of Chile’s suspended reserve accumulation program, when market conditions are conducive, would importantly strengthen external buffers. Over the medium term, consideration should be given to how the BCCh’s foreign reserve strategy can adjust to new risks, including from rising external exposures as Chile’s open economy and financial markets continue to integrate globally, with a view to ensuring long-term adequacy of reserve buffers.

Fiscal policy needs to create room for new spending needs while preserving sustainability

While Chile has some fiscal space to support the reactivation of the economy and social needs, frontloading more the deficit reduction would facilitate meeting the government’s medium-term fiscal target. The proposed 2024 budget is a welcome step toward lowering the deficit but implies significant spending restraint in outer years in the absence of political support for new tax measures.

Permanent spending measures should be conditioned on structural revenue performance to preserve fiscal sustainability. The proposed fiscal pact, which links tax reforms with higher social and security spending, aims to modernize the state, increase spending efficiency, and create incentives for growth and investment. It can be an important contribution toward a more equitable and dynamic economy. Caution is warranted, however, against relying too heavily on expected yields of the envisaged measures against tax evasion until there is strong evidence that they can materialize. Rather, further revenue raising options should be considered, such as adjustments to corrective taxes and addressing Chile’s low personal income tax collection. A gradual increase of the carbon price would contribute to achieving Nationally Defined Contribution (NDC) and net-zero climate goals. The proceeds from carbon pricing can be recycled for targeted transfers and public investment to offset the impact on vulnerable households and boost potential growth.

Refinements to Chile’s already very strong fiscal framework would enhance the resilience of fiscal policy. The adoption of a prudent debt ceiling in 2022, the introduction of annual fiscal targets along the medium-term path starting in 2024, and the proposed escape clause, under consideration in Congress, have importantly strengthened the fiscal framework. The new simplified formula for determining structural lithium revenue is another welcome recent framework upgrade that could be refined over time. Moreover, it will be important to link gradual advancement in fiscal decentralization with accompanying initiatives, such as strengthening regional public investment management capacity, enforcing control of governance risks, enhancing regional fiscal transparency and accountability, and broadening the role of the Autonomous Fiscal Council (CFA) to evaluate sub-national fiscal rules.

To strengthen financial sector resilience progressing with ongoing efforts is important

Chile’s financial sector remains resilient, but pockets of vulnerabilities warrant close monitoring. Banks’ capital adequacy and liquidity ratios stand comfortably above regulatory requirements and profitability is around pre-pandemic levels. The financial situation of corporates and households continues to be overall robust. Amid the economic slowdown and tight financial conditions, pockets of vulnerability persist in the construction and real estate sectors, smaller firms with government-guaranteed loans, and low-income indebted households. Non-performing loan ratios have increased but remain around their pre-pandemic level, with recent signs of stabilization. Although banks have accumulated capital and provisions to prepare for future increases in credit costs, banks’ ability to support economic activity could weaken if loan quality in the most vulnerable sectors further deteriorates.

In the context of heightened external uncertainty and higher-for-longer interest rates in advanced economies, policies that support buffers in the banking systems are welcome. The implementation of the activated countercyclical capital buffer (CCyB) will strengthen financial resilience in periods of stress. Calibrating the neutral level swiftly is important to provide banks with planning certainty. In this regard, the BCCh announced the review of the CCyB framework in 2024. The authorities should continue to closely monitor banks’ implementation of Basel III capital and liquidity requirements, and their preparations for the unwinding of the extraordinary pandemic liquidity measures (FCIC) supported by the BCCh’s program that issues “Liquidity Deposits” to facilitate its operational payment. The planned introduction of an industry-funded deposit insurance and bank resolution framework, and the implementation of the Financial Market Resilience Law would further improve financial sector resilience.

Financial regulation and supervision should also continue to keep pace with the digitalization of the financial sector while embracing its benefits. The new Fintech Law aims at promoting innovation in financial services and enhancing financial inclusion. At the same time, the authorities should actively assess and mitigate risks from cyberattacks, strengthening capabilities and preparedness.

Achieving a more inclusive, dynamic, and greener economy calls for further policy efforts

Further efforts are needed to strengthen economic inclusion and reduce inequality. The poverty rate fell significantly on the heels of higher household subsidies and the new minimum guaranteed pension (PGU), however income inequality remains high. Gender gaps narrowed across some dimensions, including higher employment rates for women and greater female representation in parliament, while a gender pay gap persists. Fostering more inclusive growth and lowering income gaps requires continued progress in raising the still low female labor force participation, including by ensuring sufficient childcare and flexible work arrangements, as well as lifting labor productivity by expanding access to high-quality education and workforce training that also keeps pace with new digital requirements. At the same time, caution is warranted against excessive reliance on increases in real minimum wages, beyond current plans, as they could have unintended adverse consequences on formal employment that could partially offset the gains for low-wage earners.

A pension reform remains critical to ensure adequate pensions. Chile’s full-capitalization pension system delivers low replacement rates due to a combination of low contribution density and rates, rising life expectancy, and declining returns. The situation aggravated with the pension withdrawals over 2020–21. The proposed hike in the contribution rate by 6 percentage points would significantly lift replacement rates while ensuring the adequate financing of the system. The PGU has already importantly addressed old-age poverty and improved replacement rates, but it comes at a significant fiscal cost which is likely to increase further given Chile’s demographic dynamics.

Developing lithium and renewable energy industries provide new opportunities for the Chilean economy. Increased global demand for lithium would allow to expand Chile’s production in the medium to long term taking into consideration social and environmental objectives. There is also some room for the development of related industries along the value chain in an investment-friendly environment. An institutional framework that balances the state’s strategic objectives and private investors’ interests will be an important factor to develop the industry. Moreover, Chile’s endowment in solar and wind gives it a comparative advantage in renewable energy production. Since the main bottleneck for greater use of renewable energy is the geographic mismatch between power generation and consumption, continued efforts to improve the transmission network are critical to reap the payoffs. Development of the green hydrogen industry could offer additional growth prospects conditional on technological progress.

Advances in other areas are needed to boost long-term growth. Accelerating investment is a priority and ongoing efforts to tackle long permitting processes are critical to make regulatory procedures more efficient. More can also be done to address labor market informality, which would benefit inclusive growth and revenue mobilization.

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The IMF mission team would like to thank the Chilean authorities and other counterparts for the open and constructive discussions and their hospitality.