Mission Concluding Statement 

Chile: Staff Concluding Statement of the 2024 Article IV Mission

November 26, 2024

Washington, DC: 

The economy’s imbalances have been largely resolved. Economic activity is growing around its potential, and the current account position has continued to strengthen. However, the recovery has been uneven across industries, the labor market is lagging, and inflationary pressure have not yet fully abated. Policy needs are now mainly of structural nature. Priorities include boosting medium-term growth and employment, strengthening fiscal, financial sector and international reserve buffers particularly in the context of a challenging global environment, and further reducing inequality.   

While the economy is overall broadly balanced, risks have risen.

Real GDP is expected to expand by 2.3 percent in 2024, driven by the strong mining and service exports, and 2-2.5 percent in 2025, related to an expected recovery in domestic demand. Inflation is set to remain above the 3 percent target until early 2026, primarily due to the cumulative 60 percent increase in electricity tariffs between June 2024 and February 2025. Moreover, core inflation has picked up in recent months driven by higher shipping costs and sticky service inflation. The current account deficit is on a path to narrow to 2.1 percent in 2024 and widen slightly in 2025/26 due to an expected recovery of investment. The unemployment rate remains high, partly due to the cyclical weakness in labor-intensive sectors such as construction. A conflation of other factors, such as the notable increase in real minimum wages, uncertain business outlook and new regulations, may have also played a role.

The external environment is more unstable and uncertain. The commodity price volatility linked to the economic outlook of Chile’s main trading partners and the pace of the global green transition is a key external risk. Moreover, the uncertainty surrounding monetary and fiscal policies in advanced economies could lead to tight financial conditions for longer periods of time and financial volatility. On the domestic front, concerns about crime, migration, and inequality persist; and political polarization is hindering reform progress.

A boost in Chile’s growth potential is urgently needed.

Chile’s convergence to higher-income economies has stalled over the past decade. Its modest potential growth could be partly due to the weaker connections among its industries compared to fast-growing OECD peers in Asia and Eastern Europe. In particular, the mining sector has limited ties with other domestic sectors of the Chilean economy.

Greater economic dynamism is a must to tackle many social and fiscal pressures, including to strengthen inclusion and address the challenges from population aging and climate change. The government’s growth strategy has important aspects that can pay meaningful growth dividends if swiftly and consistently implemented. Important efforts are underway. Priorities include:

• Expediting investment permit applications and environmental evaluations to facilitate investment by making the process faster and more predictable. These measures are of the highest priority as they cut across all sectors.
• Attracting investment, increasing production, and deepening the value chain to maximize the benefits from new economic opportunities related to the global green transition, notably renewable energy and the lithium industry, given Chile’s rich endowment in these resources.
• Facilitating R&D, which is still low in Chile, and better propagating the benefits of technological progress to enhance productivity growth. In this context, the proposed legislation on technology transfer could stimulate research activities by easing the restrictions on researchers at state universities and allowing them to create or participate in technology companies, and claim the proceeds from research outcomes (e.g., patents).
• Better integrating women into the labor market. Despite the successful reduction of the gender labor force participation gap by about 15 percentage points over the past decade, women’s participation still trails that of men by 20 percentage points. To support this goal, providing flexible work arrangements and improving the access to quality childcare are crucial, including by replacing the current distortionary childcare policy with a broader and sustainably financed program.

The advent of digital technologies and artificial intelligence (AI) offers an opportunity to enhance productivity. However, distributional impacts must be addressed. Chile is among the most exposed to AI in Latin America and could benefit significantly from its adoption. The productivity gain is particularly promising in the private and public service sectors. Promoting technology diffusion, addressing skill gaps, and supporting workers’ transition will mitigate replacement risks, ensuring that AI adoption benefits the economy broadly and equitably.

Following recent swift real minimum wage hikes, pacing further increases in the minimum wage should proceed with caution given the potential impact on formal employment. Giving consideration to creating a minimum wage setting mechanism would allow to insulate future decisions from the political cycle and account for economic developments.

More efforts are needed to build fiscal buffers and ensure fiscal sustainability.

The government’s medium-term goal of reaching a broadly balanced fiscal position by 2027 remains appropriate but has become more challenging. Despite major efforts, mainly cutting spending, the 2024 fiscal deficit will likely exceed its target due to sizeable revenue underperformance. Weaker-than-budgeted revenue in 2024 can also complicate fiscal policy next year. Therefore, it is welcome that the government has lowered its spending plan for 2025 in the context of the budget discussions. It will be important that current expenditure remains nimble and allows for adjustments in case revenue mobilization falls short of plans next year, while investment projects are being executed to support the economy’s growth.

To achieve a broadly balanced fiscal position over the next three years, additional policy measures of at least 1 percent of GDP are needed. The major tax compliance reform could fill part of that gap if the yields materialize as foreseen and these additional revenues are not allocated for new spending priorities. Thus, the commitment to align any structural spending increases with higher structural revenues remains critical for fiscal sustainability. At the same time, to better protect the most vulnerable, the plans to unify the fragmented social programs could improve their access, coverage, and efficacy.

The adoption of the Fiscal Responsibility Law, including the formalization of the debt anchor and annual structural fiscal targets, has further strengthened the fiscal framework. Areas for additional improvement include:

• Further enhancing the transparency of drivers of government debt that are not part of the fiscal balance (“below-the-line items”) as these are estimated to have contributed to about two fifths of the total debt increase over the past 15 years.
• Reviewing currently used forecasting methods, in line with the government’s plans, given recent revenue volatility and forecasting challenges in the context of large economic shifts.
• Preserving and rebuilding the size of the Economic and Social Stabilization Fund (ESSF) in the context of a medium-term strategy, including by saving windfall revenues, to strengthen buffers against tail risks in a more shock-prone world.
• Finally, simplifying the presentation of the fiscal targets and budget execution in the Public Finance Report to deepen the understanding of the fiscal balance rule framework.

Pension reform remains critical to ensure adequate pensions and address the fiscal costs from population aging.

Raising pension contribution rates and the number of periods that people contribute to pensions is critical to ensure sufficient old-age pensions that are sustainably financed. The minimum guaranteed pension (PGU) has significantly strengthened the system’s solidarity pillar, raised replacement ratios for many pensioners, and lowered old-age poverty. However, this has come with a high fiscal cost. With the ratio of pensioners to working age population projected to nearly double over the next two decades, it is critical to contain these spending pressures while maintaining a robust safety net for older citizens. In particular, consideration should be given to making the PGU more targeted to the most vulnerable elderly persons in addition to limiting PGU increases to inflation. The individual pension savings scheme could be further strengthened by gradually aligning women’s retirement age to that of men, linking the retirement age to life expectancy, adopting the proposed insurance that covers pension contributions during unemployment, and further incentivizing the formalization of the labor market.

For monetary policy, the 3 percent inflation target is within reach.

A cautious data dependent approach to the pace of future monetary policy rate cuts is warranted. The real monetary policy rate is currently near its estimated neutral range of 0.5-1.5 percent, with the rise in inflation since June largely driven by the hikes in electricity tariffs. Yet, there are pressures on inflation in both directions. On the one hand, core inflation (which excludes electricity price changes) showed upward dynamics in recent months, and the peso depreciation could add to inflation pressure. On the other hand, long-term rates in the U.S. have remained high and have kept domestic financial conditions tight. This development, together with the weakness in the labor market and planned fiscal tightening, could somewhat mitigate inflation pressure.

Rebuilding international reserve buffers is important for enhancing resilience.

While the flexible exchange rate plays a critical role as a shock absorber, the Central Bank of Chile’s access to international liquidity can provide an additional shield against potential external shocks. This underscores the importance of incorporating a comprehensive international liquidity framework into the Central Bank of Chile’s long-term financial stability strategy and restructuring the current composition of international reserves and other liquidity buffers by resuming the reserve accumulation program, when market conditions are conducive. The strategy and operational design should continue to follow high transparency standards, be persistent and robust to changes in external risks, and minimize distortions in the foreign exchange market.

Financial sector policies need to continue reinforcing resilience.

The financial system is overall sound and resilient, although vulnerabilities related to the real estate sector have been rising. A modest recovery in the sector is projected as the past cuts to monetary policy rates gradually transmit to lower longer-term interest rates. In addition, there are several mitigants to credit risks, including the high share of fixed-real-rate mortgages and strong underwriting standards. Nonetheless, in the risk scenario, the stagnation of the real estate sector due to higher-for-longer long-term interest rates or a slower-than-expected economic growth could increase losses for banks and insurers. Supervisors will need to carefully monitor banks and insurers’ portfolio quality and provisions, including by closing data gaps on commercial real estate and continuing to enhance stress test models to comprehensively assess risks associated with the real estate sector.

Pension fund withdrawals and rising public debt have been reshaping Chiles financial landscape. As the depth of the local financial market has fallen with the pension fund withdrawals, markets have become more volatile and sensitive to shocks. Moreover, in this context of reduced demand for local bonds and higher public debt issuance, non-financial corporations and the government relied more on offshore markets. Although these changes do not pose immediate risks, increasing the pension contribution rate would increase the pool of investable savings and further deepen local capital markets.

Continued implementation of the 2021 Financial Sector Assessment Program (FSAP) recommendations and other resilience-enhancing measures is important. By setting the neutral level of the counter-cyclical capital buffer (CCyB) at 1 percent of risk-weighted assets with a gradual and state-contingent deployment path by taking into account other capital requirements, the central bank has provided banks with planning certainty. Additional priorities include (i) completing the Basel III capital and liquidity requirement implementation, (ii) implementing the Financial Market Resilience Law to help develop the interbank repo market, enhance the BCCh’s ability to respond to financial distress situations, and strengthen the mutual fund liquidity management framework, (iii) making further progress to adopt an industry-funded deposit insurance and a bank resolution framework, and (iv) strengthening consolidated supervision of financial conglomerates. Providing budget independence to the Financial Market Commission (CMF) would help ensure an adequate budget that is commensurate to its expanding responsibilities and financial sector complexities, such as cyber security and fintech.

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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.