The following OECD assessment and recommendations summarise Chapter 2 of the Economic Survey of Chile 2005 published on 4 November 2005.
Economic management is strong, making the economy more resilient to external shocks
Chile’s performance remains strong, underpinned by the authorities’ competent stewardship of the economy. The perception of sound macroeconomic management is now well entrenched, and Chile is the only sovereign borrower in Latin America, other than Mexico, to enjoy an investment-grade credit rating. This achievement should not be underestimated. In particular:
Fiscal policy has so far been guided by the structural budget surplus rule, introduced in 2000, but not set in law, calling for a budget surplus of 1% of GDP adjusted for the effects on public finances of the business cycle and fluctuations in the price of copper.
Framed in a now fully-fledged inflation targeting set-up, monetary policy has been implemented in a forward-looking manner. Inflation is converging to the mid-point of the inflation target band of 2-4% and is expected to remain tame over the near term. The gradual withdrawal of monetary stimulus since September 2004 is appropriate.
Structural reform, facilitated by a comparatively high degree of political cohesiveness, continues to aim at unlocking opportunities for growth, making the economy more resilient to external shocks, more diversified in its export base, and less vulnerable to the vagaries of international commodity prices.
Fiscal institutions have been strengthened, but the future of the structural budget surplus rule is uncertain
The delegation to expert panels of responsibility for the estimation of trend output growth – a key parameter in the calculation of structural budget balances – as well as the reference price for copper, has greatly contributed to boosting transparency and confidence in the policy framework, by in principle helping to protect it from political interference. Insulating the fiscal stance from terms-of-trade fluctuations is a considerable achievement in the Latin American context, where reliance on natural resource-related revenue is often the main culprit for fiscal pro-cyclicality. Nevertheless, the authorities are not in favour of setting the fiscal rule in law, although they are taking steps towards maintaining the calculation of the structural budget balance as an integral part of the budget-making process in the years to come. This should encourage continued adherence to fiscal rectitude by successive administrations, regardless of their political orientation. While the principle of the structural budget rule should be maintained, the actual level of the structural budget balance will need to be set for the near term. In doing so, it will be important to take into consideration the pressures on the budget that are likely to arise in the years to come in connection with the pension system, in addition to the financing needs of the central bank, whose capitalisation remains unresolved.
Further pension reform will be required and the pre-funding of future contingencies is advisable
Recent analysis suggests that the dynamics of central government debt pose negligible fiscal risk over the medium term, predominantly by virtue of its current low level in relation to GDP. The transition costs associated with the pension reform of the early 1980s are fading. But, based on partial information available to date, the coverage of the pension system and the density of contributions are low: only about 55% of the labour force currently contributes to a pension fund and, of these, one-half do so for no more than 60% of their working lives. As a result, there is considerable uncertainty about the future cost to the budget of the guarantee of a minimum pension to those workers who have contributed but at a level that is insufficient to ensure a retirement income at or above the minimum pension. A related issue refers to the assistance pensions, which are not an entitlement, and hence do not pose a fiscal risk per se. But the value of these pensions is currently about one-half of that of the minimum pension, and this discrepancy may well not be politically sustainable over the years. Closing this gap is likely to affect the incentives facing individuals to save for retirement and would in turn affect the density of contributions and the cost to the budget of alternative social protection policies over the longer term. It is therefore important to find an appropriate balance between the incentives for saving for retirement and the desirable breadth of social protection, which should be high on the policy agenda. Dealing with these contingencies calls for pre-emptive action, which could involve some pre-funding, benefiting from the currently healthy fiscal position. Options for increasing the density of contributions, in particular for females and the self-employed, could also be considered. Fostering transparency in the disclosure of information on, and regular updating of, actuarial projections, preferably as an integral part of the annual budget-making process, would contribute to mustering the necessary public support for further reform in this area and allow individuals to save more, if necessary.
Fiscal consolidation has allowed for a counter-cyclical policy stance while reducing public indebtedness
Fiscal management has been beyond reproach in recent years. The main achievement in this area is the maintenance of a counter-cyclical policy stance. This owes much to the gradual reduction in the public debt overhang, resulting from continued adherence to the structural budget surplus rule and its well-functioning, credible mechanism for smoothing copper-related fluctuations in revenue through the Copper Stabilisation Fund. The consolidated net public debt (central government and central bank) came down to less than 6% of GDP in 2004 from nearly 34% of GDP in 1990. The stock of debt is much higher when taking into account government guarantees of public enterprise liabilities, as well as the “recognition bonds” issued to cover the transition costs associated with the pension reform of the early 1980s. It will therefore be important to build on the achievements of recent years by resisting pressure for greater activism in the years to come justified on the basis of low indebtedness and the need to satisfy multiple social demands. In particular:
The steady decline in indebtedness has generated an “interest dividend”, allowing scarce budgetary resources to be channelled to cost-effective, externality-rich social programmes, consistent with attainment of the government’s social objectives, while maintaining a relatively low, pro-business tax burden. But Chile’s record in education, evaluated by international standardised tests, as well as some health indicators, leaves ample room for improving the efficiency of government spending in these areas. It will be important to ensure that future increases in public social spending translate into better outcomes and that sources of finance be found predominantly through the reallocation of budgetary resources away from lower-priority outlays, rather than by raising the tax take.
Low public indebtedness has also contributed to making the Chilean economy less dependent over time on external financing and hence more resilient to adverse shocks, although private external debt is large. Domestic debt management has been prudent and could continue to gradually reduce the stock of USD-denominated liabilities and replace inflation-indexed debt by CLP-denominated debt paying a nominal coupon, contributing to the development of the domestic fixed-income market. The authorities are aware that vigilance will be required to ensure that the withdrawal of USD-indexed debt does not put undue pressure on the foreign exchange market. Also, the pace at which inflation-indexed instruments are redeemed will need to be guided by a judicious assessment of the demand for these securities by pension funds and insurance companies, which hold the bulk of traded government debt.
Chile has maintained a counter-cyclical fiscal policy stance, 1990-2005
Source: Ministry of Finance and OECD calculations.
Monetary policy remains cautious and medium-term inflation expectations appear well anchored
The inflation targeting framework for monetary policymaking has been strengthened over the years and is functioning well. In 1999, the central bank abandoned its policy of also targeting the nominal exchange rate, which it had pursued since 1984. In doing so, it has allowed the exchange rate to play a greater role in the stabilisation of activity in response to external shocks. In 1999-2000, the monetary framework for fully-fledged inflation targeting was put in place, including the upgrading of the central bank’s modelling and forecasting capabilities and the strengthening of its communications strategy to enhance transparency and credibility in the policy framework. There are nevertheless options for consideration within the central bank’s policy research agenda. With headline and expected inflation already safely anchored in the 2-4% target range, the central bank could consider the pros and cons of targeting core, rather than headline, inflation and the associated adjustments to the width of the target band.
Inflation targeting is working well: inflation is within the target band
Source: Central Bank of Chile and OECD calculations.
Return to the Economic Survey of Chile 2005
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