Chile - Economic Briefing August 2002

Government and Central Bank Act in Unison to Stimulate Growth  (continued)

Central Bank lowers interest rates amid subdued domestic economy

With core inflation under control, the Central Bank has moved yet again to provide the Chilean economy with an additional monetary boost. Shortly after the publication of the July edition of the Consensus Forecast, the Central Bank decided to lower its benchmark lending rate by 75 basis points from 4.0% to 3.25%. While a more expansionary stance was generally expected, the scope of the move surprised, as markets had anticipated a cut in the range of 25 to 50 basis points. On 8 August, monetary authorities moved again, cutting the benchmark yet another 25 basis points to 3.0%. The Central Bank justified the moves with a more sombre outlook for the global economy. Furthermore, monetary officials stated that the domestic economy developed less dynamically than expected in May and that the pass-through of the exchange rate weakening earlier this year on the general price level was limited. As a result, Central Bank authorities expect that the current interest rate level is consistent with inflationary expectation that see consumer prices converging towards the centre of the 2-4% inflation target range. Consensus Forecast panellists have factored the more accommodating monetary policy and have lowered their year-end interest rate forecast by 30 basis points since last month.

Peso remains stable despite interest rate cut

Despite the monetary loosening, the Chilean peso remained stable in July, hovering between 690 and 700 pesos to the US$. Panellists continue to see some strengthening in the currency towards the end of the year when a pickup in the global economy should exert some upside pressure on prices for Chile’s main commodities. However, since last month, the year-end exchange rate forecast was lifted.

Government implements various tax measures to stimulate growth

On 18 July, the government announced a package of tax measures that seek to stimulate the sluggish economy. The new measures seek to generate higher tax certainty, reduce taxes that affect investment, diminish financial costs, reduce red tape and lower tax costs for exports of services. The tax measures include changes in depreciation tables, which allow for an accelerated depreciation mechanism and imply a fiscal present value cost of US$ 217 million. The government will also grant special income tax exemptions to companies with foreign capital that invest abroad from Chile and thus facilitate Chile’s role as a investment platform in the region. Furthermore, the package eliminates the stamp tax for mortgage credit rescheduling (as long as these credits are for more than one year) and seeks to improve the judicial system to facilitate more effective dispute settlement in the application of tax rules and the resolution of tax lawsuits. Finally, the government plans to accelerate the entry into force of the already signed double taxing agreements with a number of countries.

IMF delivers stamp of approval

On 19 July, only one day after the announcement of the new tax measures, the Executive Board of the International Monetary Fund (IMF) concluded the Article IV consultation with Chile. The IMF considered that the authorities' objectives of promoting a recovery of domestic demand and moderate output growth this year are “broadly appropriate”, particularly in light of the still high level of unemployment. In addition, the Fund explicitly endorsed the recent lowering of the policy interest rate. Regarding the potential spill-over from Argentina and Brazil, the IMF believes that regional uncertainties could adversely affect the economy, but considered that Chile continues to be well placed to adjust to new adverse shocks in an orderly fashion.

Note:  The above text is an abridged version of the LatinFocus Consensus Forecast briefing on Chile.  For more details please click here.

For five-year forecasts, please click here.