OF THE
THE ANNUAL STATEMENT
OF
CENTRAL BANK CHILE
BEFORE
PRESENTATION
THE OF THE
HONORABLE SENATE REPUBLIC∗
Mario Marcel
Governor
Central Bank of Chile
September 2, 2020
I. Introduction
Madame President of the Senate Senator Adriana Muñoz, honorable Senators, ladies, and gentlemen:
On behalf of the Board of the Central Bank of Chile I thank you for the invitation to present the report that,
according to the Constitutional Organic Law (LOC) of the Central Bank, we must deliver annually to the Senate.
In compliance with this obligation, the following presentation includes our vision on recent macroeconomic and
financial developments in the Chilean and international economy, as well as their perspectives and implications
for the conduct of monetary policy, as contained in our Monetary Policy Report (MP Report) of September 2020.
In addition, there are other matters of institutional relevance, related to the Bank's performance in achieving the
objectives assigned by law, the evolution of its balance sheet and technological development. In the September
MP Report, along with a more detailed explanation of the Bank's balance sheet, you can find a summary of the
main decisions adopted by the Board this year to date as well as information on the management of international
reserves.
II. The Monetary Policy Report
The evolution of the macroeconomic scenario, in Chile and around the world, continues to be driven by the spread
of the Covid-19 and the containment measures needed to protect the health of the population. The information
at hand shows that, after a sharp fall at the beginning of the second quarter, in recent months the Chilean
economy has shown signs of stabilization, combining an incipient improvement in some sectors and
deterioration at the margin in others. This stabilization has responded to the evolution of sanitary restrictions,
the adaptation of various sectors to new operating conditions and the boost from economic policies.
The economic impact of the pandemic, however, is very significant and recovery will pose major challenges for
public policies, institutions, and economic agents. The magnitude of this challenge is especially evident in the
high number of people and businesses whose source of income has been disrupted. Reversing the loss of jobs,
the fall in household income and the deterioration in consumption, together with responding to the financing
needs of businesses, avoiding bankruptcies and enabling them to recover, are the greatest challenges for
economic policy at this stage.
As I will show later, based on known activity data and short-term perspectives, we estimate that GDP will end
2020 with a fall of between -4.5 and -5.5%, which compares to the -5.5 to -7.5% range estimated in the June MP
Report and which implies a significant recovery in the second half of the year. However, the closing of the capacity
gaps that widened in this period and the convergence of inflation to the target will only be completed by 2022.
Moreover, this scenario is still surrounded by high levels of uncertainty and significant risks.
Let me now turn to the details of the macroeconomic scenario.
II.1. Macroeconomic scenario
The behavior of the pandemic continues to be the driving factor in the evolution of the macroeconomic scenario.
Several months after it first appeared, the Covid-19 has affected all the countries of the world over the course of
this year, but its current dynamic is varied. While some countries have seen a more favorable evolution, others
have had outbreaks or increases in infections that have yet to be brought under control. In some countries with
good sanitary responses to the pandemic, it has been possible to avoid reinstating tougher restrictions in the face
of new epidemic outbreaks. The Latin American region overall currently accounts for the largest number of new
infections, but they differ from one country to another in terms of their trajectories (Figure 1).
In Chile, health indicators have improved, and the authorities have implemented a plan for gradual
deconfinement nationwide. Thus, the percentage of the national population subject to quarantine has dropped
from its peak of 54% in July to 40% this week. Particularly marked have been the changes in the Metropolitan
Region, where the percentage of the population in quarantine has fallen from 98% in July to 46% today. In terms
of activity, the percentage of GDP generated in quarantined areas has dropped from 65 to 45%.
The relationship between quarantined territories and economic activity, however, is far from mechanical,
depending on sector-specific characteristics, the intensity of the measures in place and the actual behavior of
individuals (Figure 2). Looking ahead, the process of deconfinement is not exempt from the risk of setbacks, as
has occurred in other parts of the world and in some areas of the country.
Globally, the loosening of confinements and the increase in mobility have cooperated to draw activity above its
lowest points of April and May. Production, sales, and expectations show improvements in some countries
(Figure 3). It should be noted that in China the data for the second quarter were above expectations.
Financial markets and commodity prices have been favored by these trends, as well as by the highly expansionary
monetary conditions promoted by the major central banks. The price of copper has fluctuated around $3 per
pound and market volatility has seen significant reductions from its highs of March and April. This represents an
important difference with respect to external shocks that have affected the Chilean economy on past occasions.
Our country's economy contracted by 14.1% annually in the second quarter, its worst record in several decades.
The biggest month-on-month drop was in April, subsiding in May and recovering slightly in June and then again
in July. The sharp initial contraction also occurred in a wide range of countries, although with some nuances
(Figure 4). Among the factors behind these differences are the date that the first cases appeared, the speed of
the spread of new cases, how strictly containment measures were adopted and the response of the population.
In the case of China, the greatest impact of the pandemic was recorded in the first quarter. Peru, on the other
hand, saw a dramatic drop in the second quarter, as strict nationwide quarantine was implemented.
Incoming information for Chile suggests that activity is picking up in sectors that had been particularly hard hit,
such as retail and some services (Figure 5). This reveals that some activities have managed to adapt more quickly
to new forms of operation, notably a more intense use of online sales and teleworking. In contrast, sectors such
as construction, which are highly intensive in on-site work, have suffered greater than expected consequences,
given the territorial and time extension of the quarantines.
Because of its highly contagious nature, the pandemic caused a particularly sharp contraction in demand and
supply in socially intensive areas, directly affecting the incomes of businesses and individuals. This has had a
strong impact on the labor market, including self-employment. Thus, in the moving quarter ending in July, the
annual drop in employment affected slightly more than 1.8 million jobs. About half of this figure corresponds to
salaried jobs, mostly formal. Another 760,000 interrupted occupations correspond to non-salaried workers (i.e.
self-employed workers and employers). Given the restrictions on mobility, the latter have not only been unable
to do business as usual, but have also been unable to fulfill their traditional role of cushioning this type of situation
and probably explain a significant part of the unusual increase in inactivity (Figure 6). By sector, the fall has been
widespread, especially in retail, construction and housing, and food services.
What we see in Chile is replicated in many countries, although with varying intensity. Depending on
countryspecific conditions, there have been sharp falls in employment, significant decreases in hours worked and
increased inactivity (Figure 7). According to the International Labor Organization (ILO), compared to the last
quarter of 2019, in the second quarter of this year hours worked fell 14% globally-the equivalent to 400 million
full-time jobs. The decline has been led by South America (-20.6%), where inactivity has grown substantially. For
the remainder of 2020, the ILO anticipates that, globally, hours worked will continue to remain below
prepandemic levels.
In Chile, the reduction in labor income has continued to be reflected in the evolution of nominal wages and total
hours worked (National Statistics Institute, INE), both remaining around their historical lows. At the same time,
data from the August Business Perceptions Report (IPN), based on interviews with more than 100 company
executives and an online survey of another 760, shows that almost 70% of those surveyed indicated that their
company had cut costs, whether through reduced commissions and bonuses, cutbacks in overtime, or reductions
in base salaries, among other measures (Figure 8).
Household spending has been severely affected by the decline in income, which is reflected in the sharp
contraction of demand in the second quarter, particularly from private consumption. Especially marked is the
drop in services consumption, where social distancing measures have significant effects, such as the dramatic
drop in spending on restaurants and hotels, transportation, health care and leisure activities. Nevertheless, the
short-term outlook for consumption has improved in the third quarter due to a set of support measures and which
is reflected in better business expectations-especially for trade-and, more recently, in improved consumer
expectations. In recent months, a significant number of direct aid programs, subsidies, repayment deferrals and
tax breaks have been implemented. As a result, the balance between the fall in income and aid received improved
significantly between the second and third quarters (Figure 9).
In addition to the above, part of the pension savings was approved for withdrawal. It is estimated that this will
involve resources in the order of 6% of GDP, of which nearly half will go to consumption. As summarized in one
of the boxes of this MP Report, evidence on how the withdrawn savings are being used is still limited. Although
merely qualitative, various surveys show that it will boost both durable and non-durable consumption, while
another portion will be used to pay for financial commitments, saving and investment.
Retail sales data collected on electronic bills are consistent with a rebound in consumption in recent weeks.
According to these figures, compared with the first weeks of August and the last two weeks of July, retail sales
showed a significant rebound, concentrated in the department store segment, which had been the hardest hit
since the beginning of the quarantines (Figure 10). With regard to the possible implications for activity, the effects
on consumption would be more biased towards the purchase of goods-whose production and
commercialization has a greater imported component and is less labor intensive. Notwithstanding this, there is
no doubt that this measure will contribute significantly to the upturn in demand and activity in the near future,
as reflected in our projections. As for the longer-term effects, we must factor in the impact of the reduction in
pension savings, if it is not compensated for, on the country's investment and growth capacity.
The Central Bank, meanwhile, has adopted many measures aimed at providing liquidity to the markets and
stimulating the flow of credit to the productive sector, in order to avoid a more severe disinflationary cycle and
prevent risks to financial stability, which could raise the economic and social cost of the ongoing shock. Thus,
following the June Monetary Policy Meeting, interest rates at different terms posted an important decrease, in
line with the intensification of the monetary stimulus through the purchase of assets and the announcement of
phase 2 of the Financing Facility Conditional on Increased Lending (FCIC). The decline in long-term interest rates
was reversed during the final phase of the discussion of the withdrawal of part of the pension savings, consistent
with the fall in the prices of the assets in which they are invested. However, after a set of measures were
announced by the Central Bank and the regulators, and the Pension Funds Administrators (AFPs) implemented
a portfolio management strategy that mitigated the impacts on local markets, volatility has been reduced and
interest rates have fallen again. Stock market valuations, meanwhile, have followed a trajectory below their
foreign counterparts (Figure 11).
Policy measures designed to confront the current crisis must be able to recognize its distinctive characteristics.
In particular, the current recession differs from past episodes in that its origin is not economic, so the fall in
activity is not caused by problems in specific sectors or markets, but rather by the interruption of the normal
functioning of businesses and activities to combat the spread of Covid-19. This implies that the economic
measures adopted should seek to ensure that companies and individuals survive this period of confinement,
avoiding more permanent damage. The key to mitigating the effects of the pandemic is to get credit flowing to
businesses and allow them to cushion the major drops in their cash flows. Several measures have been
implemented with this in mind, with some elements in common. First, central banks, along with lowering their
benchmark rate to its lowest possible, have established special bank financing programs, conditional on their
increased lending. Some examples are the programs of the Bank of England (Term Funding Scheme with
additional incentives for SMEs, TFSME), the European Central Bank (Targeted Longer-term Refinancing
Operations, TLTRO), and the Central Bank of Chile (FCIC). Second, governments have committed resources that
serve as guarantees for loans, which in the Chilean case are the FOGAPE1 guarantees (Table 1). In Chile, the sum
of both programs is equivalent to just over 15% of GDP, comparable to the resources that have been committed
in Brazil, but far above what has been done in other Latin American countries, such as Peru, Colombia, and
Mexico.
Thus, the combination of the liquidity provided by the Bank, the State guarantees, various regulatory
adjustments and the adequacy of the banking system, has contributed to commercial loans showing expansion
rates above 10% by mid-year (Figure 12). This behavior of credit is very different from what was seen in past
recessions. In fact, both in 1998 and in 2008, a few months after the period of negative activity variation started,
commercial credit began to decline (Figure 13).
Thus, to date, about 230 thousand loans have been granted to small and medium enterprises linked to these
instruments. Also, almost 1.5 million restructurings have been made, 15% of which correspond to commercial
credits. As reported in one of the boxes of this MP Report, the analysis at the individual firm level shows that a
large number of these loans have reached the firms whose sales have been most affected by the pandemic.
Evidence suggests that this access to credit has supported the operational continuity of these businesses and
helped mitigate the drop in investment.
For its part, the asset purchase program announced by the Central Bank in June has helped to improve financing
conditions in the banking and corporate bond market. In this context, the outlook for investment has also
improved with respect since the last MP Report, based on the recent evolution of imports of machinery and
equipment, large-scale energy-related projects and the recently announced public investments and reactivation
measures for the period 2021-22.
Considering the performance of the economy in the second quarter, the gradual withdrawal of the most stringent
sanitary measures and the temporary boost from income support policies, the projection scenario limits the
economic contraction foreseen for 2020. Thus, it is estimated that this year GDP will fall between -4.5 and -5.5%
(between -5.5 and -7.5% in the June MP Report). This range remains wider than usual, reflecting the greater
uncertainty surrounding the impacts of the pandemic. By 2021, GDP will grow between 4 and 5% (between 4.75
and 6.25% in the June MP Report), and in 2022 it will grow between 3 and 4% (same as in MP Report), respectively.
The evolution of activity will be determined by progress in controlling the pandemic and the ability of businesses
and households to overcome its adverse effects. The projection assumes that the sectors where human
interaction is most important will continue to be affected as long as there is no vaccine, so it will take several
quarters for them to return to pre-pandemic activity levels. At the same time, both businesses and individuals
will be able to recover their income levels as activity recovers, a process in which monetary policy support will be
critical. Greater global control of the pandemic will also allow the external momentum to improve significantly
next year compared to 2020.
As for spending, after contracting by 4.2% this year, total consumption will resume positive growth in 2021 and
2022, consistent with a recovery in employment and household income, and with the positive short-term effect
of the withdrawal of pension savings. Plus, the low base that will be left by this year's contraction. The projection
is that the recovery of economic growth will result in an increase in employment, albeit with lags that will vary
according to the categories of occupations, sectors and activities involved. Thus, it is likely that, with the lifting
of the strictest sanitary measures, employment in sectors such as construction and trade will show a significant
upturn, as will self-employment. However, in activities more permanently affected by social distancing, changes
in production methods or technology, the lags may be last much longer. In the short term, the expected recovery
in consumption would be more biased towards goods-with a higher proportion of imports and a lower relative
intensity of employment-than towards services. Thus, after rising by 6.8% in 2021, total consumption will
reduce its expansion to 1.7% in 2022, considering that the temporary stimulus to household spending provided
by the various income support measures will have dissipated and that 2021 will leave a higher basis for
comparison.
Gross fixed capital formation (GFCF), in particular its construction component, will recover as quarantines are
lifted, especially in those works that were shelved. The projection also assumes that the investment projects
postponed this year will be resumed, as derived from the Survey of the Capital Goods Corporation (CBC) of the
second quarter of this year. The highly expansionary monetary policy, the increase in public investment and the
reactivation measures announced by the government will also support the recovery. Non-mining investment will
increase next year, but it will be less dynamic than was expected before the pandemic, given the higher corporate
indebtedness that has been necessary to cover the cash deficits of recent quarters. Considering all of the above,
this MP Report estimates that GFCF will contract 10.6% annually, and then grow 8% and 4.9% annually in 2021
and 2022, respectively.
The projections in this MP Report consider that this and next year the Treasury will provide a significant boost to
the economy, consistent with the various measures announced by the government. However, they assume that
this boost will gradually fade out as the economy converges to its trend growth rates and the recently announced
fiscal consolidation process begins.
Regarding the Current Account balance, contradicting the June MP Report, it is projected to be negative this year
and next. This assumes that liquidity constraints for households and businesses will be lower than expected, due
to government measures to support household income and the withdrawal of part of pension savings. Plus, a
slightly lower than expected deterioration in investment, as well as somewhat better prospects for recovery. All
this reduces domestic saving significantly in 2021 with respect to our June forecast (Table 2).
On the external front, the global growth outlook continues to suggest that, after a major recession this year,
expansion rates above the past 10-year averages will resume in 2021 and 2022. This outlook is slightly more
favorable than predicted a few months ago, especially due to better performance expected for the Eurozone and
China. This is because the greater stimulus ensured by the authorities, in addition to the deconfinements in the
European bloc and the improved performance of China in the second quarter. This contrasts with Latin America,
where the sanitary situation remains particularly complex, despite prolonged and strict restrictions in several
countries. The region is one of the hardest hits in terms of lost activity and employment, with a projected
contraction of more than 9% this year.
Accordingly, Chile's trading partners are expected to see a GDP contraction of 3.5% in 2020 and an expansion of
4.7% in 2021. By 2022, growth of 4.5% is still expected. External financial conditions will remain favorable,
consistent with a still expansionary overall monetary policy, in line with the announcements of the various
authorities, and the recovery of the world economy. The terms of trade will be better than in previous years. This
assumes that in the period 2020-2022 copper and oil prices will average $2.8 per pound and $46 per barrel
(BrentWTI average), respectively. Both projections are higher than expected in June, taking into account the actual
increases of recent months and prospects for a somewhat faster recovery of the world economy (Table 3).
Inflation will converge to 3% by 2022 and in the short term will not fall below 2% annually. Although in the short
term this trajectory is somewhat higher than was forecast in June, largely due to the expected increase in
consumption, in the medium term its main determinant continues to be the lower cumulative activity. The core
measure will remain above 2.5% in the short term, to converge to 3%, also in 2022. Two-year-ahead inflation
expectations remain at around 3% (Figure 14).
Monetary policy will remain highly expansionary, combining the policy rate at 0.5% minimum and
unconventional measures. The latter will be renewed or extended if the recovery of the economy and the
convergence of inflation to the target so require. In turn, the Monetary Policy Rate will remain at its minimum
level for much of the two-year monetary policy horizon. Thus, over the next two years, the Bank will provide a
significant monetary boost to the economy (Figure 15).
The macroeconomic scenario continues to show more uncertainty than usual. The projections recognize that
social distancing will alter the ways to operate in areas where human interaction is key quite longer. However, it
cannot be ruled out that these impacts will exceed estimates, which could be particularly harmful to the recovery
of the labor market because of the many people employed in these activities. This could further weaken demand,
negatively affect growth and inflationary convergence, and require a stronger than expected monetary impulse.
On the other hand, the picture of health risks looks more balanced than it did a few months ago. Cumulative
experience, the prevention measures and the strengthening of the healthcare systems reduce the probability of
repeating the worst episodes of previous months in the event of a resurgence of the virus. Thus, it is possible that
the deconfinements will proceed a little faster, allowing activity and employment to rebound sooner, especially
if a vaccine is developed more rapidly. In such a case, inflationary convergence would require a somewhat less
prolonged monetary impulse.
The possibility of more negative risk scenarios, especially associated with the economic wounds inflicted by the
pandemic, is still present. The various measures have made it possible to maintain credit flowing in line with
working and investment capital needs, breaking the pro-cyclical relationship of credit. Going forward the
materialization of investments, productive adjustments in sectors that have been forced to make profound
changes in their operation, and increases in activity levels, will require that this financing continue to be available.
Therefore, it is essential to ensure a sustained flow of credit, ensuring that the financial system does not see its
levels of capitalization and liquidity deteriorate, whether due to regulatory changes and/or a sharper
deterioration in the repayment capacity of households and businesses. If a credit squeeze were to occur, it would
become a recession amplifier, as on other occasions, pulling the economy out of its expected trajectory. This
would create greater demands on monetary policy, which may or may not be possible to satisfy.
The Board will continue to apply a highly expansionary monetary policy, keeping the Monetary Policy Rate at its
technical minimum for an extended time span, complemented by unconventional measures, and will keep a
watchful eye to prevent risks to financial stability.
III. Central Bank of Chile - Advances and Challenges
The Central Bank of Chile's LOC establishes the obligation to present to the Senate, on or before September 30th
of each year, "an appraisal of the advancement of the policies and programs of the current year, as well as a report
on those proposed for the next calendar year, which shall state the general economic projections on which they are
based and the effects that may occur on the main entries of the Bank's financial statements projected for that
period"2. For some time now, this has translated in more than just submitting the September MP Report to the
full Senate, introducing issues related to the Bank's performance as a state-run organization. Thus, in the two
previous MP Reports we have included our 2018-2022 Strategic Plan and the external evaluation to the policies
implemented by the Bank.
This time I would like to delve into some matters of great relevance for our institution: (1) follow-up to the
Independent Evaluation Panel's recommendations that we shared with this House a year ago; (2) the impact on
the Bank's balance sheet of the of the unconventional measures implemented; and (3) the Bank's progress from
the technological point of view.
III.1. Follow-up to the Independent Evaluation Panel's recommendations
In September 2018, the Bank's Board agreed to commission an external, independent evaluation of the Bank's
performance of its main legal mandates over the past ten years. To this end, it convened five international experts
in the fields of central banking, monetary policy, and financial stability. This Panel, chaired by former Central
Bank of Israel Governor Karnit Flug3, issued a report in September 2019, which, along with positively evaluating
the Bank's performance, made 40 recommendations for improvement. Of these, 24 referred to monetary policy,
14 to financial policy, and two to corporate matters4.
Of this set of recommendations, the Board dismissed two5 and pledged to take action on the remaining ones.
With a little less than a year to go, 23 of the 38 recommendations validated by the Board have been fully complied
with, equivalent to 60% of the total; another 10 are close to completion, and five are still under study, four of
which involve matters requiring legal reforms (Table 4).
Among the main initiatives that emerged in complying with these recommendations, the following deserve
mention (i) The updating of the 2007 document The Monetary Policy of the Central Bank of Chile, which presents
the institutional and operational framework in which monetary policy is conducted, eliminating the "tolerance
range" for the inflation target and introducing the "MPR corridor" as an instrument for communicating the
orientation of future monetary policy, (ii) The publication of the document The Financial Policy of the Central Bank
of Chile, the first of its kind in the country, which presents the conceptual framework and institutional context in
which financial policy is carried out to achieve the objective of safeguarding the normal functioning of internal
and external payments. The first of these initiatives takes on special relevance in light of the similar exercise
carried out by the US Federal Reserve, announced by its Governor last week. Meanwhile, the financial policy
framework has been especially relevant in framing the Bank's decisions in light of the various volatility episodes
experienced in Chile since last November.
From the agenda emanating from the Evaluation Panel's report, I would also like to highlight the Constitutional
and LOC Reform that entitles the Bank to acquire fiscal instruments in the secondary market to contain risks to
financial stability, especially because of the broad understanding and support we received from this Senate
during their discussion. As it was then pointed out, this power will allow the Bank to prepare itself to address
future episodes of volatility in the markets that may jeopardize financial stability and, thus, the welfare of the
population.
As for the recommendations that are nearing completion, preparing a framework agreement with the Financial
Market Commission (CMF) stands out, which includes specific areas and objectives of coordination, exchange,
information utilization and confidentiality, and reciprocal technical assistance.
Following up on another of the Panel's recommendations, the Board has agreed to have these independent
evaluations done on a regular basis. These evaluations will be conducted every two years, focusing on different
areas of institutional responsibility. The first of these will be commissioned next year and will be carried out with
the same degree of independence, rigor, and dissemination as the first one.
III.2. Special measures and balance sheet
Since November 2019, the Bank has adopted a dozen exceptional measures to face present and potential
episodes of financial volatility associated with sharp portfolio re-composition by market agents (Table 5)6. All
these initiatives have had the ultimate goal of complying with the Bank's constitutional mandate, which is the
stability of the currency and the normal functioning of the financial system, but they also have a significant
impact on its balance sheet and its net worth. These measures include the Incremental Financing Conditional on
Increased Lending (FCIC), the extension of collateral for Peso liquidity operations offered by the Bank, and the
Term Purchase and Sale Program (CC-VP) to facilitate the liquidation of pension fund assets. In addition, a flexible
credit line was established with the IMF, the Bank was included in the FIMA Repo Facility of the New York Federal
Reserve, and the volume and possible uses for a Renminbi/Peso swap line with the People's Bank of China were
expanded, significantly strengthening Chile's external position.
Several of these measures have had an impact on the Bank's assets, either by reducing them (sale of foreign
currency) or increasing them (purchase of bonds and loans to commercial banks). The adjustments on the asset
side have counterparts on the liabilities side, either by active measures (repurchase of long-term bonds from the
Central Bank), or by monetary sterilization or liquidity absorption, or finally, to respond to changes in the demand
for cash. The net effect of these operations and portfolio revaluations has an impact on the Bank's net worth.
On aggregate, these operations have involved an 86% growth in the balance sheet in one year, the equivalent of
almost 10 points of GDP. At the same time, there have been significant changes in the composition of the balance
sheet (Figure 16). Now the Bank records on the assets side internal credit items (FCIC-LCL) and local securities.
The latter yield more than international reserves, although with a somewhat higher credit risk compared to the
sovereign securities that make up the former. On the liabilities side, the counterpart has implied an increase in
short-term debt placements (PDBC) and the use of permanent facilities that drain the system's excess liquidity.
There has also been an increase in the monetary base, explained by an incr