1. Introduction

For public finance in Chile, the period 2006-2009 has shown record performance indicators in its history since the existence of comparable statistics. This is not only reflected at the level of aggregate fiscal figures, but also at the institutional consolidation of the structural balance policy. For that reason, the analysis of fiscal results from this period becomes especially interesting.

Since it doesn’t happen very often, during the administration period of 2006-2009, the two phases of the economic cycle were accentuated. First, there were three years during which the copper price, the main income source for Chile, was historically high, and that was followed by a year marked by the greatest international economic crisis since the Great Depression.

Structural balance fiscal policy, implemented in Chile since 2001, was thus subject to the difficult challenge of demonstrating its effectiveness in both phases of the cycle. Today, when signs of recovery in the activity are seen, it can be pointed out that the applied fiscal policy passed the test successfully. In turn, the experience allows for reflection on how it can be perfected.

The strengths of the fiscal policy implemented in Chile during the period 2006-2009, derive from the principle of fiscal accountability, which has implied the consideration of its long term effects referred to the sustainability of spending programs, to the non-erosion of structural fiscal revenues, to the protection of social spending and public investment and to the institutionalization of good practices which started out as voluntary. This orientation also implied a decidedly counter cyclical approach in both phases of the cycle: saving during the copper price boom and not saving during the global economic crisis; and, transversal to these objectives, applying higher spending quality, transparency and accountability standards.

In this context, the present paper describes fiscal performance of the period 2006-2009 in prospect, as well as the implemented institutional improvement concerning public finance. Section 2 briefly describes the macroeconomic scenario during the period. Section 3 gives details about the principal innovations during the period related to public finance, including the institutionalization of structural balance through Law No. 20,128 on Fiscal Accountability and the creation and management of the Sovereign Funds from the Public Treasury. Section 4 shows the main fiscal results of the period and compares them with those of the previous administrations, from 1990 up to date. Section 5 presents the conclusion and challenges concerning public finance that should be faced by the next administrations.

2. Macroeconomic Context

There are two elements of the macroeconomic context that were especially relevant for Chilean fiscal policy during the period 2006-2009. First, the historically high price copper attained in the first three years, mainly fostered by the increase in China´s demand and the other emerging Asian economies, which implied a significant increase in fiscal revenue. And second, the international financial crisis, which had a strong repercussion in Chile during the last quarter of 2008 and 2009, causing a decrease in product, employment and fiscal revenue.

Below, there is a description of the evolution of the main macroeconomic variables in Chile for the period 2006-2009. This information is summarized in Chart No. 1.

The period started in 2006, a year when the Chilean economy experienced a real growth of 4.6 % of the GDP, whereas domestic demand showed a real increase of 6.8%. Both figures were lower than those expected at the time, a result mainly of a strong increase in the energy costs, derived from higher international oil prices. This increase also had an incidence on an inflation rate slightly higher than the average target range, which reached 3.4% annually. That year was also positive for employment, because the unemployment rate was reduced from 9.2% in 2005 to 7.8% in 2006.

The world activity level kept the demand for raw materials high, causing the already high prices in 2005 to continue increasing during 2006. In this scenario, a pound of copper increased from US$1.67 in 2005 to US$3.05 in 2006, with a favorable impact on the Chilean fiscal revenue. Similarly, WTI oil reached an average price of US$66 per barrel, higher than US$56 in 2005.

2007 was characterized by a sustained increase in international prices of raw materials, which increased the price of copper to an average value of US$3.23/lb. and the price of WTI oil, to an average of US$72/barrel. Similarly, in the country, there was less availability of hydrologic resources to generate electricity due to rainfall levels, which in a context of natural gas shortage and high oil prices, considerably increased energy prices. During 2007, a decrease in global economy dynamism was also observed, a result of the sub-prime crisis, which would have its greatest effects in the subsequent two years.

In this scenario, Chile’s economy grew 4.7% in real terms, showing an important deceleration in the second semester, explained by the above mentioned increase of the energy cost. Domestic demand showed a real expansion of 7.8%, whereas real investment reached a record figure of 25.7% of the GDP. The year was positive for employment, because the average unemployment rate decreased to 7.1%.

Inflation was again over the target, reaching an annual average of 4.4%. In this increase, there was, in addition to the energy cost, the higher cost of food, due to international factors and adverse climatic conditions.

In 2008, the Chilean economy grew by a real 3.2%, showing in the last months the effects of the global financial crisis, which was displayed with a huge deceleration of the global economy, which in turn caused a strong drop in Chile’s main export prices. Thus, in the fourth quarter of 2008, exports fell 26% with relation to the same period of the prior year. In addition to this, there was a substantial increase in international interest rates, as well as restrictions to external indebtedness.

All of the above mentioned reasons led to a strong deceleration of domestic demand in Chile: while the latter grew 10.1% on average in the first quarters of 2008, during the last quarter, it shrank 0.2%, ending the year with a 7.4% annual growth. In spite of this, fixed capital gross formation obtained a new 29.7% record of the GDP. Regarding employment, it continued to grow during the first three quarters of the year, at an average rate of 3.1%. But in the last quarter, there was a gradual reduction in the creation of employment, which determined an average unemployment rate of 7.8% in that year.

The increase in food and fuel international prices, plus the price increases in generating energy and local agricultural products carried over from 2007, caused inflation, which in the first three quarters was over the 9% average for twelve months. In the last months of the year, the international economy deceleration rapidly reversed this trend, which allowed closing the year with an average inflation of 8.7%.

In 2009, the worst effects of the international economic crisis started to appear. According to the International Monetary Fund, the world GDP was reduced by 2.6% and the international trade volume shrank 12.2%. In Chile, the crisis appeared with a reduction in economic activity, especially of domestic demand, which weakened the labor market and reduced the inflation rate. Thus, during 2009, GDP fell 1.6% in real terms, whereas domestic demand shrank by 5.5%. On the other hand, the unemployment rate increased up to a 9.8% average, whereas annual average inflation dropped to 1.5%.

Fixed capital gross formation decreased 14.8% along the year because of the postponement of investment projects due to the uncertainty of the crisis, and so, the real investment rate in fixed capital was 24.9% of the GDP, which is still high compared to previous periods.

 

Rev 73 - Art Public Finance Chile - Chart 1

 

3. Perfecting Public Finance during the Period 2006-2009

3.1. Institutionalization of Structural Balance

In September 2006, Law No. 20,128 on Fiscal Accountability was issued, which institutionalized key aspects of the structural balance and the fiscal policy. Although many of them had been applied since 2001, they had previously only depended on administrative actions and the authority’s involvement.

This law gathered recommendations from organizations, such as the International Monetary Fund, Inter-American Development Bank, the World Bank and the Organization for Economic Cooperation and Development, and thus, reflects the best international practices in the field of fiscal accountability and transparency. This legal initiative had wide and transversal support, generating consensus about the relevance of fiscal discipline for the citizens’ welfare.

In the field of structural balance, the law stipulated the President of the Republic’s duty of establishing within 90 days after the date in which he/she takes office, the bases for the fiscal policy to be enforced during his/her administration. Said statement should refer to the implications and effects that said policy will have on structural balance#.1

The law also sets forth the governments’ duty to deliver information regarding the structural status of public finance, to reflect the sustainability of its fiscal policy and its macroeconomic and financial implications. In this manner, the calculation of the structural balance of the public sector was incorporated as part of the fiscal financial program#.2

3.2. Creation and Management of Sovereign Funds

The Fiscal Accountability law created two Sovereign Funds: the Pension Reserve Fund (in Spanish, FRP) and the Economic and Social Stabilization Fund (in Spanish, FEES)3. The FRP, which was perfected in its design in 2008 through Law No. 20,255 of the Pension System Reform, is destined to supplement the funding of fiscal duties derived from the solidarity basic pensions for the elderly and handicapped and the solidary pension system contributions defined for said contingencies4. This also had the objective of distributing, over time, the financial burden that should be faced by the State for the concept of these liabilities, making it sustainable and at the same time, making this responsibility transparent and explicit.

The FRP is increased annually with a contribution equivalent to the effective surplus of the prior year, with a 0.5% ceiling of the GDP and a floor of 0.2% of the GDP, plus the product of profitability generating the investment of its resources. The contributions for the concept of effective surplus will be made only until the year in which the accrued resources reach an amount equivalent to 900 million fostering units (corresponding to approximately US$40,000 million). The FRP´s resources may be used once ten years have elapsed from the effective date of the law, establishing as a maximum annual withdrawal the amount equivalent to a third of the difference between the total spending that corresponds to the respective year for the concept of the above mentioned fiscal duties and the total spending made for said concept in 2008, annually updated through the variation of the Consumer’s Price Index (IPC, in Spanish).

The FEES, in turn, refunded the old Compensation Funds of Copper Revenue (established through Decree-Law No. 3,653 from 1981 and the Loan Agreement IBRD No. 2625 CH). Its main objective is to grant fiscal stability to the Treasury, upon accruing part of fiscal surpluses to ensure funding of the public budget in loss-making years. The FEES increases annually with a contribution equivalent to the balance resulting from subtracting the contribution to the FRP and the capital contribution to the Central Bank of Chile, allowed by the Fiscal Accountability Law, from the effective surplus of the prior year. Extraordinary contributions can be made, decided by means of the decree of the Ministry of Economy, coming from the sale of assets or debt issues; as well as other resources authorized by other laws. Accrued funds can be addressed to funding the Budgets Law, to the substitution of income and/or funding of further spending occurring during the budget enforcement; to depreciations and interests for the concept of Public Debt and payment of Acknowledgement Bonds, and to funding of contributions to the FRP.

 Thus, the FEES represents a necessary supplement to the structural balance policy by avoiding the exposure of social spending and public investment to the economic cycle oscillations and strengthening the competitiveness of Chile’s economy upon facilitating public saving.

By law, the investment of resources from both funds should be decided by the Ministry of Economy and should be performed by means of hiring portfolio administration services or directly by the Treasury Service. Delegation of the management of all or part of the funds of the Central Bank of Chile is also permitted, in its capacity of fiscal agent. This capacity has been exercised by President Michelle Bachelet´s administration, through the Supreme Order No. 1.383, from 2006.

To determine the investment policy of Sovereign Funds and to give the pertinent instructions, the Ministry of Economy should legally rely on the advice of an independent Financial Committee. Order No. 621 from 2007 created this committee, regulating its functions, integration and standards of procedure.

Finally, for the sake of transparency and accountability, the law obliges the Ministry of Economy to issue quarterly reports about the status of the funds. Every three years, the Ministry of Economy also has to entrust the performance of an actuarial study in order to assess the FRP´s sustainability.

3.3 Further Improvements in Financial Management

a. Contingent Liabilities

The Fiscal Accountability law requires the government to divulge the commitments that it has assumed through granting fiscal guarantee. For that, the Budgets Direction of the Ministry of Economy should annually disclose the total amount and the characteristics of the obligations to which the State guarantee has been granted. It also has to estimate the financial commitments resulting from the application of the legal or contractual provisions which generate contingent liabilities, such as the guarantees given for infrastructure grants and those given to loans for higher education. With the purpose of facing the future cost associated to the eventual execution of any of those guarantees, the law gave the Ministry of Economy the capacity to establish provisions or hiring insurance to cover said risks.

b. Contingency Program against Unemployment

The Fiscal Accountability law gave permanent character to the Contingency Program against Unemployment, which has been annually established in the Budgets Law, and established requirements for the actions intended to face eventual high unemployment problems at national, regional, provincial or community level. Supreme Order No. 1,606 from 2007, of the Ministry of Economy established the guidelines, mechanisms and application procedures of the Program resources. Thus, the program may operate when the quarterly national unemployment rate is equal or higher than 10% or when it exceeds the average of this indicator in the previous five years. The program may also be applied in regions or provinces with an unemployment rate equal or higher than 10%, or in communities wherein the unemployment rate is equal or higher than said percentage, even if the respective region or province is lower.

c. Capitalization of the Central Bank of Chile

The Fiscal Accountability law gave the Treasury the capacity, through the Ministry of Economy, to make capital contributions to the Central Bank of Chile, up to an annual maximum amount equivalent to the balance resulting after subtracting the contribution made to the FRP from the effective surplus, with a limit of 0.5% of the Gross Domestic Product of the previous year. This capacity was set for a term of five years as from the date of publication of the law and was exercised in 2006, 2007 and 2008#.5 This capacity was justified to improve the assets of the Central Bank of Chile, which was slightly frail since it had to rescue the private banks as a result of the crisis in 1982, and a result of the accumulation of international reserves in the nineties. In order to assess the impact of capital contributions and to check the improvement of the Central Bank of Chile´s asset situation, the law orders the Ministry of Economy to entrust an economic-financial study.

4. Performance of Public Finance during 2006-2009 in Perspective6

4.1. Consolidated Central Government Spending

To assess the dimension of the goods and services that the governments provide to citizens, a useful approach is the dimension of public spending (Graph No. 1), especially its social spending and investment components. Social spending includes all the social protection, education, health and housing programs. For this reason, its dimension is an indicator of the benefits received by people from public policy in these areas. On the other hand, investment includes the projects of infrastructure of public works, health, housing, education and sports facilities, among others, in all the country regions, having influence on the potential growth capacity of the economy and on the generation of direct or indirect jobs.

Upon analyzing these figures, the execution of the Fiscal Boost plan in 2009 stands out as it is fostered by the government to make the economy more dynamic and to generate employment in view of the international economic crisis. The plan considered measures for US$4,000 million, equivalent to 2.8% of the GDP, which, according to the International Monetary Fund, positioned it, at the time of an announcement in January 2009, as the fifth largest in the world, in terms of GDP percentage. Among the most relevant public spending measures is an extraordinary public investment program with the amount of US$700 million and a special $40.000 bond for family dependents for beneficiaries of the Family Grant (in Spanish, SUF), of the Chile Solidario System and receptors of family allowances, which implies over 3,700,000 beneficiaries7.

Considering the dimension of the plan, it is pertinent to analyze the evolution of public spending with and without it. The total spending of the average Consolidated Central Government for the period 2006-2009, including the plan, turns out to be similar to the percentage of the GDP to the 1990-2005 average (20.8% versus 20.6%). The public investment component in 2006-2009 also follows the trend in prior years (2.3% versus 2.4% of the GDP), whereas the social spending component presents a positive difference (13.9% versus 13.5% of the GDP), aligned to the implementation of a social protection system for the citizens (Chart No. 2). If 2009 Fiscal Boost plan were not considered, social spending for the period 2006-2009 would be equivalent to 13.7% of the GDP and would be above the average amount for the period 1990-2005, whereas the investment would be equivalent to 2.2% of the GDP, slightly below the average of the period being compared.

 

Rev 73 - Art Public Finance Chile - Graph 1

 

Rev 73 - Art Public Finance Chile - Chart 2

 

4.2. Volatility of the Spending of the Consolidated Central Government

The dispersion of public spending regarding its trend helps to identify its volatility. Less volatility is desirable because of its impact at the macroeconomic level, its higher predictability of the fiscal policy and its effect on the beneficiaries of government programs who do not suffer from sudden changes in the services received. The latter is especially relevant for the population because letting the public spending be subject to the ups and downs of the economy, implies implementing public policies that have to be cut later, because of the lack of resources to support them.

This indicator has been established assuming an exponential growth trend for spending in the last 20 years. From the trend, the 2009 Fiscal Boost plan has been excluded, which was adopted precisely to move the spending away from its trend, increasing it with the purpose of acting in a counter cyclical manner before the effects of the global economic crisis. Thus, for the period 1990-2009, a volatility of spending of the Consolidated Central Government of 2.69 % average is confirmed. In addition to measuring average dispersion for the total number of years under analysis, the spending trend is considered in each sub period, with the aim of measuring the volatility of each administration’s spending regarding its own trend (Chart No. 3). This measurement shows that in the period 2006-2009, spending showed an average dispersion of 0.84% regarding its trend (excluding the Fiscal Boost plan), not much taking into account the variation experienced by the macroeconomic scenario, and it was less than the average variation of the period 1990-2005, which reached 0.99%#.8

 

Rev 73 - Art Public Finance Chile - Chart 3

 

4.3. Effective Income of the Consolidated Central Government

The analysis of the total income of the Consolidated Central Government (Graph No. 2) allows an approximation to the Treasury’s capacity to sustain its spending, which, as already pointed out, is an indicator of the goods and services supplied to the citizens. Period 2006-2009 is clearly the one with the highest average fiscal revenue since 1990, reaching 25.4% of the GDP, which is equivalent to 3.6 percentage points more than the average for 1990-2005 (Chart No. 4). This is mostly due to the high copper prices, especially between 2006 and 2008, although it was also influenced, among other factors, by the decrease in tax evasion which, in the case of VAT, passed from levels higher than 20% in the nineties, to less than 10% nowadays9.

 Rev 73 - Art Public Finance Chile - Graph 2

 

Rev 73 - Art Public Finance Chile - Chart 4 

4.4. Effective Balance of the Consolidated Central Government

The Effective Balance, defined as the difference between the overall income and the total spending of the Consolidated Central Government, is traditionally used to analyze the Treasury’s financial sustainability, understanding that it is not feasible to keep deficits for a long time if they are not compensated by surpluses in the mid-term. International experience shows that the Treasury´s financial insolvency has disastrous economic and social consequences on the population, from which it can take years to recover. For this reason, monitoring this variable is a key issue.

In general terms, this sustainability condition is completely fulfilled during period 1990-2009 in Chile (Graph No. 3). Consistent with average spending that has not increased substantially with respect to the prior administrations as percentage of the GDP, combined with significantly higher fiscal revenues, a record average effective balance of 4.6% of the GDP can be observed during period 2006-2009 (Chart No. 5).

These high effective balances are closely related to a structural balance policy, which is a determining factor of the decision to not spend all the available income in the period 2006-2008, but only that considered as long term, saving the difference associated to transitory income. Precisely, the saving of these resources, has allowed the sustainability of the effective deficit projected for 2009.

 

 Rev 73 - Art Public Finance Chile - Graph 3

 

Rev 73 - Art Public Finance Chile - Chart 5 

4.5. Structural Balance of the Consolidated Central Government

A more precise measurement of fiscal sustainability is the structural balance of the Consolidated Central Government, defined as the effective balance adjusted according to the cyclical effects of the economy which affect fiscal incomes. Following the criteria defined by the IMF and the OECD, adapting them to the own features of the Chilean Treasury, the cyclical effects to consider in our country are mainly the existing gaps between effective and tendency GDP, and among effective copper and molybdenum prices and their respective long term prices.

In this manner, the structural balance distinguishes movements in fiscal performance which come from political decisions from those coming from the cyclical effects pointed out above, enabling a better diagnosis with regard to its sustainability.

From the moment the government adopted the structural surplus policy in 2001, the volatility of structural balance has been decreasing (Graph No. 4). This is also valid for period 2006-2009, with an average of 0.6% of the GDP being equal to the one in the previous sixteen years (Chart No. 6).

Evidently, in ex post structural balance , the ex ante fixed goal is the determining factor, which in recent years has decreased from a surplus of 1% of the GDP between 2001 and 2007, to 0.5% of the GDP in 2008, and 0% of the GDP in 2009 and 201010. It is worth mentioning that for 2009, the projection is a structural deficit of 0.4% of the GDP, which, although being a deviation from the goal, in part explained by the higher spending implied by the Fiscal Boost plan, does not even remotely consider relinquishing the structural policy because the Budgets Law for 2010 was elaborated and approved in a manner consistent with the preset goal.

 

 Rev 73 - Art Public Finance Chile - Graph 4

 

Rev 73 - Art Public Finance Chile - Chart 6

4.6. Central Government’s Total Debt

The government’s debt level is also an important indicator of its financial sustainability, because it is not feasible to keep a high level of indebtedness in relation to the GDP for a long period of time without falling into the risk of insolvency. To keep public debt of small magnitude increases the Treasury´s credibility as debt issuer, which improves the access to external funding and reduces the indebtedness cost of the companies that issue debt at an international level, because the sovereign debt acts as a point of reference for the rates the latter pay.

Every year since 1990, the Chilean government has never had such low debt levels as in period 2006-2009 (Graph No. 5). Thus, on average, for President Michelle Bachelet´s administration, a gross debt equivalent to 5.4% of the GDP is projected, in contrast to that in the period 1990-2005 which reached 19.8% of the GDP (Chart No. 7), and in even more marked contrast with 1990, when the gross debt rose up to 45% of the GDP. Even though in 2008 and 2009 a slight increase of gross debt is seen, partly to fund the Fiscal Boost plan, the trend indicates that it will remain in its historically low level.

 

Rev 73 - Art Public Finance Chile - Graph 5

 

Rev 73 - Art Public Finance Chile - Chart 7

 

4.7 Spending on Interests of the Consolidated Central Government

High levels of debt of the consolidated Central Government not only can indicate its weak financial position, but also can increase its funding cost and make access to new debt difficult; effects that were passed on to national companies. It also implies allocating resources of the public budget to interest payments, giving up the supply of goods and services to the citizens.

During this last period, as the debt has been reduced to historically low levels, average spending on interests has been decreased to record levels (Graph No. 6).These obligations have been minimized to 0.6% of the GDP and to 2.9% of the consolidated spending on average, in contrast with the burden of 1.6% of the GDP and 8% of spending in the period 1990-2005 (Chart No. 8).The importance of paying less interests lies in that those resources, instead of supporting financial obligations to settle past obligations, may be assigned to current public policy priorities, either of investment or social spending, for the direct benefit of the citizens.

 

Rev 73 - Art Public Finance Chile - Graph 6 

Rev 73 - Art Public Finance Chile - Chart 8

 

4.8. Financial Assets of the Public Treasury

As counterpart of the debt level, the level of financial assets of the Central government is a sign of financial support.

Within the context of the structural balance policy, the Treasury´s high incomes during the period 2006-2009 meant an efficient accumulation and investment of the highest level of financial assets that Chile has had since 1990 (Graph No. 7). It is estimated that they will reach 12.4% of the GDP average during President Michelle Bachelet´s administration, in contrast with 4.0% of the GDP on average for the period 1990-2005 (Chart No. 9). Even though a decrease in the level of financial assets is projected for 2009, in part because they were used to fund the Fiscal Boost plan, it is estimated to close the year with a level equivalent to 11.4% of the GDP, which implies that the next administration will inherit financial assets like no other in the country’s history.

 

Rev 73 - Art Public Finance Chile - Graph 7

 

 

Rev 73 - Art Public Finance Chile - Chart 9

4.9. Income through Interests of the Consolidated Central Government

A large accumulation of financial assets of the Consolidated Central Government not only provides sustainability to spending programs, but it also generates income through interests that may be used to fund the social spending or public investment budget in the short term.

Although its percentage of total income and of the GDP is still lower than other income allowances, the trend indicates that income through interests have gained importance, directly associated to the accumulation of financial assets occurring during period 2006-2009 (Graph No. 8). These incomes pass from a representation of 0.2% of total fiscal income during period 1990-2005, to 1.8% during period 2006-2009 (Chart No. 10). Therefore, nowadays, the Chilean Treasury has an additional source of revenue to be used for the citizens’ service, provided by the interests of its financial investments. This source of income, in addition, has an adequate institutional support in the Fiscal Accountability Law, which sets forth that the Minister of Economy should rely on the advice of a Financial Committee to determine the investments of the assets of the Sovereign Funds (FRP and FEES).

 

Rev 73 - Art Public Finance Chile - Graph 8

 

Rev 73 - Art Public Finance Chile - Chart 10

4.10. Net Debtor /Creditor Position of the Consolidated Central Government

The net debtor/creditor position of the Consolidated Central Government is perhaps the most precise and revealing indicator of its financial solvency. By combining record levels of high financial assets as well as low debt assets, the period 2006-2009 also presents the best net position since 1990 (Graph No. 9a). For the first time, a net creditor position is shown, equivalent on average to 7.0% of the GDP during period 2006-2009, which contrasts against the net debtor position during period 1990-2005, which reached an average of 15.8% of the GDP (Chart No. 11a). As net creditor, others owe the Chilean government more than what it owes others, something that had never happened before in history.

 

Rev 73 - Art Public Finance Chile - Graph 9a

 

Rev 73 - Art Public Finance Chile - Chart 11a

International indicators of financial position usually exclude pension system fiscal liabilities, basically for not being duly quantified or documented, especially in the countries having apportionment systems. In the case of Chile, Acknowledgment Bonds can be included, because there is updated and detailed information about the evolution of the payment foreseen for this concept over time. Fiscal accountancy indicates the active stock of this pension system liability as information attached to the Statistic Report of Public Debt, but, in compliance with international practices, it is not included in the Central Government Gross Debt.

With a more accurate measurement of financial position, which includes the Acknowledgement Bonds as public liabilities, the period 2006-2009 is just as outstanding as the one showing a more solid financial position since 1990 (Graph 9b). On average, it shows a net debtor position of only 1.7% of the GDP. This radically contrasts with the net average debtor position of the period 1990-2005 which reaches 37.5% of the GDP and even more in the 1990’s, which was 74.4% of the GDP (Chart 11b).Thus, by including the Acknowledgment Bonds, the projection is to end 2009 with a debtor position of 3.3% of the GDP, by far, the lowest in the history of Chile since the beginning of comparable statistics.

Rev 73 - Art Public Finance Chile - Graph 9b

  Rev 73 - Art Public Finance Chile - Chart 11b           

4.11. Country Risk

The perception that foreign investors have about Chile is reflected in the country risk. The government’s fiscal management is one of the factors that have a strong incidence on the investors’ confidence. Therefore, adequate management translates into a lower country risk, improving the access and cost of external funding which the government and national companies can choose.

To measure the evolution of Chile’s sovereign spread, and considering this indicator not only reflects fiscal management, but also other variables, it is pertinent to analyze its values compared to a benchmark. That’s why Chile’s sovereign spread is usually compared with the average risk of Latin American countries and the global EMBI (Emerging Markets Bond Index), which summarizes a weighted average of sovereign spreads from different emerging countries. This information is available for the period starting in May 1999 and ending in December 2009.

As it can be observed in Graph No. 10, during the entire period, Chile’s risk has been lower than that of the countries analyzed. This situation continued when the international economic crisis started, in which, although Chilean risk increased, the level of increase was lower than that of the reference countries. Moreover, whereas Chile’s country risk is almost reaching the levels prior to the crisis, this has happened more slowly than for the rest of the sample on average. In comparison, during the period 2006-2009, the country risk has been higher than for the period 2000-2005 (Chart No. 12), which is explained through the afore mentioned effect of the international economic crisis. However, the trend in recent months indicates that the historically low levels observed in the first years of the present administration are about to be restored.

 

Rev 73 - Art Public Finance Chile - Graph 10

 

Rev 73 - Art Public Finance Chile - Chart 12

 

5. Conclusions and Challenges

During the period 2006-2009, noticeable progress has been made in the field of fiscal policy in Chile, especially in the development of the institutionalism of public finance with the purpose of increasing the sustainability of its future management. The demanding test of struggling with both phases of the economic cycle has also been passed successfully, which can be seen in the results showing record levels from the time we have access to comparable statistics.

With regards to institutionalism, the promulgation of Law No. 20.128 about Fiscal Accountability stands out. Among other issues, it defined a framework for the Structural Balance fiscal policy; created the Sovereign Funds intended to supplement funding of the fiscal obligations deriving from the pension system and to grant financial stability to the Treasury; established the State’s obligation to divulge its contingent liabilities and gave permanent character to the Contingency Plan against Unemployment.

Regarding fiscal performance during the period 2006-2009, the figures highlight the current solidness of public finance compared to the performance from 1990 onwards, the first year we have access to comparable statistics. In fact, fiscal income has reached historical levels and has been managed efficiently and responsibly, as demonstrated by the high accumulation of financial assets by the Public Treasury and the reduction of indebtedness to the lowest levels in the last 20 years. For the first time since 1990, Chile has a net creditor position, which has to be particularly highlighted if we consider that in 2009, it faced the severe international economic crisis with a determined counter cyclical fiscal policy, intensive in public spending, especially in investment and social spending.

This means that the promises of benefits for the citizens made by the Chilean government in recent years can be kept. A good example of this is the pension services.

However, even with the robust fiscal institutionalism inherited by the administration taking office in 2010, this does not mean that there is nothing more to be done in the field of public finance.

The first challenge that must be faced will be the gradual withdrawal of the fiscal boost realized in 2009. On the one hand, it will not be easy for an economy and an employment generation that is starting to become dynamic, to abruptly cut the public spending that was defined as extraordinary. But on the other hand, the inertia of keeping transitory spending programs to cope with a specific circumstance should be avoided. This challenge is the core of the counter cyclical fiscal policy, which should be applied in both phases of the economic cycle, by saving during the economic booms without giving in to short-term pressures, and by not spending much when faced with a decelerating economy, even though this may imply temporary deficits.

A second challenge is related to the institutionalism of the Structural Balance policy. It is necessary to continue perfecting its calculation method, seeking balance between precision and simplicity so that it reflects the trend situation of the Treasury as best as possible, but which, at the same time is easily understandable and accountable.

A third challenge, of permanent nature, refers to constantly improving public spending. This is significant because it is not enough to ensure the availability of fiscal resources and the sustainability of the benefits granted to the citizens. If they are not pertinent, their quality becomes low or they are not delivered timely and efficiently. A specific task in this field is to consolidate the line of New Program Evaluation that forms part of the Management Evaluation and Control System, which sets forth that any structural reform or relevant public policy takes into account a design for evaluation since its implementation starts, considering, if applicable, experimental evaluations in pilot programs or taking advantage of the gradual nature of the reforms.

 

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Dirección de Presupuestos (2009), “Apoyo Fiscal para la Creación de Empleo”, Capítulo III del Informe de Finanzas Públicas del Proyecto de Ley de Presupuestos para 2010, Ministerio de Hacienda, Chile (“Fiscal Support for Employment Creation”, Chapter III of the Public Finance Report of the 2010 Budget Bill, Ministry of Economy, Chile).

Marcel, M., M. Tokman, R. Valdés y P. Benavides (2001), “Balance Estructural del Gobierno Central, Metodología y Estimaciones para Chile: 1987-2000” (“Structural Balance of the Central Government, Methodology and Estimates for Chile: 1987-2000”), Estudios de Finanzas Públicas, No. 1, Dirección de Presupuestos, Ministerio de Hacienda, Chile (Public Finance Studies, No. 1, Budgets Direction, Ministry of Economy, Chile).

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Notes

1In virtue of this mandate, Economy DS No. 1,259, dated 2007, sets forth the bases of the fiscal policy for President Michelle Bachelet´s administration, establishing the goal of structural surplus, projecting the patrimonial situation of the public sector and making available the use of public resources based on efficiency and transparency criteria.

2It is defined that the structural balance should reflect the budgetary financial balance that the Central Government would have submitted if the economy had been placed at its trend level, excluding the effect of cyclical fluctuations of economic activity, of the price of copper and other factors of similar nature on the Central Government´s income and spending in the respective period. For a detailed analysis of structural balance methodology applied in Chile, see Marcel, Tokman, Valdés and Benavides (2001), and Rodríguez, Tokman and Vega (2006).

3For further analysis of the legal framework governing the administration of the Sovereign Funds in Chile and about the principles that have oriented the policy with regards to recent years, see Contreras et al. (2008).

4For an analysis of pension system fiscal duties in Chile, see Arenas de Mesa et al. (2008).

5Executive Orders No. 1,272 from 2006, No. 698 from 2007 and No. 600 from 2008, of the Ministry of Economy.

6A first version of this section was included as part of the presentation on the Status of Public Finance from 2009, of the Chilean Ministry of Economy.

7For further details about the Fiscal Boost Plan, and other measures in response to the international economic crisis, see Budgets Direction (2009).

8Volatility of public spending in a particular year, corresponds to the absolute value gap observed between the effective spending and the trend, expressed as percentage in relation to trend spending. Volatility of public spending in a period of n years corresponds to the weighted average of the volatility observed in every year considered.

9For a detailed analysis of tax income in Chile, see Rodríguez, Escobar and Jorratt (2009).

10For an analysis supporting the change of goal, see Velasco et al. (2007).