Central Bank of Chile: An example of independence and financial control

You were appointed Governor of the Central Bank of Chile in 2011, during the administration of President Sebastián Piñera, which gives you a far-reaching perspective of the institution’s evolution over the past years. What would you say are the most important achievements of the Central Bank during this period?

We have a very positive balance considering that, despite the inevitable volatility that we face each year, we managed to keep inflation under control, at around 3%, which is the target that the Central Bank has set. In general, we had a calm period in financial terms, which allowed us to build up what I believe to be a well-deserved reputation and prestige. On the other hand, the Central Bank has been able to consolidate its autonomy over the past 25 years.

Chile is considered Latin America’s economic miracle, transforming itself into one of the most stable and prosperous countries in the region. Nonetheless, it has recently suffered an economic slowdown and growth expectations have decreased significantly. In your opinion, what were the main keys for Chile’s success and what are the current challenges the country is facing?

This is a very complex question, but in simple terms I would single out the strong institutions and adequate policies as the base of Chile’s success. When we refer to Chile’s economic miracle, we are talking about the last 30 years during which the economy grew at a very strong pace. The golden period of Chile’s economy spanned from 1985 to 1997 when the country’s growth rate was over 7% per year.

Recently, we began to see economic deceleration. In 2013 the economy grew by 4.1%, while in 2014 we expect growth to be below 2%. Part of this slowdown mirrors the international economic cycles, particularly the mining downturn. But at the same time we cannot blame all our deceleration on external factors. I believe that as a country, we face important challenges on several fronts such as energy, productivity and the quality of education, among others, to foster investment and long-term growth.

In any case, from a short-term perspective we project that the economy should start to gradually post higher rates of growth during next year.

To what extent does the volatility of international markets affect Chile?

It has a major impact on us, because Chile’s economy is small and very open. Therefore whatever happens in the rest of the world will inevitably have effects on us. For example, recently there has been increased volatility and a drop in the price of commodities, which has had a direct impact on our economy, especially in the case of copper. On the other hand, Chile’s main commercial partner is China (accounting for 25% of our exports), so whatever happens to the Chinese economy will affect our economy as well.

Neighboring countries like Colombia and Peru have good growth expectations for 2014. What does Chile need to do to increase its competitiveness regionally?

If our neighbors have good growth rates it is definitely good news for Chile as well.

In our case, we have many structural challenges from the microeconomic point of view. One of them is energy, as the cost of energy in Chile is high and it is affecting our overall competitiveness. The current administration has set ambitious goals in the energy agenda. We need to develop more projects in order to have more affordable, clean energy.

Infrastructure is another challenge. Here Chile has improved a lot in recent years thanks to the concession agreements. We have to continue focusing on this area and keep developing, as this is a dynamic process that never ends.

Over the longer term, we also face challenges in the quality of our education system. When we compare ourselves to other Latin American countries, the quality of our education is good. But if we apply international OECD standards, Chile is in the lower part of the rankings. There have been some improvements, but there is still a lot of work to be done.

And very importantly, even though we have made major improvements in cutting the red tape, there are still many investment projects that remain paralyzed. They often have all the necessary licenses, but they still have difficulties to begin their operations. Therefore, I believe the state has to be more agile in order to facilitate things for investors and allow those that comply with all the regulations to start their operations as soon as possible.

The 2008 global economic crisis had a major impact on financial markets worldwide. Nevertheless, Chile managed to weather the storm better than many other economies, despite having numerous foreign banks in the market. What were the main strengths of Chile’s financial system that protected the market from the external shocks?

It is true that we have a strong presence of foreign banks in Chile, but we have put in place a subsidiary system that isolates those banks from their parent companies. This basically means that even though foreigners own the banks, their funding comes from domestic sources and on the assets side they are not different from other domestic banks. In addition there are adequate levels of capitalization and liquidity in our banking system.

Another key element was that the Chilean economy did vey well during that critical period. In 2009, at the peak of the global financial crisis, Chile’s GDP dropped 1%. But during the next four years we picked up and could enjoy an average growth rate of GDP above 5% per year.

One of the reforms that President Bachelet announced is the reform of the Banking Law. Could you tell us more about the main goals of this reform?                                                                                                

For the time being, the Supervisory Authority for Banks and Financial Institutions is discussing this reform internally. They announced that they would send the draft of the bill to Congress in mid-2015.

The main goal of this reform is to amend the local regulations in accordance with the new international standards of Basil III. The second aspect is related to providing more autonomy to the Supervisory Authority for Banks and Financial Institutions. And the third priority is to develop more efficient mechanisms for the resolution of banks.

What are your priorities in terms of monetary policy?

The Central Bank of Chile operates with a goal of keeping inflation in check at an average 3% (with a tolerance range of 2% to 4%). Since 2001 and until recently, the average inflation has been exactly 3.1%, which allowed us to win over the market’s credibility, as we have been able to achieve our goals.

Up until mid-2013, our inflation rate was very low, way under our targets. But since May 2013 our currency has depreciated significantly. We believe that this currency depreciation has been positive in our present situation, but it creates pressure on inflation as imported goods become more expensive. In October 2013, we had less than 2% inflation, but now we are above 4%. Obviously, we are not happy with that figure, but we believe we will return to our 3% target in the first half of 2015.

With regards to monetary policy, we have had a more expansionary approach because the economy began decelerating considerably. We have cut 200 points off the monetary policy rate, from 5% in October 2013, to 3% currently. Furthermore, long-term interest rates have also dropped significantly and they are now at an all-time low. Therefore, monetary policy is having an impact on market interest rates.

Why did you decide to have an expansive monetary policy despite the increased inflation?

One of the consequences of a low interest rate is the depreciation of the exchange rate, which has a direct effect of inflation. We believe this increase in inflation is transitory. We are not concerned about past inflation, but about expected inflation. And what we see in the future is a low inflationary pressure, because most of the depreciation has already occurred and we do not expect significant further effects. The international inflation that has an effect on Chile is low, and in addition there is slack in our economy as it has slowed down and it is growing below potential, so there is little pressure on prices.

The United States is Chile’s number one foreign investor and the two countries traditionally enjoy strong economic ties. Do you believe the time is right to boost further the commercial relations between the two countries?

The US is the largest economy in the world and it has always been a very important partner for Chile, therefore it is always a good time to enhance the business relations between the two countries. Today, when we look at the developed economies, the US is without a doubt in the best shape. Foreign investment in general, and in particular US investment, is very important for Chile’s development. So I believe an additional effort in terms of commercial and financial relations with the US is vital. It has traditionally been on the agenda of all our administrations for the past several decades.

I would like to stress once again the macroeconomic strength and stability of Chile’s economy, which is based on four fundamental pillars. The first one is an autonomous Central Bank with a monetary policy based on an inflation target and a flexible exchange rate, which gives our economy the necessary flexibility. Secondly, we have a very healthy fiscal policy based on structural balance rules, which means that we save during good times in order to be able to spend during the rainy days. Moreover, the public sector in Chile is a net creditor; it has more assets than liabilities and that is something that very few countries can boast about. Thirdly, our financial system is very strong, with strict regulation and supervision. And last but not least, we have an open economy both commercially and financially.

As a conclusion, those are the four basic pillars of a robust and trustworthy economy with a solid structure and strong institutions.