Document ofThe World Bank

FOR OFFICIAL USE ONLY

Report No. 23329-CH

MEMORANDUM OF THE PRESIDENT

OF THE

INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT

TO THE

EXECUTIVE DIRECTORS

ONA

COUNTRY ASSISTANCE STRATEGY

FOR THE

REPUBLIC OF CHILE

January 23, 2002

Country Management Unit Argentina, Chile, Paraguay and UruguayPoverty Reduction and Economic ManagementLatin America and Caribbean Regional Office

This document has a restricted distribution and may be used by recipients only in theperformance of their official duties. Its contents may not otherwise be disclosed withoutWorld Bank authorization

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CURRENCY EQUIVALENTSUs$1= 671 Chilean Pesos (as of December 5, 2001)

FISCAL YEARJanuary 1-December 31

ACRONYMS AND ABBREVIATIONS

APL Adaptable Program LoanCAE Country Assistance EvaluationCAS Country Assistance StrategyCEPI Special Commission on Indigenous PeoplesCODELCO Copper Development CorporationCONADI National Corporation of Indigenous DevelopmentCONAMA National Commission for the EnvironmentDDO Deferred Draw-Down OptionEA Environmental AssessmentESW Economic and Sector WorkGDP Gross Domestic ProductGDLN Global Distance Learning NetworkGEF Global Environmental FacilityIBRD International Bank for Reconstruction and DevelopmentICR Implementation Completion ReportICT Information and Communication TechnologiesIDB Inter-American Development BankIDF Institutional Development FundInfoDdev Information for Development ProgramIFC International Financial CorporationIMF International Monetary FundLIL Leaming and Innovation LoanMERCOSUR Southern Cone Common MarketMIGA Multilateral Investmnent Guarantee AgencyOECD Organization for Economic Cooperation and DevelopmentOED Operations Evaluation DepartmentPHRD Policy and Human Resource Development FundR&D Research and DevelopmentSERNAM National Women's ServiceSME Small and Medium-size EnterpriseS&P Standard and Poor'sUTNDP United Nations Development ProgramWBI World Bank Institute

Vice President: David de FerrantiCountry Director: Myrna AlexanderLead Economist: Paul LevyTask Manager: Veronica Salatino

FOR OFFICIAL USE ONLY

THE REPUBLIC OF CHILE

COUNTRY ASSISTANCE STRATEGY

TABLE OF CONTENTS

Executive Summary (i)

A. INTRODUCTION I

B. MACRO-ECONOMIC PERFORMANCE 1

Economic Performance IKey Factors 2Rapid Recovery 4Vulnerability to Shocks 5

C. SOCIAL DEVELOPMENT 5

Poverty and Social Indicators 5Rejuvenation of Social Programs 6Impact on Poverty and Income-Distribution 8Vulnerable Groups 9Governance and Civil Society II

D. CHILE'S DEVELOPMENT CHALLENGES 12

Poverty Reduction in the 21s' Century 12Growth Prospects 12The Challenges 13

E. THE GOVERNMENT'S PROGRAM 19

Expansion of Civil Liberties and National Unity 19Equal Opportunities and Inclusion 20Promotion of Growth in a Globalized and Competitive World 21

F. THE WORLD BANK ASSISTANCE STRATEGY 22

An Evolving Relationship 22Lessons and Progress in Realizing Past CAS Objectives 23The FY02-06 Program 28Vehicles for Bank Group Assistance 29Country Program Monitoring 35

This document has a restricted distribution and may be used by recipients only in theperformance of their official duties. Its contents may not otherwise be disclosed withoutWorld Bank authorization.

ANNEXES

Annex A2 Country at a GlanceAnnex B2 Selected Indicators of Bank Portfolio Performance and

ManagementAnnex B3 Bank Group Program SummaryAnnex B3 Bank Group Fact Sheet - IFC and MIGA ProgramAnnex B4 Summary of Nonlending ServicesAnnex B5 Poverty and Social Development IndicatorsAnnex B6 Key Economic IndicatorsAnnex B7 Key Exposure IndicatorsAnnex B8 Operations PortfolioAnnex B8 Statement of IFC's Held and Disbursed PortfolioAnnex B9 CAS Program Matrix (FY2002-FY2005)Annex B1O Development Priorities

MAP IBRD 25555

EXECUTIVE SUMMARY

Introduction

i. This CAS provides an update on the country's performance and its developmentstrategy since the last CAS was prepared in 1995 and repositions the Bank Group for thefuture. Over time, the relationship between the Bank Group and the Republic of Chilehas evolved. At the beginning of the 1990s, the agenda shifted from economic reforms tothe social sectors, environment, rural poverty alleviation and institutional development.The focus changed again in the mid-1 990s when the Government decided to reduce itsexternal borrowing from the international financial institutions. At the end of the 1 990s,lending was renewed, adding technology and reinforcing support for education and localcapacity building.

ii. IFC's experience mirrored that of IBRD: as the Chilean private sector gainedaccess to longer-term credit and sophisticated financial products, IFC becameincreasingly selective during the 1 990s. This meant targeting activities where IFC wouldhave a strong role and significant development impact, including greenfield projects,non-traditional industries, regional operations, second-tier companies and specializedfinancial transactions. IFC's involvement further narrowed so that there was noinvestment approval in FY98. In FY99, IFC resumed selective financing in response tothe decline in growth and the Government's request for support in priority areas.

iii. Today, faced with new challenges, Chile and the Bank Group are, once again,reevaluating needs and laying the basis for a changed relationship in the coming years.The relationship remains selective focusing on areas in which the Bank has a comparativeadvantage in drawing upon global knowledge, sustaining a policy dialogue, andexploiting synergies with other operations and past experiences. As outlined in the CAS,the program aims to support programs and activities which deepen and sustain Chile'sefforts at poverty reduction with a mix of technical and financial support. Notably, inthis time of heightened global and regional risks, slower growth, low commodity pricesand reduced capital flows, the program includes the possibility to use the Bank's newDDO instrument for risk management. IFC will continue its selective engagement inhigh impact, government priority areas to help the private sector weather this period andplay a role in higher, sustained growth.

Recent Economic and Social Performance

iv. Chile has had, by far, the most robust economic performance in Latin Americaand has social and economic indicators that are the envy of its neighbors. Its progress inreducing poverty, especially in the 1990s, has been notable. Chile averaged over 6.6percent economic growth per year during the 1 990s despite an economic downturn in1999. Growth reached 5.4 percent in 2000 and 3.1 percent in 2001. Extreme poverty isnow at about 4 percent of the population and overall poverty levels have been halved,dropping to between 17 and 21 percent of the population, depending on the poverty line

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used. Even during 1999, preliminary data indicate that poverty reduction wasmaintained. This reflects past economic reforms, combined with strong publicinstitutions and the maintenance of a solid macro-economic policy framework. There aremany ingredients to Chile's economic success, notably, high investment and savingsrates, an open economy, a strong financial sector with an autonomous central bank, stablefiscal management, and prudent monetary policy. Growth has been a powerful factor inexplaining Chile's success in reducing poverty but another important factor has been theconcerted effort by the past three democratic governments to put in place social programsand policies which address both opportunity and equity.

Development Challenges

v. Sustained and rapid growth has been at the heart of Chile's past success inreducing poverty, accounting for much of the decline in the proportion of poor and to theimprovement in overall welfare. Thus, continuing to grow at a fast pace is of criticalimportance for the future, along with policies and programs aimed at making growthmore inclusive. However, maintaining such rapid growth will likely be a more difficultchallenge in the next 2-3 years, given that Chile, as a small open economy, is necessarilyvulnerable to adverse global and regional developments. Thus, while long-termprospects for Chile's continued economic and social progress remain very positive, therisks that, in the short-run, Chile may not be able to sustain the growth and povertyreduction achieved in the 1990s are higher today than they might have been prior toSeptember I1%h .

vi Currently, Chile faces several points of vulnerability. The external environmenttoday is much less hospitable for Chilean exports which are sensitive to developedcountry demand and continue to be dominated by primary products. Despite verysubstantial diversification since the 1970s, copper still accounts for about 40 percent oftotal exports and, with copper prices depressed, an important source of revenue andforeign exchange earnings is vulnerable. In addition, foreign direct investment andexternal financing, which have been important all through the 1 990s, may not be asforthcoming because of heightened regional uncertainties, especially in neighboringArgentina, and risk aversion on the part of investors. This could lower overall investmentrates. It could also increase the refinancing risks faced by the private sector whoseindebtedness accounts for about 40 percent of GDP. Compounding these factors arechanging trends in global markets, in turn leading to shifts in demand for Chile'sproducts and introducing new requirements in terms of technology, skills, andknowledge.

vii. Faced with these increased uncertainties, one of the challenges facing Chile is toexpand and diversify its risk management mechanisms. Moreover, the combination ofhigh unemployment (currently about 9%), relatively low levels of skills among thepresent adult labor force, and the difficulties associated with matching educationalcontent to changing demands, make productivity and human capital developmentcontinued high priorities. At the same time, sustainable use of natural resources, onwhich Chile's success depends, is now even more important.

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viii. In addition, while there have been enormous advances across many socialindicators, there are still many poor people facing increasing hurdles in achieving asatisfactory standard of living. Income inequality stands out as being relatively high inChile and is reflected in continuing severe disparities among different demographicgroups and between rural and urban populations. Especially vulnerable groups includeChile's indigenous populations, youths, female-headed households and those living inrural areas. Social policies and programs need to be refined and adapted to respond betterto the needs of these groups. At the same time, local institutions, which carry the majorresponsibility for delivering social programs, can be strengthened. Underpinning theseefforts, a key requirement is a modem, efficient state that is responsive to its citizenry,accountable and transparent.

The Government's Program

ix. Over the medium-term, Chile is aiming to take its substantial pastaccomplishments further, inter alia by addressing social equity, inclusion andopportunity, while keeping pace with rapid global changes. The development agenda setby the present Chilean Government fully hones in on these concerns. Since taking overin early 2000, the Government has been pursuing a comprehensive program, involving aseries of new initiatives within an overall policy framework and set of core goals whichprovide full continuity with the priorities established by predecessor governments. Theoverall framework emphasizes maintenance of a conducive, stable macro-economicframework, strong public institutions, high investment in human capital and socialprotection for the most vulnerable groups. The Government continues to see the privatesector as the primary driver of employment creation and production, with the publicsector facilitating and creating opportunities for private participation.

x. In terms of new initiatives/areas of special focus, the global trend towardsincreased demand for knowledge- and skills-intensive products has led Chile to deepenits focus on education, which had already been a major part of the program ofpredecessor governments since 1990. The Government is also attaching high priority toaddressing the increasingly important issues of global competitiveness linked toinformation technology, communications, research and innovation. It is expected thatprogress in these areas will help to diversify the economy and create new opportunities inthe fast-growing knowledge economy. In parallel, Chile will continue to focus on soundmanagement of its natural resource base through ensuring that appropriate andsustainable development takes place and, in keeping with its continued commitment toefficient poverty reduction, move forward with initiatives to refine social protection andservices for the poor, the isolated and the vulnerable. Moreover, in part to help ensurethe success of the preceding efforts, the country will press forward in its effort to put inplace an accountable, responsive, "modern" state.

xi. In addition to the above, and taking into account the uncertain externalenvironment, Chile is seeking ways to manage risks pro-actively, especially in the eventof unprecedented volatility in international financial and commodity markets beyond

iii

what could be cushioned by the country's present risk management tools. Chile has putin place a system of fiscal management that builds in automatic stabilizers and has formany years been able to rely on its Copper Stabilization Fund to smooth the impact ofchanges in copper prices on public revenues. Yet, prudent risk management underconditions of higher risk point to the need for additional measures to ensure fundingsources in the event of simultaneous external shocks.

The Bank Group Program

xii. The Government priorities highlighted above constitute the core of the program ofpartnership between Chile and the World Bank Group over the next five years. The CASsets three broad goals: (i) sustaining economic growth and social progress; (ii)heightening inclusion, especially of rural populations and vulnerable groups; and (iii)modernizing the state as the underpinning for the two previous objectives. The content ofthe program is selective, focusing on actions aimed at deepening and sustaining povertyreduction across the range of vulnerable groups. In addition, given the risks associatedwith the current global economic slowdown and heightened regional uncertainties, theBank's assistance strategy includes the option of additional financing in support ofstructural reforms.

xiii. It is anticipated that the FY 02-06 program could include up to six investmentoperations for total lending of $250-300 million. At the current time, these are expectedto be as follows:

* Public Expenditure Management: Modernizing Chile's public expendituremanagement, including integration of systems (accounting, treasury, humanresources, etc) and real time availability of data from decentralized agencies.

* Life Long Learning: Upgrading skills of adults, including giving a second chanceto those who have dropped out, by facilitating access to technical and othereducation and labor mobility.

* Watershed Management: Supporting the development of a framework,institutions, and capacity to manage Chile's environmentally sensitive watershedswith the goal of finding sustainable development paths.

* Rural Infrastructure: Instituting programs of public-private, mixed servicedelivery to provide rural, typically poor populations with economically,environmetitally and socially sustainable services. The services could includeelectricity, renewable energy, communications, water, sanitation and others.

* Technology and Innovation: Scaling up the ongoing LIL for the MillenniumInstitutes as the corner stone for promoting increased R&D, business-academiclinkages, research networking and effective management of research programs.

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* Strengthening Local Service Delivery: Implementing service deliveryimprovements across an array of programs while designing new programs to fillgaps and improving the instruments for eligibility, monitoring and evaluation.

xiv. As a risk management measure, mitigating against possible adverse externalevents (e.g., prolonged global recession, lower commodity prices and reduced capitalinflows), this program of investment and technical assistance loans would becomplemented by support for structural reforms in the arnount of $250-350 million.Although Chile is among the few emerging market economies that are relatively well-equipped to cope with such potential shocks, the Government is of the view that apersistent and prolonged, unsettled global environment could sap Chile's considerablerisk management capacity. From available Bank instruments, the Government hasselected the Deferred Draw-down Option (DDO) in order to provide maximum flexibilityin managing risks in an uncertain global and regional environment. Chile fully meets thecriteria set out for the use of this instrument: notably, (i) Chile has not used Bankresources to the fullest extent; (ii) exposure is low; (iii) Chile is in good standing withthe international capital market; and (iv) it has a strong track record in pursuingconsistent macro-economic policies and reforms.

xv. Several areas of possible reform, consistent with the proposed CAS objectives andthe Government's development agenda, have been identified and could form the basis ofa structural adjustment program suitable for Bank support. One potential area ofstructural improvement is the health sector, based on the on-going deliberations of thePresidential Commission on Health and reflecting past Bank analytical work. Otherpossibilities include the regulatory framework for public services, the efficiency of publicexpenditures, particularly in infrastructure, and the social protection and delivery system.These are areas in which the Bank has accumulated both country and global knowledgeand where this knowledge could strengthen the likelihood of successful and sustainablereforms being implemented. As always, an actual move to a Bank-supported adjustmentprogram would be contingent on a satisfactory macro-framework and agreement on thespecific content of the reforms.

Non-lending Services

xvi. A selective but active program of non-lending is planned. Activities range fromnew GEF operations to the Development Gateway, Infodev, Global Distance Learning,capacity building for indigenous municipal leaders, plus analytical work. On the latter,several topics have been identified including: (i) examining how to expand the capacityof SMEs to contribute to economic growth and employment generation; (ii) assessingChile's capacity to face the challenge of a knowledge based economy; (iii) taking asystems approach to social risk management and social protection with an emphasis oncoverage for vulnerable groups; and (iv) building up knowledge on the specific needs ofthe rural populations in terms of basic services. Another assessment of poverty would beundertaken, as would a review of Chile's fiduciary framework for public procurementand financial accountability. The Government has also indicated several areas in which itwould continue to request technical advice from the Bank on a reimbursable basis.

v

Portfolio Management

xvii. With only five operations under implementation, representing total loans of $280million and $117 million undisbursed, Chile's portfolio is small and generally problemand risk free. There is no major fiduciary concern with several actions agreed and/orunderway to address the few areas where improvement is needed.

IFC and MIGA

xviii. As of December 31, 2001, IFC's portfolio in Chile stood at $131 million.Similarly, MIGA has been moderately active in Chile, supporting projects worth just over$30 million in each of FY98 and FY99. MIGA's current exposure is $22.2 million andthere is one application received for a potential project in infrastructure. Looking ahead,IFC expects to help the private sector respond to the global economic uncertainties andthe unsettled regional context. IFC remains focused on projects in high impact areas,including SMEs (through financial intermediaries), specialized financial market activity,infrastructure, and the social sector, guided by the Government's priorities and the privatesector's demand for improving competitiveness.

Risks and Creditworthiness

xix. For the Bank Group, Chile represents low risks: exposure is low, developmentmanagement capacities are strong, and the track record of achieving development impactis high. The country possesses strong institutions and has followed consistent andprudent policies. There is little doubt that, all other things being equal, Chile would beable to implement successfully its development agenda with minimal assistance from theinternational community. But Chile is not immune to the present global and regionaluncertainties. It has a number of strengths on which it can draw, notably, its strongexternal position and solid fiscal position. It has undertaken preemptive financing andcan draw upon its Copper Stabilization Fund. Nevertheless, prudence warrants thatprecautions be taken.

Board Discussion

xx. Chile is one of the best performers among the Bank's diverse middle-incomeborrowers. It has not yet reached the threshold for graduation but has performedexceedingly well over the past 15 years. Commensurately, the support from the BankGroup has declined sharply over time and has shifted focus in response to changingcountry needs. At the present time, the country faces new risks and challenges that theBank Group is being asked to help address and mitigate. A continued engagement isbeing sought. The following issues are suggested for Board discussion:

* Is the diagnosis underpinning the CAS sufficiently comprehensiveand integrative?

vi

* Does the CAS strike the right balance between support for individualprojects and support for broader policy and institutional changes?

* Is the program of lending and non-lending instruments adequate and inline with the Bank's comparative advantage?

* Among the various risk management instruments available from theBank, is the DDO the best option?

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MEMORANDUM OF THE PRESIDENTOF THE INTERNATIONAL BANK FOR RECONSTRUCTION AND

DEVELOPMENTTO THE EXECUTIVE DIRECTORS ON A

COUNTRY ASSISTANCE STRATEGYFOR THE

REPUBLIC OF CHILE

A. INTRODUCTION

1. The purpose of this Country Assistance Strategy (CAS) is to renew thecollaboration between the Republic of Chile and the World Bank Group for FY02-06.The last CAS was presented in May 1995. Since then, the collaboration between theBank and Chile has evolved. This CAS outlines that relationship and the main features ofthe program. A selective relationship remains the basis for the Bank Group's plannedcollaboration with Chile.

2. As described subsequently, the program builds on Chile's success in reducingpoverty. It aims to support activities that deepen and sustain that process, bringingtogether the Bank's global knowledge and financial support. The IBRD programprovides a mix of technical support and advice with sustained financing to act as acatalyst and to provide a margin for additional financial support should circumstanceswarrant. As slower growth and external shocks affect Chile, IFC will continue selectiveengagement in high impact, government priority areas, to help the Chilean private sectorweather this period and play a role in higher, sustained growth.

B. MACRO-ECONOMIC PERFORMANCE

Economic Performance

3. Over the past two decades, Chile's growth rates have been among the highest inthe world. This performance can be attributed to sustained implementation of economicreforms, including deregulation of factor markets, trade liberalization, control over fiscalbalances, and steady macro-economic management. But this was not a smooth path, withsignificant economic and social hardship, particularly after the collapse of the exchangerate regime and the eruption of the debt crisis in 1982 which led to a decline in GDP of14 percent. At that point, unemployment peaked at some 20 percent of the labor forceand remained in double digits for several years. Chile emerged from the debt crisis in1984 and since then has experienced sustained growth, averaging an unprecedented 6.8percent per year through to 1999 when the country was affected by the aftermath of the1997 East Asia crisis.

Table 1: Macroeconomic Indicators - Chile

Estimate1995 1996 1997 1998 1999 2000 2001

Growth (%)GDP at market prices 10.6 7.4 7.4 3.9 -1.1 5.4 3.2

Shares to GDP (%l)Investment 25.8 26.9 27.2 27.4 22.1 23.4 23.7National Savings 23.7 21.8 22.3 21.8 21.8 21.9 21.6Current Account -2.1 -5.1 -5.0 -5.7 -0.3 -1.6 -2.1

Central Govermment Balance (-deficit) \1 2.6 2.3 1.9 0.4 -1.5 0.1

Non-financial public sector balance (- = deficit)\2 2.6 2.1 1.0 -1.2 -2.5 -1.7 -1.2

Central Bank Balance (- = deficit) -0.6 -0.7 -1.1 -1.1 -1.1 -0.9 -0.9Total Public Sector Balance (-=deficit)\3 2.0 1.4 -0.1 -2.3 -3.6 -2.6 -2.1

External DebtVGDP 33.3 33.5 35.3 43.4 50.5 52.2 58.6External Debt Service/GDP 7.2 9.8 7.4 5.5 8.2 8.6 10.0

PercentageConsumer Price Index 8.2 6.6 6.0 4.7 2.3 4.5 2.6

\1 Ministry of Finance, Chile.\2 IMF definition. Includes Central Government and PublicEnterprises.\3 IMF definition. Includes Central Bank balance

Key Factors

4. Investment and savings have been at the heart of Chile's growth: investment as ashare of GDP averaged 23 percent from 1984 to 1999, while national saving ratesaveraged 20 percent. Investment was particularly strong in the latter part of the 1990s,reaching 27 percent of GDP. This compares to an average rate of investment of less than20 percent of GDP in the 1980s and a national savings rate of about 15 percent in the late1980s. More than one-third of Chile's growth since 1985 has been due to physical capitalaccumulation, followed by labor force expansion and human capital improvements, andincreases in total factor productivity.'

Table 2: Factors Accounting for Growth (1986-2000)

Average Growth Physical Capital Labor and Human Total FactorRate Accumulation Capital Productivity

6.6 percent 2.5 percent 2.3 ercent 1.9 percentSource: Gallego and Loayza

'See Gallego and Loayza, "The Golden Period of Growth for Chile", November 2001.

2

5. A strong financial sector, with an autonomous central bank, has contributed tothis. The size of the financial system is approximately four times as large as in the early1 980s, reflecting the concerted effort after the banking crisis of 1982 to improve bankingregulation and supervision. As a share of the economy, banking deposits represent closeto 50 percent, one of the highest levels in Latin America. A strong financial sectorconveys confidence to both investors and savers. The reform of the pay-as-you-gopension system in the mid-eighties was also important, contributing to the pool of savingsto be accessed by domestic investors.

6. There have been other ingredients to Chile's success. Chile is a small, openeconomy. Trade liberalization helped efficient resource allocation, ensuring a rapid andsustained growth in mining and natural resources. This growth has been export led:exports have averaged 9.6 percent growth per year since 1984 and trade now accounts forabout 75 percent of GDP. Exports alone have climbed from 29 percent of GDP in thelate 1980s to around 40 percent at the end of the 1990s. While copper remains a key partof Chile's exports (accounting for 37 percent of the total),2 there has been significantdiversification into forestry, fishing, wines, fruits and other agro-based products. In the1970s, these products were negligible, accounting for only 3.7 percent of Chile's totalexports. By 1998, they represented 33.9 percent of total exports.

7. As noted above, total factor productivity has been important in explaining growth.Chile, along with Argentina, had the highest rate of productivity growth in LatinAmerica, about 2 percent per year throughout the 1 990s.3 This can be attributed tosubstantial investment in equipment and machinery, the increase in years of schooling,high levels of in-house training for workers, low levels of regulatory burden and taxes,access to financing, availability of basic infrastructure, and macro-economic stability,among others. International comparisons of competitiveness put Chile at the same levelas many countries in South-East Asia, rating 27th among all countries included in the2001 review by the World Economic Forum.

8. Solid fiscal management has been a mainstay of Chile's economic policies,coupled with a strong predilection for refraining from tax increases as the remedy for anyfiscal problems. Prudence in handling copper revenues via the Copper Stabilization Fundhas contributed to this fiscal restraint.' Current public revenue accounts for 22-24percent of GDP, a stable share since the early 1 990s, even though net transfers fromcopper sales have fallen substantially as a share of total revenues. There have beenconsistent fiscal surpluses by the central government, averaging 1.4 percent of GDP up to1999. This fiscal performance has proven to be a key element to bring aboutpredictability and contributes to the lengthening of the planning horizon for investmentand economic development. At the same time, the financial performance of Chile's

2 This is down from 46 percent of total exports in 1990 and 76 percent of exports in 1970.3 See Competitidad: El Motor del Crecimiento, BID, 2001.4 The Copper Stabilization Fund accumulates revenue when international prices are above a reference price(the average long-term price estimated by experts) for use when prices fall below that price. At present, thereference price is 90 cents per pound. Under current circumstances, the Fund would be expected to transferabout $290 million to the national treasury in 2002. It presently has a balance of about $500 million.

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public enterprises5 -dominated by CODELCO (the publicly owned copper mine)-hasgenerally been positive, with net contributions to the central treasury in all years except1993. Transport, ports and water supply companies have tended to be the worstperformers while copper mining and petroleum have been the best.

9. Monetary management was another key ingredient. With the primary objective ofreducing inflation, the Central Bank has conducted monetary policy with prudence,gradually reducing the rate of inflation from more than 20 percent at the end of the 1 980sto around 3 percent by the late 1990s. The exchange rate regime has changed over time:a fixed exchange rate from 1985 to 1994 was replaced by a sliding band up until 1999.Since then, the Central Bank has a managed floating exchange rate with inflationtargeting as the main policy objective.

10. These factors have all played a role in attracting foreign direct investment (FDI)over the years. FDI has averaged 3.2 percent of GDP per year and accumulated to about$36 billion during the 1990s. Notably, this level of investment matched Chile's currentaccount deficit, indicating that Chile was able to finance its external needs with a stablesource of foreign savings. Chile also avoided some of the negative effects of the largecapital flows to emerging markets in the 1 990s by limiting transitory inflows.

Rapid Recovery

11. In 1999, the economy faltered and experienced a drop in GDP of 1 percent as aresult of the world slow-down triggered by the crisis in East Asia in 1997. This wasaggravated by low commodity prices, particularly copper. Gross investment fell by 25percent, associated with a rise in unemployment, from 6.1 percent in 1997 to 9.7 percentin 1999. The central government's fiscal stance shifted to counter-cyclical spending,including temporary municipal employment programs, showing a deficit of 1.5 percent ofGDP. This deficit was financed by using the Copper Stabilization Fund. Also, low levelsof public debt gave the Government ready access to financial markets.

12. The economic decline was short lived and appropriate macro-economic responsesquickly reversed the situation. Growth was restored in 2000, reaching 5.4 percent, thehighest in all of Latin America. In 2001, growth continued, albeit at a slower pacebecause of an increasingly difficult external environment. Growth is estimated at about3.2 percent for the year, with a trade surplus of about $1.5 billion, and a current accountdeficit of about 2.1 percent of GDP. Growth has been aided by counter-cyclical publicspending, based on a structural surplus of 1 percent. This concept consists of managingexpenditures to keep public sector finances in equilibrium relative to the estimatedpermanent (or long-term) component of public revenues: in other words, the structuralbalance measures the fiscal surplus after removing transitory components of bothrevenues and expenditures.6

5 See Aspectos Macro-econ6micos del Proyecto de Ley de Presupuestos del Sector Publico del Ano 2002,October 200 1.6 The methodology is based on the IMF's recommendations and is similar to systems used in the UnitedKingdom, Switzerland and New Zealand.

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Vulnerability to Shocks

13. Other factors have been important in Chile's recovery from the 1999 slowdownand its relatively low level of vulnerability. These include its high level of internationalreserves in relation to short-term debt, the strength of the banking system, and the lowlevel of public debt, only 15 percent of GDP in 2000. These factors are consistent withChile's external position. The Government continues to access international financialmarkets with a strong showing in terms of country risk (S&P rating A-). It ratesfavorably on market based assessments of external vulnerability (such as credit ratings,bond spreads, and indicators of fiscal solvency and liquidity) and has recently engaged inprecautionary international financing: with the highest investment grade rating in LatinAmerica, the Government secured $650 million in October 2001, with a 10-year bond at7.2 percent interest.

14. Yet, there are points of vulnerability. The major vulnerability is the country'scontinued dependence on copper which still constitutes close to 40 percent of exports,and 10 percent of GDP. Copper prices have been highly volatile: prices reached a forty-year low in early 1999 and continued to fall in the early part of 2001, albeit recoveringslightly at the end of 2001. Other natural resources based exports-wine, fruits, fishing,timber-also tend to be sensitive to developed country demand now affected by the postSeptember 11 th decline in economic activity. As an energy importer, Chile can also bevulnerable to higher oil prices: energy imports constitute about 2 percent of GDP. Inaddition, the private sector-in contrast to the public sector-has been relativelydependent on both foreign direct investment and debt financing. The private sector'sexternal indebtedness, about 40 percent of GDP, could expose it to refinancing risks inthe event of a reduced access to the international capital market. Thus, a prolongedglobal recession, depressed commodity prices and reduced capital flows-all occurringsimultaneously-could constitute a significant shock for the Chilean economy.

C. SOCIAL DEVELOPMENT

Poverty and Social Indicators

15. Chile's sustained economic growth during the 1990s has been accompanied by adramatic reduction in poverty: income poverty dropped from about 40 percent of thepopulation in 1987 to 17 percent in 1998, using the lower poverty line, or from 47 percentin 1987 to 21 percent in 1998 using the upper line.7 Preliminary data for 1999 and 2000show that the economic slowdown in 1999 did not deter poverty reduction and acontinuing decline was observed in the last two years. Remarkably, only about 4 percentof the total population was below the indigence line in 1998, down from 13 percent in1987. This reduction was more accelerated in the early 1990s but has been consistent

7 See the two Poverty Assessments prepared for Chile: Poverty and Income Distribution in a High GrowthEconomy, 1987-1995, report number 16377-CH, dated November 25, 1997, and its update, covering 1987-1998, report number 22037-CH, dated August 30, 2001.

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throughout the period. Importantly, the reduction in poverty has been a function of therapid growth in per capita income: between 1987 and 1998, real per capita incomeincreased at an annual rate of 5.7 percent. The Bank's 1997 Poverty Assessmentestimated that growth contributed to 73 percent of the observed reduction in poverty inthe period.

Table 3: Key Social Indicators

1990 1998 16. Not only has incomePopulation (millions) 13.1 14.8 poverty been reduced but a wide

Poverty variety of social indicatorsIndiPence (headcount, %) 9.0 39 continue to improve as shown in

Lower bound (headcount, %) 33.1 17 0 Table 3. Chile is ranked 38 outUpper bound (headcount, %) 38.9 21.2 of 174 countries included in the

UNDP's Human DevelopmentEducation Index; the country stand outs in

Primary education coverage (%) 94.0 97.0 terms of life expectancy andSecondary education coverage (%) 77.0 83.0 infant mortality rates which areIlliteracy (%, older than 15 years) 6.2 4.6 similar to those of OECD

Housing countries, and is advancing wellDwellings meeting local standards (%) 79.0 87.7 in indicators of education

coverage. As shown in AnnexHealth B5, Chile is well ahead of

Life Expectancy (years) 74.4 75.4 comparators in the LatinLife Expectancy-female (years) 77.4 78.2

Infant mortality (per '000) 16.0 10.3 merca Region with regard toMortality under 5 years (per '000) 20.0 12.5 many social indicators.

Physicians (per '000) 1.1 1.2Hospital beds (per '000) 3.3 2.8 Rejuvenation of Social

Health expenditures per capita (1998 $) 182.0 289.0 Programs

Labor Market 17. Improvements in socialUnemployment rate %)7.8 6.2 iniaoshvcmeadin

Participation in labor force-men (% 75.5 74.6 indicators have come hand-in-Participation in labor force-women (%) 30.9 35.0 hand with rejuvenation of public

Average years of schooling for workers (years) 9.8 10.5 programs. During the 1 980s,Increase in Employment (base year 1990) 100.0 115.5 reforms were undertaken to

Increase in Mean labor income (base year 1990) 100.0 155.0 education, health, and socialSource: World Bank and Govemment of Chile security services, with the goal

of creating an incentiveframework for their efficient delivery. This entailed the transformation of the pay-as-you-go pension system to a private system based on individual contributions now beingreplicated in other countries. In the case of education, the public education system wasdecentralized in the early 1980s and converted into a quasi-voucher system, based onschool attendance, in which students could attend private or municipal schools free oftuition. In 1981, higher education was opened to private sector institutions and fees wereintroduced at public universities. In health, starting in 1979, the Government reorganizedthe health service into 26 autonomous units, decentralized public health services tomunicipalities and promoted private sector participation in the delivery and financing of

6

health services. This latter move was accomplished by allowing pre-paid private healthinsurers and by establishing a public health financing agency, while targeting publicspending to low income groups. Both public and private financing agencies depend ondeductions from wages, supplemented by premiums and co-payments for private insurers.

18. The renewed attention to social services in the 1 990s did not entail reversal of thereforms enacted earlier, nor alter the mix of public-private provision of services. Whathas changed is the diversity and funding of public social programs while the privately runprograms continue to flourish. Public expenditures in education, health, housing, socialsecurity and other social services have all increased. These areas accounted for 67percent of total government spending (less interest on public debt) in 1991. By 1999,they reached 71 percent of total government spending. This increase in publicexpenditures was not accompanied by increases in taxes, since the tax reform introducedin 1990, and the share of public revenue in the economy has stayed relatively constant.Nor was the expansion of social programs financed by an increase in fiscal deficits, asChile continued to maintain a fiscal surplus, with the exception of 1999. Thus, the shiftin expenditures was accomplished through reallocations.8

19. The largest share of funding goes to support the public pension system: thisrepresents 44 percent of total social spending or about 6.2 percent of GDP. But theincrease in public spending has been most evident in education. By 1990, publicspending on education had dropped to about 2.5 percent of GDP, from a high of 5.1percent in 1982, and enrollment in primary education was declining, as was coverage ofthe relevant age group. This trend has been reversed (see Box 1) and public spending oneducation is currently the equivalent of 4.3 percent of GDP. Meanwhile private spendingon education has also increased, now accounting for 3.3 percent of GDP, bringing thecountry's total educational spending to 7.6 percent. This increase in spending was part ofa broad-based program of educational reform supported by Bank loans. Not only hasspending increased, new targeted social prograns have been added. In total, the centralgovernment spends about 1.5 percent of GDP on diverse social subsidies and programs,50 percent more than the level as in 1991. One such program is a subsidy for water andsewerage services introduced in 1990, aimed at ensuring that no family pays more thanfive percent of income for water and sewerage services. Another example is Chile Joven,begun in 1994, to provide job training for youths, using an innovative mix of public-private delivery.

20. There is still a long way to go to satisfy fully the welfare needs of the population.The Bank's Poverty Assessment included an analysis of the existing deficits in socialwelfare -as measured by attainment of education, access to health services, and qualityof housing-using appropriate standards of service. This analysis shows that fewChileans have deficits along all dimensions but about half of the population is lackingalong at least one dimension. The most critical deficiency exists in education, followedby housing. Among the poor these deficits are more pronounced, with twice as manypoor persons having a deficit in educational attainment, as compared to the non-poor.

s The main areas in which expenditures declined proportionately include defense and interest on publicdebt. The savings on interest alone amounted to 1.3 percent of GDP between 1991 and 2000.

7

Box 1: Improving Education

There has been considerable progress in improving Chile's education system as a result of a concertedeffort during the 1990s. A number of quantitative indicators support this conclusion. In the case ofprimary schooling, these are as follows: (i) enrollment of 5 year olds has increased from 28 percent (1991)to 82 percent (1996); (ii) repetition rate for 6-13 year olds has fallen from 12 percent (average for entireprimary cycle in 1991) to 6 percent (1996); (iii) average years to graduate from primary school has fallenfrom 12.4 years (1991) to 9.7 years (1996); (iv) cognitive achievements in municipal schools in Spanishand mathematics have increased at a faster rate than those in private paid schools and private subsidizedschools; and (v) rural schools participating in improvement programs have significantly improved theirscores outpacing the average. The gap in scores among municipal schools has been reduced, as has thestandard deviation of their scores. In the case of secondary education, accomplishments during the 1990sare the following: (i) secondary coverage has increased from 78 percent (1995) to 84 percent (2000); (ii)the average number of years to completion has dropped from 5.4 years (1993) to 5.0 (2000); (iii) the drop-out rate has decreased by about 10 percent meaning that there were about one-third fewer drop-outs by theend of the 1990s; and (iv) the completion rate has increased from 68 percent (1985-90 cohort) to 73 percent(1995-2000 cohort). One of the particular accomplishments during the 1990s has been the expandedcoverage of rural populations from only 50 percent (1990) to 77 percent (2000). Similarly, coverage for thepoorest students has increased from 73 percent (1990) to 82 percent (2000). In the case of eighth grade testscores, performance in municipal schools has increased significantly in natural sciences and history, withnegligible differences in mathematics and Spanish, in the period 1997 to 2000. Nevertheless, it remains thecase that education scores for private-paid schools-unadjusted for socio-economic factors-remain higherthan scores for municipality-run schools, indicating that there is still room for improvement.

Impact on Poverty and Income Distribution

21. Much of the renewed attention to social programs has served to reduce poverty:the Bank's 1997 Poverty Assessment estimated that the increase in social spending wasresponsible for 27 percent of the reduction in poverty seen in the early 1990s. The mostrecent Poverty Assessment demonstrates the important impact of social spending onincome dispersion. Income inequality in Chile is a long-standing concern and is an areain which Chile is most similar to its Latin American neighbors. As of 1998, Chile's Ginicoefficient stood at 0.547 showing no significant change since 1988. This distribution ofincome is more equal than that in Brazil, comparable to that in Mexico, less equal than inArgentina, and considerably worse than that in Uruguay and Costa Rica. But, whilemany countries have seen a deterioration in income distribution during the 1990s, Chile'sGini coefficient has remained stable. The rural areas tend to show more inequality thanthe urban areas because of the faster rate of income increase among the urban populationthan the rural population. The latest preliminary data for 1999 and 2000 show that thissituation continues to prevail.

22. The Bank's analysis of social programs in Chile demonstrates that socialprograms can go a long way to transfer income to those less well off. 9 Income data inChile include incomes plus cash transfers but do not explicitly include the equivalentmonetary value of in-kind public services which are delivered free to beneficiaries.Many of these programs are intended for the poor and reduce constraints withinhousehold budgets. Thus, the more programs benefit the less well off, the more they

9 For more details, see Chile: Poverty and Income Distribution in a High-Growth Country, 1987-1998,report number 22037-CH, dated August 30, 2001.

8

contribute to income equality. Chile's Gini coefficient falls from 0.56 to 0.50 whensocial programs are included.' 0 This impact was most notable in the latter years of the1 990s. Subsidies for education were the main contributor to improved equality, followedby health, monetary transfers, and housing. For the poor, social programs make amaterial difference in their welfare, almost as much as earned income. Importantly, theanalysis shows that these benefits accrue most in the urban centers, dominated by theSantiago metropolitan area because of its size, and less to the rural populations which aremore prevalent in the poorest regions of the country, indicating that a better distributionof benefits between rural and urban populations would be desirable.

Vulnerable Groups

23. Despite the improvements seen throughout the 1990s, poverty remains a problem.Some of the key factors to explain the occurrence of poverty are laid out below:

* Education has been the single largest factor in explaining the differences betweenthe poor and the non-poor. Those who have had the least success in leavingpoverty tended to be young workers with low education, female heads ofhouseholds with low education, workers in the agriculture sector, those outside ofthe labor force or unemployed persons with low education, and the elderly withlow levels of education. As of 1994, the most extreme cases are voungagricultural workers in the south (Regions VI to X) (58 percent poor) aiidunemployed heads of households with low education in the rural areas (80 percentpoor). Nevertheless, the highest concentration was among young workers, eventhose with post-primary education, especially in the non-tradable sectors.

* Geography also makes a difference, second in importance to education. TheBank's analysis showed that location (the district or comuna level) was importantin explaining poverty, even after controlling for other factors. Thus, there is aphysical dimension to the problem, with pockets of hard core poverty that aremore pronounced in rural areas than in urban ones. There has also been lessprogress in reducing poverty in Regions other than Metropolitan Santiago, whichhalved its poverty rate from 1987 to 1994. Those Regions less successful inreducing poverty-and which continue to have high poverty rates andconcentrations of rural populations-are in the south (Regions VI through X).

* Another way to examine poverty and vulnerability is by ethnicity. Estimates ofthe size of the indigenous population in Chile vary but range from 5 to 10 percentof the total population. Regardless, these peoples remain among the poorest andmost vulnerable groups. The incidence of poverty is 36 percent for theindigenous as compared to 23 percent for the non-indigenous (1996 data) and 65percent of indigenous families are in the lowest two quintiles of incomedistribution. They encounter difficulties in securing employment because ofdiscrimination and low levels of technical skills (Box 2).

10 The Gini coefficient used in this analysis has not been adjusted for adult equivalency while the figurecited in paragraph 21 was adjusted for adult equivalency.

9

Box 2: Indigenous Peoples

Indigenous issues in Chile have become increasingly relevant to policy makers. While there is no currentnation-wide estimate of the size of the indigenous population, according to the 1992 population census, thissegment of the population represented about 7 percent of the total. Other estimates range up to 10 percent.Alnost 80 percent live in urban areas belying the traditional image of indigenous peoples. By ethnicgroup, the Mapuche are the largest-just over 80 percent--followed by the Aymara. Geographically,Region IX (south) has the largest share, followed by Region I (far north) and Region X (far south). Thereare differing estimates on the concentration in Metropolitan Santiago.

Indigenous people have poverty rates about 60 percent higher than the rest of the population, have aboutone-half the incomes of the non-indigenous, and are more likely to be in unskilled jobs or agriculture.Schooling is about 2.2 years below the average years for the non-indigenous. The indigenous are twice aslikely to rely on the public health system and are more likely to suffer from diseases such as diarrhea,tuberculosis, and parasitosis. Only 65 percent of indigenous households have electricity, 58 percentrunning water, and 41 percent sanitation connections, while the level of service for non-indigenoushouseholds would typically be 50 percent higher. For the rural indigenous people, mainly Mapuche, theissues of access to land, conflicts with the forestry industry, disputes over damn construction, and waterrights have created social tensions. For many indigenous people, discrimination based on their physicalappearance, behaviors and beliefs, and the lack of social and economic mobility are constants in their lives.

At the beginning of the 1990s, the situation faced by Chile's indigenous peoples was critical. An accordwas signed with the new government, establishing CEPI, the special commission for indigenous peoples, anew law was passed in October 1993, changing the legal framework, and a new institution, CONADI, wasset up to implement the law through special programs. As a result there have been some significantimprovements. Nevertheless, there are many remaining challenges concerning the status and recognition ofChile's indigenous peoples and increasing their welfare and inclusion. A task force established in May1999 led to a new development plan -Pacto de Respeto Ciudadano-in August 1999. But differencesremain, particularly over access to land and water. A new IDB-financed project is to provide directassistance to indigenous organizations to develop their self-management and institutional capacities.

* Age and gender can be factors explaining poverty but are not significant ones.These two factors only explain a small share of the differences in poverty andincome levels with the gender dimension losing relevance in the l990s while agehas become slightly more important. The program of guaranteeing basic pensionsfor the elderly has helped in reducing poverty among that group. For specific,small sub-groups, however, these dimensions can be critical: this is the case ofnon-working female heads of households who had a poverty rate of 35 percent(1994). Younger women (less than 35 years of age) were considerably worse off(45 percent poverty rate) even if they were working. At the same time, familysize for such households has been decreasing over time, accompanying a generaldecline in fertility in the country, with the exception of adolescents (Box 3).

10

Box 3: Gender Dimensions

Many indicators suggest that women's status has increased and that women have reached parity with men.School enrollment is almost equal; fertility rates are the lowest of the Region; and maternal mortality ratesare comparable to those in high-income countries. But a closer look at social indicators reveal importantgender differences. This is most noticeable in the area of labor force participation where labor forceparticipation by women, at 35 percent, is the lowest among Latin American countries. In particular, poorwomen are less likely to be employed in Chile than in other countries: lacking child care, some 65 percentof poor women are not economically active, as compared to only about 45 percent among the non-poor.At the other extreme, women with university degrees only earn 47 percent of comparable men's earnings.Gender differences have emerged in education with boys having higher drop-out and repetition rates thangirls. Also, it is notable that contraceptive coverage in public hospitals only reaches 20 percent of womenin childbearing years and this service is only available after the first pregnancy. Teenage pregnancy is agrowing concern, especially in the rural areas where 64 percent of such pregnancies occur.

This situation points to the need for tailored interventions aimed especially at gender-related problems. Tothis end, the Government, working with the National Women's Service (SERNAM), plans to institute anew system of gender analysis and assessment, called Gender Equity, to ensure that all public programspromote and incorporate gender equality in the delivery of their programs. SERNAM, the agencyresponsible for promoting gender equality, benefited from an earlier IDF grant to strengthen its capacity: ithas been quite effective in putting gender on the public agenda and specific activities have beenincorporated in the Municipal Development II project with support of a Japanese PHRD grant.

Governance and Civil Society

24. Chile's progress during the 1990s has been accompanied by changes in societalrelations and relations with the state. No doubt the most significant change has been thereturn to democracy following a long transition from military rule. This was successfullyaccomplished and the country has progressed in deepening democratic institutions.Members of Congress are freely elected, following active public debate by the candidatesand with a low level of absenteeism by the voting population. Since the return todemocracy, Chile has been led by three successive governments of a coalition, called theConcertaci6n por la Democracia, of left-of-center parties. The process ofdemocratization is continuing at the local level, first, with municipalities (direct popularelections were held in 1991) and then with regional governments (elections in 1996).

25. There are residual social and political issues that take time to be resolved (seeparagraph 49). UJNDP's 2000 Report, entitled Human Development in Chile: MoreSociety For Governing in the Future, examines this phenomenon: 50 percent of theinterview sample thought that talking about the past would negatively affect the ability ofChileans to maintain positive relations between them. This report shows that Chile is acountry in which differences of interests and opinions are seen more as obstacles tonational unity, rather than a positive expression of social diversity. Compared to othercountries in which similar surveys have been conducted, social capital within Chileansociety is weak and mutual trust is lacking: only 32 percent of respondents hadconfidence in others. This is also reflected in the rather low level of participation in civilsociety organizations as compared to other countries. According to UNDP study, only 34percent of the adult population participate in any form of organization, religious orotherwise. Despite the fact that there are numerous civil society organizations in Chile,

they suffer from a shortage of experience, technical know-how and financialvulnerability.

26. The slow development of civil society in Chile contrasts with the strengths of itscentral public sector. According to assessments by the Bank and other internationalgroups, Chile is rated high on law and order and the quality of its bureaucracy, and lowon levels of corruption. Central public sector institutions score high in economicmanagement, structural policies, and overall public sector management, out-rankingregional counterparts and income-group comparators. Probity and ethical standards areexpected among public officials and politicians. According to the results of the UNDPstudy, more than fifty percent of the population had trust in their government, policeforce, and universities. An exception was the legal system: a large majority did notconsider the legal system and the way in which the "rules of the game' are played as fair.In addition, a majority felt that they are discriminated against in access to public servicesbecause of their economic standing. Political parties and unions rank much further downthan the public sector in terms of trust while religious institutions rank the highest of all.

D. CHILE'S DEVELOPMENT CHALLENGES

Poverty Reduction in the 21't Century

27. As the preceding analysis indicates, Chile is well positioned as it enters the 215'century. Its per capita income, currently estimated at $4,630 I, is comparable to that inMexico and Brazil. Importantly, levels of income inequality remain high, despite publicpolicies and programs to offset the effects, and there continue to be significantdifferences among demographic groups, notably urban- versus rural-dwellers. The shareof the population that has not attained all of the basic social goals in terms of educationattainment, access to health services, and adequate housing stands at close to half. Thus,there is the continuing challenge to increase welfare for a large share of the population.In addition, concerted efforts are needed to reach the poor who are less able to benefitfrom growth.

Growth Prospects

28. Chile is not imnmune to global events. It is a small, open economy, integrated intothe world market with exports sensitive to the perforrnance of industrialized economies.The immediate impact of the events of September 11, 2001, is that short term growthprospects for Chile will remain below their historical levels. For 2002, growth isexpected to be about 3.3 percent in real terms, reflecting the Government's presentcounter-cyclical fiscal stance and a moderate expansion of exports as growth among theindustrialized countries recovers. The main factors affecting Chile's short-term growthrate include: (i) global demand for exports, most notably copper; (ii) potential riskaversion among investors; and (iii) prevailing regional uncertainties, particularly inneighboring Argentina. Although Argentina only accounts for 3.2 percent of Chile's total

"GNI per capita, World Bank Atlas, 2001

12

exports, developments in Argentina could affect particular Chilean industries, such astourism, and the posture of Chilean companies that have invested in Argentina. Slowergrowth could have consequences for employment.

29. Beyond 2003, there is reason to be optimistic. The country should continue toreap the benefits of the persistency and consistency of its macro-economic policies andinvestments in human capital. The Government expects that Chile could grow in therange of 4.5 to 5.9 percent annually, with average growth about 5 percent or greater overthe decade. These rates are well within Chile's historical levels and its potential. 12

Realistically, they also reflect: (i) the likelihood that traditional sources of growth in thenatural resource sector may not grow as fast as they have in the past; (ii) the aftermath ofglobal events that may take some time to be overcome; and (iii) the lag in the impact ofhuman capital improvements on new potential sources of growth. These projections,moreover, are subject to global and regional risks beyond Chile's control. On the downside, if the global economy is very slow to recover, Chile's medium term growth ratesmight be several percentage points lower. The consequences of this would be: (i)increased need to be selective in any new public spending initiative; (ii) activation ofpublic resources to support temporary public employment programs to compensate forpersisting high unemployment rates; and (iii) continuing prudence in fiscal managementto stay within the one percent structural surplus policy. On the upside, higher growthcould create more fiscal space. Thus, precautionary measures, continuing close attentionand flexibility are needed as long as present global uncertainties prevail.

The Challenges

30. Chileans policy-makers are aware of, and ready to face, the short-term challengescreated by the more uncertain global environment and they are prepared to continue thepath of sustainable growth and social equity. In looking to the future, there are threebroad challenges-sustaining growth and social progress, making that process moreinclusive, and modernizing the state. These are summarized below.

1. Economic Growth and Social Progress

31. The main challenge for Chile will be to sustain rapid growth. There may, indeed,be a downward shift in foreign direct investment and it may be necessary to move fromgrowth primarily based on factor accumulation to growth increasingly based on increasesin productivity. This shift will require greater focus on the quality of human resourcesand knowledge.

32. In the past, Chile has benefited from high rates of investment which have had thedual impact of generating output and labor intensive employment, largely in construction.The 1999 recession put a sharp brake on investment, and commensurately employment:sectors leading Chile's economic performance in the recent past were mining,telecommunications, water, electricity and gas, while construction, commerce,manufacturing, and agro-based activities declined. Even though the long-term prospects

12 Past studies by Chilean academics estimate Chile's growth potential to be about 6.5 percent per year.

13

for Chile's growth sectors-- mining, forestry and fishing--continue to be encouraging,they are not likely to grow as fast as in the past. On the other hand, Chile's industrialsector is small, heterogeneous, and dominated by small and medium scale enterpriseswhich could be a much more dynamic part of the economy.

33. Part of the challenge will be to enhance further the country's investment climate.This is aided by the Government's on-going efforts at improving the regulatoryframework and corporate governance, and deepening financial and capital marketreforms. The Government is advancing rapidly in these areas, with the recent approval ofthe new law of Public Offerings that provides protection for minority shareholders andother reforms in the area of capital markets. Pending issues in judicial administration arebeing addressed; these changes should positively affect investors and citizens. TheGovernment's emphasis on infrastructure in support of growth, largely through the on-going concession program, has been validated in several recent regional studies. One ofthese predicts that a reduction in logistics costs would result in the highest welfare gainfor Chile due to the importance of trade in the economy.' 3 Other studies highlight theimportance of infrastructure, showing that each dollar spent on infrastructure can return$1.18 in benefits. Thus, for the economy to restore a fast pace of growth, infrastructurewill have to grow commensurately. There is also room for efficiency gains: for example,port efficiency could be improved, as reforms enacted in 1997 are slowly coming intoeffect; there are ways in which competition in the electricity sector could be strengthenedas industrial electricity prices are considerably higher in Chile than in neighboringArgentina;14 and in the case of telecommunications, privatization has not yet led tosignificant tariff reductions especially for local service while the introduction ofcompetition for long distance calls in 1995 has led to lower rates for consumers (seeTable 4). From the point of view of enterprise development, there seems to beconsiderable opportunity for local linkages and formation of competitive clusters,especially for smaller firms.

34. The agenda should also further address issues of productivity and humancapital. The present focus on education - including adult education - is essential, as issupport for innovation and technology. On information and communications technology,Chile displays some encouraging features (see Table 4). The number of computers perperson is quite high but behind Costa Rica and Uruguay. Chile stands out in terms of useof e-mail, relative to other Latin American countries. On the side of R&D, Chile hasdemonstrated a consistent increase throughout the 1 990s, bringing such investment toabout 0.65 percent of GDP. While far less than what is spent in OECD countries, thislevel is among the highest in Latin America. Similarly, the number of researchersrelative to the size of the population is high in Chile as compared to its neighbors but lowin comparison to OECD countries. (However, the export of goods with a hightechnology content is nascent and is substantially overshadowed by the export of basicraw materials.) Finally, the arrival of the Internet during the last five years has

13 See Eric Bond, "Trade Structure and Development: The Role of Logistic Costs in Latin AmericanCountries", Background Paper for the Regional Flagship Report, 2001.14 See "Productivity, Competitiveness and Economic Reform in Argentina: Was It Enough?", FIEL,August 1999.

14

introduced a new dimension to the problem of universal access and goes beyond theproximity to a public telephone. In Chile, availability of Internet infrastructure isconfined and the take-up of Internet sites is less than that in Uruguay, Mexico, andArgentina. Internet use tends to be concentrated among a narrow social base, consistingprimarily of university students and self-employed professionals. Hence, the expansionof access to the Internet will require programs to make service financially and culturallyaccessible to SMEs and other segments of the population.

Table 4: Selected Information and Communications Technology Indicators

Country Telephone Cost of Local Mobile Personal InternetMainlines Call Telephones Computers Users

(% population) (US$ per 3 (% population) (% population) (per 10,000)minutes)

LAC 13 .09 8 4 191Chile 21 .12 15 7 467

Argentina 20 .09 12 5 243Uruguay 27 .18 10 10 1,000Mexico 11 .14 8 4 188Brazil 15 .03 9 4 208USA 66 .09 31 51 2,665

Australia 52 .16 34 47 3,158UK 57 .19 46 30 2,083

35. Education has been a top priority all through the 1 990s. Evidence shows that theincrease in public spending and accompanying reforms to the basic and secondaryeducation systems are paying off (Box 1). Nevertheless, privately paid schoolingcontinues to show gains in student attainment so that the gap between public and privateschooling is closing only slowly. As a result, institutionalization and deepening of thecurrent education agenda remain a high priority. Moreover, improvements to quality andequity are only beginning in post-secondary streams where it is expected that most of thenew entrants to the labor force will be trained. Thus, it is very important that theGovernment continue the process of reform begun in the 1 990s with the support of twonow completed Bank-financed projects for primary and secondary education and the on-going Higher Education project.

36. Added to this is a growing concern about the "stock" of Chile's labor force.International studies show that the average level of functional education of the labor forceis relatively low: only 39 percent of the adult population in Chile has completed eightyears of schooling and almost 50 percent of the literate labor force does not meet theminimum standards of reading and writing necessary for a modem employment sector.Thus, the agenda on human capital development has been expanded to include adulteducation, training and skill development, and mobility in the labor force.

37. Such initiatives will have bearing on Chile's ability to generate jobs. The 1999economic downturn evoked a sharp rise in unemployment which was not reversed duringthe 2000 recovery. Meanwhile, among Chile's poor, the chances of having onehousehold member unemployed rose to 1 -in- I0, 60 percent greater than for the average.

15

Unemployment data show that this rise has been generalized, by age, education, andregion, indicating an upward shift across the board. Statistics for 1998-2000 indicate theemployment creation was more likely for those with superior levels of education than forthose with only basic education. Those with the most difficulties were youth, and thosein agriculture, mining and industry and in the center and south (Regions IV, V, vm andIX). The lack ofjob creation was notable by smaller firms (with less than 50employees).' 5

38. Performance in 1998-2000 has raised some concerns about Chile's long-termcapacity to create jobs and generated an on-going debate in the country on the causes ofthe relatively slow recovery of employment since the 1999 downturn. Some of thefactors being discussed include slack domestic demand and spare capacity, the lastingimpacts of the recent adjustments made by firms, and relatively rigid labor marketregulations. Chile is among Latin Arnerican countries with relatively high and bindingminimum wages16 and, while the costs of terminating employment are close to theaverage for the region, these costs are higher than that in Brazil, Argentina andUruguay.17 Also, Chile's present unemployment insurance program reaches a fraction ofthe unemployed-only 8 percent of all unemployed workers in 1998 received benefits--highlighting the need for more attention to employment fluctuations in the design ofsocial protection programs especially for those in the informal sector. Recently adoptedreforms to the system of unemployment insurance, based on individual accounts, have yetto make a significant difference in coverage or benefits.

2. Making Growth More Inclusive

39. The benefits of growth can be better shared among Chileans. All Regions but oneexperience poverty rates at least 50 percent higher than that of Metropolitan Santiago,reflecting the differences in the composition of their respective populations, with theRegions outside of Santiago possessing a larger share of rural populations. Even thoughonly 14 percent of the total population is rural, this is swayed by the dominance ofMetropolitan Santiago accounting for half of the total population. Thus, excludingSantiago, the share of rural populations is likely to be some 30-40 percent.

40. As highlighted below, rural populations are more likely to be poor andindigenous, lack basic services and show significant differences in social indicators. Inthe case of education, for example, Region VII in the south, one of the poorest, had a netsecondary enrollment rate of 70 percent as compared to 84 percent nationally. Overall,net enrollment in the rural areas for secondary education is only 77 percent as comparedto 92 percent in the urban areas (even though the gap has been closing since 1990).Another example is that only 75 percent of rural households have electricity, and 65percent access to safe water. In the case of electricity, there has been considerableimprovement in the last five years, as a result of the Government's efforts to expandservice, up from 50 percent in 1994. The new goal is to have 90 percent of the rural

'S See Panorama Laboral 2000, ILO, dated February 2001.16 Ibid. However, this conclusion contrasts with that of the recent IDB study on competitiveness.17 See Competitvidad: El Motor del Crecimiento, BID, 2001, citing data from Heckman and Pages, 2000.

16

population served by 2005 with an increased role for isolated, renewable energy systemsto reach remote areas.

41. There may be environmental benefits from decongestion of the major center,Santiago, which suffers from pollution and urban congestion problems. On the otherhand, many of the Regions - particularly those where mining, forestry, and fishingdominate-encounter their own environmental problems due to the fragility of these eco-systems. Given Chile's geography-a narrow country, divided by mountain ranges-andits wide variations in rainfall, combined with its dependence on hydro-electricity andirrigation for more than 35 percent of agricultural production, appropriate watershedmanagement is critical. Sustainable, equitable development at the regional level is acomplex agenda that combines infrastructure, services, capacity building, and sustainablemanagement of natural resources. It also entails the equitable allocation of publicresources taking into account both need and implementation capacity. Given the natureof Chile's remaining poverty, local actions will play an increasingly important role tostimulate income-earning activities and to target and improve social services.

42. While growth has gone a long way in reducing poverty during the 1990s, growthcan be more inclusive, not only across Regions but across groups. Importantly, inequityin the access of the poor to higher education-the bottom 20 percent of the incomedistribution received only 6 percent of the resources in the late 1 980s-are now beingreversed, with support of the on-going Higher Education Quality Project. Many of thepoor-who either drop out of secondary school or not do progress to a quality post-secondary education-do not fare well in the labor market. 18 Moreover, a large numberof youths - about 24 percent-continue not to graduate from the secondary system,resulting in youth unemployment problems.' 9 Particular groups which tend to have highpoverty and unemployment rates, and low levels of education warrant attention: drop-outs of secondary school, youths at risk, young women, female heads of households,indigenous peoples and rural workers.

43. Thus, vulnerability remains a concern even though extreme deprivation has byand large been eliminated and Chile has relatively developed, universal systems ofeducation, health insurance and social security, plus a wide variety of targeted socialprograms. Two programs deserve mention: Chile Joven and Capacitaci6n para MujeresJefes de Hogar (Training for Female Heads-of-Households). Both of these programsprovide training and support in securing employment for the groups with the lowestchances of finding jobs.

44. The 2001 Poverty Assessment shows that coverage of some targeted programscould be expanded, especially those with a high distributive impact: notable ones aresubsidies for child care which should be important for poor women to be able to workoutside the home and family allowances which can offset the low wages that most poorwomen earn in the domestic service industry. These transfers are highly positive in termsof income distribution and their expansion need not be at the expense of increased overall

18 For both boys and girls, the drop-out rate is highest in the first year of secondary education,19 The main reason for dropping out is reported to be the need for extra family income.

17

spending as some targeted programs show considerable leakage, so that some tighteningof criteria could generate savings. This is most pronounced in the case of housingprograms and water subsidies. Finally, changes in Chile's successful scoring system ofbeneficiary eligibility could make social programs more responsive. Combined with theresults of the regular household living standard surveys,20 the two-page form (called theficha CAS or social stratification form) constitutes a cost-effective way for determiningeligibility for many social programs at once and is used by local governments toadminister programs. But the form itself and the scoring mechanism may be rigid andnot take into sufficient account variations in income.21 linprovements to this system andhow it is used are important at the local level because of the decentralized administrationof many social programs.

45. The present framnework of social protection can be further refined. One area ofconcern is participation in the pension system: a substantial share of workers are in theinformal sector - 38 percent as of 1998-and 33 percent of all workers do not contributeto social security, up from 20 percent in 1990.22 This could create an additional financialburden on the pension system as these workers reach retirement age. Already the publicpension for non-contributors, benefiting 350,000 persons, has increased four-fold in thepast twenty years, now accounting for 1.2 percent of GDP. Another concern is how toprovide Chile's aging population with health care coverage and to insure the rest-especially families with young children-against catastrophic health care costs. Thechanging health profile-away from infectious diseases and toward chronic and life-stylediseases-needs to be taken into account. Equity considerations in the health systemdeserve attention. At present, there is no consensus on how health care reform in Chileshould take place but the dual insurance system leads many to consider the system asinequitable. This is aggravated by slow progress in changing management and incentiveswithin the public health system (see paragraph 52).

3. Modernization of the State

46. Underpinning Chile's ability to meet the above challenges is the capacity of thestate. As discussed earlier, the central public service stands out when compared to otherdeveloping countries. One indicator of improving budget processes is the halving of"reserved" funds, that is, funds whose spending purpose is not disclosed, to no more than0.1 percent of the total. There have also been a series of innovations in public budgeting,including a Competitive Fund which provides flexibility and can fumd programs, mainlyin the social sectors, which might not otherwise have been adequately fimded or at all,and incentive bonuses of up to 3 percent of their wages to public employees working inagencies which have accomplished their institutional goals. At present, 109 publicservices are subject to performance monitoring and 120 programs have been evaluated.

20 As explained in the Poverty Assessments, Chile has a two-year cycle of household surveys that provide arich data set on living standards.21 For a fuller discussion of thefiche CAS and the issues of targeting and coverage, see Chile: Poverty andIncome Distribution in a High Growth Economy, 1987-98, report number 22037-CH, dated August 31,2001.22 See Panorama Laboral 2000, ILO, dated February, 2001.

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Decentralization is also part of the program as local institutions take on moreresponsibility for managing investments.

47. This performance can be strengthened even further by: (i) implementing a systemof integrated public expenditure management to provide real time information todecision-makers and provide more standardization in reporting across agencies, thusfacilitating monitoring and evaluation; and (ii) addressing some of the rigidities whichexist in the resource management system, notably over human resources. At the sametime, relaxing such controls especially over hiring and staffing transfers- without theattendant systems to instill accountability and measure performance-runs the risk ofundermining fiscal stability. As the country moves to even more decentralization ofservices, changes should be done cautiously, adding flexibility with performance andaccountability, including to society at large as being proposed under Government's StateReform and Modernization Program (see paragraph 56). There is opportunity for morepartnerships with the private sector to accelerate investment in non-traditional areas, suchas hospitals.

E. THE GOVERNMENT'S PROGRAM

48. The above challenges have shaped the Government's program. During PresidentLagos'six-year mandate, which began in March 2000, new initiatives are planned whilecontinuing the main thrust of the on-going economic and social program. The agenda setout by the Lagos Administration is comprehensive and follows closely on those of itspredecessor administrations of the Concertaci6n coalition, providing continuity in theoverall policy framework. The essential priorities remain sustainable and equitablegrowth and poverty reduction, via a conducive macro-economic policy framework, strongpublic institutions, investment in human capital and social protection. The Governmentcontinues to see the private sector as the driver of employment creation and production,with the public sector facilitating that process and creating opportunities for privateparticipation. New initiatives under the Lagos Administration lie in three primary areas.

Expansion of Civil Liberties and National Unity

49. These initiatives acknowledge that the transformation to democracy has beenincomplete. Plans include eliminating outdated laws, carried over from the militaryregime, on matters such as censorship, and deepening democratic processes. TheGovernment has proposed to Congress a number of Constitutional reforms that, amongother things, relate to the Armed Forces, the National Security Council, the ConstitutionalTribunal, the electoral system and non-elected senators. The Government has alreadybegun the process of modernizing family law, providing more rights to children andwives and introducing family courts, and dealing with the emerging societal concernsabout security, personal liberties and crime, including the implementation of a newcriminal justice system. Finally, it plans to build on Chile's strong sense of nationalidentity and promote the expression of Chilean culture, sports and social organizations.

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Equal Opportunities and Inclusion

50. The second set of initiatives focuses on employment and assurance that allChileans have equal access. To aid in the transition to full employment, the Governmentwill continue to provide temporary municipal-run employment relief, in programs such asreforestation and housing. The present plan is to generate a total of about 150,000 suchtemporary jobs in 2002, the same level as in 2001, triggered into action if theunemployment rate surpasses 9 percent. The Government also plans to enddiscrimination against indigenous and women, much of which is felt in the labor force.23

51. The Government will continue to deepen efforts to improve the quality andrelevance of education (Box 1). Part of this will reduce inequality in education, byexpanding full day schooling, adding information technology to schools, and providingmore student loans and scholarships. To this will be added a new emphasis on adulteducation and life long leaming, addressing the needs of adults, especially poor youthswho need a second chance at attaining secondary education. Access to informationtechnology will be expanded through info-centers, providing a solid legal basis for e-commerce and use of ICT and facilitating interaction with the state by Internet.

52. A major effort will be directed to improve health services, building on therecommendations of the on-going Presidential Commission on Health. Some of thefeatures of the reforms which are presently being debated include options for a solidarityfund, risk-adjusted universal insurance, and the definition of a mandatory universalbenefit package with individuals in the publicly run system gradually being able to havethe choice to move to private insurers and providers. New impetus would be given tohealth care management, budgeting, and incentives for performance. Such reforms at thehospital level could be accompanied by private concessions and/or managementcontracts. Attendant elements of this initiative include greater attention to primary healthcare and prevention. Pensions would be increased and the problems of non-contributionto the social security system addressed.

53. Reducing tax evasion is a key part of the Government's program to increaseequity. A new law on tax evasion has been passed and its implementation is expected toadd about 0.8 percent of GDP to tax collections even though Chile already has arelatively low level of tax evasion. Other dimensions of the program include:(i) addressing the deficiencies in housing, targeting the lowest 20 percent of the incomedistribution, with accompanying urban renewal; and (ii) upgrading public mass transportservices in the Santiago area, thus addressing many environmental concerns in the urbanareas. Similarly, the Government intends to continue its focus on sound natural resourcemanagement in the rural areas, watershed management, protected areas management, theuse of mercury bromide in the agricultural sector, and adoption of environmentally soundpractices in the forestry sector.

23 Women and youths have the highest unemployment rates in the country. Data are not available onunemploymnent rates among indigenous peoples. Anecdotal evidence suggests that under-and un-employment among indigenous is also very high.

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Box 4: Integrating Environmental Concerns

Chile's success is founded on a market-based growth policy based on its comparative advantage in naturalresources. At the start of the 1990s, mining, fishing, forestry and industrial pollution were largelyunregulated. Visibly poor air quality in Santiago and the mounting destruction of forests highlighted theneed for action. Thus, the Government made protection of the environment and sensible management ofChile's rich natural resources an important part of its progran. The strategy took into account that part ofthe cost of past growth was being borne by the population and the country's resource base while, at thesame time, recognizing that over-regulation and too much control could be counter-productive. Thus, thesearch was for an approach that combined use of economic incentives and regulations explicitly takingenvirornmental factors into account.

This led to the creation of the national environmental comrnission, CONAMA, in 1992. Chile's cautiousand practical approach resulted in a small, decentralized agency, beginning with the basic steps, addressingpriority areas in a gradual manner. The goal was to create a capacity for information management, analysis,and debate. Part of CONAMA's work, with the support of the Bank-financed Environmental InstitutionsDevelopment Project, was to update legal regulations, develop procedures and guidelines for environmentalassessments, sponsor educational campaigns, and develop information systems. CONAMA has maderemarkable advances. The number of staff working on environmental concerns in the government grewfrom six to 350. There are environmental units in ten ministries and there is a solid track record in impactassessment, policy analysis and information systems. By 1999, norms were approved for 14 differentsectors of activity. Sector by sector, advances have been opportunistic; that is, authorities have seizedopportunities as they arose so that progress has been faster in some areas than others. This is particularlythe case of mining and fisheries (including the aquaculture industry) that lag, as compared to forestry whereprogress is taking place. Perhaps the best accomplishment has been the creation of a space for informneddebate.

Promotion of Growth in a Globalized and Competitive World

54. The third set of initiatives covers enhancing Chile's ability to compete. Whilemany of the actions to be pursued in the other two areas-most notably in the area ofeducation and information technology-will contribute to this endeavor, actions areenvisaged to address some of the recognized bottlenecks. This entails capital marketreforms: improving self-regulation of banks, incentives for risk capital formation,creating new stock markets, expanding the range of mutual funds which can be managedby financial institutions, improving regulation of investment funds and financialintermediation, and modifying credit rating mechanisms especially for SMEs. In acompetitive environment, it is important for Chile to improve efficiency in the provisionof electricity, telecommunications, water, and transport. As these markets evolve, Chileintends to reassess its regulatory environment and ways to stimulate both newinvestments and competition to ensure efficient resource allocation and pricing. Privatesector investment, especially in infrastructure, subways, and housing, will be promoted,along with partnerships in other public services such as hospitals. This program willinclude a multi-actor dialogue on improving competitiveness. Finally, the Government'sprogram entails measures to stimulate innovation via adoption of "clean" technologies,quality control, information and communications technology, and bio-technology.

55. On international trade, Chile is collaborating with its MERCOSUR neighbors andis currently advancing in trade discussions with the USA for a possible bi-lateral trade

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agreement. It expects the on-going trade talks with the European Union to be completedas early as mid-2002. These efforts continue the path that Chile has followed for the pasttwo decades, in liberalizing its trade relations on a bilateral basis, making Chile the mostopen economy in Latin America. In all of these discussions, a positive investmentclimate enhanced by Chile's track record, respect for the law, and environmental andother regulations will be beneficial.

56. Modernization of the state remains a continuing feature of the Government'sprogram. This process is being deepened as part of the State Reform and ModernizationProgram, instituted by the Lagos Administration. State-of-the-art information systemsare an important feature, notably in public procurement-via chilecompra. cl-and inelectronic transaction processing including tax payments-via tramitefacil.gob. cl. In thiscontext, an integrated financial management system for public expenditure managementis pivotal, along with efforts to improve the overall control environment. Issues oftransparency also include improved management of Chile's contingent liabilities,especially those that arise because of concession contracts, guarantees of public debts,minimum pensions, insurance schemes, etc. Concern about transparency andaccountability is further reflected in the Government's plans to strengthen the AuditorGeneral's Office, with IDB assistance, and to put in place an Office of the PublicDefender. There are plans to embark on an ambitious program of institutional reformthat proposes merging several ministries along functional lines. Decentralization anddeconcentration are key features, with the goal of increasing the share of publicinvestments at the regional level.

F. THE WORLD BANK ASSISTANCE STRATEGY

An Evolving Relationship

57. The World Bank Group has been a major partner in Chile's development effort.Chile was, in fact, the first developing country to borrow from the World Bank in 1948.This long relationship has, by and large, been a successful one: the recently completedCountry Assistance Evaluation carried out by OED of the IBRD program from FY81 toFY00 considers the results of this joint effort to have been highly satisfactory (see Box5), highlighting progress in institutional development as particularly encouraging. Thenew strategy laid out in the following section builds on this successful past, helping toaddress the challenges of the future. A more detailed review of the accomplishmentsunder the previous CAS follows.

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Box 5: OED's Country Assistance Evaluation

OED's Country Assistance Evaluation rated the outcome of the Bank's program in Chile for 1981-2000 ashighly satisfactory. Bank assistance supported substantial institutional development and time has shownthat achievements have a high likelihood of being sustained. One of the highlights has been institutionaldevelopment: OED's CAE states that: " [the Bank's] assistance helped to shape new institutions andorganizations to make public expenditures more efficient and to produce better social development". Onefficacy, OED rated the program as achieving substantial effectiveness. Overall, outcomes were rated asbeing more successful in the early period, before 1991, as compared to more recent experience, reflectingthe changing and complex nature of these operations such as the Small Farmers Services, Housing SectorII, and Valparaiso Water Supply Projects. Operations in Chile rank among the most cost effective per loanapproved.

Five lessons stand out: (1) programs can be effective if the countiy is committed to stable macro-economicpolicies; (2) the Bank may be more effective in promoting reforms with a succession of structuraladjustment loans, an early feature of the Bank's program with Chile; (3) changes in incentives andinstitutions in the way social services are delivered and natural resources managed can bring in the privatesector; (4) when there is insufficient information, the better route may be to pilot programs: test results canbe a powerful tool to convince stakeholders of the benefits of reforms; and (5) even in a country with assophisticated as Chile, the Bank should abstain from insisting on reforms if ownership is weak.

Source: Chile-Country Assistance Evaluation, OED, dated September 26, 2001

Lessons and Progress in Realizing Past CAS Objectives

1. IBRD Lending

58. The 1995 CAS, covering FY96-98, set out four areas for support: (i) upgradinghuman capital necessary for international competitiveness; (ii) addressing pockets of ruralpoverty through sustainable natural resource management; (iii) leveraging resources forChile's outdated and overloaded infrastructure; and (iv) mitigating damage caused byurbanization and strengthening environmental management. 2 4 This program wasselective, with about one operation planned per year, including one guarantee, in theareas of highways, water and sewerage, education, rural poverty and environmentalpollution. The planned level of lending, totaling $155 million, was significantly less thanthat of the previous periods (see Table 5). In the end, the Bank approved five loans inFY96-99 for $210 million. There was no new lending in FY00 and FY01 as thetransition to the Lagos Administration took place. IFC's experience during this periodmirrored that of IBRD and both institutions saw their level of support decline in the1990s, to resume during the economic decline of 1999.

59. Implementation ofthel995 CAS reflected the Government's decision in 1996 tocurtail new borrowing and to reduce exposure under on-going operations that led tocancellation of $160 million of the portfolio and prepayment of $515 million. This shiftwas accompanied by a new program of reimbursable advisory services (Box 6). Theportfolio, which consisted of 14 projects under implementation in FY95, shrank to 5projects by the end of FY01. Following approval of the Secano Agricultural

24 See Report No. 143 70-CH, dated Aprl 17, 1995.

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Development Project in FY96, no new loan was approved until three loans--the HigherEducation Project, the Second Municipal Development Project, and the LIL forMillennium Institutes--were approved in FY99, reflecting Chile's heightened emphasison the quality of human capital and institutional development as prerequisites forbenefiting from the emerging knowledge economy.

Table 5: IBRD Commitments by Sector: FY85-99 (US$ million)

Sector 1985-89 1990-94 1995-99 Total 60. As the portfolioAdjustment 750 0 0 750 matured and a number ofInfrastructure 332 295 120 7T47 rtoswrEducation and Health 0 287 185 472 operations wereIndustry and Finance 215 130 0 345 completed during theHousing and Urban Development 280 0 0 280 latter part of the 1990s, aAgriculture 56 140 15 211 rich set of lessonsWater and Sanitation 66 50 0 116Public Sector Management 1 39 15 65 emerged from theTotal 1,710 941 335 2,986 respectiveAverage per year 342 188 67 199 ImplementationCompletion Reports (ICRs). The following summarizes the key results of the operationscompleted during the latter part of the 1990s:

* Human Capital: The shift in lending towards the social sectors in the early 1990shas born fruit. In primary education, under the Basic Education Loan (Ln. 3410-CH,approved October 1992 and completed June 1998), results include: the introductionof special education for disabled children, school-based health screening, and thecomputer-internet based communications network called Enlaces; improvedpedagogy and learning materials, including libraries; upgrading of rural schools andexpansion of pre-school education including the training of mothers; and institutionalstrengthening of the Ministry of Education including the introduction of standardizedtesting. In the case of secondary education, under and the Secondary Education Loan(Ln. 38836-CH, approved May 1995 and completed June 2001), the mainachievements were: upgrading learning materials and learning resource centers;mobilizing teachers and students to be proactive in the change process includingcultural and voluntary activities; updating the curriculum; and improving teachermethods. While still at a relatively early stage of implementation, the HigherEducation Project (Ln. 4404-CH, approved in FY99) is beginning the process ofimproving quality, equity and efficiency at that level. Equally, in the case of health,the two completed operations-Health Technical Assistance and Rehabilitation (Ln.3427-CH, approved in December 1991 and completed in December 1997) and theHealth Sector Reform Loan (Ln. 3527-CH, approved in November 1992 andcompleted in August 1999)-were successful in meeting their objectives. There werea number of accomplishments, notably in the area of decentralization and laying thebasis for institutional and policy reforms.

* Rural Poverty: Success was mixed under the two Bank-financed projects. In thecase of the Small Farmer Services Project (Ln. 3473-CH), the ICR shows that theinitial hypothesis that small, poor farmers could graduate from state-subsidizedextension services and credit to privately run, non-subsidized services was not

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feasible and the project failed to meet its objectives. As a result, how to assist bestthis group of rural poor had to be rethought. A new approach was devised relying onprivate-sector delivery of extension and financial services, with only partial costrecovery. The Secano Agricultural Development project (Ln. 3974-CH), in its ICR,shows that this new approach could work and some small, poor farmers can break outof being marginal producers. However, the potential for replicability andsustainability is not considered high because of the fiscal costs involved in providingthe subsidized services. One of the more general lessons derived from past work inthe rural sector is that poverty reduction also depends on non-farm income generatingactivities, along with infrastructure and social services to integrate better thesepopulations. This lesson will be applied in the proposed Rural Infrastructure Servicesand Watershed Management Projects. Continuing Bank technical advice is beingsought on how to evaluate the efficiency and effectiveness of agricultural programs.

Infrastructure: Bank support for infrastructure dropped during the latter part of the1990s, prompted by the private sector's successful access to financing combined withthe Government's progress in concessioning new investments. In part, this is aconsequence of the Bank's past support, including the completed First and SecondTransport Projects which were rated best practice by OED. These loans supported aprogram of investment and institutional development with far-reaching results,including: (i) the transformation of the highway agency into an efficient organization;(ii) construction, upgrading, and rehabilitation of some 79,000 km. of roads; (iii)ensuring that economic criteria were used for decisions on road investments; and (iv)private participation which increased the efficiency of these expenditures and inducedthe Government to spend more on maintenance. On-going support under the ThirdRoad Sector Loan (Ln 3833-CH) is accompanying the Government in furtheringinstitutional reforms.

Urban and Environmental Management: There have been clear advances on theinstitutional side: the Bank's support for establishing a new environmental institutionunder the CONAMA Loan (Ln. 3529-CH, approved November 1992 and completedDecember 1999) was successful in establishing an environmental managementcapacity, particularly on urban pollution issues. It contributed to generatingawareness of environmental issues and helped foster informed debate. Nevertheless,CONAMA still faces major challenges in promoting enforcement and improvingnatural resources management in key sectors closely linked to important extractiveindustries (Box 4). As for global environmental issues, the experience shows usefulways to mobilize grant resources for innovative programs (e.g., Montreal Protocol)and their full potential is yet to be tapped. The earlier attempts at pursuing reformsunder the Second Housing Loan (Ln. 3331 -CH) were unsuccessful and the plannedfinancial support for urban development did not materialize because of changinggovernment priorities. Even though a potential project for addressing air quality inthe greater Santiago area also did not materialize, because of the decline in overallborrowing, Santiago has been an active participant in the Regional Clean AirInitiative and is now working on a climate change GEF operation integratingtransport and urban growth issues.

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* Public Sector Management: Efforts under the Second Public Sector ManagementTechnical Assistance Project (Ln. 3411 -CH, approved October 1991 and completedJune 1997) have had lasting impacts. This project advanced institutionalimprovements, focusing on the needs of the newly restored democracy. It aidedbuilding in-house analytic, information processing, and administrative capacities incore agencies. Support continues at the municipal level, under the First and SecondMunicipal Development Projects, strengthening the core capacities of this level ofgovermnent in a sample of municipalities as well as introducing innovations in theareas of gender and indigenous peoples.

Box 6: Fee-based Advisory Services

In mid- 1996, the Bank and Chile signed an accord for providing, at short notice, technical advice on apartially reimbursable basis. The rationale was to enable Chile to access global experience and advice thatwould have been less readily available in view of the reduced level of Bank activity. It was also to serve asa catalyst for bringing together government agencies to focus on specific issues. Among the features of theBank's involvement desired by the Government was objectivity that the authorities did not think wasalways possible by engaging private sector consultants. The Bank saw the benefit of continuing to workwith a member that was tackling state-of-the-art or frontier development issues.

From July 1996 to May 1998, when the program was replaced by the Bank-wide fee-based advisoryservices program, the Bank provided assistance in five areas: (i) airport concessions; (ii) toll roads;(iii) higher education; (iv) regulatory institutions; and (v) hydrocarbons. In total, the Bank was reimbursedabout $220,000 for staff time, consultants and travel. Most of this advice was of short duration withoutfollow-up; an exception was the work on higher education which ultimately led to a new loan beingprepared and approved in FY99.

As a precursor to the Bank-wide program adopted in 1998, the program with Chile provides severallessons. The first is that, being demand-driven, success depended on the local capacity to identify andarticulate needs. The second is that the advice being sought from Bank staff was usually cutting edge and achallenge; thus, Bank staff welcomed the opportunity. Third, there were many demands and coordinationby the Ministry of Finance was critical. Recipient agencies were asked to cost-share. And finally, since theprogram was designed to provide short-term advice, it was not always the best instrument to address areaswhich demanded longer term support. On the side of the Bank, isolated provision of advice was not alwaysfollowed up or integrated into broader country strategy nor was this knowledge available to others.

Since the program of advisory services with Chile was subsumed under the Bank-wide program in 1998,Chile has called upon the new program three times. The first case was support for the continuation of theBank's involvement in education. The second case was specific assistance in the area of health, buildingon the conclusions of the ESW completed by the Bank. The third case involves the evaluation of thecontingent liabilities that the Government has under various concession agreements in infrastructure. Otherpossible assigmnents are being discussed, including the identification of public-private partnerships in non-traditional areas such as hospitals.

2. Portfolio Management

61. With five projects under implementation, representing total loans of $280 million,with $117 million undisbursed, Chile's portfolio is small and problem and risk free at

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present.25 The Third Road project is moving into its final stages, as is the MillenniumInstitutes LIL, closing in FY03. All on-going projects remain relevant to Chile'sdevelopment agenda and are consistent with the Country Assistance Strategy.

62. There is no major concern on the fiduciary side reflecting that: (i) project auditsare up-to-date and do not reveal any systemic issues; (ii) Chile has been working with theIMF on upgrading its public accounts and transparency; (iii) there has been no recentmis-procurement under Bank-financed projects and complaints from bidders are rare; (iv)Chile's public procurement system, considered relatively good, is being improved underthe 1999 Public Procurement Law; (v) IDB is providing assistance in strengthening theOffice of the Auditor General; and (vi) corruption is perceived to be low and thestandards of probity high. A combined Country Financial Accountability andProcurement Assessment is planned to validate this assessment (see Table 7). In themeantime, the proposed Public Expenditure Management Project, which accompaniesthis CAS, will address areas identified for improvement.

3. Economic and Sector Work

63. In addition to fee-based advisory services (Box 6), a steady program of ESW wascarried out, consisting of one major piece per year on topics usually suggested by theGovernment. Among the most recent ones was analysis of catastrophic health costs thatshowed that these costs were not concentrated with the elderly, rather with youngfamilies with children. The study further brought to light other problems in thefunctioning of Chile's health insurance system. Two other studies were the PovertyAssessments in FY98 and FYOO-O 1.26 These reports have advanced techniques inmeasuring poverty and understanding the impact of social services on poverty andincome distribution. They have provided the underpinning for preparing this CAS. ThePolicy Notes, a series of papers commissioned by the Bank from two local universities inFY00, provided an overview of concerns within the Chilean academic community andprovided insights into ongoing debates in Chile, notably on public spending in education.

4. IFC and MIGA

64. During the 1980s, the private sector in Chile received broad IFC support. In the1 990s, as the Chilean private sector improved its access to longer-term credit andsophisticated financial products, IFC became increasingly selective. This meant in thelatter part of the 1 990s targeting activities in which IFC would have a strong role andsignificant development impact, including greenfield projects, non-traditional industries,regional operations, second-tiered companies that lack market access and specializedtransactions in the financial sector, such as fund management and venture capital. TheCorporation's involvement further narrowed in FY98 when there were no investment

25 The operations currently under implementation are: Road Sector III, Municipal Development II, HigherEducation, Millennium Institutes LIL, and the Montreal Protocol.26 See Chile: Poverty and Income Distribution in a High Growth Economy, 1987-1995, Report Number16377-CH, dated November 25, 1997, and its update, covering 1987-98, Report Number 22037-CH, datedAugust 30, 2001.

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approvals. In FY99, IFC resumed selective financing in response to the decline ineconomic growth and the Government's requests for support in priority areas: a total of$37 million was approved for a rail transportation project and a continuing investment ina copper producer in FY99, followed by a $104 million investment (includingsyndications) in a port project in FY00. As of December 31, 2001, IFC's portfolio forChile stood at $131 million (including syndications).

65. Since FY95, MIGA has been moderately active, supporting projects worth $31.3million in FY98 and $31.4 million in FY99 in the mining and oil and gas sectors,respectively. As a result of reductions of guarantee coverage, MIGA's current exposurein Chile is only $22.2 million. While no new contracts were signed in FY00 and FY0 1,MIGA has received an application for a potential project in the infrastructure sector.

The FY02-06 Program

66. This Country Assistance Strategy builds on Chile's success in reducing povertyand aims to support activities to sustain and deepen that process. In light of Chile'sprogress during the past decade, the proposed program for FY02-06 focuses selectivelyon areas in which the comparative advantage of the World Bank Group can come intoplay, bringing together global knowledge, past experience and the ability to sustaindialogue and to exploit synergies with other activities.

Box 7: Consultation in Preparing the CAS

The consultations carried out for preparing this CAS focused on the linkage with the Bank's PovertyAssessment. The Poverty Assessment laid out four main themes: (i) the importance of sustainable growth,since growth has been the driver of poverty reduction since 1988. Productivity improvements,enhancements of human capital and labor mobility, technology, and employment creation, especially bySMEs, were considered key. Moreover, for growth to be sustained, natural resources, such as watersheds,sensitive lands, and air quality, have to be managed; (ii) the need to target those less likely to benefitreadily from economic growth, such as youths, women heads of households, the elderly living in the ruralareas, and indigenous groups. Many of these have limited education and may benefit from a secondchance. Opportunities for them might arise in small firms and in small centers. Others may require moreresponsive social programs; (iii) the disparities that exist among Regions and groups, especially betweenthose living in the rural areas versus urban centers. Thus, access to services and local capacities to provideservices and administer programs could be reinforced; and (iv) the continuing challenge of meeting thebasic needs of the population, notably in education, health and housing. While absolute deprivation is low,the needs of the population with deficiencies remained high-almost 50 percent of the total.

This diagnosis and the accompanying proposals for the CAS were presented to two civil society groups inNovember 2001. The first consisted of about 200 academics, students, and policy makers, sponsored bythe University of Chile. The second was a group of 20 leaders of non-governmental organizations. Thismeeting was facilitated by the Secretariat-General of the Presidency. The NGO leaders are part of theCommission on Participation formed by President Lagos to add new mechanisms for involving civil societyin public programs. Both audiences responded favorably to the poverty analysis and to the Bank'sproposals, endorsing the main thrusts of the proposed program. Feedback from the group of NGOshighlighted the weakness of local administrations in implementing social programs and the need forincreasing public sector accountability. This group also noted potential areas to improve futureassessments of poverty. Equally, feedback from the academic group included comments on measuringpoverty in the future, and the need for more exhaustive and systematic evaluation of social programs.

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67. There are three broad objectives for the program corresponding to the maindevelopment challenges facing the country, namely: (i) sustaining overall economicgrowth and social progress; (ii) heightening inclusion, especially of rural populations andvulnerable groups, with an emphasis on opportunity and social services; and (iii)modernizing the state as the underpinning for development. In each area, the proposedprogram provides technical support and advice with sustained financing as a catalyst. Italso includes support for structural reforms with the option of deferring actual use of thefunds.

Vehicles for Bank Group Assistance

2. IBRD Lending Services

68. The proposed lending program for FY02 to 06 would be approximately $500 to$650 million. The average amount of lending-about $100 million per year - iscomparable to past lending during the 1 990s and represents a significant decline from the1980 and early 1 990s.2 7 The first part would consist of up to six investment loans,roughly one each year, for a total of about $250 to $300 million. This program wouldconsist of traditional investment and technical assistance loans, with perhaps one APL.Table 6 lays out the expected operations, the links with CAS objectives and the rationalefor Bank involvement. There is no specific lending trigger with the understanding thatprojects would only be prepared and presented for Board consideration if specific projectgoals are agreed and the overall implementation of Chile's economic program remainssatisfactory.

69. The second part of the Bank's program would consist of one or two SALs,depending on the scope and timing of the agreed program, with the Deferred Draw-Downoption (DDO), for a total of about $250 to $350 million. The choice of the DDO by theGovernment reflects the heightened risks facing Chile in the current global and regionaleconomic environment, long with many other countries, and represents a precautionarymove by Chile to manage potential risks in the future. This approach is consistent withthe objectives of the proposed strategy and responds to the recommendations made byOED in its Country Assistance Evaluation. It meets the criteria laid out for the possibleuse of the DDO instrument (Box 8).

27 Because of the electoral cycle and the transition to the next administration in 2006, no lending isanticipated in FY06 with the goal of consolidating activities in anticipation of the change and preparing thebasis for reviewing the Bank's collaboration at that time.

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Box 8: Rationale for a DDO

The Board paper for the DDO, R2001-0174, dated September 26, 2001, provides the criteria for itsuse. Applying those criteria to a possible DDO operation in Chile, it is apparent that:

. Chile, an upper-middle income IBRD borrower, has made much less use of the Bank'sfinancial resources than it might have: in the 1990s, average lending fell to only about 20percent of that in the 1980s.

* Chile is in good standing with the international fnancial markets, accessing those marketswith the lowest spread of all Latin American countries.

* Prudent risk management under conditions of higher risk both globally and regionally point tothe need for additional measures to ensure funding sources in the event of simultaneousexternal shocks.

* Chile's external financing requirements-comparable to that in the economic downturn facedin 1999-could be in the range of 1-1.5 percent of GDP, or US$700-1,000 million.

. A strong reform package could be expected from Chile: it is a country with a solid trackrecord in designing and implementing reforms and maintaining sound macro-policies.

* The Bank's exposure in Chile is extremely low, reflecting both the level of past lending andprepayments in the mid-1990s.

70. The goal would be to support a series of reforms, still at an early stage ofdefinition in terms of content, structure, and timing, to enhance Chile's long-termstructural performance. Several areas of reform have been identified, consistent withCAS objectives. First, it is anticipated that the reform agenda could cover measures toimprove the health system, a priority for the Lagos Administration. Second, the reformagenda could include other reforms emanating from the proposed ESW on social servicesaiming to reinforce social service design and delivery. Other reforms could address thepresent system of public works financing and the current regulatory framework and otherareas related to improving public expenditures. The Bank's ability to act as a catalyst forchange and to monitor performance would be important criteria in formulating thecontent of the proposed operation or operations. In all of the possible areas identifiedabove, the Bank has already undertaken, or has planned, the required ESW and relatedanalytical work. Support through the DDO would only materialize if there is agreementon a strong refonn package and a satisfactory macro-economic framework in place.

30

Table 6: Possible Investment Lending Services

Possible CountryProposed Project Objectives Assistance Rationale for Bank Opportunity forProjects Strategy Involvement Partnership

_________________ ~~~~Obiective

Public Modernizing Chile's system Modernization The Bank brings to the project IDB addresses publicExpenditure of public expenditure of the State global experience combined auditing andManagement management to integrate core with its ability to work across participation. The IMF

financial systems, install real agencies. provides advice ontime processing and accounting structures andstandardize reporting and transparencymonitoring_

Life Long Upgrading skills of adults, by Sustainable The Bank has more than ten IDB would assist drop-Learning facilitating access to Growth years experience in the sector, outs and youths at risk

technical and adult and can integrate adult and has assisted ineducation, giving many a Inclusion education with parallel actions technical education. Itsecond chance, as well as in higher education and also aims to promotenew opportunities for skills, secondary education. female laborand increased labor mobility participation.

Watershed Demonstrating sustainable, Sustainable The Bank can build on pilotsManagement multiple use of water Growth under GEF and on the(with GEF) resources in watersheds that extensive global knowledge in

involve environmental Inclusion natural resources management.concerns, indigenous The ability to work withpopulations and competing diverse groups is important.interests plus multiple actors

Rural Improving access to basic Sustainable The Bank has already piloted IDB has worked inElectrification rural services, especially in Growth similar programs and can expanding electricity-Infrastructure isolated, poor areas, by mobilize GEF resources for services as part of the(with GEF) exploiting altemative sources Inclusion non-traditional energy sources. national grid.

of energy, and alternative The Bank can also work withmixes of supply and delivery private concessionaires tomechanisms. mobilize their participation.

Technology and Modeling best practices and Sustainable The Bank-financed IDB is providing supportInnovation building capacities and Growth Millennium Institutes LIL is for physical facilities, the

processes for effective being successfully non-traditional sectorsresearch and innovation by implemented. The Bank's and applied research bynetworks of institutions with participation in scaling up firms.greater linkages to would bring global knowledgebusinesses. and intemational linkages.

Social Service Strengthening capacity to Inclusion Synergies with other Bank- IDB support is aimed atDelivery and identify beneficiaries and financed operations aimed at social investment funds,Social deliver social services to at Modemization municipalities combined with and various at risk groupsProtection risk and vulnerable groups, of the State core knowledge of health and (disabled, indigenous,

including rural populations, education as well as best youths, elderly) andwhile improving targeting, practices in social risk social problems such asmonitoring and evaluation. management. domestic violence.

31

3. IFC and MIGA

71. The role that IFC and MIGA can play in Chile complements that of the Bank.Like the Bank, IFC would continue to be selective and respond to changing countryconditions. Currently, the private sector is coping with slower growth coupled by theadverse effects of the global economic uncertainties and difficulties in Argentina. IFCwill help the private sector respond to these conditions in support of the Government'spriorities, particularly growth and competitiveness. Looking forward, IFC's strategyremains focused on high impact areas, including wholesale support for SMEs, specializedfinancial market activity including housing finance, infrastructure, and the social sectors.IFC's focus will be guided by the Government's priorities and the private sector'sdemand for improving its competitiveness. There are presently three projects in thepipeline for power and infrastructure.

72. MIGA's strategy is to continue to facilitate foreign direct investment in Chile andto counteract the adverse effects of the global and regional crises. The relative decline inMIGA activities in Chile has been partially due to the improvement in Chile's investmentclimate and the perception of decreased political risks in the country. MIGA'sinvolvement will focus on risks that are not adequately covered by the private insurancemarket. In addition, MIGA is looking to support Chilean firms investing in othercountries by providing them with political risk coverage.

4. Non-Lending Services

73. GEF and other grants: Chile has been an innovative user of mid-size GEFgrants (Santiago Foothills and Valdivian Forestry Management) and the MontrealProtocol. Two GEF grants integrated into investments are being developed: oneaccompanying a Bank loan to support the proposed Watershed Management project andanother complementing government investments in Sustainable Transport and AirQuality Management. Further opportunities will be explored including the proposedRural Electrification/Infrastructure project. Chile also will be one of the first participantsin the Carbon Prototype Fund with an investment in a flow-of-the-river hydroelectricgenerating plant. Equally, there are opportunities to employ trust funds for smallinnovative activities. An example is the Norwegian Trust Fund for a tri-countryprogram-Chile, Peru, and Bolivia-to support the south-south capacity building ofindigenous-led municipalities, linked to the Bank's ongoing Second MunicipalDevelopment project.

74. Economic and Sector Work: The planned program of Bank-sponsored ESWwould be selective, consisting of one major analysis per year with cost sharing asappropriate by assignment of officials to work with Bank teams. While it is notanticipated that every analysis would be done this way, such joint products would lead tomore opportunities for internalization within the Government and greater efficiency andimpact of the studies. The topics which have been identified as of high interest to theGovernment and the Bank and the rationale for Bank involvement are laid out in theTable 7. In addition to formal ESW, the Bank and Chile will continue to pursue

32

opportunities for fee-based advice (Box 6) and to collaborate with staff exchanges as wasdone in the case of education.

Table 7: Proposed Economic and Sector Work

Proposed Study Objective CAS Rational for Bank Involvement PartnershipsStudy Objective &Complementarities

The New Assessing Chile's capacity Sustainable This tri-country study (Chile, 1DB has investment programsEconomy to face the challenges of a Growth Argentina, and Uruguay) supporting research and is

knowledge-based positions the Bank to understand facilitating access by firms toeconomy, examining the Modemization policy and program implications technology. Participation ofbroad country position of the State of the knowledge economy. By local businesses, academicwith more detailed look at using methodologies developed institutions in the consultativee-government, e- by WBI and already applied in process.commerce (especially for Korea and Brazil, the Bank canSMEs) and e-education accumuiate global knowledge

and international benchmarking.

Social Risks Taking a systems Inclusion This study would provide a IDB is active in delivery ofand Social approach to managing system wide view of social social programs and hasProtection social risks and social Modemization protection, as the basis for concentrated on specific

protection of vulnerable of the State identifying gaps and designing groups. Consultation withgroups, examining long- new programs and policies. It NGOs and academic groups.term needs and delivery, would employ the conceptualbuilding on the initial frameworks established bydiagnosis in the Poverty recent regional studies and theAssessment Social Protection Network.

Smnall and Assessing the capacity of Sustainable An under-developed sector, IDB has provided considerableMedium Scale SMEs to contribute to Growth SMEs are not well understood. financial support for SMEsEnterprses growth and employment, A systematic assessment is and has an active interest in

along with the Inclusion needed to guide reforms and the sector. Consultation withconcomitant role of the policies. There are synergies diverse business organizations,State. Modemization with other Bank-financed think-tanks and local

of the State programs, notably Life-Long organizations.Leaming, Rural Infrastructure,and Technology and Innovation,

Rural Determining the needs of Sustainable This assessment would provide IDB has provided funding forInfrastructure rural populations for basic Growth the baseline needed to determine the Regional Development

services in the areas of the nature and scope of a Fund that may be a fundingwater. electiicity, Inclusion potential operation, along with source for future investments.communications. and the complementarities with other Also, many services areaccess, along with Modernization actors, presently provided by privateinstitutional and policies of the State sector concessionaires.to support greater access.

Fiduciary Validating the status of Modernization Assurances that fiduciary Potential exists for IDB andAssessment financial accountability of the State responsibilities are being the Bank to cooperate in a

and public procurement as addressed by the borrower is an joint undertaking as they are inwell as measures currently underlying feature of the Bank's Argentina and Paraguay.planned or underway to work. In the case of Chile, theaddress areas of aim is validating and monitoringimprovement. improvements.

Poverty Continuing to examine Sustainable Poverty reduction remains the Continued collaboration withAssessment poverty in order to Growth reason for Bank involvement in academic groups, as well asUpdate contribute to sustainability the country. Continued poverty stakeholders.

and enhance Inclusion assessments are needed tounderstanding of the ways update and refine the ensuingin which poverty reduction Modemization strategies.can be effective of the State I .

33

5. Global Programs and Connectivity

75. Chile is an active partner in the Bank's global initiatives that were not featured inthe last CAS. An example is global distance learning: a GDLN center, connected to nineother sites, was established with the University of Chile in April 2001. The Enlacesprogram under World-links is another example: Enlaces initially began under the Bank-financed Primary Education Project and is being expanded to cover almost the entirepublic system, with 30 universities participating. The Bank is also continuing earlierwork in Chile, under the WBI's Alliances for Poverty Reduction, supporting theidentification of best practice cases of public-private-civil society partnerships to reducepoverty. This program was extended in collaboration with the Ministry of Planning toencourage participation. InfoDev has financed an innovative trial program to establishtelecommunication centers with Internet connections in poor neighborhoods, especially insmall towns and remote areas. And, finally, civil society organizations are activelyconsidering joining the Development Gateway.

6. Partnerships

76. Collaboration with the other IFIs remains important. The IMF's macro-economicmonitoring provides a valuable source of information for the Bank. Should the proposedDDO operation materialize, it is expected that the Fund would provide active input intoassessing the macro-economic program. The IMF also periodically provides Chile withtechnical advice: for example, the IMF's analysis of issues in public expendituremanagement in July 1999 contributed to the formulation of a request for financial supportfrom the World Bank.

77. In the case of the IDB, there are complementarities between the two institutionswith the IDB having a more diverse program. The level of lending anticipated by theIDB for CYOO to CY02 is about $600 million with the program to be reassessed at theend of this calendar year. Examples of collaboration include:

* IDB is providing financial assistance to the Office of the Auditor General, whichis responsible for Chile's public auditing. This will constitute a key linkage withthe Bank's proposed support for Public Expenditure Management.

* Another critical area is the IDB's support for indigenous peoples. The agreeddivision of labor is that the Bank would integrate ethnicity-as well as gender-into programs rather than deal with them on a stand-alone basis and that the IDBprovides direct assistance under its Indigenous Communities Project.

* The third area of collaboration is technology where, by agreement, the Bank'sfocus is on research and innovation processes with the IDB emphasizing supportfor institutional and physical capacities, such as technology parks.

34

Country Program Monitoring

1. Performance Indicators

78. Chile sets a high standard for development performance. It aims to restore highlevels of growth, averaging at least 5 percent per year, and to maintain the downwardtrend of poverty reduction, reducing the present rate of 17 percent (lower bound) or 21percent (upper bound), while lowering unemployment below the 10 percent mark. Whilecontinuing to reduce poverty overall, a goal would be to reduce differences acrossRegions and groups. At present, the difference between the national average and therural and indigenous populations ranges from 50 to 60 percent depending on the location;that gap would be reduced overall to less than 50 percent. At the same time, a goal wouldbe to show improvements in social services and coverage in programs, along withimplementation of the state modernization program. The following table summarizesindicators of performance over the medium-term (see Annex B9 for more details).

Table 8: Performance Indicators

Baseline Medium Term Corresponding Bank PerformanceProgram Development Goals Indicators Targets Indicator

(1998) (2005-07)

Sustaining growth and social progress(i) increasing R&D investment .65% GDP 1% GDP LIL scaled up

(ii) increasing female labor market 38% 42% Life Long Leaming Project's targetparticipation for female participation met

(iii) increasing grade 8 scores in municipalschools Local improvement programs in place(a) Spanish 238 250 in target municipalities

(1999)(b) Mathematics 238 250

(1999)Modemizing the state

(i) integrated financial management N/A Accomplished Processing time delays reducedsystem in place

(ii) increasing e-govemment and virtual N/A Public records/information centers tax

(iii) expanding non-traditional private N/Aprovision of services Pilots Pilot in hospitals functioning

(iv) increasing share of public investment 46%resources managed at regional level (2000) 50% Criteria adopted on the distribution of

public investment funds by RegionPromoting Inclusion

(i) increasing rural coverage ininfrastructure services(a) water 65% >75% Targets met within project(b) electricity 75% >90% population.

(ii) reducing poverty gap between regions 60-50% <50%and groups Poverty Analysis demonstrates targets

(iii) increasing coverage by poor of social met.programs(a) family allowances and subsidies 32% >50% Agreement reached on expanding(b) child-care 3% >5% coverage and reducing leakage.

Improvements toficha CAS. Programfor target municipalities in place.

35

2. Risk Management and Creditworthiness

79. Chile has an excellent track record of servicing debt to the Bank Group and Bankexposure in Chile is limited. As of December 31, 2001, Chile had IBRD debt outstandingand disbursed of $734 million, amounting to 0.6 percent of the IBRD portfolio. Chile'stotal public sector debt is very low at $10.1 billion, representing only about 15 percent ofGDP; of this, $3 billion is external.

80. Chile's strong creditworthiness reflects its excellent track record of developmentmanagement and macroeconomic performance over the past decade. However, thecountry remains vulnerable to global and regional events that are largely beyond itscontrol or ability to influence. Particular risks are arising from the present pronouncedand widespread global economic downturn that will reduce demand for Chile's exports atthe same time as lower copper prices to which Chile remains sensitive due to the highshare of copper exports. In addition, the present international climate could adverselyaffect investor confidence and could dampen interest in new investments by bothdomestic and external investors. While contagion has so far been limited, the recentevents in Argentina creates additional uncertainties for the overall investment climate inthe region, and specifically for Chilean corporations operating in Argentina and thosevulnerable to exchange rate pressures following several years of growing private externalindebtedness.

81. These conditions present a challenge for Chile even though the country has agood track record of dealing with shocks and it has a number of strengths to helpwithstand those shocks. Chile is one of the few emerging market economies which canafford to undertake counter-cyclical fiscal and monetary policies. On the monetary side,a flexible exchange rate, healthy reserve levels and moderate inflation have been able tocounteract recent external shocks. On the fiscal side, its automatic stabilizationmechanisms including the Copper Stabilization Fund and a strong fiscal position haveplaced Chile in a good position. It has already taken precautionary measures to accessthe international capital markets. It also can rely on strong public institutions to carryforward a solid policy regime. Nevertheless, the prolonged persistence of a negativeinternational and regional environment could ultimately sap Chile's capacity to withstandsuch adverse conditions. Thus, prudence in the time of high uncertainty warrants that theCountry Assistance Strategy include instruments that provide optional access to externalfinancing in support of structural reforms.

3. Future Evolution

82. Even though Chile is one of the best performers among the Bank's diversemiddle-income borrowers, graduation is not foreseen as an immediate prospect: whileperformance has been excellent over the past fifteen years, income levels are still belowthe threshold for triggering a review of the country's situation. Present projectionsindicate that reaching that level could take several more years reflecting the changing

36

economic conditions and prospects. In the meantime, the challenges to be faced havebeen made more acute by recent global events.

83. One of the lessons from the past is that there should be flexibility in responding tochanging country needs. The Bank's partnership with Chile is an example of thatflexibility: over the past fifteen years the level and content of the financial and technicalsupport sought from the Bank has changed several times and Chile is now seeking asustained Bank involvement, at least for the foreseeable future, aiming to deploy thesupport of the Bank Group selectively to high priority areas. Thus, the CAS reflects thecontinuing engagement between the Bank and Chile for the period FY02 to 06.

James D. WolfensohnPresident

ByShengman Zhang

Washington, DCJanuary 23, 2002Attachments

37

Chile at a glance 1/24/02

LaUn Upper-POVERTY and SOCIAL America middle-

Chile & Carib. Income Development dlamond'2000Population, mid-year (millions) 15.2 516 647 Life expectancyGNI per capita (Atlas method, US$) 4,610 3,680 4,620GNI (Atlas method, US$ billions) 70.1 1,895 2,986

Average annual growth, 1994-0

Population (%) 1.4 1.6 1.3 G GLabor force (%) 2.0 2.3 2.0 GNI pGross

per ,pnimaryMost recent estimate (latest year available, 199440) capita enrollment

Poverty (% of population below national poverty line) 21Urban population (% of total population) 86 75 76Life expectancy at birth (years) 76 70 69Infant mortality (per 1,000 live births) 10 30 28Child malnutrition (% of children under 5) 1 9 ,, Access to improved water sourceAccess to an improved water source (% of population) 94 85 87Illiteracy (6 of population age 15+) 4 12 10Gross pnmary enrollment (% ofschool-age population) 101 113 107 - Chil

Male 103 .. 106 - Upper-middle-income groupFemale 100 105

KEY ECONOMIC RATIOS and LONG-TERM TRENDS

1980 1990 1999 2000Economic ratuoS

GDP (US$ billions) 27.6 30.3 67.7 70.5Gross domestic investment/GDP 21.0 25.1 22.1 23.4Exports of goods and services/GDP 22.8 34.6 29.0 31.8 TradeGross domestic savings/GDP 16.9 28.4 23.9 24.5Gross nabonal savings/GDP 13.5 23.2 21.8 21.9

Current account balanceJGDP .. -1.6 -0.3 -1.6 Domestic InvestmentInterest payments/GDP 3.3 4.5 3.5 4.1 savingsTotal debtVGDP 43.8 57.5 50.5 52.2Total debt service/exports .. 27.1 28.6 27.5Present value of debtGDP .. .. 53.1Present value of debWexports .. .. 179.1

Indebtedness1980-90 1990-00 1999 2000 2000.04

(average annual growth)GDP 4.2 6.8 -1.1 5.4 4.1 - ChileGDP per capita 2.5 5.2 -2.4 4.0 2.9 Upper-middle-income groupExports of goods and services 6.9 9.4 6.9 7.5 6.1

STRUCTURE of the ECONOMY1980 1990 1999 2000 Growth of investment and GOP (%)

(% of GDP)Agnculture 7.3 8.7 10.3 10.5 4Industry 37.4 41.5 33.9 33.5 20

Manufacturing 21.5 19.6 16.1 15.9 o'Services 55.3 49.8 55.8 56.0 95 o 97o

Privateconsumpton 70.7 61.9 64.1 63.1General government consumption 12.5 9.8 12.0 12.4 - GDI 0 GDPImports of goods and services 27.0 31.4 27.2 30.8

198090 199040 1999 2000 Growth of exports and Imports (%)(average annual grow th)Agnculture 5.9 4.2 -0.7 7.6 30

Industry 3.5 6.0 2.7 4.5 20

Manufacturing 3.4 4.6 -0.7 4.3 10Services 2.9 5.2 -0.7 5.0 oi

Private consumption 2.0 7.4 -3.1 4.1 -IC as go 97 go N ooGeneral govemment consumption 0.4 3.9 2.5 3.5 -20Gross domestic investment 6.4 8.9 -25.5 13.7 Exports Im,portsImports of goods and services 1.8 11.0 -14.3 10.1

Note: 2000 data are preliminary estimates.

The diamonds show four key indicators in the country (in bold) compared with its income-group average. If data are missing, the diamond willbe incomplete.

Chile

PRICES and GOVERNMENT FINANCE1980 1990 1999 2000 |Into b

Domestic prices Inflation I%)(% change)Consumer pnces 35.1 26.0 2.3 4.5 10 Implicit GDP deflator 28.8 21.2 3.5 4.1

Government finance(% of GDP, includes current grants) oCurrent revenue .. 20.6 22.5 23.7 95 90 97 98 99 °0

Current budget balance .. 2.5 2.5 3.7 - GDP deflator OCPIOverall surplus/deficit .. 0.8 -1.5 0.1

TRADE1980 1990 1999 2000 Export and Import levels (USS mill.)

(US$ millions)Total exports (fob) 4,706 8,373 15,616 18,158 25,0N9

Copper 2,125 3,810 5,889 7,347 200Fruits 340 757 1,212 1,122 20009

Manufactures 1,751 2,739 7,152 8,172 1000

Total imports (cif) . 7,742 15,137 18,089 10o0.

Food ~ i lFuel and energy 1,208 1,799 2,890 5.000 lCapital goods .. 2,137 3,270 3,702

94 95 96 97 98 go 00Export price index (1995=100) .. 77 67 73Import price index (1995=100) 88 111 122 U Exports U ImportsTerms of trade (1995= 100) . 88 60 60

BALANCE of PAYMENTS1980 1990 1999 2000 Current account balance to GDP (%)

(US$ millions)Exports of goods and services . 10,222 19,406 22,087 0Imports of goods and services . 9,173 18,056 21,209 1Resource balance .. 1,049 1,350 878

Net income .. -1,731 -1,881 -2,404Net current transfers 197 453 538 -3

Current account balance . -485 -78 -989 4-

Financing items (net) .- 2,853 -605 1,186 s

Changes in net reserves .. -2,368 683 -198 -3

Memo:Reserves including gold (USS millions) .. 5,358 15,013 15,211Conversion rate (DEC, /ocal/US$) 39.0 305.1 508.8 535.5

EXTERNAL DEBT and RESOURCE FLOWS1980 1990 1999 2000 E

(US$ miltions) Compositlon of 2000 debt (USS mill.)Total debt outstanding and disbursed 12,081 17,425 34,167 36,849

IBRD 163 1,860 877 808 A STIDA 21 14 8 7 A |

Total debt service 2,706 2,772 5,548 6,067 | :9,921 _ _ L 6 770IBRD 25 249 181 187IDA 0 1 1 0 | E 494

Composition of net resource flowsOfficial grants 9 73 14 0Official creditors -145 294 -83 -106Private creditors 2,234 1,187 -3,666 2,261Foreign direct investment 213 590 4,366 -1,103Portfolio equity 0 320 130 -261 |F: 18549

World Bank programCommitments 74 130 161 0 A -16RD E -BilateralDisbursements 14 251 43 48 B -IDA D -Other multilateral F -PrivatePrincipal repayments 9 120 111 116 C-IMF G-Short-termNet flows 5 132 -68 -67

Interest payments 16 130 71 70Net transfers -11 1 -139 -138

Development Economics 1/24/02

Annex B2Page 1 of 1

CAS Annex B2 -Selected Indicators* of Bank Portfolio Performance and Management

As Of Date 12/11/2001

Indicator 1999 2000 2001 2002Porffolio AssessmentNumber of Projects Under Implementation a 7 8 5 5Average Implementation Period (years) b 2.9 3.8 4.4 4.8Percent of Problem Projects by Number a c 0 0 20 0Percent of Problem Projects by Amount a, c 0 0 3.5 0Percent of Projects at Risk by Number a, d 0 0 20 0Percent of Projects at Risk by Amount a,d 0 0 3.5 0Disbursement Ratio (%) e 44.6 21.2 22.2 12.3Portfolio ManagementCPPR during the year (yes/no) no yes yes yesSupervision Resources (total US$ '000) 647.62 643.75 302.06 244.39Average Supervision (US$ '000/project) 49.82 58.52 50.34 48.88

Memorandum Item Since FY 80 Last Five FYsProj Eval by OED by Number 36 11Proj Eval by OED by Amt (US$ millions) 2776 413.8% of OED Projects Rated U or HU by Number 11.1 18.2% of OED Projects Rated U or HU by Amt 11 22.2

a. As shown in the Annual Report on Portfolio Performance (except for current FY).b. Average age of projects in the Bank's country portfolio.c. Percent of projects rated U or HU on development objectives (DO) and/or implementation progress (IP).d. As defined under the Portfolio Improvement Program.e. Ratio of disbursements during the year to the undisbursed balance of the Bank's portfolio at the

beginning of the year: Investment projects only.* All indicators are for projects active in the Portfolio, with the exception of Disbursement Ratio,

which includes all active projects as well as projects which exited during the fiscal year.

Annex B3

Page I of 2CAS Annex B3 - Bank Group Program Summary Chile [IBRD]

As of Date 01124/02

Proposed IBRD/IDA Base-Case Lending Program a

Fiscal year Proj ID US$(M) Strategic Rewards b Implementation b(HIMIL) Risks (HIMIL)

2002 CL Pub Expenditure Management 23.2 H H

CL-Lifelong Learning and Training 75.7 H M

Result 98.9

2003 CL-Watershed Management APL/total 150.0 H H

CL - SAUDDO 300.0 H M

Result 450.0

2004 CL-Rural Electricification/Infrastructure 30.0 H M

CL-Technology-Innovation 20.0 H M

Result 50.0

2005 CL-Local Service Delivery 20.0 M M

Result 20.0

2006 0.0

Tot FY02-06 Result 618.0

a. This table presents the proposed program for the next three fiscal years.b. For each project, indicate whether the strategic rewards and implementation risks are expected to be high (H), moderate(M), or low (L).

Template created on 1/24/2002.

Annex B3Page 2 of 2

[IFC/MIGAI

CAS Annex B3 (IFC & MIGA) for ChileChile - IFC and MIGA Program, FY 1999-2001

1999 2000 2001

IFC approvals (US$m)* 36.88 38.70 0.00

Sector (%)OIL, GAS AND MINING 68 0TRANSPORTATION & WAREHOUSING 32 100

Total 100 100 (n/a)

Investment instrument(%)Loans 0 90Equity 27 10Quasi-Equity** 73 0Total 100 100 (n/a)

MIGA guarantees (US$m) 62.67 62.67

* IFC's account only (not reflecting Participants').** Includes both Loan-type and Equity-type.

Annex B4

CAS Annex B4 - Summary of Nonlending Services -As of January 23, 2002

Product Completion FY Cost (US$000) Audiencea Objective b

Recent completions/Underway

Health Insurance Issues - Old Age and FY00 147 Government, ProblemCatastrophic Health Costs Bank, Public solving,

dissemination KnowledgeGeneration

Policy Options, including Poverty FY01 265 Government, KnowledgeBank Generation

Social Risks and Protection FY02 147 Govemment, ProblemBank solving,

KnowledgeGeneration

New Economy FY03 214 Government, Knowledge[joint task Argentina, Chile & Uruguay] Bank, Public Generation

dissemination

Planned

SMEs FY03 175 Government, KnowledgeBank Generation

Fiduciary Assessment FY03 100 Government, ProblemBank solving,

KnowledgeGeneration

Rural Services FY04 175 Government, ProblemBank solving,

KnowledgeGeneration

Poverty Assessment FY05 175 Government, ProblemBank, Public solving,dissemination Knowledge

Generation

a. Government, donor, Bank, public dissemination.b. Knowledge generation, public debate, problem-solving.

Annex B5Page I of I

Chile Social IndicatorsLatest single year Same region/income group

Latin Upper-America middle-

1970-75 1980456 1993-99 & Carib. Income

POPULATIONTotal population, mid-year (millions) 10.3 12.0 15.0 508.2 571.5

Growth rate (% annual average for period) 1.7 1.6 1.4 1.6 1.4Urban population (% of population) 78.4 82.6 85.4 74.9 75.4Total fertility rate (births per woman) 3.2 2.7 2.2 2.6 2.4

POVERTY(% of population)National headcount index .. .. 20.5

Urban headcount index ..

Rural headcount index .. ..

INCOMEGNI per capita (US$) 1,110 1,420 4,630 3,800 4,870Consumer price index (1995=100) 1 21 124 140 131Food price index (1995=100) .. 19 118

INCOMEICONSUMPTION DISTRiBUTIONGini index .. .. 57.5Lowest quintile (% of income or consumption) .. .. 3.4Highest quintile (% of income or consumption) .. .. 62.0

SOCIAL INDICATORSPublic expenditure

Health (% of GDP) .. .. 2.7 3.3 3.3Education (% of GNI) 4.1 4.4 3.6 3.6 5.0Social security and welfare (% of GDP) 8.2 11.8 8.3 7.4 7.9

Net primary school enrollment rate(% of age group)

Total 94 89 89 91 94Male 94 90 91Female 95 90 88

Access to an Improved water source(% of population)

Total .. 86 94 85 87Urban .. 97 99 93 94Rural .. 22 66 62 68

ImmunizaUon rate(% under 12 months)

Measles .. 92 95 90 90DPT .. 91 94 87 88

Child malnutrition (% under 5 years) .. 2 1 9Life expectancy at birth(years)

Total 66 72 76 70 69Male 63 69 73 67 66Female 69 75 79 73 73

MortalityInfant (per 1,000 live births) 55 20 10 30 27Under 5 (per 1,000 live births) 96 35 12 38 34Adult (1I-59)

Male (per 1,000 population) 301 218 140 207 233Female (per 1,000 population) 177 120 72 122 143

Matemal (per 100,000 live births) .. .. 20Births attended by skilled health staff (%) .. 95 100

Note: 0 or 0.0 means zero or less than half the unit shown. Net enrollment ratios exceeding 100 indicate discrepanciesbetween the estimates of school-age population and reported enrollment data. Latest year for access to improved watersource data is 2000.

2001 World Development Indicators CD-ROM, Worid Bank

CAS Annex B6 - Key Economic Indicators - Chile Annex B6Page I of 3

Acrual EFtiinateIndicator 1995 1996 1997 1998 1999 2o00 2(101 2012 20(163

National accounts(as % GDP at currentmarket prices)

Gross domestic product 100,0 100.0 100.0 100.0 100.0 10O 100.0 1 100.0Agriculturea 9.2 9.0 8.4 10.4 10.3 10.5 10.5 10.5 10.5

Industrya 35.3 35.2 35.1 33.1 33.9 33.5 33.5 33.5 33.5

Servicesa 55.5 55.8 56.5 56.5 55.8 56.0 56.0 56.0 56.0

Total Consumption 72.4 75.3 75.5 77.4 76.1 75.5 74.7 74.1 74.9

Gross domestic fixed 23.9 24.9 25.5 26.0 21.9 22.3 22.6 23.4 23.5

investmentGovernment investment 3.9 5.2 4.9 6.2 5.8 5.5 5.6 5.8 5.8

Private investment 19.9 19.7 20.6 19.8 16.0 16.8 17.0 17.6 17.7

(includes increase instocks)

Exports (GNFS)b 30.5 28.7 28.1 26.7 29.0 31.8 34.3 34.6 34.3

Imports (GNFS) 28.7 30.9 30.9 30.9 27.2 30.8 32.7 33.2 33.9

Gross domestic savings 27.6 24.7 24.5 22.6 23.9 24.5 25.3 25.9 25.1

Gross national savingsc 23.7 21.8 22.3 21.8 21.8 21.9 21.6 22.4 22.2

Memorandum itemsGross domestic product 65215.9 68567.6 75285.7 73063.4 67657.5 70545.0 64041.5 65272.8 67231.0

(US$ million at currentprices)Gross national product per 3880.0 4370.0 4740.0 4860.0 4610.0 4670.0 4489.5 4397.7 4370.3

capita (US$, Atlas method)

Real annual growth rates(%, calculated from 1995prices)

Gross domestic product at 10.6 7.4 7.4 3.9 -1.1 :5.4 3.2 3.3 5.0

market pricesGross Domestic Income 16.7 2.7 9.3 -6.2 -3.0 8.5 3.2 3.3 5.0

Real annual per capitagrowth rates (%, calculatedfrom 1995 prices)

Gross domestic product at 9.1 6.0 6.0 2.6 -2.5 4.1 2.0 22 3.9market pricesTotal consumption 7.6 6.7 7.2 2.9 -3.9 2.8 1.2 1.2 5.8Private consumption 8.3 7.3 7.5 3.0 -4.4 2.9 1.1 1.] 6.0

(Continued)

COUNTRY - Key Economic Indicators Annex BO(Continued) Page 2 of 3

Actual EsiimateIndicator 1995 1996 1997 1998 1999 2Otn 200 20J2 2003

Balance of Payments(US$n.)

Exports (GNFS)b 19359 19066 20772 18949 19406 22087 21939 22584 23047Merchandise FOB 16024 15405 16663 14830 15616 18158 18050 18772 19617

Imports (GNFS)b 18299 20418 22281 21580 18056 21209 20957 21687 22779Merchandise FOB 14643 16496 18220 17346 13951 16722 16790 17468 1834'3

Resource balance 1060 -1352 -1509 -2631 1350 878 982 897 268Netcurrenttrrnsfers 306 508 519 463 453 538 165 165 624

(including official currenttransfers)

Current accormt balance -1346 -3511 -3728 -4143 -78 -989 -1345 -1436 -1681(after official capital grants)

Net private foreign direct 2205 3445 3353 1842 4366 -1103 44 1528 158SinvestinentLong-term loans (net) 1596 2037 3561 3402 1430 1482 740 790 924

Official .. .. .. .. .. ..

Private .. .. .. .. .. ..

Other capital inet, including -1394 -790 23 -3167 -6401 808 1682 283 379errors and omissions)Change in reserves (-=increase) -1061 -1181 -3209 2066 683 -198 -1120 -It65 -12t1

Memorandum i.'emsResourcebalance(%of 1.8 -2.2 -2.7 -4.2 1.8 1.1 1.5 1.4 0.4GDP at current marketprices)

Annual growth ratesMerchandise exports (FOB) 38.1 -3.9 8.2 -11.0 5.3 16.3 -0.6 4.0 4.5

Primary 45.1 -5.3 9.4 -17.2 4.7 18.0 -0.6 4.0 4.5Manufactmres 29.2 -1.8 6.4 -2.2 6.0 14.3 -0.6 4.0 4.5

Merchandise imports 34.5 12.1 10.3 -4.5 -19.4 19.5 0.5 4.0 5.0(CIF)

Public finance(as % of GDP at currentmarket prices)eCurrent revenues 22.2 23.4 23.2 22.9 22.5 23.7 22.0 22.0 22.0Current expenditures 16.7 17.6 17.7 18.8 20.0 20.0 19.6 19.2 18.8

(Continued)

COUNTRY - Key Economic Indicators Annex B6(Continued) Page 3 of 3

.ActuaJ F iimati,Intdicuior 1995 1996 1997 1998 1999 20)1) 201W' 2'jti 21i1'G

Current account surplus(+) 5.4 5.8 5.6 4.1 2.5 3.7 2.4 2.8 3.2or deficit (-)

Capital expenditure 3.6 4.1 4.2 4.3 4.4 4.0 3.9 3.9 3.9Foreign financing -3.0 -2.9 -0.4 0.8 0.9 0.1 -1.1 -0.7 -0.3

Monetary indicatorsM2/GDP(atcurrentmarket 39.0 42.7 44.5 45.8 51.3 49.6 49.6 50.1 50.1prices)Growth of M2 (%) 25.8 19.6 16.3 9.6 14.8 6.2 7.1 8.1 8.2Private sector credit growth 124.2 119.0 122.8 76.3 103.7 113.0 100.0 100.0 100.0total credit growth (%)

Price indices( 1987 =100)Merchandise exportprice 162.8 136.3 135.5 110.6 108.4 118.7 106.3 105.9 106.4indexMerchandise import price 133.5 149.0 150.7 149.0 148.4 162.8 149.2 147.9 145.1indexMerchandise terms oftrade 122.0 91.5 89.9 74.3 73.1 72.9 71,2 71.6 73.4indexRealexchangerate 119.4 123.8 135.3 132.8 126.0 126.7 127.0 127.5 128.8(US$/LCU)fReal interest ratesConsumer price index 8.2 6.6 6.0 4.7 2.3 4.5 2.6 3.6 3.0(% growth rate)GDP deflator 9.3 1.7 4.0 2.5 3.5 4.1 3.8 3.6 3.0(% growth rate)

a. If GDP components are estimated at factor cost, a footnoote indicating this fact should be added.b. "GNFS" denotes "goods and nonfactor services "c. Includes net unrequited transfers excluding official capital grants.d Includes use of IMF resourcese. Should indicate the level of the government to which the data refer.f "LCU" denotes "local currency units." An increase in US$/LCU denotes appreciation.

CAS Annex B7 - Key Exposure Indicators - Chile Annex B7Page 1 of I

IridiLailcr j995 , ", - -l . 1.o~Irkd,-5201 .t; 19,9j-,,, 4 ; 2002 '2003

Total debt outstanding and 21736 22979 26701 31691 34167 36849 37499 38410 39527

disbursed (TOD)) (US$m)a

Net disbarsements (US$m)a 258 1243 3722 4990 2476 2682 650 911 1117

Total debt service (TDS) 4696 6720 5571 4018 5548 6067 6404 5624 5C17(USSm)a

Debt and debt service indicators

TDO/XGSb 112 121 129 167 176 167 171 170 172TDO/GDP 33 34 35 43 50 52 59 59 59TDS/XGS 24 35 27 21 29 27 29 25 22ConcessionaL/TDO .. .. .. .. .. ..

IBRD exposure indicators (%)IBRD DS/public DS 28.7 10.1 13.8 15.4 23.2 22.5 9.3 19.3 33.0Preferred creditor DS/public 81.6 30.7 54.5 33.4 48.6 55.7 21.8DS (%)cIBRD DS/XCS 4.3 1.8 0.9 0.9 0.9 0.8 0.8 0.8 0.8IBRD TDO (US$n)d 1372 1047 980 945 877 808 730 953 901

Of which present value ofguarantees (US$m)Of which DDO (US$m)f .. .. .. .. .. .. .. 300.0

Share of IBRI) portfolio (%) 1.3 1.0 0.9 0.8 0.7 0.7 0.6 0.7 0.7IDA TDO (US$m)d 10.7 L0 9.3 8.6 7.9 7.2 6.5 5.8 5.1

IFC IUS$;m) \c .g

Loans \h 243.0 185.5 128.0 130.7 94.4 62.4 44.5Equity and quasi-equity \i 51.0 61.9 59.9 50.4 58.7 58.7 58.3

MIGAMIGA guaranlees (US$m) .. .. .. .. 62.7 62.7 0 0 0

a Includes public and publicly guaranteed debt, private nonguaranteed, use of IMF credits and net short.

term copital

b. 'XGS' denotes exports of goods and services, including workers' remittances.

c. Preferred creditors are defined as IBRD, IDA, IFC, the regional multilateral development banks, the IMF, and the

Bank for International Settlements.

d. Includes present value of guarantees.

e. Includes equit) and quasi-equity types of both loan and equity instruments.

f. "DDO" denotes Deferned Drawdown Option. It is not expected to be disbursed.

g. Includes IFC's account only (not reflecting Participants'). Values do not reflect off-balance sheet items such

as guarantee and risk management products.

h. Includes (i) Loan and (ii) Quasi-Equity (Loan-type).

l Includes (i) Equity and (ii) Quasi-Equity (Equity-type).

Annex B8 [IBRD]Page 1 of 2

CAS Annex BB -Chile

Operations Portfolio (IBRDIIDA and Grants)

As Of Date 1211112001

Closed Projects 57

IBRDIIDA'Total Disb,rsed (AcO-e) 156.20

of whoch has been repaid 17 72To.al D,sbrr-sd (Closed) 2,935.60

ofch,ch rhas beer repa,d 2.786.90Total Dlsbursed (Acve - Closed) 3.091.84

ofch has been repaid 2.B04.83

Total Unrisborsed (At,ve) 117 27Tore UJdisb!rsed (Clos-d) c 20Total Jvdisb-rsed (Active Closed) 117 27

Active Proiects Difference Between

Last PSR Expected and Actual

Supervision Rating OrIional Amount In USS Millions Disbursements "

Project ID Project Name Development ImMlementatlon Fiscal Year IBRD IDA GRANT Cancel. Undisb. Orig. Frm RevedOblectives Proaress

P055480 CL MUNIC DEVT It S S 1999 10.1 8.5 7.4P055481 CL-HIGHER EDUCATION HS S 1999 145.4 101.1 47 6P063386 CL-MILLENNIUM INSTITUT HS HS 1999 5 0.5 0.5P006576 MONTREAL PROTOCOL S S 1993 6.5 2.6 -2.7 -2.7P006661 THIRD RD SCTR S S 1995 120 7.1 7.1 7.1Overall result Result 280.6 6.5 119.8 60 4 5

a Intended disbursements to date minus actual disbursements to date as projected at appraisal.

Annex B8 [IFC]Page 2 of 2

CAS Annex B8 (IFC) for Chile

ChileStatement of IFC's

Held and Disbursed PortfolioAs of 12/31/2001

(In US Dollars Millions)

Held Disbursed

FY Approval Company Loan Equity Quasi Partic Loan Equity Quasi Partic1991/93 Aconcagua 0.00 6.45 0.00 0.00 0.00 6.45 0.00 0.001991/94/96 BOMASA 0.86 4.80 0.00 0.94 0.86 4.80 0.00 0.941999/02 CBT 0.00 8.66 0.00 0.00 0.00 8.66 0.00 0.00

1999 CBTI 0.00 0.00 1.70 0.00 0.00 0.00 1.70 0.001989/91/99 Escondida 0.00 7.48 17.90 0.00 0.00 7.48 14.15 0.00

1996 FEPASA 13.78 0.00 0.00 5.70 13.78 0.00 0.00 5.701990 ING-MLF-Nature F 1.20 0.00 0.00 1.80 1.20 0.00 0.00 1.80

1994/96/97 Moneda Mgt 0.00 0.46 0.00 0.00 0.00 0.46 0.00 0.001993/94 Pangue 0.00 2.82 0.00 0.00 0.00 2.82 0.00 0.00

1994 Pionero Fondo 0.00 9.33 0.00 0.00 0.00 9.33 0.00 0.001996 Proa Fund 0.00 7.34 0.00 0.00 0.00 7.34 0.00 0.002000 San Antonio 35.00 3.70 0.00 65.00 12.25 3.70 0.00 22.752002 TFSA 0.00 4.44 0.00 0.00 0.00 4.44 0.00 0.00

Total Portfolio 50.83 55.50 19.60 73.44 28.08 55.50 15.85 31.19

Approvals Pending CommitmentLoan Eauitv Ouasi Partic

Total Pending: 0.00 0.00 0.00 0.00

Annex B9Page I of 3

Chile CAS Program Matrix (FY2002-FY2005)

The program supports three main objectives: (i) sustaining Chile's economic growth and social progress; (ii) inclusion, especially across groups and regions; and (iii) modemization of the state to underpin theprevious two objectives. Complementary actions in these three areas are expected to generate improvements to the well-being of the Chileans population as a whole, with increased equity in terms of access toopportunity and public services for the poor and vulnerable.

Country Goals: Growth rates > 5 % per yearUnemployment<10%Poverty <17 %

1. Sustaining Economic Growth and Social Progress

Diagnosis Strategy/Actions Specific Self-Evaluation Indicators InstrumentsCountry Performance

Indicators World Bank Group Major Related Activities of._____________________ _ ESWOther Donors

ESWChile's track record of sustained Growth Policy Notes (01)economic growth has led to New Economy (03) IDB is engaged in supportingdramatic reductions in poverty Position Chile to take advantage of Investment in R&D increased A coherent approach to the SMEs (03) technology innovations, S&T,levels. However, the first new opportunities for growth while to 1% of GDP New Economy has been Other non-lending/TA and funding of regionaldownturn in 11 years and a rise in preserving this capacity as conditions adopted. Assessment of Contingent infrastructure. It is alsounemployment in 1999 show that warrant. Quality of labor Liabilities providing TA for theChile cannot be complacent. force/international education A new system for assessing Private Participation in Non- preparation of new highwayEfforts are needed to continue to Leverage investments in infrastructure scores skills of labor force in place. traditional public services concessions, SMEs, localdiversify the economy, adopt new with private participation. Air Quality fishing plans and forestrytechnologies, and sustain Participation by women in Resources for higher Regulatory Issues systems.productivity growth, Eouity the labor force increased Education more equitably Agricultural Policies andcompetitiveness, human capacity from 38% to 43% distributed, especially to Programsand employment creation. Improve stock of human capital and private technical schools and Lending

support those with low levels of Increased Private investment to students from poor SAL/DDO (03)This growth strategy should further productivity. in "superior" infrastructure families. Life Long Learning (02)take into consideration equity, and non-traditional public Watershed Management (03)environmental sustainability, and Sustainabilith services Innovations in R&D Technology -Innovation (04)regional disparities, within a sound management acknowledged Supervisionmacro-framework. Develop sustainable approaches for Sound management of and generalized. Third Highway ((95)

natural resources management, liabilities to private sector Higher Education (99)By and large the policy framework especially watershed and forestry, and Successful cases of multi- Millennium Institutes (99)

and institutional capacity exist for for pollution reduction, actor collaboration on IFCthis. Bank Group assistance aims sensitive environmental Possible investment in theat helping Chile facc new issues which can be financial, SMEs, infrastructurechallenges and frontiers, replicated publicized. and social sectors.

Global ProgramsGEF mid-size grant forValdiva Foresty Management,Santiago Foothills. Air Quality.Montreal ProtocolCarbon Fund Prototype

Note: Other nonlending services include fee-based advice, technical assistance, policy advice and trust funds.

Annex B9Page 2 of 3

2. Inclusion

Diagnosis Strategy/Actions Country Performance Self-Evaluation Indicators InstrumentsIndicators

World Bank Group Major Related Activities ofOther Donors

Chile has done a solid record in the Service Delivery ESW IDB is planning to provide1990s of expanding access to Coverage of targeted program Ficha CAS system improved Catastrophic Health Care (00) assistance for housing,social services and to improve the Improvement to the responsiveness increases from 32 % to 50 % for targeting social Policy Notes/Poverty community development forquality and relevance of education and capacity of local agents to provide for family allowances and programs. Assessment (01) indigenous groups,in particular. These services go a targeted social programs and improve from 3 % to greater than 5 % Social Risks and Protectionsignificant way in reducing income management of universal education for child-care. Systemic approach adopted (02)inequalities. and basic health for managing social risks. Rural Infra. Services (04)

Participation in private Poverty Update (05)Yet, coverage of targeted programs pension plans increases from Advice reflected in the Other nonlending/TAis low and there is high leakage in Oualitv 62% to 75% recommendations of the Health Reformnsome. Moreover, the health system Health Reform Commission. Lendinghas considerable inequities and Reform of the health care system Health care reform which SAUDDO (03)inefficiencies. Non-contributors to providing protection against critical addressed quality, equity and Explicit programs for social Ruralthe private pension system creates a health crisis, within a financially solidarity adopted. programs included in Electrification/Infrastructurefuture risk. sustainable framework municipal agenda with pilots (with GEF) (04)

Standard test score for 8h in place in target Strengthening LocalFinally, there continue to be areas Continued implementation and grade in mathematics and municipalities Institutions (05)in which are isolated and lack basic consolidation of improvements in Spanish in municipal schools Sunervisionservices. The main deficiencies are education system increased respectively by 5 Rural services - electricity, Second Municipalin housing and education. Rural percent. water and Developmentareas have special needs in Coveraee telecommunications- Global Programsinfrastructure Regional disparities reduce in expanded according to plan Info-Dev (Tele-centers)

Rationale framework for social terms of access to basic in target areas Distance Leamingprograms focusing on managing risks, services for rural populations Carbon Fund Prototypeespecially for the aged and thoseunemployed or with very low - water from 65% toincomes, and youth at risk 75%

- electricity fromIncrease participation in private 75% to 90%pension funds Reduce gap in poverty levels

between regions and groupsExtend services in rural areas for from >50% to <50%electricity and telecommunications

Further empowerment ofschools and localadministration in education.

Expand access by poorwomen to reproductive healthservices

Annex B9Page 3 of 3

3. Modernization of the State

Diagnosis Strategy/Actions Country Performance Self-Evaluation Indicators InstrumentsIndicators

World Bank Group Major Related Activities ofOther Donors

Chile ranks very high in public Core Manaaement Functions ESW IDB is providing support tosector institutional capacity and in Real time integrated financial Real time information Policy Options/Poverty strengthen the Accountingother indicators of govemance, Develop modem, integrated information available available and performance Assessment (01) General's Office. It is alsoprobity and judicial security. management system able to cope with measures publicly available. Social Risks and Protection providing assistance toHowever, there are vestiges of the decentralized agencies Performance based (02) improve understanding byformer military rule which still management system in place Equity-need based criteria Fiduciary Assessment (03) public services of the needs ofhave not been overcome, many Public-Private Participation with access by public. adopted for allocation of Poverty Update (05) indigenous groups andfunctions remain highly central funds to partnerships between civilcentralized, and the relative Expand the array of opportunities for More flexible, performance municipalities. Other nonlendinglTA society and the public service.strengthens and roles of local and private participation in non-traditional based regimes in place to Support for association of The IMF is advising onregional levels of govemment are areas, such as hospitals and jails. manage HR function in public Gender and indigenous municipalities in indigenous transparency of publicevolving towards more sector. concems introduced in areas. accounts.decentralization. Decentralization municipal prograns. Support to incorporate gender

Increase in share of public in municipal programs.Like many countries, Chile too can Redefine role for regional funding managed by regions Municipalities connected to Private participation intake advantage of technology to govemments following explicit criteria. distance learning. Public servicesmake public services moreresponsive, transparent and Strengthen capacity of municipalities Private participation in non- Pilot program of private Lendingefficient. Finally, discrepancies in to carry out their functions, traditional services hospital management in Public Expenditurethe quality and access to services particularly social services introduced. place. Management (02)can vary widely depending on SAL/DDO (03)location and population Transparency and Accountability E-govemment Strengthening l.ocalcharacteristics (especially for established/number of virtual Institutions (05)indigenous groups). Facilitate information access, across information centers; core

segments of society and civil society public records available Supervisionparticipation. electronically Second Municipal

Development (99)

Global ProeramsDistance Lann

Annex B10CAS Annex B10 - Chile Page I of I

CAS Summary of Development PrioritiesAs of Date 12/12/01

Country Major issue b Country Bank Reconciliation

Network area performance a Prioirty priorityc of country andBank priorities d

Poverty Reduction & EconomicManagementPoverty reduction excellent sustaining rapid growth high highEconomic policy excellent sustaining rapid growth high moderate ongoing dialog, advisory servicesPublic sector good HR mgt, local capacity high highGender good participation high high

Human Development DepartmentEducation excellent adult skills high highHealth, nutrition & population good equity and efficiency high highSocial protection good coverage high high

Environmentally & SociallySustainable Development

Rural development good regional disparties high highEnvironment good natural resource mgt high highSocial development fair indigenous, participation high moderate IDB

Finance, Private Sector & InfrastructureFinancial sector excellent high low FSAP, ICF selectivePrivate sector excellent SMEs high moderate advisory services, IFC selectiveEnergy & mining good sustainability high moderate ongoing dialog, IFC selectiveInfrastructure good private participation high moderate advisory services, IFC selective, ongoing dialog

a. Use "excellent," "good," "fair," or "poor."b. Indicate principal country-specific problems (e.g., for poverty reduction, "rural poverty;" for education, "female secondary completion;" for environment, "urban air pollution").c. To indicate priority, use "low," "moderate," or "high."d. Give explanation, if priorities do not agree; for example, another MDB may have the lead on the issue, or there may be ongoing dialogue.

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