Chile
Fiscal Stimulus to counter the credit crisis '08-09
Chile’s government this week announced a $4 billion bundle of measures aimed at creating 100,000 jobs and helping poorer families. It can easily finance the resulting fiscal deficit forecast at 3% of GDP this year because it built up a war chest of public savings when prices for copper, its main export, were high.
01/2009-
Chile’s economy probably will expand 2 percent this year as the government rolls out countercyclical measures, tapping an estimated $26 billion in fiscal assets, analyst Francisco Errandonea wrote in a note to clients today. “Savings accumulated by the Chilean government during the 2004-2008 copper price rally should help Chile to defend itself from the weak external macroeconomic environment,” he wrote.
how are other countries handling the credit crisis: see here: fiscal stimulus and crisis recovery 2009
Arguments for FDI investment in Chile
- Test market for entering Latin America. If it works there, it will work in the rest of Latin America. But, if you fail there, at least you failed small. So, for fast innovation, its a good strategy to enter Chile first, test, and expand if successful. This is a model that many companies follow. see our discussion on rapid innovation and expansion and also on "fast failing
- Free trade agreements: Chile has more regional or free trade agreements than any other nation in the world (good for future business expansions and low duties).
- High levels of GDP / person: It has one of the strongest economies in Latin America.
- Transparent laws: foreign investment and tax laws are well defined (There are not special deals on the law as we do in Mexico)
- Predictable laws: the government doesn’t change these laws every year.
- Education: the population is well educated
- Respect for the law: you don’t see drivers in Santiago running over red lights)
- Law and order: unlike many latin american countries (Brazil, Colombia, etc), there is not an active "war on drugs", where you may see army soldiers and drug dealers fighting
- Quality of life: mountains, wine, outdoor activity, Patagonia, etc.
Chile has great benchmark for other Latin America…relationship of business with economy, govt…and relationship of education.
Counterpoints:
- Longer logistics: extra shipping from Chile (as compared to Mexico, for example). In terms of air shipments, its still just a day away, but from a personell standpoint, its easier and faster to commute to US or European markets from other countries.
- Labor is more expensive in Chile for engineers than in some other latin countries
- Capital controls (eliminated recently) - the law known as "the encaje" rerquired companies to deposit money at 0% interest
Main industries
Chile’s economy depends heavily on its mineral exports which are surging (note: there is a China-dependent risk here, though).
Mining accounts for 40% of Chile’s export income. A drawback is that mining is a very capital-intensive industry, employing only 74,000 people. Codelco, Chile’s largest copper company produces 10% of the world’s copper. The recent rise in copper prices has prompted several strikes when miners demanded higher pay. This has slowed the growth of the economy. The government has recently imposed additional charges on mining companies to take advantage of the sharp rise in mineral prices, raising at least US$100 million a year.
The resultant wage hikes could pose a problem. The government hopes to contain wage hikes because production costs are rising steeply.
In the manufacturing sector most firms are either small or of medium size.
Processed fruits and vegetables and fine wines are important foreign-exchange earners but exports have slowed as the peso has appreciated.
Meanwhile, pulp and paper producers are pumping billions of dollars into new capacity and the construction industry is booming. Part of the rejuvenation is due to the benefits of a recent free trade agreement with the US, which makes it easier to export textiles and some agricultural products and could also attract more US investment to the country.
Chile's agricultural sector depends on livestock rearing in the plateau and extensive crop farming in the central region. Policy makers have also been trying to channel more capital into non-traditional areas such as seafood and wine, but the rise in the value of the peso is hurting agribusiness. The growth of farm output slowed in 2006 as the result of poor weather conditions.
Economy
Between 1990 and 2006, growth averaged more than 5% a year, per capita income tripled in dollar terms, and the poverty rate was cut in half, to about 18%. In 2006, however, the pace of growth slowed. Income inequality remains high. Consumer spending has been strong but there is still considerable idle productive capacity. Critics blame inflexible labour laws and are unhappy with public health reforms, not least because they are being financed with a one-point hike in VAT.
Exporters are also displeased with the way that the export boom has driven up the value of the peso. Aside from these weak areas, the government appears to making considerable progress. Poverty levels have been cut in half since the return of democracy, partly thanks to the creation of a minimum wage.
For foreign investors, Chile’s stability is also a welcome change from that of its neighbours. External conditions remain favourable. However, increases in petroleum import prices have raised costs further and dampened disposable income growth.
Chile currently holds a number of free trade agreements (FTAs) with various countries, such as Canada, Mexico, South Korea, the United States, as well as with the European Union. The FTA with the US took effect in 2004, and will lead to completely duty free bilateral trade within 12 years.
Energy
Chile reportedly has only 150 million barrels of crude oil reserves, relying mainly on imports for most of its hydrocarbon needs. Oil production is 15,100 barrels per day and has been in decline for more than twenty years, as existing wells have matured and exploration efforts elsewhere have proven unsuccessful. Chile has 3 refineries and intends to invest US$264 million to modernise these facilities. The country also has natural gas reserves of about 3.5 trillion cubic feet but little domestic production.
However, consumption has skyrocketed in the last ten years. The country has vigorously explored for natural gas reserves, but has so far had little success. In 2004, Argentina began restricting natural gas exports to Chile, with cuts reaching nearly 50% of contracted volumes on some days. Santiago, in turn, has been forced to reconsider its energy policy, which, prior to the import restrictions, assumed an increased use of natural gas and power imports from Argentina.
Imports and Exports
| Asia-Pacific |
39.3 |
Latin America |
36.4 |
| Europe |
28.2 |
Europe |
20.6 |
| Latin America |
15.5 |
North America |
20.2 |
| North America |
15.4 |
Asia-Pacific |
18.6 |
| Africa and the Middle East |
1.3 |
Africa and the Middle East |
3.4 |
| Australasia |
0.3 |
Australasia |
0.8 |
Inequality is an issue
The distribution of income in Chile is a serious problem. Almost a quarter of citizens live below the poverty line and the country's richest 10% have incomes that are 15 times greater than those of the poorest 10%. Because of the gap, social tensions are rising. The inequality of incomes also puts greater pressure on the government to establish a viable pension system and the new government has produced a plan for this.
International disputes
Chile has an ongoing disagreement with Bolivia about its demand for the restoration of access to the Pacific Ocean. The two countries have not had diplomatic relations since 1978 but the situation has deteriorated since the president of Bolivia restated the claim in 2004. Since then, relations have improved somewhat and in 2006 Chile scrapped import duties on most Bolivian products. Chile and Argentina have solved most of their border disputes, but in 2004 a new disagreement arose after Buenos Aires decided to cut energy supplies to Chile.
History
free markets challenges state control
Macro Economic success
Chile is a model of sound macroeconomic policy, outperforming the rest of the region for the past several years. Which factors have contributed to the economy’s success?
Fiscal Policy
Fiscal Policy is a set of tools that a government can use to influence the short-term business cycles (through the Aggregate Demand) of an economy. The Fiscal policy can be thought of as two different sections. First of all, there is government spending on such items as education, health care, pension, and infrastructure. The second policy tool is taxes, which governments can use to affect the level of investment and savings in a country. By combining both tax and spend policies, a government can have a big effect on the short term Aggregate Demand (AD) and therefore the output of a nation (GDP).
Chile is generally considered to have sound fiscal policies. For example, last year its budget surplus was around 4.8% of GDP (or US$5.4bn) and this year it is likely to be even higher . With copper as the nation’s number one export, Chile’s national budget has definitely benefited from its historical high prices recently.
While higher copper prices in the past couple of years have definitely helped Chile, they also have backed up the windfall of high copper prices with many sound economic fiscal policies. The government has (so far) been very good at resisting the pressures to spend the extra revenue windfalls. This is in large part due to the fiscal rule passed in 2000 requiring copper-related revenue windfalls to be saved in good times and to retire debt and finance spending in lean years. Compliance with this rule is paying dividends.
In addition to additional transparency rules, Chile has also been benefiting from an overall lower level of debt. As a percentage of GDP, Chile’s net debt accounted for less than 6% of GDP in 2004, down from about a third of GDP in 1990. This has allowed the government to increase its spending on social programs without needing to increase its dependence on foreign financing. As a result of sound fiscal management, Chile now maintains one of the best credit ratings (an investment-grade, S&P A+ rating) in Latin America.
In the future, Chile will face rising pressure from social groups (such as labor unions) who will want a larger and larger share of the windfall of copper earnings. Whether or not the government is able to withstand those pressures, and keep spending under control, will be a big indicator in the effectiveness in maintaining Chile’s long term fiscal responsibility. Someday in the future, it is likely that copper prices will fall, and maintaining sound fiscal policies in the up market should help Chile weather the storm of a down (copper) market.
Another challenge related to future fiscal policy is related to how well Chile is able to reform the pension system. Most analysts seem to agree that the system needs an overhaul. The cost of this system could build up if not addressed.
Source: Ministry of Finance and OECD calculations.
Fiscal indicators
(% of GDP)
2005 2006 2007 2008 2009 2010
Government expenditure 19.6 21.0 20.3 20.4 20.4 20.9
Government revenue 24.3 26.3 23.5 22.1 22.2 22.4
Budget balance 4.7 5.3 3.2 1.7 1.8 1.5
Source: The Economist Intelligence Unit.
Fiscal Reform
Not only in terms of fiscal reform, but in general we could say that Chile’s macroeconomic management has been exemplary. The same as for many countries, fiscal revenues –and therefore the results in fiscal balance- would very closely follow the fluctuations of the nation’s greatest commodity, the copper, during the 1970-1987 period. This is coincidental with the military government, which lead to a strongly hierarchical process for formulating and executing budget.
The structural reform since the return to democracy in 1990 has been facilitated by a high degree of political cohesiveness, with progressive concentration of powers in fiscal matter.
A second generation of fiscal reforms where implemented during the 90’s as cash limits to budget exceptions, a budget execution reporting system that would monitor the area on quarterly and monthly basis, performance indicators (more than 500), program periodical evaluations (Government Program Evaluation System) by a panel of independent experts, and the Management Improvement Programs (MIPs), which are aimed to improve the public management by linking goal attainment to employees’ monetary rewards.
In part affected by the international financial crisis, 1997-99, fiscal balances deteriorated by nearly 4% of GDP, moving from a surplus of 2.5% of GDP in 1996 to a 1.5% deficit in 1999. In consequence the behavior of the new government in over public finances was a major source of uncertainty among economic agents. Since 2001 the Lagos Administration faced this challenge by committing itself to pursue a strict fiscal
policy rule: starting 2001 the government would generate a structural budget surplus
equivalent to 1% of GDP.
From 2001 on, other recent developments helped improve and deepen the fiscal reform, like: improvement of mid-term fiscal planning, prevention of inertial funding within the budget by efficiently reallocating part of it, raising accountability in order to close the budget cycle and lately the Public Finance Reform Program.
The major current challenge is to entrench fiscal rectitude, given that the structural budget surplus regime adopted in 2000 is not embedded in law and future administrations may choose to abandon it. Pressures for fiscal expansion activism should not be underestimated in the future in an environment of relatively low public indebtedness and in view of the need to satisfy multiple social demands.
Macroeconomic Policy
The Central Bank of Chile has successfully implemented prudent macroeconomic policies based on inflation targeting under a floating exchange rate. This, along with a high copper price, has allowed Chile’s economy to outperform the rest of Latin America for the last several years. Despite being of the center-left party of Chile, President Michelle Bachelet has continued a very liberal economic policy, moving forward with free trade agreements with: China, Japan, Panama, and India. Further FTAs are expected with Colombia, Ecuador, Malaysia, and Thailand.
The Central Bank of Chile has increased the discount rate 14 times since September of 2004. This has been a trend of monetary policy tightening to curb inflation and maintain it within the target 2-4% range. The last rate hike was implemented in August 2006, where the rate was increased to 5.25%. It has not increased since as the economy is starting to show signs of price stability, with mid-term inflation expectations fixed at 3%, well within the target range.
Chile has open market operations with the following long-term bond rates (as of 12/1/06): 2-year 5.43%; 5-year 5.51%; and 10-year 5.59%. These moderate yields on long-term government securities reflect a sound and stable economy. Higher interest rates would reflect the government’s need for financing and a higher-risk financial system. The principal rating agencies (Standard & Poor’s, Moody’s, and Fitch) give Chile a grade of A or AA. The banking system’s reserve requirements are at 9% for current deposits; 3.6% for time deposits and an additional 10% for deposits in foreign currency.
In recent years, government surplus has been declining gradually. This will continue to follow, as President Michelle Bachelet will increase government spending in the implementation of social reform and in line with falling copper prices.
Exchange Rate
Until 1999, the Central Bank used a crawling band exchange rate to ensure that inflation was brought under control. This system consisted in pegging the exchange rate to a basket of currencies.
After years of successfully keeping inflation on track –one of the main purposes this system aimed- the Central Bank decided to float the peso in 1999. At the same time the money supply was contracted, and as a result interest rates shot up and output declined slightly due to drops in investment and consumption. The Central Bank was then sending the strong message to the public about its commitment to check on inflation, and therefore refraining it to be triggered, along with the exchange rate. The cost of this change was an increase of 2 to 3% in unemployment.
This change in exchange rate, jointly with a successful fiscal policy helped the country’s economy remain relatively in good shape in face of its neighbor’s huge financial crisis, Argentina. This helped show Chilean economy’s performance relatively shielded from other Latin American countries crisis, and made the country more attractive for foreign investment.
Property Rights
Property Rights is defined by “the ability of individuals or firms to own, buy, sell and use the capital goods and other property in a market economy”. These ownership rights are enforced though the legal framework and the set laws permit the economy to define their nation’s property rights, to operate and control their inventions, to define the terms of contract and a system for fairly resolving disputes. They can also be set in place to protect intellectual property rights such as patents, copyrights, business and trade secrets and electronic media. As part of the rights bestowed on the individual or corporation is the control of the property, the right to benefit from it, the ability to transfer or sell the property or exclude others from it. “The ability for individuals to own and profit from capital is what gives capitalism its name.”
Strict property rights can help correct the market failures within an economy. Technology as a product of research and development is not cheap but is easily copied by others. Government can eliminate externalities by setting the necessary regulation in place to prevent reproduction of these goods that would negatively affect those entities that invest in it. Assuring protection of property rights is indispensable in order for an economy to attain intellectual and tangible property that would allow betterment of the production process and bring the real output closer to the potential output. Capital formation, or social overhead is essential and technologies are two important wheels of growth. Property rights set the adequate foundation for these to be created, developed and produced freely and securely.
Chile is has taken “fundamentally pro-market policy direction” and that includes the area of the protection of the intellectual and property rights with one of Latin America’s most liberal policies on licensing agreements. This is because they are in favor of authorizing all types of arrangements between the foreign parent company and its subsidiaries in Chile; it authorizes all types of arrangements, including those between foreign subsidiaries and their parent companies.
Chile upgraded their property rights legislation by the request of the World Trade Organization to tighten the enforcement of its laws. Chile elevated its “standards of production of property rights to be in accordance with the WTO’s Trade-Related Aspects of Intellectual Property (TRIPS) of 1994”. Law 19,996 has applied since December 1st 2005 and covers a complete set of regulations on intellectual property as part of the Industrial Property Law.
Some of the positive outcomes of the updated Chile’s Industrial Property Law include:
• simplifies procedures to register, oppose, renovate and annul industrial-property rights
• extended time of patent protection to 20 years.
• Modernized the dispute-settlement procedures for trademarks and patents
• created a specialist tribunal case for industrial-property rights cases with 3 specialist judges that are replaced every two years and with doubled quantity of examiners.
• provides for the expiration of trademarks that are not effectively used in the country
• it increased penalties for piracy in hopes to be a more effective deterrent, violations were raised, pirated goods and equipment to produce them is now confiscated and doubled fines for second-time offenders.
• It extends benefits to small companies and individual inventors with a deferred payment option for registration fees until the registered invention begins to yield profits in addition to them being eligible for state loans.
• It makes a distinction between the exchange rate used for tax purposes and the free-market rates when remitting royalties, which was ignored in the past.
Chile’s attention to property rights focuses in providing accessible registration, protection to all at a low-cost. Through its reform, the law does a good job of simplifying the application process and of shortening the waiting period for the applicant. The government is using high-tech tools to achieve greater efficiency such as the internet, for example, trademark-registration process used to take 6–8 months, but this has been cut sharply by the introduction of an online application system
The implementation of the law has had positive results in a short time. Most firms in the car-parts, chemical, electronics and metal-processing industries manufacture in part under foreign licenses. Use of franchises has been rapidly growing in Chile in recent years, particularly in the fast-food business. Some recent licensing agreements in Chile include US franchises like Subway, Applebee’s, Starbucks and McDonald’s.
Deregulation
Deregulation in Chile has taken place since the mid-1970s. The successful deregulation of the non-urban transportation system led to the total deregulation of the mass transportation sector. This first led to higher fares, but as companies entered the market, competition forced prices downward with a greater number of routes and frequency.
Deregulation in Chile has been successfully implemented in various sectors, including: telecommunications, water and sewerage services, energy, transportation, financial services, infrastructure and mining. This has gone in hand with major privatization efforts, particularly in the 1980s. Chile privatized telecommunications, power supply, water purification, and steel mills during this decade. The deregulation of these sectors included the elimination of price fixation and controls, elimination of legal restrictions to investment and operation of enterprises, external opening, and institutional reform of basic services for electricity, telecommunications and water.
In 2006, President Bachelet’s administration has made substantial progress in facilitating investments into electricity generation and distribution in order to prevent a mid-term energy crisis. By the end of 2006, it is expected for the government to further deregulate the Administradoras de Fondos de Pensiones (AFPs, private pension funds). This intended to secure a greater diversification of risks and higher returns for the individual pension accounts. Furthermore, the government is expected to reform capital markets in an aim to facilitate financing for small companies and the development of the risk capital industry.
Trade Liberalization
Trade policies consist of tariffs, quotas and other regulations that restrict or encourage imports and exports. One particularly important index related to this policy is net exports, which is the numerical difference between the value of exports and the value of imports. In the case of Chile, if we analyze its trend during the last five years, we can observe that net exports have been constantly growing:
Over the last few years, Chile has taken a number of steps to promote free trade or to broaden regional markets by signing Free Trade Agreements (FTA) with other countries or regions as part of its integration in the world economy. Chile already signed FTAs with the US, Mexico, Canada, the EU, and most of the Latin-American countries. In October 2006 Chile signed an FTA with China and is likely to sign another FTA with Japan before the end of the year. In August 2006, Chile ratified the P4 Trans-Pacific Strategic Economic Partnership Agreement with Brunei, New Zealand and Singapore. Chile is also likely to conclude FTAs with India, Malaysia and Thailand in 2007-08.
Export volume growth will continue to be driven by non-copper exports, many of which will be helped by Chile’s network of free-trade agreements (FTAs). The FTA with China will be especially important, as China is now Chile’s second-largest export market. According to projections by the foreign ministry, the treaty will yield a rise of 1.4 percentage points in Chile’s GDP and will create 34,500 new jobs.
China, Chile sign supplementary free-trade agreement on services
04.13.08
China and Chile have signed a supplement to the China-Chilean Free Trade Agreement covering the bilateral opening of the service trade, officials said. In a statement published on the website of Ministry of Commerce, the supplementary agreement covers 23 sectors in China, including real estate, mining, air transportation, computer, management consulting and the environment.
Meanwhile, Chile will also open 37 sectors, including law, tourism, engineering, computers, advertising, real estate, retail and manufacture. The two nations committed themselves to opening up their service sectors in accordance with World Trade Organization rules, under a supplementary agreement to their formal free-trade pact signed in 2005.
The services free-trade agreement covers 23 sectors in China, including computers, management consulting, mining, sports, environment and air transport, the official Xinhua news agency reported. Legal services, architectural design, engineering and real estate are among the 37 Chilean service industries listed in the agreement, the agency said.
The trade agreement, which is expected to be implemented on Jan 1, 2009, is the first services free-trade agreement signed between China and a Latin American country, the statement said.
Chile is a major supplier of copper and wine to China, while China sends computers, cars and electronic goods across the Pacific. The deal, which expands a 2005 agreement, covers 23 industries in China and 37 in Chile, and the two countries aim to bring it into force from the start of 2009.
Hu and Bachelet agreed that the two countries should increase cooperation in culture, education, technology, personnel exchanges and in international forums such as the United Nations. State media quoted Bachelet as saying Chile wanted more cooperation with China in politics, trade, investment, agriculture, Antarctic scientific exploration and climate change. Bilateral trade soared by 65 per cent year on year to a value of 14.7 billion dollars last year, following the implementation of the free-trade agreement in October 2006. Chilean exports to China rose to 10.3 billion dollars, boosted by trade in copper and wine, according to Chinese statistics.
In November 2005, China and Chile signed bilateral free-trade agreement, which did not include services sector. That agreement was implemented in October 2006.
In 2007, bilateral trade between the two countries was 14.7 bln usd, up 65 pct, the ministry said.
Privatization
Since the 1940s, the industrial sector in Chile has expanded rapidly, largely due to the government efforts of diversification but over time many privately held industries have been nationalized. Military governments in the 1970s and 1980s began the process of privatizing and deregulating the economy. Civilian governments, which took over from the military in March 1990, have continued to reduce the government's role in the economy while shifting the emphasis of public spending toward social programs.
Chile has become a shining example of how privatization efforts can fuel economic growth. In Chile, businesses are now predominantly owned and controlled by private interests, even in the energy sector. The exception is the mining sector, which is the single biggest industry in the country.
An interesting theme for analysis in Chile is the privatization of the Social Security system, which is currently used as a case study by other countries like the US who are looking to implement new reforms in that area. Chile’s public pension program was foundering in the 1970s. The system was extremely complex, consisting of over 100 different retirement regimes. The retirement program’s funding situation was similarly dire and the program’s numerous problems were exacerbated by widespread tax evasion. In 1981, the Chilean government took the radical step of phasing out the country’s troubled publicly funded social security program and mandating participation in a system of privately managed individual accounts which were managed by private investment firms called AFPs. Although many advocates of Social Security privatization continually crow about Chile’s high returns under individual accounts, they ignore the fact that Chile cut social spending, raised taxes, and cut benefits in order to pay transition costs (it is estimated that the government will continue to pay until 2050), and that these individual accounts have increased economic inequality and left workers vulnerable to market downturns. Once these factors are taken into account, the case for privatization becomes much shakier.
Pension System in Chile - a model for the USA?
Chile’s private pension fund system (the AFPs), has attracted a lot of international attention.
Chile may have been a pioneeer in privatized pension system, but they are not necessarily the best, nor did they do it the best way. So, looking to Chile as a model for other countries to model is foolish.
Criticisms:
It may sounds obvious, but you cannot have high pensions if you have low salaries. In Chile, the average wage as of end October 2007 was around U$ 676 per month, only 130 % more than the minimum wage. If we take the average pension received by the 634,523 persons who were claiming it as of end October 2007, it amounted to a mere U$ 323 per month, 48 % of the average wage and just 10 % more than the minimum wage. If you live in Chile, you will know that it is not exactly a fortune.
The problem is = the size of the "informal economy", in which people work, but do not pay taxes, nor contribute to retirement funds, and therfore will never see the benefits.
Barriers to FDI (Foreign Direct Investment)
FDI is defined as a long-term investment by a foreign investor in an enterprise resident in an economy other than that in which the foreign investor is based. In order to qualify as FDI the foreign parent company must get management control over the local affiliate. This allows differentiating FDI from portfolio investment (the investor only seeks financial gains and not management control).
During the 1990's, FDI gross inflows to Chile represented an annual average 6.4% of GDP. There was a record high inflow of US$ 9.9 billion in 1999, with a significant drop later Mostly consequence of a sharp downturn in international economic conditions, which reduced FDI globally. Between 2001 and 2003, the mergers and acquisitions market collapsed in the face of global economic uncertainty, this trend represented a return to more sustainable and realistic FDI levels. FDI flows into Latin America were also affected by instability in some of the region's countries and the heavy losses sustained by many investors. Risk aversion -accentuated by shareholder pressure in firms that experienced difficulties also helped to explain weaker FDI in the region.
Chilean government maintained a politic of attracting FDI, since Pinochet military government in the 70s. To attract multinational companies to invest in Chile government has used several strategies. An important one signing numerous trade agreements, bilateral and multilateral, presenting Chile with its stable economy and politics as a launch pad for doing business with its numerous trade partners, such as the USA, Canada, Mercosur countries, several Western Europe nations, Russia, and China and India, more recently, etc.
Chile has also developed an optimal infrastructure network, and several legal tools to help ease foreign investment.
The most commonly used mechanism to channel foreign investment in Chile is called the 1974 Foreign Investment Statute (DL 600). It allows foreign investors to establish legally binding contracts with the Government. These contracts guarantee non-discriminatory treatment of foreign investors, define the conditions under which capital or other forms of investments can be transferred into Chile. Under DL 600, more than 54 billion dollars in investment or 83% of total FDI inflow in the 1974-2003 period got into Chile.
All these elements allow us to rank Chile as a country with low barriers to FDI, with a long-term policy of attracting FDI as a way to consolidate and grow their economy.
Financial Liberalization
Under President Allende, the financial sector had been nationalized. The allocation of credit was not based on clear economic criteria. The liberalization of the financial system was one of the Chicago-trained economists under Pinochet top priorities. This included re-privatization of the banking sector, lifting of interest ceiling in order to reinstate the market with a real floating rate of interest as the equilibrating mechanism, and encouraging the establishment of new banks and other financial institutions.
Liberalization started already in 1974 with the lowering of reserve requirements and the permission to establish non-bank financial institutions (NBFI), so-called financieras, which were free of rules as to setting interest rates. In October 1975 the commercial banks also were freed from restrictions as to interest rates. Between 1975 and 1978 all the banks, except the Banco de1 Estado and two small banks that were involved in difficulties of a legal nature were privatized. The public sector was even prohibited to invest in the banking sector. A number of banks were sold to conglomerates or grupos that used the newly acquired banks to finance their own expansion.
The freedom to set up new banks increased in the number of domestic private banks from 18 in 1973 to 26 in 1981 and the number of foreign banks from 1 to 19. A measure of the increase in financial intermediation is the increase in the total real volume of credit to the private sector over that period by more than 1100 per cent. But this relaxed control resulted in a financial crisis during 1983, where the government had to take over 2 of the largest private banks, close 3 and intervene other 5. The central bank bought private banks’ nonperforming portfolios in exchange for promissory notes that bore a real interest of 7 per cent, whereas the banks were under the obligation to repurchase their debt in the future, against a 5 per cent real interest rate, subsidizing the commercial banks.
After 1984 although the economy minister was educated in Chicago, the government did not return to the extreme hands-off policy. Monetary policy was aimed at preventing interest rates to increase to the levels of the pre-1983 period. Another factor that started to influence is the availability of funds from the AFPs (Administradoras de Fondos de Pension), which brought large sums of money to the financial markets contributing to keeping interest rates at more reasonable levels.
FDI has had low barriers since Pinochet government, but portfolio investment was not allowed for foreign investors. The way to prevent it was that foreign capitals entering Chile had restrictions on the length of time they had to remain in the country; this was set as a period of five years initially, but in the 2000 this restriction was eliminated, also simplifying the process by which a foreign investor can get a tax ID in order to be able to trade locally. Portfolio investment has finally been completely liberalized for foreigners, thus converting Chile to a liberal economy, so we can classify it as having widespread financial liberalization.
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For more information
• Brazil, Colombia, Chile: Latin America Local Bond Preview. Bloomberg, March 10, 2006. Retrieved on November 28, 2006 from http://www.bloomberg.com/apps/news?pid=10000086&sid=aNR0C67cK8_s&refer=latin_america
• Country Finance. The Economic Intelligence Unit, November 2006. Retrieved November 28, 2006 from http://portal.eiu.com.ezproxy.t-bird.edu/report_dl.asp?issue_id=931362278&mode=pdf
• Country Forecast. The Economic Intelligence Unit, November 2006. Retrieved November 28, 2006 from http://portal.eiu.com.ezproxy.t-bird.edu/report_dl.asp?issue_id=1131360698&mode=pdf
• Country Commerce. Economist Intelligent Unit. February 2006. Retrieved December 2, 2006 from http://portal.eiu.com.ezproxy.t-bird.edu/index.asp
• Chile: Still a Latin tiger? OECD Economics Department, Luiz de Mello and Nanno Mulder, January 2006
• Chile Foreign Investment Committee. Retrieved on November 27th, 2006 from http://www.cinver.cl/index/plantilla2.asp?id_seccion=1&id_subsecciones=94
• Country Watch database, Chile Foreign Investment Climate. Retrieved November 27th, 2006 accessed through IBIC Remote databases, from http://www.countrywatch.com.ezproxy.t-bird.edu/cw_topic.aspx?type=text&vcountry=36&topic=INFIC
• Economic Survey of Chile 2005. Organization for Economic Co-operation and Development (OECD)- 4 November 2005
• Financial liberalization and financial fragility: the experiences of Chile and Indonesia compared. Retrieved December 2nd, 2006 from http://ideas.repec.org/p/dgr/vuarem/1994-56.html
• Embassy of Chile in the United States - Economic Department. Retrieved on November 27th, 2006 from
http://www.chileusafta.com/invest%20in%20Chile.htm.
• Latin American Economic and Business Report, “CHILE: IMF forecasts 5.5% growth”. Intelligence Research Limited, 2006,
• Review of the Individual Action Plan of the Republic of Chile Peer Review Study Report. Asia-Pacific Economic Cooperation. Kim, Sangkyom. Retrieved on November 28, 2006 from http://www.apec.org/content/apec/news_media/fact_sheets/chile_iap_peer_review.html
• Samuelson, Paul, and Nordhaus, William. Economics – Eighteenth Edition. New York, NY, USA: McGraw-Hill. 2005.
• Samuelson, Paul, and Nordhaus, William. Economics – Eighteenth Edition. New York, NY, USA: McGraw-Hill. 2005. pg. 195
• Samuelson, Paul, and Nordhaus, William. Economics – Eighteenth Edition. New York, NY, USA: McGraw-Hill. 2005.pg. 35
• Social Security Privatization in Chile: A Case for Caution. Economic Opportunity Institute. Idemoto, Steve. September 2000. Retrieved on November 28, 2006 from http://www.econop.org/SocialSecurity/SS-SocialInsecurityChile.htm#NeedReform
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