STAFFDEL MEACHAM - CHILE'S ECONOMY AND DEVELOPMENT

UNCLAS SANTIAGO 001114 SENSITIVE SIPDIS STATE FOR H, WHA/BSC, EEB/IFD/ODF TREASURY FOR BLINDQUIST COMMERCE FOR KMANN E.O. 12958: N/A TAGS: ECON EFIN ETRD EINV PREL OVIP CI SUBJECT: STAFFDEL MEACHAM - CHILE'S ECONOMY AND DEVELOPMENT REF: A) SANTIAGO 575 B) 08 SANTIAGO 812 C) 08 SANTIAGO 1139 ¶1. (SBU) SUMMARY: Senior Senate Foreign Relations Committee Staff Member Carl Meacham traveled to Chile October 26-28 to review the state of the economy, the history of Chile's development, and the work of international financial institutions (IFIs) in country. The Chilean economy suffered a recession in 2009 as a result of the global economic crisis, but the GOC quickly implemented a fiscal stimulus package and many economists expect a recovery by the end of the year. Chilean officials and independent NGO representatives told Meacham that Chile's economy has survived the worst of the global economic crisis as a result of its strong fundamentals and is well-positioned for possible growth of between 4-6% in 2010. Experts explained to Meacham that Chile's development history has been marked by a reliance on private sector investment rather than IFI lending. They said that current IFI lending is focused mainly on projects that bring technical expertise to Chile, rather than those that build infrastructure. The Ministry of Finance noted the GOC is working to change the role of IFIs in medium-income countries like Chile. Meacham reviewed the Inter-American Development Bank's loan to the Transantiago public transportation system as a case study of IFI lending in Chile. He heard competing views, some highly critical of Transantiago and the IDB loan, and some emphasizing the benefits of Transantiago. END SUMMARY. ¶2. (U) Meacham's visit was part of a study by Senate Foreign Relations Committee staff to assess the efficacy of IFI operations around the world in the current global economic climate, as requested by Senator Richard Lugar (R-IN). During his trip to Chile, Meacham met with representatives from the Ministry of Finance, the Ministry of Transportation, the national industrial and business federation (SOFOFA),the U.S. Chamber of Commerce (AmCham Chile),the government development agency (CORFO),the Inter-American Development Bank (IDB),Libertad y Desarrollo (LyD - a think tank),and members of the Chilean Congress. Economic Background: Effects of Crisis -------------- -------------- ¶3. (U) As a result of the 2008/2009 global economic crisis, Chile is in a recession due principally to falling export demand and industrial production. GDP growth slowed to 3.2% in 2008 and the economy contracted by 4.5% in the second quarter of this year. GDP may shrink by between 1.5% and 2% for the whole of 2009. However, growth is expected to return by the end of the year. Experts surveyed in the Central Bank's November economic expectations survey forecast that GDP could grow by as much as 4.4% in 2010. The unemployment rate hit a peak of 10.8% in September and though it has subsequently begun to fall again, it remains a continuing concern for the public and the GOC. The banking sector is stable and although credit growth slowed in line with the economy, there are signs it is beginning to recover. ¶4. (U) Before the recession, Chile's counter-cyclical macroeconomic policies led to the accumulation of a $22 billion copper windfall sovereign wealth fund. As a result, Chile had significant resources with which to respond to the economic slowdown. The GOC first announced fiscal stimulus measures in November 2008, followed by the announcement of a major $4 billion package in January 2009. Combined with subsequent measures, the stimulus package is worth 2.9 percent of GDP in 2009, financed in large part by asset sales from its copper savings fund. Stimulus measures include investments in public infrastructure, labor training, increased social transfers, tax cuts, and increased lending to small- and medium-sized enterprises (SMEs). GOC Steps to Mitigate Crisis -------------- ¶5. (SBU) Carl Meacham met with Igal Magendzo, Macroeconomic Coordinator at the Ministry of Finance, October 28. Magendzo told Meacham Chile's strong economic institutions and fundamentals had helped shield the economy from the worst of the global economic crisis. He explained that Chile's open economy had nevertheless been hit hard (e.g., 40% losses in export revenue due to price drops resulting from decreases in global demand). Magendzo posited that Chile had nonetheless been able to take advantage of the crisis to position itself for a rapid recovery. He cited Ministry forecasts for potential growth of up to 5% in 2010. ¶6. (SBU) Magendzo explained that unemployment, though still high, had not breached 11%. Many in Chile had feared unemployment in high double digits as a result of the crisis. He also noted that although the economy was currently experiencing deflation, the plethora of indexed instruments helped lessen the effects on the Chilean consumer (e.g., the major unit of account, "unidad de fomento," used in mortgages and most consumer loans, is indexed to inflation). ¶7. (SBU) Magendzo said Chile had been one of the first countries to implement a large fiscal stimulus package in response to the crisis. As a result, he claimed the shock of the economic slowdown (the fall from the peak of growth to the nadir of recession) would be one of the "softest" in the region. Magendzo told Meacham the GOC's stimulus had effectively created a social protection network to minimize the worst of the downturn. The stimulus measures were varied including: some $200 million in shovel-ready public works projects, about $400 million in one-time cash transfer payments, temporary tax breaks, employment incentive plans (including special programs targeted at youth unemployment),a pro-credit initiative to improve competition in financial markets, and improved access to capital for SMEs. Magendzo underlined that the Ministry believed the ultimate end to the crisis would be when the U.S. economy recovered. Possible Signs of Recovery -------------- ¶8. (SBU) Andres Concha, president of the Chile's influential business and industrial federation (SOFOFA),met with Meacham October 26. Concha reviewed the key sectors in the Chilean economy, noting he thought the worst of the recession had passed. He said that although industrial activity had fallen by almost 9% in the last quarter, there are positive signs in the economy, leading to speculation that Chile could grow by 5-6% next year. [Note: This is on the high end for 2010 growth forecasts. End note.] ¶9. (SBU) Concha explained that copper accounted for roughly 60% of Chile's exports and its price recovered from a low of $1.30 in 2008 to a high of almost $3.00 at the end of October. He emphasized this could help spark a recovery in the Chilean economy. Concha credited demand from China for contributing to the resurgence in copper's price. He said the housing and banking sectors are sound, though construction slowed significantly and banks suffered strains on credit lines during the height of the crisis. Concha claimed Chilean borrowers suffered but were better off than those in the U.S. He noted other sectors are recovering more slowly, like agriculture, which is dependent on the U.S. market. Forestry products have been hit equally hard, leading Concha to estimate that forestry exports will remain flat until 2011. He also cited the significant damage to the salmon industry caused by a virus infecting the fish. ¶10. (SBU) Concha told Meacham he was more optimistic about Chile's economic situation now than in previous months; however U.S. growth would be a key contributor to Chile's own recovery. Concha also explained that a cheap dollar might be helpful for U.S. industry, but it complicated the picture for Chilean exporters. Concha predicted the global economy is entering a period of fluctuation. Chile's Development - Private Sector Takes Lead -------------- -------------- ¶11. (SBU) In a meeting with AmCham Chile October 26, President Ricardo Garcia and General Manager Jaime Bazan told Meacham that since the military government, much of Chile's development has been led by private sector investment. Garcia explained that most of Chile's infrastructure, from ports to highways, had been built through concessions and public-private partnerships. He noted that this innovative model relied on stable investment conditions. Garcia said, however, that the global economic crisis had affected that investment climate in Chile. He pointed out that many companies, especially in the U.S., had experienced capital restrictions from losses or debts that could not be rolled over, forcing them to delay or withdraw investments in Chile. Garcia cited the example of Citibank, which prior to the crisis had a 10% stake in Banco de Chile. He explained that Citibank had been widely expected to purchase a majority share in Banco de Chile, but it had not done so because of the effects of the crisis. ¶12. (SBU) Meacham met with representatives from the government development agency (CORFO),led by program manager Stephen Ruddell, October 27. CORFO reaffirmed Chile's development model relied on private resources, rather than lending from IFIs. CORFO said it works with IFIs only on a few select projects (e.g., fostering innovation, for which the GOC has received a $30 million World Bank loan). The CORFO representatives emphasized that their organization is one of the few GOC agencies that is self-sufficient, receiving dedicated funds from mining royalties, as assigned by the GOC. They noted that CORFO's projects are almost exclusively with the private sector, particularly with SMEs, where the agency usually assumes 50% of the risk in a given project. IFI Lending to Chile - Focus on Technical Expertise -------------- -------------- ¶13. (SBU) On October 28, Meacham met with Eddy Linares, acting IDB representative in Chile. Linares emphasized that the IDB had been working in Chile for a long time, during which it had seen a marked shift in the types of projects approved and implemented in country. He underlined that the IDB's lending portfolio is the biggest among IFIs working in Chile (including the World Bank). Linares also noted that the number of public works projects has dropped to a very small percentage. He explained that the majority of current projects are focused on bringing technical expertise to Chile, such as: energy diversification, improving education, forestry conservation, fostering tourism, and working with Chilean think-tanks to promote government decentralization. Linares also noted Chile is now a net creditor to the IDB. ¶14. (SBU) In his meeting with the Ministry of Finance (paras 5-7), Igal Magendzo told Meacham the GOC has asked the World Bank to reexamine its role in medium-income countries, like Chile. Magendzo reported that the GOC believes the World Bank no longer needs to provide capital in these countries, but should focus more on providing technical expertise. He also noted Chile wants a more active role in the World Bank and has become more of lender and contributor than a net borrower. Magendzo said Chile will look to make the same transition in the IDB in the near future. Recent IFI Case Study - Transantiago Background -------------- -------------- ¶15. (SBU) Meacham reviewed the Transantiago public transportation system as a case study for recent IFI lending in Chile. In February 2006, the city of Santiago replaced its previous transportation network of competing, privately-owned buses with what was proclaimed as a new state-of-the-art public transportation system, Transantiago. It was designed by the Lagos Administration and implemented by the Bachelet Administration. After Transantiago's inauguration, the public heavily criticized flaws in the system including: overcrowding, increased wait and transit times, and general lack of functionality. However, there have been recent improvements (see paras 21-22). Transantiago has been running an operating deficit due to fixed fares, significant fare evasion, expensive technology, and high fuel prices. ¶16. (SBU) The GOC tried to cover the system's deficit, by requesting and guaranteeing two loans to Transantiago in 2008: $10 million from the state-owned Banco Estado and $400 million from the IDB. The Controller General (which assesses the legality of government policies) approved the loans. However, in September 2008, the Constitutional Tribunal ruled the loans unconstitutional, and Chile entered a period of technical default on the IDB loan. For almost a year, the GOC attempted to negotiate a solution to Transantiago's funding, as well as its outstanding IDB debt, with the Chilean Congress. In August 2009, the Congress approved a subsidy for public transport throughout Chile worth about $3.5 billion until 2014, which would also cover Transantiago's operating deficit,. The Congress also approved repayment of the IDB loan ( $448 million) by the first half of 2010. [Note. See refs B+C for further background on Transantiago. End note.] Competing Views on Transantiago - A Complete Mess -------------- -------------- - ¶17. (SBU) Axel Buchheister, director of judicial studies at the think tank Libertad y Desarrollo (right-of-center),met with Meacham October 26. Buchheister was the lawyer who successfully led the case in the Constitutional Tribunal challenging the IDB loan to Transantiago. He said the premise of the case was that the GOC did not have the authority to request and guarantee a loan between two private entities (the IDB and the Transantiago Financial Administrator - AFT) without appropriate legislation. Buchheister characterized the GOC and AFT efforts to solve Transantiago's operating deficit as a complete mess. He alleged a murky relationship existed between the GOC and AFT when they set up a Special Account for Reimbursement to pay for Transantiago. The Account was neither fish nor fowl in that it received public and private funds and the AFT reportedly administered it but according to instructions from the GOC. ¶18. (SBU) Buchheister told Meacham that the IDB's loan to Transantiago was not only poorly conceived and executed, but it represented an attempt to "intervene" in local Chilean politics (to rescue Chile's ruling left-of-center Concertacion coalition from a potential embarrassment). [Note: Libertad y Desarrollo is associated with the opposition, right-of-center Alianza coalition. End note.] Buchheister accused the IDB of failing to study the problem adequately, failing to require necessary reforms, and lending at unreasonable risk to a poorly identified entity (the Special Account for Reimbursement). Buchheister further alleged the GOC had pursued this loan because it though it would not require legislation in Congress, something that would have been necessary if the GOC wanted to tap Chile's copper savings to pay for Transantiago. ¶19. (SBU) Meacham met October 27 with Deputy Carlos Olivares (independent),former head of the Congressional Transantiago Investigatory Commission. Olivares called Transantiago a "public policy that failed." He went on to allege that the issue of Transantiago had forced a split in the Concertacion coalition, forcing some members (such as Olivares himself) to leave the grouping. Olivares explained that after the September 2008 ruling of the Constitutional Tribunal, the Congress had established the Investigatory Commission. He said the facts uncovered by the Commission were "strange" in that it was hard to understand why the IDB had loaned money to a "broken system." Although Olivares credited the IDB with coming to testify voluntarily before his Commission, he felt many details remained unresolved (including the exact nature of the Special Account for Reimbursement). Olivares vowed to take up the issue again in March 2010, if he were re-elected in December. Competing Views on Transantiago - Errors Made but Fixed -------------- -------------- -------------- ¶20. (SBU) During Meacham's meeting at the IDB (see para 13),Eddy Linares countered Axel Buchheister's assertions. Linares explained that feasibility and environmental impact studies, as well as certain criteria, are standard procedure for the few infrastructure projects with which the IDB is involved in Chile. He claimed the loan to Transantiago had been no exception; those studies and criteria were applied. Linares pointed out that the IDB had even predicted the possibility of non-repayment by the GOC. Linares said the IDB had documentation on all this, which it had shown to the Congressional Investigatory Commission, and which could also be shared with Meacham. Linares noted the IDB loan had not yet been repaid, but according to the legislation, the GOC had until the end of February 2010. ¶21. (SBU) On October 28, Andres Gomez-Lobo, chief advisor to the Minister of Transportation, met with Meacham. In a frank assessment of Transantiago, Gomez-Lobo noted the system had been an ambitious reform implemented practically overnight, leading to its three main problems: lack of necessary technology, lack of required infrastructure, and lack of incentives. Gomez-Lobo called the GOC's subsequent efforts to fix Transantiago "surgery without anesthesia." ¶22. (SBU) Gomez-Lobo claimed Transantiago was finally showing marked signs of improvement. He cited a series of indicators: accidents were down significantly, average wait times for buses had recently begun to fall, pollution was also showing a reduction, numbers for those using the system had increased, and bus drivers were now part of the formal labor market (unlike the previous system). Gomez-Lobo said the World Bank had called Transantiago the most modern transportation system in Latin America. He maintained that Transantiago would continue to have high costs, but that the new subsidy law passed by Congress and a plan to start phasing in fee increases would help sustain the system in the long run. ¶23. (U) This cable has been cleared by Carl Meacham. SIMONS