Transcript of meeting of the Executive Directors of the Bank, held on Thursday, July 18, 1957

STRICTLY CONFIDENTIAL INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT ONE HUNDRED THIRTY-THIRD SPECIAL MEETING or EXECUTIVE DIRECTORS BOARD ROOM INTERNATIONAL BANK BUILDING WASHINGTON, D. C. THURSDAY, JULY 18, 1957 The meeting was convened at 10:05 o'clock a.m., Mr. Eugene Black, President, presiding. .... STRICTLY CONFIDENTIAL 2 CONTENTS -------- Agenda Item Proposed Loans to Chile Mr. Waterston - Loan Aspects • • • • • • • • 3 Mr. Larsen - Economic Aspects •• • • • • • • 8 Mr. Wals ted - The Projects • • • • • • • • • 12  3 STRICTLY CONFIDENTIAL MR. BLACK: I would like to welcome to the meeting Mr. Mansour, who is acting in behalf of Mr. Shoaib. We are \ glad to have youwith us. MR. MANSOUR: Thank you. MR. BLACK: The purpose of this meeting is to consider t e two proposed loans to Chile. I would like to first call on Mr. Waterston. MR. WATERSTON: Mr. Chairman, Lota and Schwager are the two largest coal companies in Chi le. Within the Bank, we almost alway·s couple their names, but they are in fact separa e companies. Both are privately-owned and their stock is wide l distributed. Lota has been in existence for over a hundred years, and Schwager for more than a half century. Both have experienced and enterprising managements. As Mr. Walstedt will explain later, the fact that the coal reserves of both companies lie under the waters of the Pacific Ocean has required solution of some special problems. The objective which the Bank is being asked to help realize by making the loans now being considered is the continued economic operation of both mines. Although Lota and Schwager today produce substantial quantities of coal, they cannot continue to . operate profitabl without modernizing and expanding their operations. STRICTLY CONFIDENTIAL 4 For Lota, completion of its development program will mea some expansion of production, but mainly lower costs. For Schwager, which can continue the present level of operations without undue increases in costs only through 1961, completio of its development project not only would raise the present levels of output substantially but would also insure continua tion or operations after the present workings have been ex- hausted. Continuation and expansion of production of the Lota and Schwager mines is also vitally important to Chile. Without the output from these companies as it will be after the projects are completed, Chile would have to find an addltional $40 million in foreign exchange each year to purchase an equa amount of imported coal. The reference, incidentally, to 1his hypothetical saving was erroneously given as 70 million in the documents which were distributed to you. Both Lota and Schwager have already spent substantial of their own to start work on their development projects. Bank loans would make it possible to complete them. Most or the local currency for the projects wi~l be provided by the companies themselves. However, through the Chilean t Corporation, which would be a co-borrower in both loans, additional local currency will be made available, largely fro the sale of U. S. surplus commodities in Chile. STRICTLY CONFIDENTIAL 5 Legislation which would permit the Chilean Government t o guarantee the Lota and Schwager loans was recently approved b the Chilean Congress and is expected to become effective by publica·tion before the Bank loans would be signed. At the request of one of the borrowers and in agreement with the Chilean Government, we have ~ded another sentence to Section 3 . 06 of both guarantee agreements covering the government's price policy for coal. Revised pages 6 , incorporating the new sentence, are be • fore you and are intended to replace the original pages 6 in both guarantee agreements. Miss Morsey is now in Chile working out some of the de- tails of the mortgages which Lota and Schwager would give t he Bank to secur, the proposed loans. There may be some minor changes in the list of properties to be mortgaged. In his letter of April 12, 1957 to President Ibanez, Mr. Black reminded President Ibanez that in Mr. Black's lett& of June 25, 1956, he had indicated "that as a first step, the Bank would concentrate on loans for the Endesa and Lota and Schwager expansion programs and, if the stabilization prograa continued to be carried out effectively, would later consider other high priority projects." As a condition for further lending after the Endesa and Lota and Schwager loans, Mr. Black asked President Ibanez in his letter of April 12 to tell us how his government planned STRICTLY CONFIDENTIAL 6 to continue the stabilization program and specifically Taieed questions about three areas needing attention. The first of these was the ourtailment of credit to 'the private sector; the second, the reduction of imports, which wa necessary because of the fall in copper pri~es; and, finally, the financing of the impending fiscal deficit. · Mr. Black also asked what steps the government is t~king to reduce the level of official medium-term debt and to put the railroads in a sound financial condition. In his reply of May 9, 1957, President Ibanez gave no answers to the item concerning curtailment of credit to the private sector and to the reduction or imports necessary becau e of the fall in copper prices, and he indicated that he would borrow from abroad, as it turns out, to cover the expected deficit from the failure to reduce imports and in the internal budget. While President Ibanez in his reply made a firm statement on his government's policy to restrict official medium-term foreign borrowing, he said he was relying on a 25 percent in- crease in railroad freight charges to help rehabilitate the railroad finances. This is a step in the right direction but in our opinion insufficient. Since Mr. Black's letter and President Ibanez's reply were concerned with prospective bank loans of the railways and the roads, it is our plan to follow- up on the Chilean letter a  7 STRICTLY CONFIDENTIAL get more specific and meaningful assurances if we decide to go ahead with the transportation projects. We are expecting information on these projects sometime next month. Thank you, sir. MR. BLACK: Thank you. I might add to what Mr. Waterston has just said and to my letter on page 6, that latter part of paragraph 26 -- "Chi e faces a temporary exchange problem which it is seeking to resolve by extending its lines of credit from New York Banks. ' I think the Board should know that the Chilean Governmen is also negotiating a loan with the Export-Import Bank. I don't know what will happen there. This will be a balance of payment loan, as I understand it, and if it is granted I also understand it will be about $15 million. That isn't menti one in this report. I thought you should know that. I call on Dr. Larsen. Is that about right, Mr. Hooker? MR. HOOKER: Well, I think you go a little far in saying it is being negotiated. They have expressed a desire for assistance from the Export-Import Bank, but to my knowledge there are not any negotiations going on as of now. MR. BLACK: Well, I use the word "negotiation" in a wide sense -- rumored. MR. CALLAGHAN: You are trying hard.  8 STRICTLY CONFIDENTIAL MR. LARSEN: Mr. Chairman, gentlemen, today the dominant economic topic when one is talking of Chile is, of course, th stabilization program. I might remind the Board that before its adoption the cost of living index in Chile increased 84 percent in 1955. In 1956, it increased 38 percent, a con- siderable achievement. The hope had been both of the Chilean authorities and of friendly observers that the rate of increase this year would be reduced to about 20 percent, cumulative improvement. But certain adverse circumstances have occurred not under the con trol of the Chilean authorities, the most spectacular of whic is the fall in the price of copper from its previous 35 cents a pound to the present 28 cents a pound. This seems an annual loss in foreign exchange earnings o the order of magnitude of $50 million and a loss of budget revenues 1n domestic budget of 24 b1111on~venty-four thou million. A considerable pa.rt of the Chilean budget revenues are derived directly from copper. At the same time, there is a severe agricultural drought which has greatly reduced agricultural production and has, fo example, reduced wheat production about 20 percent. And, again, at the same time there was a doubling i n the world price of sugar, and sugar is one of Chile's largest foo imports. STRICTLY CONFIDENTIAL 9 The result has been a slowing down in the progress of the stabilization program. The cost of living index increased 10.2 percent through the first four months of this year com- pared with 10.8 percent in the first four months of 1956, No all that increase, however, can be traceable to purely financi 1 causes in an inflationary sense because they also reflect the customary market consequences of an agricultural drought. It is, however, clear that as of now the Chilean authori- ties are in a difficult position. They confront the prospect of a substantial budget deficit and they have not yet reduced imports to a level which could be financed from current ex- change earnings. They have, however, continued to take actio along the lines of stabilization. In May of this year, as Mr. Waterston has said, they· raised railroad rates 25 p&rcent. This, it is true, is ·not enough to eliminate the railroad deficit but was a politicall courageous act if you will recall the rioting and death in. Santiago when they endeavored to raise bus fares. In July of this year, they abolished the last of the con sumer subsidies on foodstuffs and the last of the urban bus transportation subsidies. This eliminates a considerable budgetary drain which previously existed. Their credit program, their program for the expansion of commercial ba.nk credit in the private sector for the first si months of this year was initially 10 percent. In the upshot, STRICTLY CONFIDENTIAL 10 it was 17 percent expansion. The ceilings were raised becaus of the agricultural drought and distress in that area. The present program for the second half of this year is an ex- pansion of commercial bank credit of 8.3 percent, half of the first period. The government has submitted to Congress new tax proposa designed to raise increased budgetary revenues. Unfortunatel there is not much time remaining for Congress to approve that to confer much benefit on this fiscal year. They probably will not be enacted, if at all, before October or November, which wouldn't benefit this year very much; and they had es- tablished a mechanism which appears to be effective for the control of incurring of medium-term credits bearing the govern ment guarantee of· the credits of government departments and agencies. The most disturbing feature as of now but one which could be removed tomorrow, of course, is the pegging of the free ts trading rate of exchange, the rate of exchange at wh:1.dl impor . into the country are at about605. Both the Bank and the Fund have been concerned with this and have pressed the Central Benk to reconsider its position and allow that rate to go, to depreciate. The Central Bank has said that it is aware of the advant of so doing but it is also aware of the disadvantage in terms of increasing cost of living and political difficulties. STRICTLY CONFIDENTIAL ll In summary then, speaking of July of this year, stabiliz - tion appears to have lost momentum. The question then is whether this loss is temporary· or permanent, and there is no positive answer to that question at the moment. But I would like to remind ourselves that we in the Bank supported stabilization in the belief that it would strengthe the economy of Chile, that it would improve Chile's growth prospects and would hence enhance Chile's creditworthiness beyorxithe point where it otherwise would have been. Success- ful stabilization represents an improvement over an existing condition. But the present situation, even if projected on pessimis ic lines, does not impair Chile's creditworthiness for these proposed loans. As is pointed out in the President's report, Chi le is rapidly repaying externa,l debt. Since 1948 to now, before receiving the coal loans, will have repaid $80 million of long-term debt. That is to say, the level now outstanding of long-term debt is $80 milli n less than it was in 1948. If these coal loans be granted, there would have been a net reduction in debt or $58 million. By the time the first amortization payments become due o these coal loans, Chile will have repaid a further $55 millio on existing outs tmding debt. At the same time, she has increased her medium-term debt $15 million. STRICTLY CONFIDENTIAL 12 So, after granting the coal loans and taking into accoun medium-term debt, there is a net reduction of $43 million. In support of these coal loans, there is also the exchange saving aspect which Mr. Waterston mentioned. MR. BLACK: Thank you, Mr. Larsen. Mr. Wala ted t. MR. WALSTEDT: Mr. Chairman, gentlemen, as Mr. Waterston mentioned, the Lota project is essentially an organization project with only minor increase in output. However, the weight of the operation would be shifted to new mining area that the company has been developing for some time. In Schwa r, on the other hand, there would be 50 percent increase in out- put in the company's going mine. Both companies have been facing similar difficulties. They have reached the limit of economic expectation based upon e sent methods of operation, but they have lacked the their pr. funds for large-scale modernization. It is in particular the haulage and the transportation system that needs improvement in order to permit the mining of coal far out under the sea and as deep down as 900 meters in the case or Schwager. Both companies need new coal preparation plants in order to provide a more marketable grade and get rid of the problem or disposing of the so-called slack coal that has been plaguin them for some time. There would be no essential change in the present method STRICTLY CONFIDENTIAL 13 of mining the coal which is based upon orthodox European practice. Both of these projects were examined last year by Mr. Hammond, who is the managing director of Powell Duffryn Technical Services Limited of London. Mr. Hammond spent six weeks in Chile, and he affirms that the projects are soundly conceived and the managements capable of carrying them out. Although the proving of coal reserves under the sea presents many difficulties, the confidence with Which Schwager ~eserves can be estimated is greatly increased by the fact tha they have reached the seams at the level they will be working. In Lota's case, the appraisal is facilitated both by their development of derivatives and by the evidence from the adjoining workings at Schwager. Schwager's proven reserves at the proposed rates of out- put would last through 1 79. That is way beyond the period of the proposed loan. Although at Lota the proven reserves would last only until 1970, it may ?e safely assumed that by that time a substantial portion of the presently inferred reserves would have been proven, thus permitting full-scale operations well beyond the period of the bank loan. The financial projections are based upon very conservativ assumptions with respect to the dates of completion of the project, the estimated investment cost, the proposed rates of output. STRICTLY CONFIDENTIAL 14 In both cases, the companies could reproduce substantiall more than has been assumed in the financial forecast should th market permit. It is estimated that Lota and Schwager will be able to supply about $15 million equivalent and $13 million equivalent respectively, towards their total financial requirements, 1957-1962, that is, during the construction period, and in cases these total financial requirements both for the project and for certain other necessary expenditures is estimated abou $27 million equivalent. The companies will be aided by the fact that the Chilean Government has abandoned price controls on coal and has promis d not to reinstitute them. No change in the present price level has been assumed, however, in the financial forecast. At the end or the construction period, the debt to equity ratios from both companies would be about 45 to 55, a sound ratio for an industry with a relatively assured and stable market like the Chilean coal industry. The average selling price assumed, the same as the presen price,averages about $15.50 equivalent. This is slightly above the average price charged by rural mines but rather lower than the prices ruling in Belgium or Northern France, which gives an indication that this is a sound industry from the point of view or its relative costs compared to other coal producers. MR. BLACK: Thank you. STRICTLY CONFIDENTIAL 15 Are there any questions? Mr. Hockin. MR. HOCKIN: Mr. Chairman, I have one or two questions ' arising out of the general analysis of the market for coal, chiefly out of Annex IV to this appraisal which is given us under Tab 5 of the report, and this Annex IV, which is a general analysis, applies to both the loans proposed. It seems to me that we are faced here with an issue whic h we want to consider rather carefully. That is the issue of the appropriateness of Bank investment of a fairly substantial size in an industry which apparently needs a level of protec t! n of the order of 50 percent. I notice from Annex IV that the heavy taxes and import duties which are at present levied on the imports of black oils, fuel oil and black diesel oil, is something over 50 per- cent on c.i.f. value;. and taking into account these taxes, I get the impression that the output of Chilean coal is then jus about competitive with this imported fuel. I think this suggests orie or two questions to my mind, · first of all arising out of the use which is likely to be made of the coal which is produced. As we have been told just now and as evident from the reports, the effect of the two loans taken together will be an increase in coal output. There seems to be some doubt in the mind of the person writing this Annex IV as to whether all STRICTLY CONFIDENTIAL 16 this increase in output can in fact be sold. There seems to be a suggestion that there will be surplus coal as a result of the production at the levels indicated. Some of this coal, a fair proportion of it, is apparently intended to go into the railroads, and another fair proportion into Chilena Blectricidad. In both of these, the consumption of coal is assumed to rise quite considerably. Now elsewhere in this report there are comments made as t the consumption of fuel which seem to have a bearing on the likely level of consumption of both of these two, both the railroads and the electrical power output company. To begin with, the statemert is made that Chile is very rich in hydropover ·resources, which have thus far been only partially developed. Long range plans aim towards an even supply of hydro power throughout nol'D181 years and taking ad- vantage of the difference seasonally, and so on. In these schemes, thermal power will play only a very limited role. The suggestion to me there is that Chile has large, un- tapped hydropover resources which are waiting for economic development, and the suggestion seems to be that it would be i fact economic to develop them. This is of importance to gener power users. It also seems to be of importance to the rail- roads, for there is reference later on in this same annex to electrification of the railroads which is currently planned. STRICTLY CONFIDENTIAL 17 In fact, in the section on railroads where there is a discussion of the effect of electrification on the likely c aar sumption ·or coal, we come upon the statement: "The reasonuag behind these different assumptions vill have to be clarified~• So, it seems to suggest to me that there is some question here as to the likelihood that the railroads will in fact go on increasing their consumption of coal in this way. Now we have statements at various places in this document which suggest that the Chilean Government is very interested . in maintaining the consumption of coal, at least at the levs-111 currently reached. We have, for example, the statement: "In view of the present government policy of favoring Chilean coal, it has been asslll"ed that the companies can plan for minimum annual sales to power stations of a certain amount, 420,000 tons." We also have a statement which suggests that the Chileall Government is prepared to step in in terms of perhaps taking special measures to stimulate coal consumption and lower coal. production costs and also to coordinate the consumption of various types of fuels. The general impression I gain from this is that the coal. . companies feel reasonably assured of markets, partly because of the level of protection which they already enjoy, amounti., to about 50 percent, and partly because they feel that if in fact this level should not in effect prove to be sufficient STRICTLY CONFIDENTIAL 18 Chilean Government will take whatever other steps are neces- sary to protect their position. Now I think that this is something we would want to con- sider rather carefully, whether the Bank should encourage the further production of coal in a situation of this sort, and I am not suggesting -- I am not necessarily saying no, we should 't, but I would .like to have some further evidence of the thinking of the Bank staff on this matter. My concern arises not merely because this is an industry I which apparently requires a fair level of protection but also apparently because it is an industry which requires protection in the face or technological cha.Dge which affects its position Coal in many places in the world 1s rather on the· defensive against oil and hydroelectric development. We have evidence 1 these reports that hydroelectric development seems to be an economic thing for Chile, although there are no figures given but just the general statement. We also have talrly good figures giving an 1nd1cat1on of the competitive position of imported oil in the Chilean econom, and it therefore seems to me that we must be careful about encouraging at considerable cost the development of an industr lb.ich 1s 1n this technological position of being overtaken by new developments. This 1s important not just 1n connection with the profit- ability of the various operations of the coal companies and STRICTLY CONFIDENTIAL 19 the likelihood that the Bank will be repaid, because that seems to be well taken care of, but it seems to me important especially in economies such as the Chilean economy where, for example, we have heard evidence this morning and we have seen evidence in these reports and elsewhere of, for example, the importance of copper to Chile. Now I have gathered from this report that two-thirds of the -- I think it is two-thirds -- volume of fuel oil imports are used by the copper mines. I don't know the relative posi- tion of fuel as a cost component in the output of copper, but it seems to me this is somethirl,g we might have a look at be- cause in a position where Chile depends to such a large degree upon exports or copper for government revenue and foreign ex- change earnings, I think that any element which adds to the cost of copper production is something that has to be scrutin- ized pretty carefully; and it seems to me that if we get into a position of investing large sums of money in coal which re- quires a maintenance of the 50 percent protection against fuel . this could have some implications on the cost or copper pro- duction in a country of that sort. This, or course, by the way, has some implications for th statement made here that loans to the coal mines result in a foreign exchange saving to Chile because, on the one hand, it may mean that Chile imports less fuel oil, but, on the other hand, it may mean that her copper costs have gone up to such a STRICTLY CONFIDENTIAL 20 extent that it affects her earnings of foreign exchange on tha side. Well 1 these are the kinds of questions which I have 1n mind 1 Mr. Chairman 1 and I wondered if the staff could give an indication of their .thinking on these matters. As I say 1 I don't want to suggest that I am opposed to th loan 1 but these are questions which I think might be explored little bit this morning. MR. WAI.8TEDT: The point raised 1 I th1nk 1 is a ver7 good one and one that we have paid 1 I would say1 particular atten- ~on to and 1s one of the reasons why we have made such a de- tailed market study in thiS particular case • . In a general way 1 I would like to bring attention again to the fact that although this level of protection against oil may seem high 1 it is a fact that Chilean coal is cheaper than coal in most European countries and 1 therefore 1 the reasons that have led European governments to favor their own coal in- dustry are probably very similar to those that have inspired · the Chilean Government in this case. However 1 more specifically1 I would also like to bring 7our attention to page 13 of the technical report -- this is the Schwager project -- under economic justification 1 where paragraph 54 ia devoted really to answering the question 7ou have raised. I think when we make an analysis from a commercial point STRICTLY CONFIDENTIAL 21 of view, we make some very conservative favorable assumptions that in a combined way sometimes gives a misleading impression or the soundness of the project. For instance, when we assumed that the prices for oil SJ,IB Z C,.S IS would go back to the level they had before the Swi11 Piaea and )I we know that they have been raised in the United States as wel as elsewhere, I think this is an extremely cautious assumption I am not sure that it is realistic, but we assumed it from a commercial point of view, not to be careless. In the same way, we have confidence, really, that the companies will be able to produce coal more cheaply than they have assumed, and I think that in particular in the later year their margins of profits are such that it will permit some re- duction in prices if it will be necessary to meet competition from oil. Finally, an average comparison with fuel oil does not tak into account that in many fields coal is fully competitive. For instance, an important use for this coal and for the metal lurgical oil is for the steel industry. They are fully com- petitive with imported coal. Now you mentioned the railroads and the power companies. Now as far as the railroads go, there isn't really any increas in their consumption assumed and I think the reference you mad was to a difference between our more conservative estimates as to the date at which electrification would take place and STRICTLY CONFIDENTIAL 22 the estimates supplied by the companies. Nov as far as oydropower versus thermal power goes, I think the situation is this, that although Chile is a country rich in hydropower resources, the resources that have to be exploited in the future are located further south and the costs of transmission up to the major industrial areas in the country are considerable and mine-based power station would be a more economical way of producing power than power from some of the hydro installations further south. Further on, thermal power will be needed to firm up the system, and we are satisfied -- and I have checked this quest! n very careful]J with our power speoialists -- that this amount of thermal power will be needed. Now I think there was one more point. Yes. About the Chilean Government, I would say this, that per- haps the report gives a little too much emphasis to these pledges we have received from the Chilean Government indicatin their affirmed desire to support these projects if necessary. We don't really believe that will be necessary. We believe that under the present situation the companies will be able to realize their objectives and the estimated earnings without any special measures on the part of the Chileall Government. I don't know whether that answers it. Iwm. BLACK: Does that answer your question, Mr. Hockin? MR. HOCKIN: I think it gives an indication that these STRICTLY CONFIDENTIAL 23 matters have in fact been considered, Mr. Chairman, which is the main thing. MR. BLACK: I think there is another point in the hydro- electric power development, that it would cost an awful lot or money, plus time. I mean there is no question about that, even if it was economical, and there is a question there wheth r it would be economical because of the location or sites, but even if it was, it would cost an awful lot or money for the . Chilean Government to,pay. MR. HOCKIN: Yes. My question was really directed to whether the money we are spending here was better directed to hydroelectric development, but I gather from the answer that in fact it isn't economical certainly in all areas; there is room for some development but not enough to offset .the neces- sity for coal. MR. BLACK: Mr. Donner. MR. DONNER: ~he question raised by Mr. Hockin generally refers to the problem whether Chile in its protectionist polio es might not follow. a course adverse to its own interests. Now sometime ago, I came across a news item Which was not in connection with these coal projects but which seemed to sup ply a little mor~eight still to the general question put befo e us by Mr. Hoc kin. Last year Chile issued a law according to which not less STRICTLY CONFIDENTIAL 24 than 50 percent of maritime exports should be transported on Chilean bottoms. I heard from Mr. 'Waters ton 1n the meantime that that law so far is a pious wish since the Chilean fleet i far too small to transport that much. I have also been told that there is a transitory provisio available to the Chilean authorities which enables them in the meaning of the . law to declare as a Chilean ship -- 1n the meaning or the law every ship which transports goods to Chile or from Chile. So far as the statutes stand, obviously, no extreme pro- jection, distortion of the trade situation takes place, but, nevertheless, such a law standing in the books probably serves as an incentive to shipping interests to fill in this gap, build up the fleet, and later on then insist, and the govern- ment would comply, that the law be enforced. Now if that takes place, a situation could arise in which capital, Chilean or other capital, flows into markets and ship building which is profitable but is profitable only by th protectionist measures. The result would be that such a coWltry like Chile, which is in dire need of development funds, would put capital into channels which, if the distortion in prices due to legislative action were not available, then would go into economically mor advisable investment fields like electricity, power stations, and so forth. STRICTLY CONFIDENTIAL 25 So, therefore, I wonder -- and I am only putting the ques tion forward since the question or protection measures has been raised anyway -- that if at any time, I would imagine, th Bank in discussing the broad outlines and concepts or Chilean development policies, whether it would not be a good thing to draw their attention also to the disadvantages they might in a more general sense have to incur if such things as envisaged this are really made effective. MR. BLACK: Well, I think you did right. I agree with yo on that. Mr. Thurn. MR. THURN: Mr. Chairman, I have a variety or good reason tor supporting these two loans, but as I go on record tor so doing I would like to raise two or three questions. ¥ )t The .first 1S' a very wide question. It is the attitude or the Bank towards inflationary policies. I admit this is a rather tedious question, but I don't thtnk we can escape it completely. I would like to refer to the historical part of the repor on the two loans. This historical part says that the Bank was first approached in the year 1949 tor loans to the two com- panies. Well, this is quite a vintage negotiation. Well, nothing came or it at first, no action was taken, it says in 1h1s historical part. And why was no action taken? It wasn't taken because or the deterioration or Chile's financial posit! n. STRICTLY CONFIDENTIAL 26 Well, this raises a question why did Chile's financial and economic position deteriorate? In the two reports, no reason is given. But in the economic report we got on the 16th of April, there is a wealth of information on that subject, and I think the reason is very well given 1n paragraph 9. It says there: "Gross national production has been stagnating over the last ten years as an inevitable result of accelerating inflation. " In this same report, there are plenty of other references to the cause-effect relationship between inflation, price con- trols, and economic difficulties. Well, the question arising now is: Has the situation changed? Have the inflationary policies been abandoned and ne policies adopted? Well, we read about attempts made in this direction, you see, and we hear about the results this.morning. We have an estimated rate of inflation ~f 20 percent in this year t 17 percent in the year 1958. What concerns me is that there is so little confidence in the stability of the Chilean curren This becomes apparent if one reads the contract between the Chilean Government and the Corporacion de Fomento and the two mining companies providing the local currency for it. Both these contracts provide for a maintenance of the value of cur- •ncy. It proposes such a clause on the companies. This, I think, raises a fundamental question: Has the STRICTLY CONFIDENTIAL 27 attitude of the Bank towards inflatiopary policies changed? Does this mean that whereas in former years inflation was con- sidered an obstacle to Bank lending now this situation is or has to be more or less accepted? This is the first question I would like to raise. MR. BLACK: My answer to that is no. MR. THURN: The answer is no. MR. BLACK: No. MR. THURN: Well~ this is very satisfactory. The second is the justification of the two loans. It aays here in the summary of the appraisal of the two projects under letter "H" that the loans are economically justified for ,the following reasons: first, saving of foreign exchange; second, prevention of local unemployment; and, third, guarant7 of strategic minimum supply. I am summarizing a little bit. Well, I thought the justification of Bank loans and the object of Bank loans was better service to the consumer of facilities provided with Bank money, that it was a high rate of productivity and an increasing standard of living. Now somebody who reads this might come and say, "Well, apparently the object of Bank loans has become the promotion aelf-sufficiency -- economic self-sufficiency -- and the main- . tenance of a determined structure of employment." This is the second question. STRICTLY CONFIDENTIAL 28 The third was about price controls. I feared that price controls might be reimposed again as the momentum or inflation gains, but here I have no more concern because this morning we get this paper where it says that the government has assured the companies that there won't be any more price controls and tree market prices vould be allowed to develop. The final question is a very short one. That is about dividend limitations. I wonder 1.f we are not going a little bit too far here. !he companies are not dispos~d to distribute more than 20 per- cent of their earnings after taxes, after management and worke participation, etcetera, to the shareholders. Well, the estimated earnings of Lota, one of the companie, in 1 58 is 275 million Chilean pesos. Well, 20 percent vould amount to 55 million Chilean pesos. Fifty-five million is onl just over one percent of the equity -- well, of the atookholde investment, I would say -- just over one percent. And if we ~evaluate the assets of the companies, a possibility which is mentioned in one of the paragraphs of the report, 1r we do tha, Yell then, the return on the stockholders' investment would be less than one percent. Now that is all right for me, but I mean won't it limit the possibilities of these companies 1n future years of raising equity capital? This is the final question. STRICTLY CONFIDENTIAL 29 Well, the first has been answered, just the last two abou the justification of the loans and the 20 percent dividend limitation. MR. WAL8TEDT: Perhaps I could answer two of those ques- tions you raised. The one where you spoke of the economic justifications in terms of foreign exchange savings ·and insuring strategic mini- mum supply of coal, well, as it is stated here in the section on economic justification, it goes through the analysis that I just made in answer to the other question and it ends up with this conclusion that on certain more favorable assumption the average protection needed would be only about 10 percent. In other words, among other things, if we had a protec- tion that was graduated so it was different for coking coal and taking all these other aspects into account, 10 percent in a country where many other industries are also benefitting from a tariff protection which tends to increase the general level of cost and for an industry employing a great number of people, for an industry which does save the country a lot of foreign exchange, doesn't seem to me out of line. I think it is not correct to say that the major focus is on these aspects, but these are the aspects that we picked out to justify the very moderate degree of protection that is sho in the main after careful analysis. As for the question of limitation, I think that is a very STRICTLY CONFIDENTIAL 30 good point, and I think I should give a little of ·the backgro d there on dividend limitation. One of the factors to consider is this, that the companie have postponed this investment for a long time. Now they are not really in good shape. This work should have been under- •ken sometime ago. It is reasonable that they themselves make certain sacrifices during .this period of construction. Now in our division we raiss:3the question of the limita- tion and the companies themselves suggested that they would be villiDg to limit themselves to this percentage which corres- ponds roughly to their present dividends. Now your point regarding . the possibility or raising new equity still has some validity, but they would not be able to raise any new equity until this construction project has been completed, and at· that time this particular limitation falls away. So it wouldn't be an obstacle to raising the rate • .MR. THURN: Thank you very much. MR. BLACK: Mr. Hoo kin. MR. HOCKIN: Mr. Chairman, this question or foreign excha ge saviDgs keeps rearing i ts ugly head all the time, and I think we should be very careful about the way we look at it. We hav heard the statement . many times that this production of coal will save Chile $40 million in foreign exchange. I presume this is on the calculation that if the coal is not produced t y would have to import coal or other kinds or fuel. STRICTLY CONFIDENTIAL 31 However, as I suggested in connection with the copper mines, it might well be that a cheaper source of fuel would, in fact, make Chile's export industries more competitive and might, in fact, result in greater foreign exchange earnings · which would more than offset the increased cost foreign ex- change wise of importing the fuel. I think that these are things that really need to be proved pretty widely before we can just say that because you produce so much coal, therefore, you don't have to import t ha. much fuel and the foreign exchange saving is the value of t hat imported fuel. MR. BLACK: Mr. Lieftinc k. MR. LIEFTINCK: Mr. Chairman, I would just like to thank you and the staff for the additional information ve have re- · ceived this morning with respect to the President's reply to your letter. I take it from the information given that the answer is · not fully satisfactory but that this presents a basis for action at least with respect to the present loans under con- sideration. Mr. Hockin and Mr. Thurn have raised a few points which % also had in mind. May I take from the answer given to the question raised by Mr. Thurn on the economic justification ot tie project that the justification given under "H" on page 2 ot the summary and conclusion of the technical report, the fore STRICTLY CONFIDENTIAL 32 exchange savings and prevention of the local unemployment and the guaranty of the minimum supply or fuel from domestic sourc s , is more intended to be a justification of the protection given " by the government to the coal mines and leas a justification of the proposed loans to the Bank? If that is my correct understanding, I would feel much more confident with respect to the future policy of the Bank with respect to loans. ~. 'WALSTEDT: I think that is a correct statement. I think the emphasis 1n the summary was a little unfortunate, and I think you have clarified the meaning very well. MR. LIEFTINCK: Mr. Chairman, with respect to these coal mines, I think it is very clear from the papers the very good technical report we have before us -- that these are rath r poor mines. The output per man shift is in one case o.60 tons and in the other case 0.74 tons, which 1s almost half of the poorest mines figure for the poorest mines in Belgium which are· gradually being closed doWD. Now I would like to have some clarification as to why the · price of coal 1n Chile nevertheless compares unfavorably with the price 1n 'Western Europe. Is that because labor cost is so very low or is it because the depreciation bas been very un- satisfactory and not calculated sufficiently in the cost? I have the impression that it is both, but I am particu- ~rly interested in the labor costs. STRICTLY CONFIDENTIAL 33 As a result of the investments to be made, labor· produoti vity will certainly go up, but I wonder when making the profit ability calculations whether the staff has taken into consider - t!on the probability that this very low level of wages will ap parently be maintained in Chile. That reflects itself as a matter of fact on the prospects of the mines from the point of view of their earn1.ns power. As things stand today, I do think that the staff is rathe optimistic in its qualification of the Lota earnings, that during the last year they had been substantial. When one loo more carefully into the data presented to us, it becomes · clear .that the economic costs, while calculated on a reasonable bas! , must have been higher and that the earnings have been favorabl influenced by protection. Even so, I think the earning power has been low and indications from Sc~wager still would be lower. This reflects itself in the quotation of shares which in- dicates in the case of Lota 18 percent of nominal value, ·in th case of Schwager 25 percent of nominal value. Now the expects ~ons of the staff are towards a great improvement in this re- apect . It is stated that in due course, after these investments have been made, the expected .return on the net equity in the case of Lota would be 14 percent, in the case of Schwager 23 percent, which is excellent, ! J •• · aays the staff. • • ~ ~ .. < STRICTLY CONFIDENTIAL But I do hope, Mr. Chairman, that these anticipations wil be fulfilled. If so, shareholders will certainly see a sub- stantial rise of the value of their shares and perhaps condi- U.ons will become favorable for raising more equity capital. I do not state that I share in these optimistic views, this is the implioation of the paper, and I wonder if' this is true, if it would not be possible after certain number of indeed to make an effort to raise more equity capital and re- pay the Bank loan. With respect to the increase of production in comparison 1he expected consumption on which Mr~ Hockin has already made ~ some remarks, the staff ppoints out that there are good pros- pects to dispose of certain possible surpluses for sales of coal to Argentina, and I would like to know from the staff if possible whether they can substantiate these prospects. From another paragraph in the paper I took that for geo- graphical re&S'ons Chilean coal is not very favorable for dis- position on the Argentina market as compared with European coa, but perhaps they have worked out some scheme, and, if so, that vould improve the prospects. I have one final question with respect to the free market JI-ices which will be assured to both companies. The thing is a very important premise, and I would like to ask whether this means at the same time that the price concessions at present given to the railroads and the gas companies will be abolishe. STRICTLY CONFIDENTIAL 35 MR. WAI.STEDT: . thing I would answer first: One When in the President's report it is said that Lota's earnings were aubstantial in recent years, I think really that what ve had 1 aind was that they were substantial in relation to Schwager. I think all ve can say is that they are reasonably good. Nov that brings us to a more important question which is the one you raised: How is it that with companies having a reasonably good record or, in the case of Sohwager, an in- different earnings record, and the costs are quoted very low, how can we be so optimistic about their future prospects? Well, that goes back to the fact that in this mine under the present circumstance they have just reached the end of the road. The present methods are no longer suited to the type of operations they have. Intrinsically, however, this is a good mining property, and with their program there is every reason to believe that they should be able to earn a very good profit on their investment and I think that the forecasts made are extremely conservative. Nov this brings us to another point that you also raised. Suppose that 1n earnings on the profits workers ask for a greater aha.re of these profits? I think that they probably will. I think 1 t 1s quite likely maybe that the prof! ts will be a little leas than assumed and the workers would claim as ~ ly greater share. I think th18 is a possibility that should be envisaged, STRICTLY CONFIDENTIAL but again I see no reason for believing neither on general terms nor on the basis of their past labor relations that the workers would claim such a share of these earnings that it would endanger the financial stability of the companies. Now you raised also the question of comparison with Euro- pean prices, how is it that with this relatively low product- ivity their prices still are relatively low. Well, one reason, of course, is that the wages in Chile are considerably lower than in Europe. I think another ex- planation is that coal has been in short supply in Europe and the price for coal is based to some extent, in spite of the subsidy, upon operations that are somewhat less deficient than reasonably efficient operations. It is necessary to blve such a price in order to get as much output as possible in a per- llllDent shortage situation. Now With respect to the price concession, we have been assured both by the companies and by the representatives of Fomento that this concession that they had to make to the gas companies was an exceptional sacrifice that they made to coope ate with the government's anti-inflation program and that very definitely it would last only through the year. Of course, in a situation like that, one cannot be ·abso- lutely sure that they will not be exerted, that the same kinds of pressure won't be exerted 1n some future year, but again th J total quantity importance of this concession is not such as to STRICTLY CONFIDENTIAL 37 throw the whole calculations overboard. With respect to sales of coal to Argentina, certain quan- ttties of coal -- I am not familiar now with the exact quantity have been included Wlder the Chilean-Argentina trade agreement and further on there is every reason to believe that when the San Nicholas Steel Plant in Argentina goes into operation they will be very interested in obtaining coking coal from Chile &rd the negotiations with the Argentinians have already been started by both companies. They are in close contact with con sumers, not only the steel company but also the gas works in Argentina; and on · the basis of conversations I had with them, I think that there are good prospects of sales to Argentina. MR. BLACK: Mr. Mejia. MR. MEJIA-PALACIO: Mr. Chairman, a week ago we approved the loan to India. The meeting was so friendly that you made the remark to Mr. Rao that 90 percent of the speakers were in favor of the loan. It was a big loan, and it was made to a country with inflation, with restrictions, with deficits, etcetera. I wouldn't wonder that you made the remark today to Mr. Pane that 100 percent of the speeches were very oritic~l of the to Chile. I want, at least, to be one percent who praised loan to Chile and to say, Mr. Chairman, that I don't agree wit many theories that we have heard this morning in this meeting. As to the opinions against the protection of the mines or  38 STRICTLY CONFIDENTIAL industries in Chile, we protect our industries in Latin Americ as the United States protects the industries here and Europe . hers, in the same way and for the same reasons. Chile has been historically a mining country, coal and oopper. Agriculture is something relatively new. So they are trying to protect the two more important industries in the OO\llitry. I think that the loan we are making to Chile is going to help the country in their fight against inflation that is really something that you cannot find very easily anywhere. The Government of Chile has been fighting for a year against inflation, even taking into consideration that it can cause th loss of power to the actual party or the actual government. They have been fighting against everything. So, we are helping a good cause and we are helping a good government that is trying to do the best for the country. So I am very pleased that we made this loan to Chile, and it was almost time that we made a loan to Latin America beoaus l>r many months we haven't done anything. Last year we had only 50 millions to all 20 Latin America countries -- $50 million in a year. It means less than one loan to several countries; so it was very little that we have been loaning to Latin America. Now that we have this loan, I think the picture will be better for the g~vernments. We hope that the loans to Ecuador STRICTLY CONFIDENTIAL 39 vill be presented ver7 soon and that we can tell the Governo~ that the Bank is doing better in Latin America. MR. BLACK: A:ny other questions? Mr. 'Watanabe. MR. 'WATANABE: I just wanted to get some factual informa- tion 1n connection with a possibility mentioned about the expo t of coking coal to Argentina. That just raised my interest in the future possibility of getting coking coal to Japan across the other part of the world. So I would like to knov to what extent it involves· coking coal and is there any future possibi - ity of deposit large enough tor export? MR. 'WALSTEDT: I vouB say that what is needed here is not very substantial deposits of coking coal. The sales of coking coal that we have assumed here are based upon conservative es_tima tes as to what portion of the seams will contain the grades which are suitable for coking qualities. Actually on the basis of the first samples they have taken from the seam they have just reached, it appears that it contains rather more coking coal than the seams presently ex- ploited. ' So it is conceivable that they may be able to produce -- I don't lmow ~- a quarter of a million tons, perhaps even more of coking coal. But 1n no case do I anticipate any really substantial, decisive quantity. MR. BLACK: Any other questions? STRICTLY CONFIDENTIAL 4.0 If there are no further questions, I would like to state that there will be a small participation in this loan by the Grace National Bank of New York, $100,000 of each loan, a tota of $200,000 • • If there is no further discussion, may I have a motion to adopt the draft resolution covering both these loans. (Motion made to adopt the draft resolutions, duly seconde and unanimously carried • ) .MR. BLACK: I declare the motion carried. Mr. Pane. MR. PANE: Mr. Chairman, I want to express my appreciatio to the Board for the approval of these two loans to these two companies and also to the management for the efficient handlin ot the negotiations. I want also to express my appreciation on behalf of the Chilean Government authorities to the management of the Bank, e1pecially, for the favorable disposition shown by the Bank e~en under the present circumstances in Chile where they are confronting a very serious economic problem. I am happy to see that this good disposition is based upo mainly the confidence on the part of the Bank that the Chilean Government will be able to cope with these problems and will be capable to carry out the stabilization program in Chile. Thank you, Mr. Chairman. MR. BLACKs Thanks.