Chile - Notes for discussion : Chilean loan application (Vol. 1 of 2) : Volume one

L- 18 NOTES FOR DISCUSSIO01 CHILEAN LOAN APPLICATION October 20, 1947 ILt G'PY After a comprehensive analysis of the Chilean loan application submitted to the Bank, 1ir. Roberto Vergara (the representative of Fomento and the Chilean Railroads) was told, on YMay 21, 1947, by Mr. Garner, that although the Bank was satisfied with the economic and technical soundness of some of the projects contained in the Chilean loan application, the Bank mas concerned over certain elements of vweakness in the structure of Chile's economy which had to be dealt with first. These weaknesses were: 1. A seriously unbalanced budget and a tendency towards increased inflation. 2. A seemingly rapid decline in Chile's foreign exchange holdings. 1, lultiple exchange rates. 4. Default on Chile's external indebtedness. In addition to these weaknesses,questions were raised as to whether the steel mill, being financed by the Exim Bank, would be of permanent economic benefit to Chile, The proposed rapid industrial development of Chile, as provided by Fomentots plan, raised the question of technical and manpower shortages and whether sufficient internal capital would be available. On October 1h, 1947, hMr. Vergara returned to the Bank with the intention of renewing negotiations. Conversations with Mr. Vergara indicate that the projects which Chile was initially interested in are still the projects for which Chile desires a loan from the Bank. They are as follows:  -2- a. For Fomento Electric power plants USlo 9.500,000 Forest industries 6-000:OO0 Port mechanization 1,5030,00 Urban and Suburban transportation 5,00O0OOO b. For the Chilean Railroads Railroad electrification 18,0009000 GRAND TOTAL US40 hLGOOO000 Conversations with Mr. Vergaras together with information which has been collected by the Loan Department, indicate that the following develop- ments relative to Chile's economic weaknessas have occurred in Chile between Yay 21 and October 14. 1. Inflation and Budget Since M'ay, the inflationary situation in Chile has tended to level- off. The stock exchange indices have fallen. Wage indices have fallen from May to June and production seems to have increased in all fields. Also, there was a decrease in the circulation of currency between Mlay 26 and June 22, 1947 (the latest available figures). However, milk and bread price increases occurred during July and August, but this, according to M.Ir.. Vergara, might reflect merely temporary shortages in imports brought about by a tightening of foreign exchange. The existing inflation is primarily caused by two factors, i.e. rising wages and a continuing budgetary deficit. Mr. Vergara states that wage increases are the result of.the pressure of political groups, namely and powerful Chilean Communistic Party. The Government has acceded to the policy of increasing wages in order to control the political situation. The Goverrunent is now endeavoring to hold wages at their present levels and has taken strong action to control the spread of Communism. The coal strike, now in process, appears to be the test of the  -3- Government strength, If the strike is brokern, Mr. Vergara feels that the Government will demonstrate its capacity to maintain its strength and contain wages writhin manageable limits. The budgetary deficit continues to be a problem. The cumulative deficit amounted to 586,800,000 pesos at the end of 1945. This deficit jumped to 1,236,900,000 pesos at the end of 19h6, and is expected to reach 2,100,000,000 pesos (not including Fomento and parastatal agencies) at the end of 19h7, unless tax reforms are instituted. Dr. Alessandri, iYinister of Finance, has submitted a concrete program to reduce the 1947 current deficit -through increased taxation. This plan also provides for commercial bank bor- rowing and the revaluation of gold reserves in the Central Bank. The law embodying this plan was approved on October 6, 1947, by the Finance Committee of the Chilean Parliament and the measure will be submitted to a vote within the next six weeks. (Enclosure A). Dr. Alessandrits program does not balance the budget. Our investigations indicate, however, that cash income will meet the normal operating expenses of the Government as well as a substantial percentage of capital expenditures. 00 million pesos will be borrowed from commercial banks. This borrowing, although not specifically allocatedy actually can be construed as being required by reason of the large development program. 2. Foreign Exchange Position and Balance of Payments From January 1946 to January 19h7, foreign exchange holdings of the Central Bank and of the commercial banks of Chile dropped from USo 124,4o0,o0o to US3 79,00Q,000. This was the figure used in the M!ay conversations betwreen the Bank and Yr. Vergara. This decline of US} 45,000,00o seems to have been checked somewvhat in 1947. The reserves  in June 1917 were US}p 62,4 million. However, US$ 7,000,000 of this decline was a payment by Fomento, which will be reimbursed by the Exim Bank at a later date. Therefore, the actual decline in reserves was only US$ 9,600,000 during the first six months of 1947. The future of the foreign exchange situation seems to have a brighter outlook. Mr. Vergara stated that the war-created backlog of imports is almost dissipated. All the employees of the Foreign Exchange Control Board were recently dismissed and replaced by new personnel. On August 11, 1947, importation of articles, which the Chilean Government considered to be non-essential or replaceable by Chilean production, was prohibited. This action is estimated to save US 9,000o,000 during the second half of 1947. Also, it has been decreed that no new imports can be shipped to Chtile which have not been paid for in advance. Although Chilets balance of payments will not be favorable this year, it is hoped that the tightened foreign exchange controls will have a beneficial effect on.balance of payments next year. 3. Myltiple Exchange Rates Chile still has four foreign exchange rates: a. The special rate (black market) does not seem to involve more than US,. 2,000,000 a year. It applies non-commercial and small transactions and is only legal for transactions under $l00. In July 1947, this rate was 47.22 pesos to a dollar. b. The.main exchange rate for most commercial and other trans- actions is 31 pesos to a dollar. This rate is the parity accepted by the Fund.  -5- c, A special rate of 19.37 pesos to the dollar applies to the foreign exchange in the hands of the copper mines which must be surrendered to the Government to cover the cost of copper production. This rate is equivale'r" to a tax on copper and has no foreign exchange significance. Although the Chilean representatives stated in I'lay that this rate would be abolished, necessary legislative action has not been passed. -,Tr. Vergara stated that this rate will be abolished when a new tax structure is developed on copper. d. A special rate of 25 pesos to a dollar applies to certain essential imports. This rate rep'laces a subsidy, and we under- stand that the I.,Y is not pressing for its imnediate elimination. Inasmuch as Chile has signed the Bretton Woods Agreement, she is obligated eventually to replace the multiple exchange rates by one rate, which will be 31 pesos to a dollar. X,r. Vergara maintains that this will be done. 4. Default It is understood that Yr. Vergara is in contact with the Foreign Bondholders.' Protective Council and is attempting to negotiate an agreement relative-to a settlement of the external debt default. 5. Fomento's Industrial .Development Program Fomento's present industrial program is very largely built around the construction of a steel plant in Chile. It is anticipated that  -6- construction on this plant will begin within the next few weeks. However, the cost of both foreign and local costs have risen since the original plans fcr the plant Were drawvn. Consequently, a serious problem exists as to the means of financing the additional cost. Inasmuch as the mechanization of ports being requested of the IBRD and the project for electrifying the Chilean railroads depends to some degree upon the success of the steel mill, it is considered that a detailed investigation of the probable success of this mill is necessary. The Bank's investigations to date indicate that the steel mill may not be economic and may possibly cause a severe strain on Chiless economy in proportion to its benefits. Further checking will be required. 6. Relationships with Copper and Nitrate Companies Chile has not yet worked Qut her tax program and exchange relationships with the copper companies. Inasmuch as the future of the Chilean economy so largely depends upon copper and nitrate companies, it is considered that the Bank should satisfy itself, when considering a loan, that the future of these industries is assured. Mr. Vergara reequested a concise statement as to the specific conditions that the Bank w.ill require to be fulfil'ed prior to the granting of a loan. Yr. Vergara also desires to know whether the Bank will make a loan to Chile, provided that these stipulations and representations are met by the Chilean Government. In this connection, Dir.. Vergara requests that the Bank state whether the Bank will grant loans for all of the proiects which have been requested by Chile. This will, of course, be subject to the Bank being satisfied as to the economic and financial value of the individual projects, as well as their engineering worth.  o 7 - Mr. Vergara waa informed that his request vould be brought to the attention of appropriate officers of the Bank. 7. Recommendations (This section has been prepared after preliminary discussion with Mr. Garner). It is recommended that the Bankts position on the Chile loan application be as follows: 1. No definitive advance commitment can be made to Chile on any loan. 2. While resumption of discussions with bondholders appears to be a favorable step toward reestablishment of Chile's credit, little progreas, if any, has been made in improving Chilets economic position since ir*. Garnerts meeting with the Chilean delegates on May 21, 1947. 3. On the other hand, certain questions have arisen which cast further doubt on Chile's economic situation: (a) Questions have arisen as to the economic and technical aspects of the steel mill, as to the increased cost of the mill, and as to whather, under the circumstances, it is a sound basiness enterprise. A full investigation should be made in order that these questions be answered; this should be done through further conversations with Exim Bank enginers, with the Betklehem Steel Company officials, with the Koppers Company, and possibly with others. (b) The future of the fo-reign-owned copper and nitrate industries in Chile has not been settled. This should be looked into with the copper and nitrate companies, and the status of future developments ascertained. In this connection, special reference should be made to Chile's tax situation.  - 8- 4, Talks should be had with the F'und in order to ascertain whether Chile is living up to its Fund obligations, and the opinion obtained as to the future of the Chilean ourrency. 5. If a fact-finding mission goes to Chile it should reexamine Fomento's development program as a whole in the light of recent economic developrents; it should be prepared, if necessary, to make or recommend technical Investi- gations of Fomento's proposed projects; on the economic situation, it should study budgetary developments, not only for 1947, but for future years; it should study the tax structure with special reference to the copper companies, the agricultural situation about which additional information is needed, current trade trends and their relation to the balance of payments; the currency question with reference to Chile's obligations to the Fund and steps toward stabilization, steps taken and proposed to curb inflationary trends. Out of such an investigation, a view could be developed as to whether an independent experts mission is required. It may be advisable to take a Fund expert and engineering consultants. 6. Mr. Vergara should be advised as follows: (a) The Bank is unable to make, in advance, any definitive commit- ment as to the loan. (b) The Bank notes with interest that Chile has taken up negotiations with bondholders, with a view to settling past defaults. It appears to the Bank in general that the economic situation in Chile has not changed substantially since May, although a favorable trend is discernible. In May the suggestion was made that Chile retain a mission of independent experts to stuLdy the Chilean economic situation and make recommendations. The Bank still feels that this would be of distinct advantage in the  - 8 a - reestablishment of Chilean credit, and is willing to ass-st, if desired, in working out the details of such a program. This is a suggestion only, and not a condition made by the Bank, acceptance or rejection of which by the Chilean author- ities would determine the Bank's attitude toward the proposed loan. (o) If Chile wishes, the Bank would be willing to send a fact-finding mission of its own to Chile. This would not be delaying tactics, but would be a fact-finding mission which would make a thorough study of present economic trends, and, if required, make techni- cal and economic investigations of the projects included in Chile's development program. The Bank cannot impose detailed and specific conditions precedent to the making of a loan. A fact-finding mission should be able to develop the current-facts and trends on the ground, and enable the Bank to reach a conolu- sion on the Chilean loan application.  -9- ENCLOSURE A Digest of the Budgetary Situation of Chile as Presented on September h, 1947, by Dr. Jorge Alessandri, Minister of Finance. Estimated Budget - 19h7 PROBLEM In Million Pesos __ ~~~~~~- (T47T Ordinary Expenditures 6294 Ordinary Revenues 6278 Ordinary Deficit 16 Extraordinary Expenditures 1950 Extraordinary Receipt Tax on Copper.. ..... ... oseoes..902 New Taxes ......... , ,,,,209 Tota ' 1111v 1111 839 Estimated Total Deficit for 1947 (including Fomento and Parastatal Agencies) Ordinary 16 Extraordinary 839 Obligations that can be deferred -14i0 State Railways 140 Transportation Enterprise 30 Fomento 300 (because of the decrease of the yield of the copper tax) Housing Fund 8 - Workers' Insurance 40 Public Welfare Institute 200 1509 Million Pesos Increases in Salaries of Gov't Employees 250 1759 I\illion Pesos SOLUTION Sources of financing of total 1947 deficit as suggested by the Minister and the President:  -10-' Increased fiscal receipts (Customs - 20% increase on excess profit tax) 600 Revaluation Gold Reserves Central Bank 600 Borrowing from Commercial BarLks hO4 1600 Yfillion Pesos Law was approved October 6, 1947, by the Finance Committee of the Chamber, COIA.IENTS Dr. Alessandri attributes the budgetary problem to increases in wages, social laws and Government spending over and above the increase of the capacity to produce of the country. This, he asserts, creates a shortage of private capital which in turn restricts production increases. The above solution should balance the ordinary budget. However, the revaluation of gold and borrowing from banks does not cure the problem permanently. Future budgets wnll be balanced only if additional revenue is raised or if development is slowed to a rate which can be met by current taxation. This is not a serious problem, however. Even though a reasonable deficit continues due to a high rate of development, Chile should be able to remain solvent.