Development of a capital market in Chile (Vol. 1 of 9)

Re Cm 42 VOL.1 .RCULA'THIN CO5PY TO BE RETURNED TO REPORTS DESK This report may not be published nor may it be quoted as representing the view of the Bank and its affiliated organizations. They do not accept responsibility for its accuracy or completeness. INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT INTERNATIONAL DEVELOPMENT ASSOCIATION DEVELOPMENT OF A CAPITAL MARKET IN CHILE Report of a Mission organized by the International Bank for Reconstruction and Development at the request of the Government of Chile THE REPORT January 19, 1965  INVTERNATIONAL BANK FOR RECIV&STPUCTI3 V A YN DEVLQLOPMJNT SecM65-35. FROM: The Secretary February 10, 1965 DEVELOPMENT OF A CAPITAL MARKET IN CHILE There is attached for information a report (C-42) dated Jarnuary 19, 1965 of a Mission organized by the Bank at the request of the Government of Chile, together with the following annexes: I. Forces Determining Investment and Saving in Chile; II. Intermediary Financial Institutions in Chile; III. Improvements in Company Law and Regulations; IV. Improving the Operation of the Stock Market; V. The Chilean Banking System; VI. Improving the Role of the Banking System in the Capital Market; VII. Relation of Inflation to Capital Markets; VIII. Improvement of Information and Analysis. Distribution: Executive Directors and Alternates President Vice Presidents Department Heads  CHTEIh CAPITAL MARKET STUDY M4ISSION Woodlief Thomas .................... Chief of Mission Richard Ewbank .......... . .. .. . .. Consultant Emile den Dunnen .......................... Consultant  TABLE OF CONTENTS Page Introduction ............ .......................... ..................1 THE REPORT Part I Nature of the Problem of Saving and Investment in Chile .... 6 Factors Affecting Saving and Investment in Chile ...... 7 Requisites for a Capital lMarket ....................... 10 Part II Recommendations of the Mission ......................... 15 TRevision of Company Law and Regulatory Procedures ..... 16 Improving the Operations of the Stock isarket .......... 20 Regulation of Investment Companies ................... 21 Establishment of Development Banks .................... 22 Development of Viarkets for Government Securities ...... 22 Broadening the Role of Banks as Savings Institutions..25 Development of a Money PIarket ......................... 27 Changes in the Role of the Central Bank .. .. 29 Flexibility of the Interest Rate Structure . . 30 Other Suggestions for Consideration .... 31 List of Annexes . . . . . . .6 .434**e**6 * ***44.i.*6.34  1 INTRODUCTION 1. In 1961 the Chilean Government officially adopted a comprehensive and ambitious Ten-Year National Development Program, which set forth eco- nomic goals for the country in the decade 1961-70. The broad objective of these goals was in effect to increase the output of the economy at a rate adequate to provide for the country's growing population and to raise the level of living for a large portion of its people. It was recognized that attainment of these goals would require substantial amounts of ca- pital investment by both the public and the private sectors. Total invest- ment would have to increase from less than 10 percent of Gross National Product (GNP) to 18 percent during the decade, while GNP itself would increase by more than three-fifths. Some of the financing needed for this investment would have to come from foreign sources, particularly in the early years, but internal saving would have to be relied upon for a large and growing portion of investment. This would require a corresponding increase in the rate of private saving, as well as of saving by the public sector. 2. Alt the request of the Chilean authorities, the International Bank for Reconstruction and Development reviewed the Ten-Year Development Program. This review stressed, among other points, the imperative need to increase saving if the financial objectives of the Program were to be realized. It follows that, to foster private saving and particularly to facilitate the flow of savings into investment in the country in the magnitude required, an effectively functioning capital market would be desirable, and, to a degree, essential. A capital market adequate for these purposes did not exist in Chile at that time, and the possibility of developing one raised formidable problems relating both to policy and to structural aspects. To help in finding ways to deal with these problems, the Chilean Govern- ment asked the International Bank for Reconstruction and Development for technical assistance in conducting a study of capital markets and finan- cial institutions in Chile. The general purposes of the study were stated to be the preparation of recommendations to the Chilean Government concerning: a. the mobilization of personal and business savings through financial institutions and the sale of securities; b. the financing of private enterprise through the sale of securities and the organization and operation of a stock exchange;  2 c. the supervision of private financial institutions; and d. the effects of corporation law on investment practices and on the mobilization of capital. 3. In compliance with this request, the Bank organized the Chilean Capital Markets Study Mission. This mission was composed of three members: Woodlief Thcmas served as Chief of Mission, Richard Ewbank as a senior economist, and Emile den Dunnen as a junior economist. Mr. Thomas had just completed forty years as Adviser to the Federal heserve Board of the U.S.A.; 1Messrs. Ewbank and den Dunnen were seconded from the Bank of England and the Nederlandische Bank respectively. The conduct of the study and preparation of the report covered a period of approximately two years, including twenty months of residence in Chile by the mission. 4. In its studies of the problem of developing a capital market in Chile the mission surveyed the structure of the country's financial insti- tutions and the nature of the broad problem of saving and investment in Chile. Attention was given to the indigenous resources of the country, as well as to its institutional structure and practices. Because of the pervasive importance of recurrent inflationary tendencies in Chile and the acute nature of such tendencies that developed again shortly after the mission was established, the effects of inflation had to be given consid- erable attention, as is explained below. 5. I]n the report herewith submitted, emphasis is placed upon recommen- dations for measures, largely of a structural nature, that might be adopted to aid the flow of saving and investment in Chile. Most of the mission's recormtendations relate to specific matters which are subject to action within the present econcmic environment of Chile. Implementation of some of them will require further study by appropriate bodies within the country to adapt them to the particular practices and structure of the country's laws and institutions. Some proposals, however, cannot be put into effect until certain difficulties requiring more fundamental measures, such as control of inflation, are corrected. The mission's proposals are not de- signed to present a complete, self-contained program that must be accepted in its entirity or abandoned completely. Although consideration must be given to, internal consistency and some measures are dependent upon the adoption of others, many of the specific suggestions can be judged on their merits and effectuated independently. 6. Essential background to the mission's report is the change that took place in the economic climate of Chile between the time the study was planned and the actual work of the mission. The study was conceived and requestd by the Chilean Government in 1961, at a time when there had existed for a brief period a state of relative stability in the Chilean financial situation after years of rampant inflation, which had damaged or destroyed many ele- ments necessary for a functioning capital market. With the existence of  3 relative stability, it was felt to be appropriate and desirable to restore or develop rules, practices, and institutions that would foster saving and the channeling of savings into domestic investment. By the time the mission was able to begin its work, howTever, Chile was again grappling with prob- lems of financial instability, currency depreciation, and rising costs and prices. Not only were these developments unfavorable for the fostering of saving and capital markets, but also the task of dealing with them took precedence over other problems in the interest and activities of both the public and the private sectors. 7. In this environment, the mission could not ignore the impact of inflation on saving and investment. It became evident from an analysis of the situation that an effective capital market does not now exist in Chile and, moreover, that such a market cannot be developed quickly or without some fundamental alterations in public and private attitudes and policies. Over the long term, avoidance of inflation or its containment within limits not often experienced in Chile during the past eight decades would help to foster a substantially higher level of savings and make pos- sible the maintenance of a properly functioning capital market. 8. Before inflation is effectively brought under control, however, the Chilean Government and private enterprise can adopt a number of measures that would help to foster the flow of savings into investment within the country. Holding up all action until inflation ceases is not necessary or desirabLe. This would be a defeatist attitude. Advantage must be taken of every opportunity for adopting measures that will improve the flow of savings and investment--and this in itself will help to combat inflation or reduce the impact of inflation on investment. Some of the measures proposed in this report would help to accomplish this result, but it must be recognized that fundamental measures beyond the scope of this study are necessary to overcome all the barriers to an effective capital market. 9. Specific recommendations given in the report for much needed changes in company law and stock market practices could be applied without waiting for the control of inflation. Their adoption would, it is believed, con- tribute in various ways to encouraging the movement of internal savings into investrment in Chile, even under inflationary conditions, and would help in moderating inflationary tendencies. It is suggested that the Government take steps to work out a proira1n for early action) along the lines of these recommendations. 10. Suggestions are made for some major modifications in banking prac- tices and procedures for carrying out monetary policy which would help in developing effective money and capital markets. Also, the mission offers suggestions for changes in public-debt management which would contribute, along wlith banking changes, to the development of a market for government  4 securities. Some of these changes might also foster the flow of saving into investment under inflationary conditions and, indeed, aid in combating inflation. However, full attainment of the goals envisioned in the far- reaching proposals with respect to changes in banking practices and monetary policy procedures will depend in part upon the curbing of inflation. 11. It should be understood that the report is not intended to be a complete survey of the problem of saving and investment in Chile. Reform of the tax system, for instance, was recently carefully studied and was in the process of legislation while the capital markets study was being conducted, although other changes are needed and some are suggested in the report. Improvements in the social security system, another important aspect of the problem, has also been the subject of a recent comprehensive study, which is presumably in the process of consideration by the Govern- ment. Provision for agricultural credit is a highly specialized subject which the mission was not in a position to study. Also, it was not the mission's task to propose changes which might be considered desirable in the large-scale programs of investment by the public sector (except as to methods of financing). Nor did the mission attempt to investigate the questions of specific inducements that might be offered to foreign capital (other than measures directed to the domestic situation that would also be applicable to investment from abroad). 12. Finally, it may be appropriate to suggest that, in the opinion of the mission, further steps toward preparation of a fully comprehensive program for the development of a capital market in Chile should be carried out by a high level commission composed in large part of informed, respon- sible, and representative citizens of Chile. Such a commission with the aid of a capable technical working staff, should conduct hearings, make specific studies, and endeavor to reach well considered conclusions and specific recommendations as to actions and policies for both the public and private sectors. The report here presented provides background ma- terial that the mission believes will be useful for the conduct of such an inquiry. In addition various background memoranda, prepared by members of the mission as part of the process of writing this report, may be sup- plied separately if desired. It may be repeated, however, that many of the proposals contained in this report could be and should be put into effect with little further study of the problem. 13. The mission is indebted to a number of persons and organizations for assistance and for facts and views that contributed to the conduct of its study and the preparation of this report. These include a number of Chilean Governmaent officials; various bankers and businessmen, both Chilean and foreigners; some of the business associations; representatives and members of the Bolsa de Commercio de Santiago; the 'eading firms of ac- countants operating in Chile; officials of investment companies; and some lawyers and economists expert in the fields covered. The number of indi- vidual contributors is so great and the extent of their contribution so varied that any attempt to select particular individuals for specific  5 mention might imply unintended discrimination. Hence more specific acknowledgements are omitted. 14. The Chilean Development Corporation (CORFO) provided facilities for the operation of the mission, in part through a contract with the Institute for Organization and Administration (INSORA) of the University of Chile. 15. Individual members of the mission worked as a group on the study as a whole. Mr. Ewbank deserves principal credit for suggestions relating to company law and the stock exchange and Mr. den Dunnen for background ma- terial on the Chilean banking system. The Chief of the Mission must assume major responsibility for the content of the report and for the recommenda- tions of the mission. 16. In conclusion, it should be pointed out that the brief report here- with submitted in two parts -- one relating to the background situation and the second presenting a summary of recommendations -- represents a synthesis of more comprehensive analyses of various aspects of the problem made by members of the mission. Results of these analyses are presented in a series of annexes, which may be obtained on request. A list of these annexes is given at the end of this report.  6 Part I NATURE OF THE PROBLEM OF SAVING AMD INVESTENT IN CHIIE 1. Economic growth and development in Chile at a rate adequate to provide for its growing population and to raise the level of living for a large portion of its people will require substantial amounts of capital investment for many years. The nature and magnitude of these needs were indicated in the Ten-Year National Development Program inaugurated by the Chilean Government in 1961. For the immediate future, much foreign capi- tal will be needed to accomplish this program, but internal saving must be relied upon to provide a large and over time a growing proportion of investment. Some of these savings will have to come from the public sector--the Central Government and autonomous public agencies--but in the long run well-balanced economic development requires that a substantial portion of investment be financed by voluntary private saving. 2. To facilitate the flow of private saving into investment, an effectively functioning capital market is desirable. Under present con- ditions Chile cannot be said to have an effective capital market, and many important and fundamental changes in structure and in policies will be needed in Chile to meet all the requisites for a fully adequate capi- tal market. Creation of a capital market cannot be effected all at once, but has to evolve over time as component institutions and practices develop. 3. Yet to obtain an increased flow of saving and investment, which is the ultimate goal of economic policies, it is not essential that there be a complete and perfect capital market. Some of the components of a capital market already exist in Chile. The flow of saving into investment may be improved by a number of actions that could be taken promptly, while other needed improvements and the development of new features can be gradually effected over a period of time. 4. This section of the report presents in summary form a listing of the principal aspects of the problem of improving saving in Chile and of chan- neling savings into domestic investment. Also included in this part is a general summary of the principal structural and operational requisites of an ideal capital market. Recognition and understanding of these features is essential as a background for the recommendations that are presented in Part II. Analyses that provide the bases for the brief conclusions set forth in a somewhat dogmatic manner in the body of the report, as well as a number of more detailed suggestions, may be found in supporting memoranda prepared by the mission.  7 Factors Affecting Saving and Investment in Chile 5. Principal aspects of the problems of saving and investment that influence economic growth and progress toward higher living standards in Chile, as well as the possibilities of developing an effective capital market, may be summarized briefly as follows: a. Capital requirements, as illustrated by the goals set forth in the Ten-Year Development Program, call for a 60 percent growth in gross national product in the decade 1961-70, with a two- and one-half-fold expansion in the annual volume of investment. b. Over half of this investment is expected to be financed through the public sector, but the amounts to be derived from private saving, for both public and private investment, are expected to increase and financing obtained from for- iegn sources to decline over the decade. c. The present volume of private saving is very small and is more than accounted for by business saving in the form of depreciation allowances and retained earnings. Individuals on balance, so far as can be determined by the unsatisfactory figures available, appear to be net borrowers or users of capital, rather than net savers. Much of the savings accumu- lated is invested directly in real estate or in individual business enterprises without passing through the capital mar- ket. Some private domestic savings are invested outside the country. d. Recurrent inflationary tendencies, which have prevailed in Chile for most of the past 80 years, have discouraged per- sonal saving and particularly the flow of saving into fixed- value financial assets. Causes of inflation have been nu- merous and involved, relating in part to various structural features of the economy and to attempts to expand consump- tion faster than productivity of the country has increased. Inflation has been made possible in recent years mostly by Government borrowing at the Central Bank to finance public sector investment, although private credit expansion has also played some part.  8 e. Financial institutions, serving as intermediaries for channeling savings by some into investment by others, are not developed in Chile to the extent needed for the func- tioning of a flexible capital market. This is largely due to lack of confidence in the maintenance of the value of money because of the persistence of inflation. The total volume of annual saving accumulations in deposit- type assets amount to much less than a tenth of the total investment in the year. Although there has been a notable increase in the adjustable accounts at savings and loan associations in recent years, they have been much smaller than accompanying demands for mortgage loans. Insurance accumulations comprise a small and declining portion of the supply of investment funds. f. Facilities for raising capital by business enterprises from private savings are inadequate. Among the largest business enterprises a substantial portion of equity capital belongs to the Government or to foreigners. A great deal of re- maining equity, particularly that of the smaller enterprises, is closely held within families or other limited groups. Much of the growth in business capital is derived from re- tained earnings, generally accompanied by stock dividends. g. Primary dependence upon internal sources of funds--retained earnings and depreciation allowances--for financing business investment does not always ensure the most effective utili- zation of resources. Formation and development of new enter- prises is difficult. To some extent this is due to the low level of private saving relative to large private investment demands, but there are also a number of institutional and structural hindrances that might be corrected. h. Laws and regulations governing the organization and finan- cial operations of companies are cumbersome and complex, imposing many unnecessary delays and hindrances upon the establishment of new companies and upon financing the ex- pansion of established companies. At the same time disclo- sure requirements and practices, auditing procedures, and restrictions on directors are inadequate to provide reason- able protection to shareholders and to stimulate the de- sire of the mass of small investors to acquire and hold shares.  9 i. Although Chile has two organized stock exchanges and although movements of share prices indicate that invest- ment in shares has generally provided a profitable hedge against inflation, the channeling of new funds into business investment through the stock market is not all that may be desired. Reasons advanced for this failure are numerous and involved. Some of them are structural and might be corrected by changes in laws, regulations, or prevailing practices. J. In Chile, where over half of all investment is financed by the central government or by autonomous agencies in the public sector, there does not exist an active market for the securities of the Government or its agencies. The result is that public-sector investment must be fi- nanced by (1) taxation or other current receipts, or (2) by foreign borrowing or aid, or (3) by Central Bank credit. The first is the most important, but it does involve dif- ficult budgetary problems and essentially is a form of compulsory saving drawn from the private economy. The second is to some degree essential but it builds up for- eign exchange obligations for the future or in any event is limited in amount and scope. The third has had highly inflationary consequences and ought to be kept within narrow limits. To help meet the continuing financing needs of the public sector investment program and also seasonal and other temporary variations in the Govern- ment's needs for funds, with reduced foreign borrowing and without resort to inflationary Central Bank credit, it is essential to develop markets for Government secur- ities that would attract private savings and temporary liquid funds. k. Commercial banks have limited resources, are faced with heavy demands for credit from customers, are required to maintain very high cash reserve requirements, and operate under restrictive rules as to types of assets they may hold. Most of these restraints have been imposed for the purpose of curbing inflationary credit expansion. Bank deposits in Chile have the highest rate of turnover of any country, re- flecting the scarcity of liquidity and the high level of interest rates that prevail in the country. The commercial banks play practically no role in the medium- and long-term capital markets. Private commercial banks are not authorized to hold savings deposits and have only limited amounts of time deposits; their holdings of long-term assets are minimal. The State Bank has a monopoly of savings deposits and is de- signed to finance business development, but its credits are nominally mostly for short terms.  10 1. Interest rates are generally high relative to those in other countries, but they are subject to maximum ceilings and presumably are not as high as they would be in a flexible market. Moreover, when allowance is made for depreciation that has occurred in the value of money, the return to lenders has been minimal or nil. Furthermore, as a result of different maximum ceilings placed on var- ious rates, of tax exemptions or tax benefits provided for some types of interest income, and of price-level adjust- ments available on some obligations, there is a high degree of distortion in the interest-rate structure. For these reasons, interest rates do not effectively serve their economic function of promoting and allocating saving and investment. m. There is in Chile practically no money market, i.e., a market in which funds may be invested for short periods and withdrawn at will with a net interest return. A mar- ket of this sort is a necessary adjunct to a functioning capital market. n. The Central Bank of Chile has generally served more as a source for financing inflation, on the one hand, and on the other hand, as an administrator of foreign-exchange controls necessitated by inflation" than as an institution for adjusting the supply of bank credit and money to the needs of stable growth of the economy. It has not been able to foster the development of a flexible money market without adding fuel to the fires of inflation. Requisites for a Capital Market 6. This summary of important aspects of the existing financial structure and trends in Chile indicate the nature of the problem of develop- ing a capital market in this country. As a further background for the mission's recommendations, it may be useful to set forth the principal req- uisites for the existence of a broad, integrated, well-functioning capital market. These should be viewed as ideals, which cannot all be achieved in Chile in the immediate future. Creation of a capita] market cannot be achieved all at once but has to evolve over time as component institutions and practices develop. 7. In any particular country, the range of factors bearing on the prob- lem of a capital market is a wide one. It includes all those factors that determine economic development in general, such as indigenous resources, legal processes, the efficiency of governmental administrative machinery, the skill of management and workers in industry and commerce, fundamental attitudes toward work and leisure on the part of the population as a whole,  11 and others that affect the willingness and ability of people to save and invest. Many of these factors are too broad or too intangible to cover in a study such as this one, which deals principally with the pertinent economic influences of an institutional or structural nature as they exist in Chile. 8. The principal requisites for the existence of a capital market in any country may be summarized as follows: a. An adequate supply of savings seeking investment is the first requisite. For this purpose, the term savings may be used in a broad sense to include liquid funds tempo- rarily held in cash or financial assets, as well as those seeking investments of a more permanent nature. b. Demand for investment funds by enterprises needing capital for productive purposes or by other borrowers to meet long-term needs such as home ownership, is the other side of the equation. In any modern developing industrial so- ciety such demands always exist to a greater or lesser extent. c. Various types of financial institutions are needed to serve as intermediaries between those who are predomi- nantly savers and those who on balance are investors. These institutions may include commercial banks, savings banks, and other deposit-type savings institutions; coop- erative credit institutions; insurance companies; and dealers in obligations of governments or governmental agencies, in corporate securities, or in mortgages on property. d. An organized stcck exchange composed of brokers and dealers in securities is a desirable adjunct to an effective cap- ital market. In addition to a stock exchange, or in lieu of one, there must be well-established facilities among brokers and dealers for buying and selling financial assets and establishing market prices. These facilities should assure depth, breadth, and resilience so as to provide rea- sonably continuous markets, in which transactions can gen- erally be effected fairly promptly at prices that reflect underlying values without excessively erratic fluctuations.  12 e. Prices and interest rates must be free to fluctuate in response to basic conditions that may influence judgments as to the values of particular assets. They should be able to vary not only as to general level but also with respect to differences between the various instruments that are traded in the market. Such variations are essen- tial in order that prices and rates can perform their economic function of influencing the allocation of re- sources. In the absence of such flexibility, capital markets cannot operate with sufficient depth, breadth, and resilience. f. Some regulation of capital-market institutions and practices--by government and through self-imposed agree- ments or consistent-ly observed traditional practices--is essential for the protection of investors and for other reasons of public policy. Yet regulations must not be so restrictive as to destroy or din.inish unduly the depth, breadth, and resilience of the important mAarkets. g. Since prices of the assets dealt in are expressed in monetary terms and commitments are often for long periods, it is desirable if not essential, for an effective capital market that there be reasonable long-term stability in the value of currency units in terms of purchasing power of goods and services or in terms of other currency units. Otherwise the inducement to save will be reduced and invest- ment will be concentrated in assets most likely to appre- ciate in value or will move to countries with more stable currencies. h. Taxation of investment assets or of returns on such assets must not be confiscatory or und"ly discrimnatory. Dis- crimnatory taxation may result in cha-mieling savings into uneconomic uses. This is an exceedingly delicate aspect of the problem. Assuming a given over-all volume of tax- ation determined by the exigencies of public policy, it can be said that if some types of activity are exempt from certain taxes or enjoy relatively favorable rates, the end result would be to impose relatively greater bur- dens on other sectors, some of which may in reality be equally or more important that the privileged sectors.  13 i. An essential complement of a capital market is a flexible money market, i.e., a market in which funds may be put to use or borrowed for short periods. The facilities of a money market are necessary for financing the activities of dealers and professionals who provide a degree of li- quidity for capital market assets. While long-term savers should not expect absolute liquidity under all conditions, some degree of liquidity is desirable to en- hance the attractiveness of ownership of financial assets. j. A money market requires in turn a system of banks and banking practices that help to provide an adequate degree of liquidity for dealing in financial assets. In addition the banking system should be able to serve as a means for mobilizing savings and channeling them into investment and thus to participate in the capital market. k. There must also be a flexible monetary policy, with Central Bank operations designed to meet temporary variations in monetary demands, as well as the longer-term needs of a developing economy. At the same time Central Bank policy should conform to the broad monetary needs of the economy as a whole and should not be diverted to meet demands for financing of specific types of borrowers in a manner in- consistent with the broad objectives. 1. A most important requisite for a capital market is the availability to the public of information of sufficient volume and promptness to enable participants in the mar- ket to make informed judgments with reasonable confidence and to minimize special advantages available only to a small number of insiders. Such information should not only relate to individual companies or assets but should also provide the basis for broad analyses of economic developments that may affect the value of investments. m. Finally, the operation of a capital market cannot rely wholly on the availability of reports and statistics, because at the best they cannot tell the whole story, or upon governmental regulation, but must also depend in large degree upon confidence on the part of investors in the integrity, honesty and reliability of the organi- zations that make ultimate use of the funds and of the financial institutions that serve as intermediaries.  14 9. It may be concluded from this summary of requisites for a properly functioning capital market, together with the preceding description of the existing financial structure and recent trends in Chile, that a broad, integrated capital market does not exist in this country and that there are many obstacles to the development of such a market in the future. Only some components of a capital market exist and most of these operate under restraints--legal or traditional--that seriously hamper their func- tioning or, because of inadequate regulation or inflation or for other reasons, they do not elicit the confidence of savers. It is not to be ex- pected that a complete and integrated capital market can exist until inflation is contained--an accomplishment which will require the adoption of many measures and policies that lie outside the scope of this study. 10. The major aim of economic policy, however, is not the development of a complete capital market, but the attainment of an adequate flow of saving and investment to promote increased productivity. Whether or not inflation is completely controlled or a fully integrated capital market established, a number of measures can be taken to foster the development of financial institutions and practices that would facilitate the flow of saving into investment. Some of these may be adopted promptly; others could follow in orderly sequence. Part II presents a number of sugges- tions for measures that should help to promote saving and investment in Chile and improve the operation of some parts of the capital market. They may also contribute, along with other measures of a more fundamental nature, to the containment of inflation and, in this event, lead to the development of a reasonably complete and integrated capital market and to the attainment of a satisfactory and sustainable rate of economic growth in Chile.  15 Part II RECOM1ENDATIONS OF THE MISSION 1. Basically, the first essential for general economic growth in Chile --and particularly for the development of a capital market--is an increase in the total volume of saving. This problem is essentially one of the productivity of the economy and the demands for consumption. A country cannot have economic growth without investment in productive activities; hence current consumption must be less than current production and the savings effected must flow into productive investment. 2. This report does not attempt to present a solution to the vast problem of establishing and maintaining a balance of production, consump- tion, and saving in the econormy of Chile. This is essentially Chile's persistent problem of inflation, control of which would require action on many fronts--economic and political, governmental and private, financial and nonfinancial--with aspects that go beyond the scope of a capital- market study. The specific measures presented in the report would contrib- ute to a solution of that problem, though they would not be sufficient by themselves to solve it completely. 3. In the mission's recommendations, emphasis is placed on changes of a structural nature, relating particularly to financial institutions and practices that would facilitate the flow of saving into domestic invest- ment. They fall generally into broad groups. The first group consists of measures directed primarily to improving the mobilization of private savings for financing private enterprise. These include change in laws, regulations and practices that concern the formation and financing of busi- ness corporations; those relating to the operation of the stock exchange and investment companies; and the proposed establishment of development banks. 4. The second group covers proposals for developing markets for Govern- ment securities and it overlaps the third group, which deals with proposals relating to the banking system. These include principally the handling of savings deposits and long-term investments by banks, the development of a short-term monev market, and the role of the Central Bank. They lead to proposals relating to the attainment of more flexibility in interest rates and to the use of value-readjustment clauses in financial obligations. 5. Finally a number of matters, not studied in any comprehensive man- nes by the mission, are mentioned as worthy of consideration for action.  16 Revision of Company Law and Regulatory Procedures 6. One of the most important barriers to economic development in Chile is the difficulty of raising funds for investment in private business enter- prise. Yet, over time, investments in the equity shares of companies appear to have been profitable and to have served as a reasonably effective hedge against inflation. Some of the reasons for the difficulties in drawing savings into this type of activity relate to fundamental features of the Chilean economic situation, principally the scarcity of savings, low pro- ductivity, and high costs. Many of the problems, nowever, are structural or legal and could be remedied. 7. The first recommendation of the mission is that company law and regulations, which appear to be complex, involved, and in some respects out of date, should be reviewed with a view to revision and codification. The mission has made a comparative study of company laws in Chile and in some other countries from the standpoint of protecting the interests of investors, as well as those of the public in general. Study has also been made of var- ious proposals advanced in other countries for revisions in such rules. On the basis of these studies, the mission would suggest for consideration a considerable number of specific and more or less detailed changes in laws, regulations, and practices with respect to the organization and financing of companies in Chile. The more important of these are the following: a. Procedures for the formation of new companies and also for issuance of new shares by existing companies should be sim- plified and expedited. At present these require a separate Presidential decree in each case. This seems unnecessary. Standard procedures and requirements as to prospectuses and company statutes or charter provisions should be established. At the same time, as suggested in connection with disclosure regulations, the interests of shareholders should be pro- tected and their desire to invest in the enterprises stAmu- lated by requiring more complete and adequate information to be given in the prospectus. b. Disclosure regulations, which now call for certain annual statements to be filed with the Superintendent 'of Corpora- tions, should be revised with a view to providing more de- tailed, accurate, and up-to-date information about company activities. This information should be made easily avail- able to shareholders--actual and potential--az well as to public authorities and to analysts of economic events. In particular, figures of sales and the major elements of costs, not now reported, should be revealed.  17 The forms of the statements should be revised to make their results clearer. Comparative figures for the previous year or two should be published with each state- ment. Certain basic information--particularly as to sales and profits--should be reported at more frequent intervals than at present. More useful and revealing information should also be included in the annual returns required to be made by companies to the Superintendencia and in the Directors' reports to the shareholders. In particular, ownership of shares by directors, officers, and leading shareholders and their transactions in shares of the co.mpany should be revealed. Also interests of directors in other companies should be reported. Suggested model forms of some of these statements and reports have been prepared by the mission. c. Auditing rules and procedures should be strengthened. It is not enough that more information be published; steps should be taken to ensure, so far as reasonably possible, that infor- mation reported is accurate. It should be made compulsory that balance sheets and income statements of sociedades anon- imas be audited by qualified external auditors--a practice followed in Chile by most large companies on their own accord but not by enough. Because of the scarcity of qualified au- ditors this regulation will have to be made applicable over a period of time. Measures should be taken to tighten accounting standards and to improve the training of auditors. Auditors should be made responsible to shareholders rather than to the board of directors, as is now the practice in Chile, and they should have the right of being heard at annual meet- ings. The form of the auditors' certification or state- ment should be tightened. Specific suggestions for imple- menting these recommendations have been prepared by the mission. d. Regulation of directorship of companies has often been sug- gested as an area in need of reform in Chile. There might be some tightening of rules as to qualifications of directors. The mission does not recommend, as is often suggested, that an absolute limit be placed on the number of directorships that a single individual may hold, but it does suggest that the share- holders and the public be informed of any multiple director- ships. Consideration should also be given to ways of revealing cases of appointed directors acting for others not eligible to be directors.  18 The method of electing directors deserves especial consideration. The mission suggests that in lieu of the existing system in which a shareholder casts all his votes for a single candidate, either a voting systema in which each director is elected by a simple majority vote, with each shareholder voting for each position, or a system of cumulative voting would be preferable. e. Measures to increase the participation of shareholders in the decisions made at annual meetings should be given consideration. In particular, the system of proxies should be revised to as- sure that all shareholders have an opportunity to appoint proxies and to give them a two-way choice as to any questions that are to be presented for voting. Individual shareholders should be provided by the company, subject to certain safe- guards, with facilities for circulating among all shareholders any substantial complaints or proposals they may wish to have considered at an annual meeting. f. Means should be irnvestigated for increasing the public offering of shares, which is rare in Chile. To some extent, this rarity is due to the underlying economic environment, but it may also be due in part to tax hindrances, to regulations, and to pre- vailing institutional practices, particularly the inadequacy of information as to the intrinsic worth of the shares. It is strongly recommended that, as a means of avoid- ing some confusion as to real value of shares and also of reducing some existing difficulties in the issuance of new shares, Chilean companies be permitted to issue shares without a stated par value. No-par-value shares have been effectively used in a number of countries and their use recommended in others. In any event cash issues of shares at prices below or above par value should be made easier than is now the case in Chile because of legal or regula- tory barriers. Recommendations as to disclosure of information in- clude a requirement for the publication of a "prospectus," giving detailed information as to the nature of a company and its financial condition, in connection with the issu- ance of new shares. A document of this particular nature is not now provided for in Chilean law.  19 g. It is also recommended that there be a strengthening of rules regarding direct sales of shares to the general public by the issuing company or by sales institutions. These should be di- rected toward safeguarding the interests of investors, for the purpose of establishing confidence and thereby increasing their willingness to acquire shares. h. Another question that deserves consideration is whether regula- tion of limited-liability partnerships (Sociedades de Responsa- bilitad Limitada) should be strengthened. This is a common and relatively important form of business organization in Chile, but these firms are not subject to any regulatory agency and do not have to publish accounts. They have previously had certain tax advantages over sociedades anonimas, but these have been reduced, if not eliminated, by the recently enacted tax law and there seems to be a movement toward shifting of firms to the corporate form. For this reason, any further measures of regulation may be held off until the effect of this change is clearer, but the question of their possible eventual regula- tion should be considered. i. Finally, careful consideration should be given to the question of the appropriate role of the Superintendencia of Insurance Companies, Corporations, and Stock Exchanges and to desirability of reorganizing the operations of this agency. Some of the recommendations of the mission, if adopted, will impose heavier burdens upon this office. Much of this relates to the assembly and publishing of reports and other information and enforcing qualitative standards. Some will charge the Superintendencia with additional administrative and investigatory responsibili- ties, involving policy judgments. The agency should be pro- vided with resources to handle the additional work load. Questions of allocating policy decisions to the Superintendencia or to some other official or agency involve major matters of governmental organization, on which the mission does not endeavor to pass Audgment. The duties suggested are of such a nature that they might best be performed by a commission rather than a single official. In any event there should be some pro- vision for broader review of fundamental matters of public policy, perhaps by an advisory committee. *More- over, arrangements for appeal with respect to rulings of substantial importance should be available.  20 Improving the Operations of the Stock Market 8. Although Chile has two organized stock markets with daily trading, the relative importance of these markets in the economy has declined in the past decade notwithstanding a marked increase in activity in the past two years. A better functioning stock market--i.e., a market character- ized by more active and reasonably continuous trading without unduly wide price fluctuations--would be essential for the development of a true ca- pital market and a broader flow of saving into corporate shares. 9. Some of the reasons advanced as causes of the inadeauate level of stock market activity raise questions that extend beyond the scope of this study, such as the flow of capital abroad because of lack of confidence in Chile's own prospects; the tax burden on corporations and on returns to investors; unsatisfactory returns from investment in shares; and certain advantages of other types of investments relative to shares. It appears, nevertheless, that some revisions in stock market rulesand practices would help to stimulate interest on the part of investors in shares of companies. 10. It should be pointed out that law and regulations governing the stock market must avoid two extremes: on the one hand, they should be re- strictive enough to limit abuses and excessive speculation and thereby bolster the confidence of investors while, on the other hand, they should not be so burdensome as to curtail activity and investmentin shares to an excessive degree. Many of the proposals previously presented regarding changes in company law and regulations might be expected to have the effect of stimulating investor interest in shares, while restraining abuses and fraudulent practices. Other recommendations advanced by the mission may be briefly stated as follows: a. Steps already taken by the Bolsa de Commercio toward reduc- tion in the number of its members might be carried further. This would enable the remaining members to operate profit- ably and provide more advisory and other services to cus- tomers and would also offset some of the effects of restric- tions in other activities recommended in b. b. There should be restrictions on the outside activities of members, which often in the past have been responsible for difficulties that contributed to a decline in confidence in stockbrokers. In particular, the holding by brokerage firms of the deposits of customers should be limited to amounts incidental to stock-trading purposes.  21 c. Restrictions on borrowing by brokers and other investors for the purpose of purchasing or carrying securities might be relaxed. Such borrowing might be permitted from brokerage houses or banks with shares as collateral but with relatively large margins--say 50 percent or more--between the market value of the shares and the amount of the loan. Some credit is needed for the smooth functioning of a stock market but large-scale increases in credit for speculative purposes should be prevented as far as possible. d. Increased taxes on transfers of shares (often proposed in Chile as a means of raising revenue for particular purposes) should be avoided. Also any other taxes or tax exemptions that re- sult in inequitable burdens on investment in shares relative to other types of investrmient should be avoided to the extent possible, giving consideration to the general requirements of the over-all tax level and structure. e. Requirements for the listing of shares or for permission to trade on the Bolsa should be strengthened. Companies granted such privileges should be required to file with the Bolsa and make available to shareholders regular reports as to changes in the nature of their business, their officers and directors, and their financial position of the types recommended for sub- mission to the Superintendencia. The Bolsa might well have somewhat different requirements as to content and frequency of reporting. It could impose auditing requirements on its listed companies before it would be feasible to have them ap- plicable to all companies. Regulation of Investment Companies 11. Remarkable progress has been noted since early 1962 in the channeling of private savings into corporate shares through the medium of newly organ- ized mutual funds. These companies now account for a significant, though still small, proportion of share ownership and probably for some increase in such ownership. The law passed in 1960 governing the organization and op- eration of such companies seems to have worked toward accomplishment of the purposes intended. There seems to be no reason for subjecting these funds to any additional regulations of a restrictive type. 12. A few changes in existing regulations, however, might be considered, including the addition of some requirement for the holding of minimum li- quidity reserves to meet potential net redemption of shares. At the same time the funds might be permitted to invest a portion of their assets in short-term obligations of corporations, which under existing rulings is not permitted. Funds are nowT prohibited from exercising voting rights on the shares they own; this rule might be relaxed up to some percentage of the  22 total paid-up capital of a corporation. Funds are now required to distribute in cash all their earnings; this rule might be modified some- what with respect to capital gains and stock dividends received by the fund. Accounts of funds should be required to be audited by qualified external auditors, as is now done in practice. Requirements as to cus- todianship of securities held by the fund and to the issuance of new certificates (cuotas) might be revised somewhat in the interest of ad- ministrative efficiency. Establishment of Development Banks 13. In order to provide a means of medium- and long-term financing for business enterprises--for which adequate facilities are now lacking in the Chilean financial structure, legislation authorizing the estab- lishment of private development banks has been recommended by the Govern- ment of Chile. Adoption of this measure is desirable and steps should be taken as soon as possible by organizers to set up a strong and adequately capitalized development bank to concentrate on industrial projects. 14. Development banks, as authorized by the proposed law, would be designed to channel funds obtained through foreign loans and as much as possible from domestic sources to economic development purposes. They would also be expected to provide to borrowers technical assistance in project formulation. 15. The proposed bill would impose some limitations on the activities of these banks to avoid interference with commercial banking activities and to prevent abuses of available funds. They would be authorized to make loans that are adjustable in accordance with changes in prices. This provision is desirable because of inflationary tendencies in Chile, because a bank's obligations might be expressed in foreign currencies or be adjustable if in national currency, and in addition because under existing law a bank would be required to adjust its capital and reserves in accordance with price changes. Development of Markets for Government Securities 16. If public-sector savings continue to be inadequate to meet all the needs of publicly financed investment, the Central Government should en- deavor to borrow a part of its needs from private savings, in order to reduce foreign borrowing and avoid resort to inflationary Central Bank credit. For this purpose it would be necessary to develop a market within the country for medium- and long-term Government securities. Also to meet seasonal and other temporary variations in cash needs, without resort to the Central Bank at times when resulting variations in the money supply would not be appropriate, there should be an active market for short-term Government securities. Such a short-term market could attract liquid funds temporarily seeking investment or at times serve as a means for supplying  23 needed cash. To foster the development of these two types of markets, which would at times overlap or be interacting, the following measures are recommended: a. The Government should offer a variety of securities to meet the different types of demands that may appear in the market. They should vary principally as to length of time to maturity, but some may have special features as to redeemability and callability prior to maturity. Some of the autonomous public agencies--such as CORFO or EIDESA--might raise money directly from the public through issuance of their own obligations or through the sale of portfolio holdings or of participation cer- tificates representing such holdings. b. Under existing conditions in Chile, it would be virtu- ally impossible to raise funds in national currency from the private sector in amounts needed, even at very high interest rates. Accordingly, it is suggested that, until there is confidence that inflation is to be kept under control, the Central Government--and perhaps some of the autonomous agencies--offer long-term securities with index- escalation clauses, that would increase in value as consu- mer prices rise. While the use of such adjustable obliga- tions raise many difficult questions, "or which experience does not supply satisfactory answers,_1l in view of the pre- vailing climate of investor confidence in Chile, limited experiments with them might be tried. If autonomous agencies sell adjustable obligations, the revenue rates of the borrow- ing enterprises should be subject to similar adjustments. c. Commercial banks, as suggested in another recommendation, should be permitted to accept savings deposits and attach adjustable provisions to such deposits held for a year or more. Banks should be permitted, or indeed required, to cover a portion of these liabilities by adjustable assets, including Government securities issued for the purpose. Such assets should be permitted to be held by banks in lieu of marginal reserve requirements against savings deposits, under conditions described elsewhere. 1/ Possible advantages and disadvantages of price-index escalation of obligations are set forth in one of the supplementary memoranda prepared by the mission.  24 d. Short-term obligations might be sold from the Central Bank portfolio or directly by the Government to commercial banks, to be held in lieu of marginal reserve requirements, under conditions set forth in the mission's recommendations re- garding the banking system. Preferably these obligations should be in the form of Treasury bills sold on a discount basis by an auction process, in limited and fairly consis- tent amounts, and at regular intervals. Maturing issues should always be paid promptly at maturity, without exten- sion of terms, although voluntary exchanges for new issues might be permitted. e. Government securities issued in accordance with thle above recommendations, should be freely marketab'le at prices de- termined by prevailing demand and supply forces in the mar- ket. Holders should be permitted to sell securities from their portfolios, except those required to be held under reserve requirements or other provisions. Correspondingly, other investors should be permitted to acquire and hold such securities. It is through such transfers that a mar- ket for Government securities would be developed. Eventu- ally dealers might begin to operate in the market as intermediaries. Limited credit facilities should be made available for such dealers. f. Interest rates and prices set by the Government--or the Central Bank--on new offerings of securities should cor- respond to those prevailing in the market, i.e., they should be at levels that attract buyers. This would no doubt mean a higher level of interest costs for the Govern- ment than now prevails on Government obligations held by the Central Bank. However, with the special inducements of index escalation or substitution for existing non-earning marginal reserve requirements, it might be expected that the interest rates resulting would be considerably below prevailing market rates on obligations not possessing one of these features. g. Amounts of such securities offered should be limited as much as possible to demands of the market for such issues. If offerings exceed demands at prevailing rates of inter- est, then rates and/or prices of the securities should be permitted to adjust to a point at which offerings will be absorbed. It is particularly important that the outstanding amounts of Treasury bills and other short-term obligations be kept relatively unchanged in order that an active and re- silient market be established for them. New issues should not be freely available "on tap" at some fixed price or rate.  25 h. Some "nursing" of the short-term market by the Central Bank will no doubt be needed at times to contribute to the maintenance of an orderly market, without excessive fluctuations in prices. Indeed, Central Bank operations that cover appropriate variations in monetary needs would be thoroughly justifiable. In general, however, the de- terminant of policy should be the monetary needs of eco- nomic growth with stability and not the borrowing needs of the Treasury. Broadening the Role of Banks as Savings Institutions 17. Banks would be able to contribute to the development of a capital market and to the mobilization and channeling of savings into investment in Chile, if some changes were made in the rules governing their operations. Mobilizing and investing savings, which are customary features of banking in most countries, are severely restricted for banks in Chile. Some limi- tations on these operations are needed to prevent them from being used as means of vitiating monetary controls or unduly impairing the liquidity and soundness of banks, but they can be permitted to some extent. To broaden these functions of banks in Chile, the following modifications of existing rules and practices are recommended for consideration: a. Private commercial banks should be authorized to accept savings deposits. This right is now restricted to the State Bank, but a customer of any bank should be permit- ted to maintain a savings account, in addition to a checking account, without having to deal with more than one bank. Moreover, competition in this area could be a healthy stimulant to saving. b. Banks should be authorized to adjust the face values of and interest payments on savings deposits held for one year or more on the basis of changes in the consumer- price index or scme other appropriate index of changes in the value of money. c. Distinctions between savings and other time deposits as to conditions of withdrawal, payment of interest, etc., should be retained or established by law or practice. Small individual holders of savings deposits should have certain advantages not permitted for large holders of liquid funds in time deposits that might be subject to large-scale withdrawals at times.  26 d. Interest rates payable on savings and time deposits might be left unregulated and be determined by the competitive forces of the market, unless there should develop evidence that competition is forcing banks to acquire unsound assets, endangering their capital margin. Rates on deposits payable within a short- term, however, might not be permitted to be as high as rates on deposits actually held for extended periods. e. Income-tax exemption of interest returns from savings and time deposits should be discontinued, except to the extent that such exemptions are permitted for competing forms of investment. f. Existing marginal reserve requirements on increases in savings deposits should be reduced arnd eventually elini- nated in a manner that would not be in conflict with prevailing monetary policy. Since these deposits are presumably held as a store of value rather than a medium of exchange, thus representing genuine savings, they could be available for investment in productive uses without having inflationary consequences. Existing basic reserve requirements should remain unchanged. Whether the same privilege is granted to other time deposits is a matter for consideration, as sucn deposits are often closer to money held as a medium of exchange than that held as a store of value. Reduction or removal of marginal reserve requirements could be effected without adding unduly to potential monetary expansion by permitting banks to substitute Government securities for such requirements and having a corresponding amount of securities sold from the portfolio of the Central Bank. These particular se- curities would preferably be long-term issues and should be marketable. g. Banks should be authorized to hold certain long-term assets --Government securities, mortgages, or other obligations-- in amounts based upon the volume of their savings deposits and capital accounts (instead of merely capital and re- serves as at present). To the extent that banks hold de- posits with adjustable provisions, they should be required to counterbalance a large portion of such deposits with adjustable assets.  27 18. Through this coambination of charnges in practices, the commercial banking system of Chile might be enrolled as active participants in the endeavor to stimulate saving, to mobilize the savings, and to direct themi into financing long-term investment in both the public and private sectors of the Chilean economy. This could be done in a manner that would not add to inflationary forces and in fact might reduce or eliminate pressures for inflationary methods of financing. 19. In line with the above suggested changes in banking practices, par- ticularly the removal of the State Bank's monopoly with respect to savings deposits, the broad question of the role of the State Bank in financing the development of industry and agriculture should be carefully examined. This question should be viewed not only in the context of the State Bank's own potentialities, but also in relation to the possible development roles of CCRFO, of the proposed new private development banks, and of the com- mercial banks which accept savings deposits. Development of a Honey Miarket 20. Essential for the functioning of a Government securities market and a broader capital market is an effective money market for trading in liquid funds. The money market serves the capital market by providing facilities for financing the distribution of financial assets that are traded in the capital market. This imparts sormie degree of liquidity to, and improves the continuity of, capital-market assets without making them completely liquid. 21. In Chile a true money market does not now exist and there seem to be no facilities whereby banks or others with a temporary excess of funds can put them to use promptly in ways that permit quick withdrawal when needed. Similarly there are only limited means for raising cash quickly on the basis of sound assets. Banks ordinarily account for the bulk of transactions in the money market as funds constantly shift among banks. In Chile, the existence of high marginal reserve requirements means that flows of funds among banks are in large part self-compensating. Any re- maining movements have to be balanced by adjustments in loans and through the medium of credit at the Central Bank--methods that may affect the total volume of credit in ways that would not be desirable at the time. 22. Proposals previously advanced with respect to the development of a market for Treasury bills would contribute to the functioning of a money market in general. Full development of such a market will have to be ac- complished gradually over an extended period of time as practices and custons change and new ones become established. Specific measures pro- posed are the following:  28 a. Mlarginal reserve requirements at banks would be reduced. The amount and timing of such reductions should depend on the monetary needs of the economy and the counter- balancing actions taken. An alternative procedure, thlat may be used as a transitional measure, would be to permit banks to meet marginal reserve requirements with holdings of Treasury bills. b. To absorb reserves released by the reduction in require- ments, the Central Bank would sell Government securities from its portfolio. This is a most essential aspect of the proposal. Simply to permit commercial banks to hold Treasury bills in lieu of marginal requirements, without a reduction in Central Bank credit, would result in an increase in total credit and money. This would be just as inflationary as an increase in Central Bank holdings accompanied by a corresponding rise in marginal reserve requirements of commercial banks. c. Banks would be permitted to trade in Treasury bills with other banks or any other holders, as long as requirements as to holdings of reserves and of such securities are met. Such trading might be expected to take place as funds shift amrong banks and their caslh positions change. Through these transactions a money market wculd develop. Non-bank holders of liquid funds might also care to participate in this i,aarket. d. Discount rates, or prices, of Treasury bills should be permitted to fluctuate in accordance with tihe forces of the market, except for such intervention by the Central Bank as may be needed to take care of wide temporary variations in demand and to maintain generally orderly conditions in the market. e. It is essential that the supply of Treasury bills issued be kept closely in line with the demands for such issues. Any attempt to sell more than the market would absorb would have the ef'fect of destroying confidence in the market and discourage participation by short-term investors. 23. It should be recognized that if inflationary fiscal and monetary practices continue to prevail in Chile it would be exceedingly difficult-- perhaps impossible--to establish an effective money market in the country. The supply of Government securities would not be limited and interest rates would reflect anticipation of depreciation in currency values, rather than the relationship of investment demands to savings or to normal variations in liquiditv needs.  29 23a. In a non-inflationary environment, i.e., one in which Government deficits or private credit demands growing out of cost increases or specu- lative ventures are not financed with the aid of Central Bank credit to such a degree that credit and monetary expansion exceeds the growth in output, the basic conditions under which banks have to operate wou'ld dif- fer from those now existing. Marginal reserve requirements, for example, would not be needed to absorb the effect of Central Bank financing of the Government. Non-bank investors would be more willing to invest their savings in escudo obligations of both the Government and private borrowers. Banks would experience smaller borrowing demands from business, and would be in a position to show more interest in the kinds of instruments suit- able for a money market. Under these conditions a money market, which is now entirely lacking, might develop. Changes in the Role of the Central Bank 24. Under the proposals previously set forth with respect to the banking system and the market for Government securities, some changes in the policies and procedures of the Central Bank from those recently followed would be nec- essary. These changes have already been suggested; they may be briefly sum- marized as follows: a. The overriding aim of Central Bank policies and opera- tions should be to extend only enough credit to supply commercial banks with reserves needed to support an appropriate expansion in the total supply of money and credit. b. Types of credit extended by the banking system, including both commercial banks and the Central Bank, may take the form of advances to the private sector or of holdings of Government obligations. Credit policies, however, should not be directed toward supplying any particular credit demands in amounts that would result in an excessive total monetary expansion. The various types of credit demands, including that of the Government, should compete for the available supply. c. The Central Bank should be prepared to provide for seasonal and other temporary variations in credit and monetary de- mands--both increases and decreases--by operations that can readily be reversed when needed. d. Attempts to peg or maintain rigid stability in interest rates should be avoided, as this would necessitate adjust- ing the supply of funds entirely to variations in demands.  30 e. To perform these functions properly the Central Bank would need day-to-day knowledge of major movements of funds in an out of the market and would also need to have a longer view of prospective and potential forces that influence the sources and uses of funds throughout the economy. Most importantly it must be guided by a clear over-all financial policy predicated upon the country's general economic situation and needs. f. To make clear the responsibility of the Central Bank for the total monetary and credit situation, rather than for any particuLar sector, it would oe desirable that the Minister of Finance, who is one of the principal borrowers, not hold the position of head of the Central Bank, which is the lender of last resort. Flexibility of the Interest Rate Structure 25. Proposals advanced with respect to debt management, banking practices, and monetary policy designed to foster the development of money and capital markets envisage a greater degree of flexibility in interest rates than has prevailed in Chile for many years. Although interest rates are high in Chile compared with many other countries, ceilings or maximum rate regula- tions have kept many rates lower than they would otherwise be. These regu- lations, together with the tendency for past patterns to persist, and also various tax exemptions and other special features, have resulted in a patch- work rate structure that does not conform to forces of demand and supply and have created distortions in saving flows and inequities in investment allo- cations. Regulations should be aimed at promoting the movement of savings into investment, not at discouraging such movement. a. In a properly functioning capital and money market, it is essential that interest rates be allowed to adjust flexibly, both in general level and in structural dif- ferences, in response to forces of supply and demand. Otherwise markets lack depth, breadth, resiliency, and interest rates do not perform their allocative functions. Under conditions existing in Chile, however, with persis- tent inflationary anticipations and the rigid structure of fixed maximum rates, any shift to a flexible market would have to come about gradually. Yet some adjustments in the rate structure and in other special features attached to loans might help to stimulate the flow of lendable funds into productive investment. More- over, many adjustments are needed to remove or diminish some existing inequities in the patchwork rate structure that has evolved.  31 b. It is suggested, furthermore, that price-index readjustable clauses be attached to a larger number of obligations of the types desirable to promote. Index- ing all desirable medium- and long-term loans and de- posits on the basis of a realistic index would be more equitable and could better serve the development ob- jectives of Chile than is possible under existing prac- tices. 26. Use of adjustable clauses on obligations might make possible the pay- ment of much lower rates of interest than on corresponding nonadjustable ob- ligations. The spread that now exists between comparable adjustable and nonadjustable obligations does not appear to be sufficiently wide to bring about desirable shifts in borrowing and lending and should be widened. Somewhat greater flexibility in permissible rates, together with adjustable provisions, might make it possible for the market eventually to establish a pattern of rates that would be both more workable and more equitable. Other Suggestions for Consideration 27. Many other measures relating to matters not given much study by the mission would also be helpful in promoting saving and investment and de- veloping a capital market. It is suggested that these be considered by the Government or others concerned and if necessary be given further study. They include the following: a. Tax reform, which was initiated by recent legis'lation, should be carried further. Particular attention needs to be given to the maze of tax exemptions and special tax privileges, which have the effect of distorting and interfering with the operation of markets in financial assets. Moreover, they are often particularly beneficial to recipients of high incomes and thus conflict with the purpose of the system of progres- sive income taxation to distribute the tax burden on the basis of ability to pay. b. Revision of social security system. Measures to revise the administration and incidence of the existing complex social security system should be adopted. This problem has already been studied by a special commission, which has prepared a report, but no action has been taken. As a minimum, the ad- ministration should be simplified, coordinated, and made re- sponsive to the broad public interest. Consideration should be given to the feasibility of reducing drains on incomes ex- ercised by contributions of employers and employees. These drains reduce the incentive, as well as the ability, to save on the part of employees and also raise costs for employers. Some of the benefits for early retirement should be reduced. Savings derived from the system should be increased if possible, or in any event directed more effectively into channels of pro- ductive investment. In any event, information as to use of funds should be made publicly available to a greater extent and more promptly.  32 c. Financing of housing in Chile has been promoted by programs that have accomplished much in directing savings into an area where new investment has been badly needed to improve living conditions. Nevertheless, some existing practices with respect to special aids to housing ownership and fi- nance should be revised by removing or reducing benefits for relatively expensive housing, the building of which has been considerably stimulated in recent years. Present practices result in directing resources into relatively expensive consumption-type investment and therefore re- ducing resources available for more productive or other- wise desirable capital purposes. The program should be confined more specifically to its stated purpose of promio- ting housing for low-income families. d. Information available to investors and to the public in general should be increased and improved with respect to collection, to promptness and frequency of publication, and to analysis. Although a considerable amount of valu- able statistics are made available with respect to develop- ments in bank credit, in housing, and in public finance, as well as to various other aspects of economic activity, ar- rangements for prompter publication and wider dissemination of the data can be improved. Comprehensive estimates of national accounts (sources of production and income) are compiled, but questions about the reliability of some of the underlying statistics cast doubt upon the accuracy of the final estimates. More par- ticularly, the estimates of savings by sectors--most important information for economic analysis and planning, as well as for the operation of a capital market--are es- pecially unsatisfactory and questionable. Although elaborate balance sheets of assets and liabilities and statements of income and profits of business corporations are required to be filed annually, the data made available contain important gaps with respect to information needed for intelligent investment and for economic analysis. Spe- cific suggestions for improvement of these data are included in the proposals relating to changes in company law and reg- ulation.  33 e. Need for analytical studies. Finally, there is need in Chile for more study and analysis of both current and long-run eco- nomic developments and for publication of the results of such studies to stimulate broad interest and provide for a better informed investor group. Government agencies, private ser- vices, banks, stock exchange houses, newspapers, and periodi- cals could do much more in this area than they have done. Publication of more and prompter statistical data is, to be sure, a prior essential for any such development, but more effective use of data can be a source of pressure for improv- ing collection and publication of statistics.  34 LIST OF ANNEXES I. Forces Determining Saving and Investment in Chile Annex - Sources and Uses of Funds of Manufacturing Corporations in Chile II. Intermediary Financial Institutions III. Improvements in Company Law and Regulations (With 6 exhibits of model statements) IV. Improving the Operation of the Stock Aarket (Including regulation of mutual funds) V. The Chilean Banking System (Description of structure and operations, 1960-63) VI. Improving the Role of the Banking System in the Capital Mlarket (Including development of a money market, as well as markets for government securities) VII. Relation of Inflation to Capital Miarkets (Including discussion of value-linked escalation clauses) VIII. Improvement of Information and Analysis