Cablegate: Federal Reserve Board Governor Kroszner a Hit in Chile


DE RUEHSG #0813/01 2492101
R 052101Z SEP 08





E.O. 12958: N/A

1. (SBU) SUMMARY: Federal Reserve Board Governor Randall Kroszner
presented the keynote address at a Central Bank-hosted conference
for representatives of the banking and financial sector in Santiago
on August 29. In his first visit to Chile, Kroszner also met with
influential business entrepreneurs, academics, financial experts,
and current and former Central Bank and government ministers. While
discussions often focused on the state of the U.S. economy, Governor
Kroszner also spoke about the challenges facing the U.S. financial
system, risk management, and the effects of the housing and sub
prime crisis. His Chilean interlocutors expressed their concerns
over increasing inflation, skyrocketing fuel costs, labor market
inflexibility, and the need to improve education in Chile. END

In High Demand

2. (U) During a packed five-day program (August 26-31), Federal
Reserved Board Governor Randall Kroszner met with Central Bank
President Jose De Gregorio, Codelco CEO Jose Pablo Arellano, Finance
Minister Andres Velasco, Bank Superintendent Gustavo Arriagada,
former Central Bank President Vittorio Corbo, and representatives
from private banks and the banking association. At a luncheon
hosted by the Ambassador, Kroszner discussed the global economy and
Chile's performance with former Finance Minister Eduardo Aninat,
University of Chile Economics and Business Dean Felipe Morande (also
advisor to Presidential candidate Sebastian Pinera), Adolfo Ibanez
University Rector Andres Benitez, former Finance Minister Carlos
Caceres, and Celfin Capital brokerage board president Juan Andres

3. (U) Several institutions held events in Fed Governor Kroszner's
honor. In addition to its conference, the Central Bank hosted two
events, one with Central Bank Board Members and a second with
financial sector regulators and key Central Bank managers. AmCham
and Banco de Chile organized a dinner with influential private
sector and bank representatives. A 16-year professor at the
University of Chicago, Governor Kroszner attended a gathering with
prominent Chilean Alumni and a private dinner with business magnate
Alvaro Saieh (who has a PhD from the University of Chicago). The
Fed Governor also visited the Santiago Stock Exchange and reviewed
the salmon industry in southern Puerto Montt, the wine sector in
central Casablanca valley, and El Teniente mine -- the world's
largest underground copper mine -- near Rancagua, south of

Central Bank: Pressure To Liberalize Energy Exploration
--------------------------------------------- ----------

4. (SBU) In a courtesy call with Central Bank President Jose De
Gregorio, Governor Kroszner expressed his thanks for the invitation
to speak in Chile and the two discussed the upcoming central bank
conference in Argentina. De Gregorio made reference to Chile's
energy concerns, noting that there was increasing political pressure
on the GOC to liberalize rules governing energy exploration.
Normally, investors working with the government are required to use
a process called "L600," which allows for contracts between the
state and private companies. However, because of environmental
sensitivities, oil drilling is excluded from the L600 process and
requires special (and thus more complex and restrictive)
documentation. However, as Chile's energy costs escalate, and
efforts to diversify energy gather steam, there has been a push to
make the process easier.

CODELCO: Copper Prices Will Stay High

5. (SBU) Governor Kroszner met with CEO Jose Pablo Arellano of the
national, state-owned copper company, CODELCO. Arellano believed
copper production would remain unable to respond to demand pressures
in the near term, which augured for sustained high copper prices.
He said despite current weakness in world demand, in 2007, copper
production had fallen short of what was promised by 900,000 tons.
Short-term capacity in copper production was limited but had been
overestimated by many experts, leading in part to the dramatic
increase in copper prices. In addition, changes made in supply
(such as new mines, or increased productivity) were often associated
with long lag times (up to 12 years in many cases). China had
accounted for almost all of the demand expansion since 2002, and was
an aggressive consumer of Chilean copper products. However, unlike
in Africa, Chinese companies had not yet sought direct equity in
copper producing companies in Chile.

Finance Minister Velasco: Econ 101

6. (SBU) Governor Kroszner's meeting with Finance Minister Andres
Velasco was a reunion of two friends who were fellow academics.
They grilled each other on the theories and models underlying
current global macroeconomic trends (e.g., price model for oil).
Ambassador Simons joined the banter, noting in the last five years,
there had been no dramatic change in the global supply of oil in the
ground, but prices had risen considerably. The main factors were an
inability to solve political risks associated with supplies and an
inelasticity of demand in countries such as China and India, where
fuel is subsidized. Velasco noted the GOC had provided a cushion
for consumers on fuel costs, but the price had increased 40% in the
last month alone. Argentina had a contract to sell Chile 18 mcm of
gas per day, but reneged, which the Ministry estimated cost Chile
one percent of GDP per year for the last three years.

7. (SBU) Velasco noted Chile enjoyed a public surplus of almost
seven percent of GDP. The Finance Ministry wanted to use the
surplus to pay down remaining debts, but there was very little left.
The Ministry had already recapitalized the Central Bank, which had
acquired debt during the banking crisis of the 1980's. It was now
examining repaying debt from Chile's transition to privatized
pension funds.

8. (SBU) Velasco also explained the budget approval process in Chile
was easier than in the U.S.: 1) Congress could not originate a bill
for expenditure without the Ministry's sponsorship; 2) the Finance
Ministry was required to submit the budget by September 30, but if a
fully approved and amended budget was not passed by the Congress
before November 30, the Ministry's original submission would
automatically become law. Velasco added that Chile's Sovereign
Wealth Funds' investment rules were quite conservative and easy to
sell to Chile's strong export lobby, because they realized intense
domestic investment risked exchange rate appreciation.

Former Central Banker: Next Team Will Do Better
--------------------------------------------- --

9. (SBU) In an office call with Vittorio Corbo, an old friend and
former Central Bank President, Kroszner exchanged opinions on the
global economy. Corbo also expanded on Chile's recent economic
difficulties. He highlighted inflationary pressures and the 38%
rise in energy costs over the last 12 months. He expressed relief
there is consensus across the political spectrum on the need to curb
inflation, which has increased to nearly 10 percent.

10. (SBU) Corbo praised Finance Minister Velasco for following
sound fiscal policies. He noted that despite national elections in
2009, the GOC is planning to decrease fiscal spending from nearly
10% of GDP to around 6% over the next year. This runs counter to
what many would expect prior to an electoral campaign. To help
reduce inflation, interest rates are being increased gradually and
could approach 10% by the end of 2008, he estimated.

11. (SBU) Corbo was critical of Minister of Labor Osvaldo Andrade,
claiming he is pursuing policies that are akin to those in the 1950s
and do not contribute to increased investment. The Minister has not
promoted a labor regime that facilitates the hiring and firing of
workers. Corbo argued that the high severance pay schemes, for
example, needed to be eliminated, which would help increase
salaries. The former Central Bank President indicated that the next
government, whether headed by Sebastian Pinera or former President
Lagos, would do a better job overall.

Chile's Economic Constraints

12. (SBU) The Ambassador hosted a lunch at the residence for
Governor Kroszner on August 28 with top economists. While much of
the conversation focused on the U.S. economy and international
financial markets, the Chilean guests expressed several concerns
about Chile's current path. Felipe Morande, a Pinera advisor,
expressed alarm over inflationary pressures from excessive
government spending, spiraling energy costs, and a lack of new GOC

13. (SBU) Eduardo Aninat identified energy, education, and the labor
market as three crucial areas that hinder Chile's advancement in the
world market. Fuel costs have skyrocketed because Chile has no
independent source of energy and Argentina failed to abide by
natural gas supply contracts. On education, he noted Chileans lack
English language and technical skills necessary to excel in the
modern work force. Aninat stated that the labor force needed to be
more flexible, facilitating the hiring and firing of workers. Stock
broker Juan Andres Camus agreed. He said that when investors
examine whether to pursue a project, they need to know the costs of
getting out. The costs associated with terminating employees are
too high in Chile, he emphasized.

14. (SBU) Former Finance Minister Carlos Caseres lamented that Chile
had lost an opportunity to take advantage of high commodity prices,
in particular for copper. He noted that levels of productivity had
decreased 3-4%, inflation is rising, and economic growth is slowing.
He argued that the current government is generally pursuing
successful public policies implemented in the past (i.e., from the
Pinochet regime), but is not doing it out of conviction.

When EF Hutton Speaks...

15. (SBU) Comment: Chilean officials and members of the private
sector expressed great appreciation for the opportunity to exchange
views with Governor Kroszner. When he spoke about the state of the
U.S. economy, the housing slowdown, and difficulties with financial
securities, his Chilean interlocutors listened attentively. At the
Ambassador's event, for example, one former Finance Minister took
copious notes. The visit proved highly productive and helped
reinforce the close bilateral relations we enjoy with GOC contacts
and the private sector.


© Scoop Media

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