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Cablegate: Staffdel Meacham - Chile's Economy and Development


DE RUEHSG #1114/01 3222018
O R 182017Z NOV 09



E.O. 12958: N/A


1. (SBU) SUMMARY: Senior Senate Foreign Relations Committee Staff
Member Carl Meacham traveled to Chile October 26-28 to review the
state of the economy, the history of Chile's development, and the
work of international financial institutions (IFIs) in country.
The Chilean economy suffered a recession in 2009 as a result of the
global economic crisis, but the GOC quickly implemented a fiscal
stimulus package and many economists expect a recovery by the end
of the year. Chilean officials and independent NGO representatives
told Meacham that Chile's economy has survived the worst of the
global economic crisis as a result of its strong fundamentals and
is well-positioned for possible growth of between 4-6% in 2010.
Experts explained to Meacham that Chile's development history has
been marked by a reliance on private sector investment rather than
IFI lending. They said that current IFI lending is focused mainly
on projects that bring technical expertise to Chile, rather than
those that build infrastructure. The Ministry of Finance noted the
GOC is working to change the role of IFIs in medium-income
countries like Chile. Meacham reviewed the Inter-American
Development Bank's loan to the Transantiago public transportation
system as a case study of IFI lending in Chile. He heard competing
views, some highly critical of Transantiago and the IDB loan, and
some emphasizing the benefits of Transantiago. END SUMMARY.

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2. (U) Meacham's visit was part of a study by Senate Foreign
Relations Committee staff to assess the efficacy of IFI operations
around the world in the current global economic climate, as
requested by Senator Richard Lugar (R-IN). During his trip to
Chile, Meacham met with representatives from the Ministry of
Finance, the Ministry of Transportation, the national industrial
and business federation (SOFOFA), the U.S. Chamber of Commerce
(AmCham Chile), the government development agency (CORFO), the
Inter-American Development Bank (IDB), Libertad y Desarrollo (LyD -
a think tank), and members of the Chilean Congress.

Economic Background: Effects of Crisis

--------------------------------------------- -----

3. (U) As a result of the 2008/2009 global economic crisis, Chile
is in a recession due principally to falling export demand and
industrial production. GDP growth slowed to 3.2% in 2008 and the
economy contracted by 4.5% in the second quarter of this year. GDP
may shrink by between 1.5% and 2% for the whole of 2009. However,
growth is expected to return by the end of the year. Experts
surveyed in the Central Bank's November economic expectations
survey forecast that GDP could grow by as much as 4.4% in 2010.
The unemployment rate hit a peak of 10.8% in September and though
it has subsequently begun to fall again, it remains a continuing
concern for the public and the GOC. The banking sector is stable
and although credit growth slowed in line with the economy, there
are signs it is beginning to recover.

4. (U) Before the recession, Chile's counter-cyclical macroeconomic
policies led to the accumulation of a $22 billion copper windfall
sovereign wealth fund. As a result, Chile had significant
resources with which to respond to the economic slowdown. The GOC
first announced fiscal stimulus measures in November 2008, followed
by the announcement of a major $4 billion package in January 2009.
Combined with subsequent measures, the stimulus package is worth
2.9 percent of GDP in 2009, financed in large part by asset sales
from its copper savings fund. Stimulus measures include
investments in public infrastructure, labor training, increased
social transfers, tax cuts, and increased lending to small- and
medium-sized enterprises (SMEs).

GOC Steps to Mitigate Crisis


5. (SBU) Carl Meacham met with Igal Magendzo, Macroeconomic
Coordinator at the Ministry of Finance, October 28. Magendzo told
Meacham Chile's strong economic institutions and fundamentals had
helped shield the economy from the worst of the global economic
crisis. He explained that Chile's open economy had nevertheless
been hit hard (e.g., 40% losses in export revenue due to price
drops resulting from decreases in global demand). Magendzo posited
that Chile had nonetheless been able to take advantage of the
crisis to position itself for a rapid recovery. He cited Ministry
forecasts for potential growth of up to 5% in 2010.

6. (SBU) Magendzo explained that unemployment, though still high,
had not breached 11%. Many in Chile had feared unemployment in
high double digits as a result of the crisis. He also noted that
although the economy was currently experiencing deflation, the
plethora of indexed instruments helped lessen the effects on the
Chilean consumer (e.g., the major unit of account, "unidad de
fomento," used in mortgages and most consumer loans, is indexed to

7. (SBU) Magendzo said Chile had been one of the first countries to
implement a large fiscal stimulus package in response to the
crisis. As a result, he claimed the shock of the economic slowdown
(the fall from the peak of growth to the nadir of recession) would
be one of the "softest" in the region. Magendzo told Meacham the
GOC's stimulus had effectively created a social protection network
to minimize the worst of the downturn. The stimulus measures were
varied including: some $200 million in shovel-ready public works
projects, about $400 million in one-time cash transfer payments,
temporary tax breaks, employment incentive plans (including special
programs targeted at youth unemployment), a pro-credit initiative
to improve competition in financial markets, and improved access to
capital for SMEs. Magendzo underlined that the Ministry believed
the ultimate end to the crisis would be when the U.S. economy

Possible Signs of Recovery


8. (SBU) Andres Concha, president of the Chile's influential
business and industrial federation (SOFOFA), met with Meacham
October 26. Concha reviewed the key sectors in the Chilean
economy, noting he thought the worst of the recession had passed.
He said that although industrial activity had fallen by almost 9%
in the last quarter, there are positive signs in the economy,
leading to speculation that Chile could grow by 5-6% next year.
[Note: This is on the high end for 2010 growth forecasts. End

9. (SBU) Concha explained that copper accounted for roughly 60% of
Chile's exports and its price recovered from a low of $1.30 in 2008
to a high of almost $3.00 at the end of October. He emphasized
this could help spark a recovery in the Chilean economy. Concha
credited demand from China for contributing to the resurgence in
copper's price. He said the housing and banking sectors are sound,
though construction slowed significantly and banks suffered strains
on credit lines during the height of the crisis. Concha claimed
Chilean borrowers suffered but were better off than those in the
U.S. He noted other sectors are recovering more slowly, like
agriculture, which is dependent on the U.S. market. Forestry
products have been hit equally hard, leading Concha to estimate
that forestry exports will remain flat until 2011. He also cited
the significant damage to the salmon industry caused by a virus
infecting the fish.

10. (SBU) Concha told Meacham he was more optimistic about Chile's

economic situation now than in previous months; however U.S. growth
would be a key contributor to Chile's own recovery. Concha also
explained that a cheap dollar might be helpful for U.S. industry,
but it complicated the picture for Chilean exporters. Concha
predicted the global economy is entering a period of fluctuation.

Chile's Development - Private Sector Takes Lead

--------------------------------------------- ----------------

11. (SBU) In a meeting with AmCham Chile October 26, President
Ricardo Garcia and General Manager Jaime Bazan told Meacham that
since the military government, much of Chile's development has been
led by private sector investment. Garcia explained that most of
Chile's infrastructure, from ports to highways, had been built
through concessions and public-private partnerships. He noted that
this innovative model relied on stable investment conditions.
Garcia said, however, that the global economic crisis had affected
that investment climate in Chile. He pointed out that many
companies, especially in the U.S., had experienced capital
restrictions from losses or debts that could not be rolled over,
forcing them to delay or withdraw investments in Chile. Garcia
cited the example of Citibank, which prior to the crisis had a 10%
stake in Banco de Chile. He explained that Citibank had been
widely expected to purchase a majority share in Banco de Chile, but
it had not done so because of the effects of the crisis.

12. (SBU) Meacham met with representatives from the government
development agency (CORFO), led by program manager Stephen Ruddell,
October 27. CORFO reaffirmed Chile's development model relied on
private resources, rather than lending from IFIs. CORFO said it
works with IFIs only on a few select projects (e.g., fostering
innovation, for which the GOC has received a $30 million World Bank
loan). The CORFO representatives emphasized that their
organization is one of the few GOC agencies that is
self-sufficient, receiving dedicated funds from mining royalties,
as assigned by the GOC. They noted that CORFO's projects are
almost exclusively with the private sector, particularly with SMEs,
where the agency usually assumes 50% of the risk in a given

IFI Lending to Chile - Focus on Technical Expertise

--------------------------------------------- -------------------

13. (SBU) On October 28, Meacham met with Eddy Linares, acting IDB
representative in Chile. Linares emphasized that the IDB had been
working in Chile for a long time, during which it had seen a marked
shift in the types of projects approved and implemented in country.
He underlined that the IDB's lending portfolio is the biggest among
IFIs working in Chile (including the World Bank). Linares also
noted that the number of public works projects has dropped to a
very small percentage. He explained that the majority of current
projects are focused on bringing technical expertise to Chile, such
as: energy diversification, improving education, forestry
conservation, fostering tourism, and working with Chilean
think-tanks to promote government decentralization. Linares also
noted Chile is now a net creditor to the IDB.

14. (SBU) In his meeting with the Ministry of Finance (paras 5-7),
Igal Magendzo told Meacham the GOC has asked the World Bank to
reexamine its role in medium-income countries, like Chile.
Magendzo reported that the GOC believes the World Bank no longer
needs to provide capital in these countries, but should focus more
on providing technical expertise. He also noted Chile wants a more
active role in the World Bank and has become more of lender and
contributor than a net borrower. Magendzo said Chile will look to
make the same transition in the IDB in the near future.

Recent IFI Case Study - Transantiago Background

--------------------------------------------- -----------------

15. (SBU) Meacham reviewed the Transantiago public transportation
system as a case study for recent IFI lending in Chile. In
February 2006, the city of Santiago replaced its previous
transportation network of competing, privately-owned buses with
what was proclaimed as a new state-of-the-art public transportation
system, Transantiago. It was designed by the Lagos Administration
and implemented by the Bachelet Administration. After
Transantiago's inauguration, the public heavily criticized flaws in
the system including: overcrowding, increased wait and transit
times, and general lack of functionality. However, there have been
recent improvements (see paras 21-22). Transantiago has been
running an operating deficit due to fixed fares, significant fare
evasion, expensive technology, and high fuel prices.

16. (SBU) The GOC tried to cover the system's deficit, by
requesting and guaranteeing two loans to Transantiago in 2008: $10
million from the state-owned Banco Estado and $400 million from the
IDB. The Controller General (which assesses the legality of
government policies) approved the loans. However, in September
2008, the Constitutional Tribunal ruled the loans unconstitutional,
and Chile entered a period of technical default on the IDB loan.
For almost a year, the GOC attempted to negotiate a solution to
Transantiago's funding, as well as its outstanding IDB debt, with
the Chilean Congress. In August 2009, the Congress approved a
subsidy for public transport throughout Chile worth about $3.5
billion until 2014, which would also cover Transantiago's operating
deficit,. The Congress also approved repayment of the IDB loan (
$448 million) by the first half of 2010. [Note. See refs B+C for
further background on Transantiago. End note.]

Competing Views on Transantiago - A Complete Mess

--------------------------------------------- ----------------------

17. (SBU) Axel Buchheister, director of judicial studies at the
think tank Libertad y Desarrollo (right-of-center), met with
Meacham October 26. Buchheister was the lawyer who successfully
led the case in the Constitutional Tribunal challenging the IDB
loan to Transantiago. He said the premise of the case was that the
GOC did not have the authority to request and guarantee a loan
between two private entities (the IDB and the Transantiago
Financial Administrator - AFT) without appropriate legislation.
Buchheister characterized the GOC and AFT efforts to solve
Transantiago's operating deficit as a complete mess. He alleged a
murky relationship existed between the GOC and AFT when they set up
a Special Account for Reimbursement to pay for Transantiago. The
Account was neither fish nor fowl in that it received public and
private funds and the AFT reportedly administered it but according
to instructions from the GOC.

18. (SBU) Buchheister told Meacham that the IDB's loan to
Transantiago was not only poorly conceived and executed, but it
represented an attempt to "intervene" in local Chilean politics (to
rescue Chile's ruling left-of-center Concertacion coalition from a
potential embarrassment). [Note: Libertad y Desarrollo is
associated with the opposition, right-of-center Alianza coalition.
End note.] Buchheister accused the IDB of failing to study the
problem adequately, failing to require necessary reforms, and
lending at unreasonable risk to a poorly identified entity (the
Special Account for Reimbursement). Buchheister further alleged
the GOC had pursued this loan because it though it would not
require legislation in Congress, something that would have been
necessary if the GOC wanted to tap Chile's copper savings to pay
for Transantiago.

19. (SBU) Meacham met October 27 with Deputy Carlos Olivares
(independent), former head of the Congressional Transantiago
Investigatory Commission. Olivares called Transantiago a "public
policy that failed." He went on to allege that the issue of
Transantiago had forced a split in the Concertacion coalition,
forcing some members (such as Olivares himself) to leave the
grouping. Olivares explained that after the September 2008 ruling
of the Constitutional Tribunal, the Congress had established the
Investigatory Commission. He said the facts uncovered by the
Commission were "strange" in that it was hard to understand why the
IDB had loaned money to a "broken system." Although Olivares
credited the IDB with coming to testify voluntarily before his
Commission, he felt many details remained unresolved (including the
exact nature of the Special Account for Reimbursement). Olivares
vowed to take up the issue again in March 2010, if he were
re-elected in December.

Competing Views on Transantiago - Errors Made but Fixed

--------------------------------------------- ----------------------

20. (SBU) During Meacham's meeting at the IDB (see para 13), Eddy
Linares countered Axel Buchheister's assertions. Linares explained
that feasibility and environmental impact studies, as well as
certain criteria, are standard procedure for the few infrastructure
projects with which the IDB is involved in Chile. He claimed the
loan to Transantiago had been no exception; those studies and
criteria were applied. Linares pointed out that the IDB had even
predicted the possibility of non-repayment by the GOC. Linares
said the IDB had documentation on all this, which it had shown to
the Congressional Investigatory Commission, and which could also be
shared with Meacham. Linares noted the IDB loan had not yet been
repaid, but according to the legislation, the GOC had until the end
of February 2010.

21. (SBU) On October 28, Andres Gomez-Lobo, chief advisor to the
Minister of Transportation, met with Meacham. In a frank
assessment of Transantiago, Gomez-Lobo noted the system had been an
ambitious reform implemented practically overnight, leading to its
three main problems: lack of necessary technology, lack of
required infrastructure, and lack of incentives. Gomez-Lobo called
the GOC's subsequent efforts to fix Transantiago "surgery without

22. (SBU) Gomez-Lobo claimed Transantiago was finally showing
marked signs of improvement. He cited a series of indicators:
accidents were down significantly, average wait times for buses had
recently begun to fall, pollution was also showing a reduction,
numbers for those using the system had increased, and bus drivers
were now part of the formal labor market (unlike the previous
system). Gomez-Lobo said the World Bank had called Transantiago
the most modern transportation system in Latin America. He
maintained that Transantiago would continue to have high costs, but
that the new subsidy law passed by Congress and a plan to start
phasing in fee increases would help sustain the system in the long

23. (U) This cable has been cleared by Carl Meacham.

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