418. Current Economic Developments, Issue No. 527, September 3, 19571
[Here follow a title sheet and discussion of unrelated matters.]
Chilean Stabilization Program Facing Further Difficulties
The Chilean economic stabilization program which was initiated in late 1955 is facing serious difficulties this year as a result of emerging economic, political and social difficulties. Internal financial controls have led to some cutbacks and unemployment, particularly in the textile and construction industries. Dissatisfaction with the program and opposition to various measures has increased and made more difficult the implementation of further measures necessitated by unfavorable economic developments. A continuing decline in copper prices, which adversely affects foreign exchange receipts and tax revenues, indicates prospective further increase in inflationary pressures. This could result in the present economic policies being changed out of political necessity by the government or by a change in government following next year’s Presidential elections. The Chilean Government has requested US balance-of-payments aid of $40 million to meet anticipated payments deficits this year and at the same time to generate local currency for use in meeting the budget deficit and in financing a housing program to relieve the recession in the construction industry. The request has been met by credits from the Eximbank and the Federal Reserve Bank of New York and an International Monetary Fund drawing.
Background The Chilean stabilization program, which was undertaken in December, 1955, by the Government of President Ibáñez with the advice and assistance of the American economic consulting firm of Klein and Saks, was fairly successful during 1956 in reducing the rate of inflation and encouraging foreign public and private investment in the Chilean economy. The program has been endangered this year by prospects of serious deficits and increased inflationary pressures, partly as a result of the effects of the decline in copper prices which far outstripped the Chilean Government’s efforts to base revenue estimates on what seemed a conservative price for copper. The Chilean budget has been based on an estimate of 35¢ a pound for copper, but prices declined to an average of 32¢ the first quarter this year and have since fallen another 2½¢. Since, as a general rule of thumb, a 1¢ drop in copper prices results in an exchange loss of $6 million in a year and loss of the peso equivalent [Page 849] of $7.5 million in revenue, the persistent decline had necessitated considerable measures both to facilitate long-run adjustment and to meet prospective serious deficits this year. (See page 26, March 5, 1957 issue.)
Opposition to Program The prospects of successful maintenance of the stabilization program this year and until the Presidential elections next year dimmed in recent months. General dissatisfaction with the stabilization program mounted despite the fact that the program had improved the lot of the Chilean worker or at least prevented the further deterioration which would have occurred in its absence. This growing dissatisfaction is attributable to increasing unrestrained political opposition to the Government on the part of opposition parties with an eye to 1958 Presidential elections. It is also due to the Government’s failure to explain its measures adequately to the public. Students and workers rioted in protest against nominal increases in bus fares in April which the Government had announced earlier but vacillated in implementing. The strength of the Government in implementation of its program was further weakened by a Cabinet crisis in early July which resulted in resignation of Ministers who had opposed scheduled price increases as an essential part of the stabilization program. The revenue outlook of the Government has failed to improve as copper prices continue to decline, and further revision of expenditures and of tax measures has been necessitated in hope of making the success of the stabilization program generally evident before elections and thus preventing reversal of present economic policies or emergence of an undesirable government.
Prospective Deficits The Chilean Government estimated that its budget deficit at the end of this year would be some 39 billion pesos. (The free banking rate is 660 pesos to the dollar.) Proposed domestic measures for this year would meet part of the deficit and leave a 24 billion peso gap. Despite considerable opposition, the Government removed subsidies from many items in July which, although resulting in an increase in prices, will help to reduce the prospective budgetary deficit by reducing expenditures and the Government has requested various taxes for increased revenue this year. Some of the budgetary relief afforded by the renewal of subsidies was, however, nullified by a simultaneous increase in family allowances.
The 1958 budget being submitted to Congress is balanced at 322 billion pesos and based on 26¢-a-pound copper. However, an estimated 20 wage increase, which is to be proposed, is not included in this budget and will cost another 30 billion pesos. This would be covered by a new tax bill which was introduced into Congress early in August, but the Executive fears that the Congress will approve [Page 850] taxes yielding only 20 billion pesos. The Government now plans to submit the budget and wage increase bills to the legislature before the taxes are finalized in an attempt to force the Congress to achieve a balance.
In an effort to adjust to the long-run situation, the Government has taken various steps to develop other industries and exports. A special study by the Chilean Government of the ailing nitrate industry made early this year considered loans to the industry and revision of the exchange rate. The Klein–Saks mission felt that these measures would endanger stabilization but made a subsequent study and developed various possibilities of strengthening the industry. The Eximbank had authorized loans in July, 1956 totaling $27.8 million to the two leading nitrate producers, nearly all of which is still unspent. The International Bank in July this year granted a $21.8 million loan for development of the coal industry and another loan for rehabilitation of the railways has been under negotiation. President Ibáñez recently accepted an Italian bid for the electrification phase of the railway program after reaching an understanding with the Bank as to subsequent refinancing.
Request for Aid In order to meet the remainder of this year’s foreign exchange and budget deficits the Chilean Government and the Klein–Saks mission came to the conclusion that foreign assistance was needed. The Government requested and the Klein–Saks mission recommended $40 million from the US during the rest of the year in the form of an Eximbank balance-of-payments loan. In requesting a loan from the Bank, Chilean officials stated that suggested assistance from the International Monetary Fund would be helpful if it were available on the same terms as the Eximbank might offer, including the authority to use the peso product of the loan to balance the budget, but it felt that such terms from the Fund would be unlikely.
The US expressed sympathy and interest in the Chilean economic difficulties but pointed out its concern over increasingly unfavorable reaction in financial circles to the requested loan which could prejudice prospects of developmental credits essential to the long-run program, as all loans are related directly to and affect the nation’s credit capacity. The US also urged that further domestic measures be taken to decrease prospective deficits this year. Favorable decision has been reached by the Eximbank Board of Directors on a loan of $12.5 million for the purchase of capital goods contingent upon the prior drawing of $12.5 million by Chile under its $35 million standby arrangement with the IMF. (The standby arrangement had been granted at the outset of the stabilization program and renewed earlier this year along with $30 million from private US banks and $10 million in a US Treasury exchange agreement.) The [Page 851] Eximbank loan is also made contingent upon certain commitments by Chile to establish and to some extent to achieve well-defined goals in the credit, monetary and exchange fields believed essential by the IMF and the Eximbank to insure success of the stabilization program. The loan would be repayable in 12 quarterly installments beginning January 1, 1959 and would bear interest at the rate of 5½. Simultaneously with approval of the $12.5 million Eximbank loan and the decision to draw $12.5 million of the standby, the Government of Chile also arranged to borrow $15 million from the Federal Reserve System by pledging part of its gold reserves as security.
Also under consideration by the Chilean Congress at present is a loan agreement covering the peso equivalent of $29.41 million arising from the latest PL–480 sale of surplus US agricultural commodities. This amount includes $1.16 million which was recently added to the loan earmark in response to a Chilean request that the loan component be increased from 80 to 85 in order to provide funds for loans to the nitrate industry. However, signature of the loan agreement has been held up by reluctance of certain Chilean legislators to accept the maintenance-of-value provisions which would entail loss of some 25 or $7.5 million to the Government as a result of decline in the value of the peso since signature of the sales agreement. Although possible Chilean refusal of the loan has been indicated, which would leave the US with the entire amount of pesos and bearing the loss in their value which has occurred plus the risk of any future depreciation as well, the US does not wish to alter the related provisions in the original sales agreement. Such action would encourage Chile to consider other firm agreements also subject to renegotiation and would establish a precedent inviting similar requests from other countries having PL–480 sales agreements which have the same maintenance-of-value provision and with loan agreements yet to be concluded. Meanwhile, Chile has requested a third PL–480 agreement totaling some $30 million over a three-year period, consideration of which has been deferred in light of problems over the pending loan agreement and of exhaustion of PL–480 obligating authority prior to recent Congressional approval of an additional $1 billion in authority. Most recent indications are, however, that a considerably smaller sales agreement will be considered.
- Source: Department of State, Current Economic Developments: Lot 70 D 467. Confidential.↩