III. ECONOMIC TRENDS AND OUTLOOK Major Trends and Outlook Chile's economy has expanded for the last eleven years, averaging over 6 percent growth per year. This growth has been led by a boom in exports, which are concentrated in primary and processed natural resources, principally copper, fresh fruit, and forestry and fisheries products. The export boom has been sparked in recent years by soaring investment, both foreign and domestic. Both the product mix of and the markets for Chile's exports are becoming increasingly diversified, with the dependency upon copper declining and Latin America joining the U.S., Asia, and the European Union as important purchasers of Chilean products. Vigorous economic growth has led to strong job creation and a gradual decline in unemployment (which was about 5-1/4 percent in mid-1994). Real wages have also risen, by around 30 percent in the last five years. Helped by an appreciating peso, inflation has declined gradually since 1990, reaching 12.2 percent in 1993. The high level of indexation in the economy has made further reductions in inflation increasingly difficult to achieve. The surge in foreign investment has kept the balance of payments positive for the last several years, and international reserves have risen accordingly. Chile received an investment-grade rating from international rating agencies in 1992, shortly after banks resumed voluntary lending to the government. Since then, several Chilean firms have raised funds in international capital markets. Despite the resulting increase in indebtedness, total foreign debt remains less than half of annual GDP. Economic growth began to decelerate from double digit rates in late 1992 toward a more sustainable pace. The slowdown continued through 1993 and into 1994 to rates well below the estimated long-term potential growth rate of 6 percent. The main causes of the deceleration were low 1993 world prices for Chile's principal export products, linked to weakness in the industrialized economies, and high domestic interest rates. GDP grew by 6 percent in 1993. Relatively weak export growth coupled with strong domestic spending led Chile to run a trade deficit in 1993, its first in 12 years. The current account deficit of US$2.1 billion was equivalent to about 4-3/4 percent of GDP. As of mid-1994, the economy is exhibiting several signs of below-potential growth: an oversupply of construction, flat or declining spending on plant and equipment, falling imports, and gradually rising unemployment. Leadership of the expansion has shifted to the export sector as increased foreign demand has led to a rebound of export prices for key commodities and stronger export volume growth. The economy should grow about 4 percent in 1994. The government projects 10 percent inflation for the year. Against the background of a strengthening world economy, the Chilean economy seems well-positioned to grow more rapidly into 1995, along with substantial improvements in its trade and current account balances. Chile's reliance on exports and interest in market diversification have led it to seek opportunities to further open several current or potential markets. The U.S. government has promised to make Chile the next country with which it will negotiate a free trade agreement. Chile will formally join the Asia Pacific Economic Cooperation (APEC) council in 1994. It has signed bilateral trade-liberalizing agreements with several Latin American nations, and has announced an interest in reaching a trade expansion agreement with the Mercosur nations. Principal Growth Sectors The principal growth sectors for 1994 and future years are likely to be mining, manufacturing, forestry, and financial services. The mining and forestry sectors have benefitted from major investments by foreign, including U.S., companies. Government Role in the Economy Businesses in Chile are predominantly owned and controlled by private interests. Prices, except those of regulated utilities, are set freely. Although the military and democratic governments of the last twenty years have privatized many state corporations, the state retains holdings in several industries, including mining, shipping, and electricity. The most important public corporation is CODELCO, the world's largest copper company, which the government has said it will not sell. In the first half of 1994, the Frei administration has sold the government's remaining share in an airline and has announced its intention to sell electricity and shipping holdings. The public sector budget is approximately 25 percent of GDP. The top marginal personal income tax rate was lowered from 50 to 48 percent in 1994 and will fall to 45 percent in 1995. Other important sources of tax revenue are the 18 percent value-added tax, corporate taxes, and import tariffs, which are 11 percent on nearly all products. The government ran a budget surplus of 1.8 percent of GDP in 1993; the surplus is expected to be lower in 1994. Balance of Payments Situation Chile's international reserves, over US$10 billion as of mid-1994, represented approximately a year's worth of imports. For the last several years, capital inflows have more than made up for any current account deficits. The 1993 current account deficit was an unusually high 4.8 percent of GDP, in large part because of surging imports and low prices for Chile's principal exports. In the first half of 1994, however, export prices rebounded, export volumes continued to grow, and imports declined along with domestic spending. The 1993 trade deficit of US$960 million was Chile's first in a decade, but the 1994 deficit is expected to be much lower, perhaps around US$300 million. Trade and Investment Barriers Chile generally has few barriers to imports or investment. Foreign firms operating in Chile enjoy the same protection and operate under the same conditions as local firms. The Chilean tariff rate is currently 11 percent on nearly all products from most countries, although many products from Latin American countries with which Chile has trade agreements enter with lower duties. Imported automobiles are also subject to luxury taxes based on value and engine size. Duties on capital goods purchased for use in export production may be deferred for a period of seven years and reduced by the percentage of production that is exported. Chile's most significant nontariff barrier is the import price band system for certain agricultural commodities, which currently applies to wheat, wheat flour, vegetable oils, and sugar. Variable duties are levied on imports of these commodities in order to keep domestic prices above the five-year average of international prices. Imports are subject to the same 18 percent Value-Added Tax (VAT) as are domestic goods. Chile's welcoming attitude towards foreign investors is codified in the Foreign Investment Statute, D.L. (for Decree Law) 600, which was promulgated in 1974 and has been liberalized several times since, most recently in 1993. D.L. 600 offers non-discriminatory treatment, a simple registration procedure, transparent rules, open access to most markets and sectors, and liberal profit and capital remittance rules. Profits may be repatriated immediately, while capital may be repatriated after one year. Foreign investors can choose to have their profits taxed at a 42 percent rate for the first ten years of their investment or at the rate that applies to local firms, currently 35 percent on fully-distributed earnings. (Chile and the U.S. have no tax treaty, so U.S. investors' income is taxed in both countries.) Investors choosing not to use D.L. 600 may invest via the provisions of Chapter XIV of the Central Bank's foreign exchange regulations. Chile's intellectual property regime, based on a 1991 law, is generally compatible with international norms, but remains deficient in important respects. The law does not provide "pipeline" protection for pharmaceutical patents filed before the law's promulgation. Because of the long lead times involved in testing new pharmaceutical products, the law will not prevent local companies from pirating foreign pharmaceutical patents for several more years. In addition, the registration procedures required by the Health Ministry to market new drugs are more onerous for the first-to-file, which tend to be foreign firms. Also, patents last for only 15 years; the term in the United States is 17 years. Finally, the law discourages payments for the use of patents that exceed five percent of sales. These shortcomings have kept Chile on the U.S. Trade Representative's "Special 301" Watch List of countries with deficient intellectual property rights protection regimes since 1989. In 1992, copyright protection was extended from 30 to 50 years. Despite the presence of copyright protection, purchases of pirated computer software and other copyrighted products cost U.S. firms tens of millions of dollars in sales per year. Software piracy as a percentage of sales is believed to be declining, as suppliers have adopted a vigorous legal strategy to protect their rights. U.S. recording industry representatives have said that the law grants more power to authors relative to producers than is the industry norm. Labor Force Continuing economic growth has led to a gradual decline in unemployment, which averaged 4.6 percent in 1993, and healthy growth of the labor force in recent years. Annual employment growth averaged 3.4 percent from 1989 through 1993. Real wages have risen steadily over the last several years as productivity has increased and unemployment has fallen. Women make up about one-third of the labor force, a share that has gradually risen in recent years. Unemployment rose in early 1994 as growth slowed, but is expected to fall as activity picks up in the coming months. From 1990 to 1993, the government negotiated annual increases in the minimum wage, primarily to take into account inflation and productivity growth, with business and labor representatives. In 1994, however, business groups refused to take part and labor negotiators did not accept the government's proposal of approximately US$120 per month, which was approved by the legislature. The minimum wage has grown by 30 percent in real peso terms in the last five years, with most of the increase coming in 1990. About 85 percent of workers earn more than the minimum wage. Workers are also paid a family allowance, which employers may deduct from their tax bills. Strike activity has been rare in the private sector, but public employees in health, education, and coal mining have held strikes in the last year. Union membership is voluntary, and about 13 percent of the workforce is unionized. Multiple unions exist in many companies, and management can negotiate collective agreements with any of the unions or with ad hoc groups of workers. Industry-wide bargaining is allowed if labor and management agree, but it is not common, and most contracts are negotiated at the company level. Third Country Competition News about Chile's successful reform, market liberalization and thriving economy have been in every major newspaper and magazine for years. The possibility that Chile may soon have some form of free trade agreement with the United States has also received extensive coverage. Positive press backed by proof in the market of its strength and dynamism has attracted the attention of many all over the world. Key growth sectors like consumer goods, environment, consulting and financial services have already attracted competitors from Europe, Asia, Canada, and other Latin American countries. The best Chilean firms, often influenced or assisted by U.S. universities and consulting firms, are determined to go global. Their strategies and investments are consistent with this objective and support purchases and strategic alliances with leading firms and technologies from around the world. Thus, the Chilean market is as competitive as it is attractive. The actual competitive scenario varies from sector to sector, but it is safe to assume that very few sectors have escaped the demands of aggressive competition. Major Infrastructure Projects Underway Public Works with Private Sector Participation (Under study and to be bid in the period 1994-1998) (US$Millions) - Highway La Dormida 140 - Highway Costanera Norte (Santiago) 120 - Highway Santiago-San Fernando 150 - Highway Chillan-Temuco 120 - Highway Santiago-San Antonio 80 - Highway Northern access to Concepcion 80 - Others (mostly hwys/road improvement) 448 ----- TOTAL 1,138 Note: Total investment in public works should exceed US$1 billion per year for the next 5 years. Ministry of Public Works wants private sector to take up to 40 percent (see list above). Source: Ministry of Public Works Mining Investment Projects (Over US$150 million -- 1994-1998) (US$ Millions) - El Abra Copper Mine 1,000 (First joint venture of Codelco with private sector: Cyprus Amax with 51 percent) In feasibility stage - Ines de Collahuasi (mine and flotation plant) 750 (To be third largest copper producer after Codelco Chuquicamata and La Escondida - BHP) In feasibility stage - La Candelaria (Phelps Dodge) 550 (Copper mining and flotation plant) In construction stage - Lo Zaldivar (Outokumpu) 400 (Underground copper with leaching) In construction stage - Quebrada Blanca (Cominco) 360 (Copper mining/leaching plant) In construction stage - La Escondida (BHP) 200 (Increase production capacity) In construction stage - Codelco Andina 200 (Increase extraction/processing capacity) - Mantoverde (Mantos Blancos) 177 (Copper mine) - Codelco Andina 137 (Underground mine) ----- - Mining SUBTOTAL (projects listed) 3,597 Note: Over US$5,000 million in copper and gold related projects for the next 5 years. Source: El Diario, June 1, 1994 and Capital Goods Corporation Capital, March 1994 Energy Investment Projects - Gas pipeline to Argentina 950 Km. 1,200 (Chilectra, Tenneco) - In feasibility stage - Central Pangue, 450 MW Hydroelectric Plant 470 (Endesa) - In construction stage - Guacolda, 150 MW Thermoelectric Plant 175 (Copec, Chilgener) - In construction stage - New Tocopilla, Thermoelectric Plant 150 In construction stage - Mejillones, Thermoelectric Plant 150 In construction stage ----- SUBTOTAL (projects listed) 2,145 Source: Capital Goods Corporation, March 1994 Forestry Investment Projects - Laja (CMPC) 220 In detailed engineering stage Industry Investment Projects - Alumysa 1,690 (Aluminum refinery or reduction plant) In feasibility stage - Laminador Planos 200 In construction stage - Methanex 200 In detailed engineering stage Commercial Building Investment Projects - Serena Norte Tourist Resort 500 In detailed engineering stage - Coraceros Tourist Resort 120 In detailed engineering stage Telecommunications Investment Projects - Development (CTC) 2,000 1 million new phone lines In construction stage ------ GRAND TOTAL OF PROJECTS LISTED 11,810 Source: Corporacion Bienes de Capital, March 1994