LATIN AMERICA: TRENDS IN FOREIGN DIRECT INVESTMENT

• Document Type: CREST
• Collection: General CIA Records
• Document Number (FOIA) /ESDN (CREST): CIA-RDP89S01449R000100090001-9
• Release Decision: RIPPUB
• Original Classification: S
• Document Page Count: 26
• Document Creation Date: December 27, 2016
• Document Release Date: July 16, 2012
• Sequence Number: 1
• Publication Date: February 1, 1968
• Content Type: REPORT

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Directorate of
Intelligence
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D. La. ie~ d
Investment.
in Foreign Direct
Latin America: Trends
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PACE NU ERS : -
TOTAL NUMBER OF COPIES
DISSEM DATE 8YD -
EXTRA OOPIES 5 3 f
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JOB NUMBER
Secret
Secret
ALA 88-10010
February 1988
copy 3 5 4
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Latin America: Trends
in Foreign Direct
Investment
This paper was prepared b ffice of
African and Latin American Analysis. It was
coordinated with the Directorate of Operations.[
addressed to the Chief, South America Division
Reverse Blank Secret
ALA 88-10010
February 1988
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in Foreign Direct
Investment
Key Judgments Many Latin American leaders seek to reverse the recession in foreign
Information available direct investment of the mid-1980s, but progress almost surely will be slow
as of 5 January 1988 and insufficient to offer regional debtors substantial financial relief.
was used in this report.
Annual inflows of investment have fallen to about 40 percent of their 1981
peak level precisely when they have been especially needed to help offset
dwindling commercial bank loans. Although there were numerous contrib-
uting causes of the.decline, the primary factors were a regionwide
economic recession and deficient economic management on the part of
Latin American governments.
Numerous governments in the region have taken some modest steps in the
past year or two to make their investment environments more appealing to
foreign business. These steps include easing regulatory restraints, cutting
bureaucratic redtape, and even implementing small amounts of economic
reform, such as trimming the public sector. Also, technocrats have devised
imaginative financial schemes, such as debt-for-equity swaps, as catalysts
for increased investment flows. For the most part, nevertheless, these
actions have been limited in scope and have not constituted dramatic policy
The beginnings of a rebound for foreign investment flows was evident in
1987, and we foresee the development of conditions that should sustain a
gradual recovery through the early 1990s. An expected moderate revival of
Latin America's economies will be likely to increase the region's attractive-
ness to foreign investors. In addition, Latin American governments, caught
between domestic political pressures to boost economic growth and the
constraints caused by scarce foreign capital resources, probably will
maintain their efforts-within the bounds of preserving national propri-
etary interests-to attract more foreign investment.
On balance, we believe Latin American countries collectively may increase
their annual foreign investment receipts by the early 1990s to as much as
double the 1986 level, but will not likely do appreciably better. Longstand-
ing sensitivities against foreign economic domination probably. will prevent
dramatic improvements of the policy climate conducive to sharp surges of
investment. Regional annual inflows of $6 billion-roughly double the
1986 dollar amount-would fall substantially short of the 1981 level in
nominal terms and probably only one-half that year's total in real terms.
Secret
ALA 88-10010
February 1988
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~.
There is also a considerable chance, however, that the economic and
political climate for foreign investment in the region could suffer renewed
setbacks, restraining foreign investment flows over the medium term at
current depressed levels. For example, continued turbulence on global stock
markets could have a dampening impact on Latin American economic
growth. Upcoming changes in government leadership in some major Latin
American countries could bring in their train more nationalistic shifts in
policy.
A doubling of foreign investment flows by the early 1990s would help Latin
American debtors meet their continuing large needs for foreign financing,
but even that amount would not significantly ease their debt problems.
Most major Latin American debtors would continue to be in the position of
having either to obtain sizable amounts of new commercial loans or to
depress further their imports of goods and services. A stagnation of foreign
direct investment simply would intensify the precariousness of these
countries' financial positions.
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Key Judgments
Economic Management 4
Raising the Appeal of Foreign Investment 7
Latin America: Foreign Investment Regulatory Controls 15
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Latin America: Trends
in Foreign Direct
Investment (C NF)
Scope Note This paper is the first look by the Directorate of Intelligence at the
potential for foreign direct investment to again become-as it was before
the early 1970s-a major source of funds for capital-starved Latin
America.
This paper
examines the effects of various foreign and domestically driven variables on
recent foreign investment trends and assesses the likelihood that changing
government attitudes and other factors will affect the investment climate in
the region.
vii Secret
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Latin America: Trends
in Foreign Direct
Investment
Numerous academic studies have noted that the
potential importance of foreign direct investment to
Latin America is greater now than ever because of the
effects of the debt crisis in hobbling the region's
economies.' Investment could become,a major source
of foreign finance at a time when most Latin countries
are hard pressed to expand their export earnings and
international commercial bank lending to the region is
diminishing. Moreover, unlike commercial lending,
nearly all direct investment is accompanied by capital
goods imports, transfers of technology, and manageri-
al know-how. Although foreign direct investment in
Latin America remains considerably depressed from
levels recorded in 1981, there is a growing recognition
of the potentially large payoffs from foreign invest-
ment on the part of Latin American governments,
some of whom have taken practical steps to encourage
increased equity inflows.
This paper analyzes the decline inr foreign direct
investment after 1981, assessing the principal ele-
ments underlying the deterioration of the investment
climate as well as the costs associated with the
investment slide. It then examines the recent signs of
a positive shift in attitudes among regional govern-
ments toward foreign investment and the tentative
liberalization of some investment controls, and weighs
the impact that evolving government initiatives will
have on the investment outlook for the region. Finally,
it addresses the likely effects of prospective foreign
investment developments on the Latin American debt
problem.
Direct investment flows to Latin America peaked in
1981 at $7.5 billion, following a prolonged period of
steady and often rapid growth. Foreign investors were
' For purposes of this paper, the term "Latin America" encom-
passes all of the independent countries of the Caribbean Basin-
including those that are non-Latin-language speaking nations-as
well as the countries of South and Central America.
Foreign Direct Investment: An Attractive
Alternative for Latin America's Debtors
Although foreign direct investment traditionally has
offered Latin American countries significant benefits
in the form of transfer of capital, technology, man-
agement, and marketing skills, its advantages are
strengthened considerably as a result of the regional
debt crisis. Aside from the potentially much greater
volume offunds it makes available, financial experts
point out that foreign direct investment has a number
of comparative advantages over commercial loans:
? It does not add to the debtor country's often
already huge foreign debt and interest burdens.
? It is used much more often than commercial loans
to expand debtor countries' productive capacity.
? It is provided for much longer periods of time than
conventional bank loans.
? It generates income payments that depend on the
investment's commercial success and, therefore,
correlate more closely with debtor countries' abili-
ties to pay.
sources, large market, and relatively cheap labor.
Even in the 1970s,
US dollar terms at an 18-percent annual average rate
despite:
? Tightened controls by a number of Latin American
governments who increasingly feared that foreign
enterprises would dominate local business activity,
exploit natural resources, and intrude in local
politics.
? A shift by Latin American governments to commer-
cial loans as a source of foreign capital-because of
their lower cost and no-strings-attached status
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Table 1
Latin America: Foreign Direct Investment Flows
FDI GDP FDI GDP FDI GDP FDI GDP FDI GDP FDI GDP FDI GDP
(percent) (percent) (percent) (percent) (percent) (percent) (percent)
Venezuela
Other
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compared with equity funds-after petrodollars
began flooding world financial markets in the mid-
1970s.
Even though direct investment declined as a share of
foreign private capital inflows from more than 50
percent in 1970 to about 25 percent in the early
1980s, it maintained a relatively stable 1-percent ratio
to total Latin American GDP and continued to make
significant contributions to Latin America's economic
development.
After 1981, Latin America's receipts of foreign equity
capital slumped badly as the climate for investment
deteriorated. Although foreign direct investment to all
the Third World stagnated, Latin America's share
had fallen from more than 50 percent to about 40
percent in 1986,E ~ Financial
press reports indicate that a growing number of
multinational companies have claimed substantial de-
clines in profitability and have curtailed or closed
their operations in Latin America. As a result, annual
net flows of foreign direct investment to Latin Ameri-
ca during the period 1982-86 fell to slightly more,
than 40 percent of the amount recorded in 1981. The
$3 billion registered in 1986 was a mere 0.4 percent of
regional GDP, the smallest such ratio in several
decades.
Although direct investment has been down across the
board, the region's largest economies suffered the
heaviest declines. Mexican and Brazilian annual re-
ceipts fell $1.6-2 billion between 1981 and 1986, while
Argentina suffered a drop of $400 million. The US
Embassy in Mexico City notes that foreign investors
cut back their business activities in Mexico substan-
tially after 1982 because of what they viewed as a
worsening business climate. According to these re-
ports, a number of major US firms liquidated their
affiliates in Mexico as a result of their growing
inability to sustain profitable operations. Press and
US Embassy reporting has described an even more
serious crisis of confidence on the part of foreign
investors in Brazil. In 1986, Brazil's foreign direct
investment receipts not only were the smallest in
nominal terms since 1970, but also were exceeded for
the first time by outflows of profit and dividend
remittances.
numer- 25X1
ous causes of Latin America's worsened investment
climate after 1981-including restrictive regulations,
violence and security concerns, labor problems, and
sagging world commodity prices. On the basis of
extensive evidence, however, we believe the principal
explanations for souring foreign investor attitudes and
the plummeting investment flows during 1983-86 can
be boiled down to the following two factors-debt and 25X1
recession, and government policies.
Debt and Recession
The contraction of international commercial lending
to Latin America coupled with the region's rising
interest payments and falling primary product export
prices contributed substantially to the decline in new
investment, especially during the years immediately
following the outbreak of the debt crisis in 1982. As
recounted in numerous US embassy reports, many
governments in the region reacted to their weakening
external payments and liquidity positions by suppress-
ing domestic demand and slashing imports. Since
much of Latin America's foreign equity investment
has been directed toward manufacturing for large and
protected domestic markets, the dampened consumer
demand discouraged foreign businessmen and caused
them to look for better opportunities elsewhere. In-
deed, one year after Mexico and Brazil experienced
their largest annual post-World War 11 economic
declines, each suffered a precipitate drop in equity
inflows. Inflows of foreign equity, however, generally
did not rebound with the Latin American economic
recoveries since 1984, but rather stabilized in a range
of $3-4 billion for the region as a whole.
The reduced availability of commercial loans also had
other less evident-and probably less powerful-ef-
fects on Latin America's foreign investment receipts.
Because multinational affiliates had relied to a signif-
icant extent on foreign bank funds to expand their
activities in Latin America,
the curtailment of commercial 25X1
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Mexico and Brazil, traditionally the two largest
beneficiaries of foreign direct investment in Latin
America, also have felt most acutely the overall
decline of equity flows to the region and almost
certainly will remain the trend setters. For example,
the two countries, which together have received more
than 60 percent of the region's investment since 1980,
alone accounted for more than 80 percent, or $3.6
million, of the $4.4 million drop in Latin America's
foreign direct investment receipts between 1981 and
1986. We believe that Mexico has begun to recover
somewhat from its foreign investment slump, but we
cannot judge whether Brazil's decline is yet bottom-
ing out.
The de la Madrid administration has gradually
overcome the impact of the nationalistic actions
taken near the end of the previous administration.
Inflows of foreign equity had risen steadily for sever-
al decades until the early 1980s despite longstanding
Mexican misgivings about foreign-owned economic
activities and increasing government controls over
them. The most significant restrictions were imposed
in the mid-1970s, according to the US Embassy in
Mexico City, and include foreign ownership limits of
49 percent-except in special instances of national
interest-and government guidelines for foreign tech-
nology transfers. It was not until 1982 that Mexico's
receipts of foreign direct investment began to plum-
met, however, because of the discouraging signal
President Lopez Portillo sent to potential investors by
nationalizing the country's commercial banks and
operations. In addition, some foreign businessmen
have made the case that general liquidity problems
have reinforced Latin inclinations to maintain rigor-
ous profit remittance restrictions.
Economic Management
Reports from US embassies have
indicated that growing anxiety among many foreign
businessmen regarding what they view as poor Latin
because of the onset of financial difficulties and a
deep recession. Despite the continued poor state of the
Mexican economy, the de la Madrid administration
already has managed to stimulate some resurgence of
equity inflows mainly by instituting an attractive
debt-for-equity swap program and expanding the
maquiladora border industries.
In Brazil, President Sarney has been worried about
the foreign investment decline, but his administration
has so far been unable to reverse it. Over the past two
years, a number of multinational companies either
have pulled up stakes or curtailed their investments
in Brazil, citing erratic government policies, price
controls, import restrictions, and threats of an ex-
panded market reserve policy. Major foreign auto
makers, for example, have responded to increasingly
unprofitable operations in the Brazilian market by
deferring sizable amounts of scheduled investment.
For example, the US Embassy in Brasilia has report-
ed that an important aspect of the heralded 1986
agreement between Volkswagen and Ford for a joint
venture known as "A utolatina " in both Brazil and
Argentina is the strengthening of both firms' competi-
tiveness by better utilizing existing plant facilities
and thus avoiding the need for large new investments.
Foreign firms may begin to rebuild their investment
operations in Brazil in 1988 provided the Constituent
Assembly does not incorporate major additional re-
strictions in the new constitution and an eventual new
government gains control of an unraveling economy.
American economic management also has been large-
ly responsible for the drop in direct investment flows,
especially since 1984. Businessmen claim that weak
fiscal, monetary, and foreign exchange policies have
fed large external payments deficits and high domes-
tic inflation, both of which severely jeopardize the
profitability of foreign business activities. They also
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Central America and the Caribbean:
The Small Players
Flows of foreign direct investment to the Central
American and Caribbean region plummeted sharply
in the aggregate after 1981, although the trend
principally reflected the experience of Trinidad and
Tobago. Largely as a result of the decline in petro-
leum prices in the mid-1980s, international oil com-
panies cut their investments in Trinidad and Toba-
go's petroleum sector to the bone.
Most other countries of Central America and the
Caribbean saw their direct investment receipts either
hold at fairly constant levels or show some backslid-
ing in the 1980s as a result of insurgencies, political
turmoil, depressed growth, and acute financial diffi-
culties. Government policies encouraging foreign in-
vestment have helped some countries considerably,
notably Costa Rica and the Dominican Republic.
Furthermore, the Caribbean Basin Initiative (CBI)-
a US program of trade and tax concessions designed
to help 27 Caribbean and Central American countries
expand employment and raise living standards-has
attracted the attention of many investors to the
region. The program's centerpiece consists of 12-
year, duty-free access to US markets for a wide range
of agricultural and manufactured goods.
Substantially rising inflows of direct investment will
not materialize in the region until political violence
and insurgency subside, primary commodity prices
show a stronger recovery, or more progress is made in
economic diversification and reform. Dependence on
earnings from primary product exports like sugar,
bauxite, bananas, and coffee is still widespread.
cite excessive reliance on import controls and price
controls as having badly hampered their operations
and squeezed profits in some instances.
The economic policy environment, in our judgment,
has been especially difficult in those countries that
have returned to civilian government in the early-to-
Table 2
Latin America: Real GDP Annual Growth
Latin Argentina Brazil Colombia Mexico
America
- CIA estimate.
b Projected.
mid-1980s, including Argentina, Brazil, Guatemala,
Honduras, Peru, and Uruguay. To varying degrees,
the new civilian leaders have depended on expansion-
ary fiscal and monetary policies and.rigorous price
controls to strengthen their domestic political posi-
tions and, accordingly, have aroused considerable 25X1
foreign business uncertainty. Efforts to avoid growth-
limiting austerity measures when at all possible have
led most of these governments to pay insufficient
attention to needed economic reforms, such as stream-
lining the public sector, broadening capital markets,
and liberalizing trade regimes. For example, the US
Consulate in Sao Paulo repeatedly noted last year
that the major causes of the continuing decline in
foreign investment in Brazil are uncertainty regarding 25X1
the Sarney administration's vacillating economic poli-
cies, rising labor costs, and government price freezes.
Regulatory policies aimed specifically at limiting and
guiding new foreign investment continued to have a
restraining effect on investment receipts, although
they probably did not play an appreciable role in the
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Figure 1
Cumulative Foreign Direct Investment
by Sector, Yearend 1985 a
Manufacturing
66.0
A Based on official statistics for Brazil, Chile, Colombia, and
Mexico, which collectively accounted for more than 75 percent of
Latin America's total receipts of foreign direct investment.
decline of these flows after 1981.2 Financial counsel-
ors explain that many of these regulations have been
on the books for years, running the gamut from entry
limitations, including the exclusion of foreign invest-
ment from certain economic sectors; through perfor-
mance requirements, such as tying special tax incen-
tives to the fulfillment of particular ownership or
export conditions; to restrictions on remittances that
affect the amounts of dividends, royalties, or fees that
a foreign firm may repatriate. For example, the
Andean Pact's Decision 24 has since the early 1970s
generally excluded foreign investment from selective
areas reserved for national enterprises and established
procedures in many others for gradually transferring
at least 51 percent of the ownership to national
investors.' In Brazil and Mexico, restrictive controls
as noted in the inset, have long hindered direct
investment flows.
' See appendix for a country surve of Latin America's foreign
investment regulatory controls.
The Andean Pact is a subregional economic integration organiza-
tion-including Bolivia, Colombia, Ecuador, Peru, and Venezue-
la-established in 1970 to promote economic and trade cooperation
Table 3
Latin America: Gross Domestic Investment
as Percent of GDP, 1980-85
An annual contraction of foreign equity flows of some
$4.5 billion on top of a more than $20 billion decline
in yearly commercial borrowings from 1981 to 1986
ravaged Latin America's balance of payments and
further constrained the region's capacity to import.
Moreover, government efforts to boost exports sub-
stantially to strengthen their depleted liquidity posi-
tions often failed, and regional export earnings have
remained fairly constant because of weak demand in
industrialized countries and sagging commodity
prices. As a result, the Latin American countries in
the aggregate were forced to slash their imports-
including substantial amounts of US-origin capital
equipment and raw materials that were crucial to
sustain industrial growth-from $105 billion in 1981
to some $65 billion annually during 1983-86. A
number of countries-including South America's
Southern Cone countries of Argentina, Chile, and
Uruguay-cut their import bills by one-half or more.
Meanwhile, regional governments drew down $12
billion, or about one-third, of their international re-
serves between 1981 and 1986.
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The slide in the inflows of foreign equity has also been
a significant contributor to the region's total invest-
ment decline in the 1980s, according to Latin Ameri-
can economists. Domestic saving rates in the Latin
American countries generally have not risen to offset
the fall in the inflow of investment from abroad and in
most instances have declined. Faced with diminished
foreign capital receipts, governments generally have
preferred to safeguard the wage and other current
spending components of their budgets and to place a
disproportionate amount of the adjustment burden on
reduced public investments.
many of the same countries that experienced the
largest reductions in new foreign investment-includ-
ing Argentina, Brazil, Chile, Mexico, and Uruguay-
also suffered the sharpest declines in total domestic
investment (see table 3). As the share of domestic
investment in GDP has slipped, the task of sustaining
growth has become more difficult for regional govern-
ments.
A number of Latin Americans have come to recognize
the harmful impact on their economies of dwindling
foreign investment and the potential benefits to be
gained in restoring these equity inflows. Accordingly,
there have been several encouraging signs in the past
year or two that a more favorable climate for foreign
direct investment may be taking shape in Latin
America. Notably, government attitudes have become
more receptive to increased foreign equity, and tech-
nocrats have devised increasingly innovative financial
and investment schemes. Conditions could change
down the road, however, to reverse this trend.
Easing Government Restraints
Government leaders in a number of Latin American
countries-including Argentina, Colombia, Ecuador,
Guatemala, Jamaica, and Mexico-recently have put
more emphasis on the private sector and market
incentives than did their predecessors. These leaders
have publicly asserted, according to press and US
embassy sources, that greater flows of foreign private
investment are desirable, especially in light of the
declining prospects of gaining large amounts of new
commercial money. A growing number of Latin
Americans are admitting that, contrary to the old
shibboleth that direct investment concedes an unac-
ceptable degree of foreign control, equity flows actu-
ally involve less foreign intervention than commercial
loans because of the rigorous austerity programs
required to obtain the latter.
Many Latin American governments, including some
of the larger recipients of foreign direct investment,
took tentative steps in 1986 or 1987 to make the
investment environment more appealing to foreign
business. For example, Mexico's de la Madrid admin-
istration issued two new resolutions waiving at times
legal requirements that foreign businesses limit their
investment in Mexican enterprises to 49-percent own-
ership, and has simplified the administrative proce-
dures for approval of foreign investment proposals.
The extent to which Mexico's next president will
choose to carry on these policies after de la Madrid
steps down in December 1988 is uncertain. Also in
1987, Argentina's President Alfonsin signed a law
opening up to foreign investors potentially productive
petroleum-bearing onshore tracts previously reserved
to the Argentine national oil company. Buenos Aires
later authorized foreign companies to remit profits
and dividends at substantially more advantageous
exchange rates than previously.
The Andean countries have made some of the-most
significant strides to ease controls over foreign-owned
businesses:
bia's economy-including the financial sector-to
majority foreign ownership and has authorized 100-
percent, foreign-owned companies in many
instances.
? Ecuador's President Febres-Cordero has reopened
the mining, petroleum, and other sectors to foreign
business activity, eased requirements to transfer
ownership to local interests, and facilitated profit .
repatriation.
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? The Venezuelan Government liberalized its foreign
investment legislation by relaxing requirements that
foreign firms divest to minority positions, increasing
allowable profit remittances, and reducing bureau-
cratic impediments to foreign investment tenders.
In light of these individual moves, the five members of
the Andean Pact approved in early 1987 a major
reform of the Decision 24 restrictions against foreign
investment. As a result, according to US embassy
reporting, the number of foreign companies required
to transfer majority ownership to local companies has
been reduced substantially and those foreign compa-
nies still subjected to the transfer requirement are
given considerably more time to do so. Most impor-
tant, individual governments are now allowed to set
their own rules governing the entry of foreign invest-
ment and the amount of profit foreign businesses can
remit abroad.
For its part, the Sarney government in Brazil, unhap-
py with the recent drop in investment inflows, has
been working on a plan to attract more foreign
investment through increased inducements. Accord-
ing to the press, the plan would include the establish-
ment of tariff- and regulation-free export zones, tax
breaks for some investors, and a reform of bureau-
cratic procedures for reviewing investment applica-
tions. Enactment of the plan is uncertain, however, as
it will still depend on the blessing of the Constituent
Assembly. Many of the more nationalistic members of
the assembly not only oppose liberalization measures
but are also urging the incorporation of tighter re-
straints on investment in the new constitution they are
helping to draft.
US embassy and financial press sources also note
some improvement of the regulatory environment
among the region's smaller countries. In the Central
American isthmus, the Governments of Costa Rica
and Guatemala are attempting to entice more foreign
investment through favorable regulatory treatment.
Inspired by the Caribbean Basin Initiative, the
Dominican Republic and Jamaica are relaxing their
investment restrictions and are offering tax and tariff
concessions to encourage greater foreign business
activity in those island economies.
Foreign Direct Investment An Emotionally
Charged Issue
Despite the emergence of a new generation of Latin
American leaders more sympathetic to foreign direct
investment, strong nationalistic sentiment continues
to thrive throughout much of the region and to find
expression through various influential interest
groups. Often these groups-including politicians and
technocrats, industrial elites, and labor groups-are
well positioned and carry sufficient clout to combat
and weaken policy initiatives they deem harmful. For
example, the US Embassy in Mexico City notes that
a number of officials in the Mexican Government
frown on foreign investment and are dragging their
feet in processing applications, despite the campaign
of President de la Madrid's administration to accel-
erate foreign investment flows. Nationalistic elements
in the Brazilian governing party, the PMDB, are also
resisting President Sarney's efforts to invite more
equity capital from abroad, according to the US
Embassy in Brasilia. Even in Quito, where the
Febres-Cordero government has been especially ag-
gressive in its quest for expanded inflows of equity,
many influential Ecuadoreans are proponents of
state-led economic development and oppose liberal-
ized private-sector investment policies.
Evolving Financial Schemes
Latin American governments, in cooperation with
foreign banks and businessmen, have begun to devise
imaginative financial schemes designed to encourage
increased foreign investment while providing some
relief from the countries' onerous debt burdens. By far
the most prominent of these are the so-called debt for
equity swaps (see inset). A leading Latin American
economic news service estimates that swap transac-
tions in the region probably amounted to $2-2.5
billion in 1987. Although neither debtor governments
nor foreign private investors can judge accurately how
much the investment generated by the swap schemes
adds to direct investment totals, they agree that a
substantial part of it represents new investment fi-
nancing. As US investment counselors have pointed
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out, purchasing bank debt at a discount makes other-
wise marginal investments in many countries reason-
ably attractive to foreign businesses.
Chile and Mexico have been implementing debt swap
programs for more than 18 months, and each has
already converted more than $1.5 billion in equity.
Chile's program has become the most successful in
the region because of its clear-cut rules and minimal
conditions for foreign investor eligibility. In roughly
two and one-half years, Chile's swap transactions
have trimmed 8 to 10 percent from the country's $20
billion medium- and long-term foreign debt. About
one-third of the dollar value of the swaps has generat-
ed new foreign investment, while the rest involved
Chilean nationals.
Mexico's swap program has been somewhat different
in that the government allows only foreign investors to
participate, regulates the dollar amount of conversions
over time, and negotiates the terms of each contract
on a case-by-case basis. Mexico has been involved in
the region's largest swap deals, including agreements
with Volkswagen to convert $280 million to equity
and with Chrysler to convert $100 million to equity.
Mexico City has curtailed swap transactions since
October, however, because it claims that the 1987
average monthly flows of $100 million contributed to
the rapid acceleration of the money supply and price
A number of other Latin American countries are
inaugurating or preparing similar debt-to-equity con-
version schemes, although some probably will offer
less attractive terms than Chile or Mexico:
? Ecuador completed several swaps under a modest
program limited to private-sector debt launched in
March 1987, but foreign investors participated in
only a minor share. Quito suspended the program in
August to review its effectiveness and plans to re-
introduce a more liberalized version to attract more
foreign investors after the currently beleaguered
sucre stabilizes.
Debt-for-Equity Swaps: A Growing
Latin American Phenomenon
The debt-for-equity swap has been gaining momen-
tum in Latin America in the past year as debtors and
creditors have found it a useful device for easing the
debt problem and investors are drawn to it as a
source of cheaper financing. In a typical conversion of
debt to equity, a multinational company or other
private investor buys a certain amount of a Latin
American country's debt from an international com-
mercial bank at a discount and redeems the debt
instrument at the debtor country's central bank at
full face value-or near full face value-in local
currency. The company then invests the proceeds in
the local Latin American economy. Alternatively,
international commercial banks may swap their debts
for equity investments of their own, but generally
prefer to avoid that practice because of their lack of
experience and expertise in managing nonfinancial
enterprises. The discounts for Latin American debt
available on secondary markets vary widely from 85
percent for Peru's debt to little more than 10 percent
for Colombia's debt.
The swaps generally offer significant benefits for all
participants. The creditor banks converting their own
debt to equity-which so far have predominantly
been European and small- or medium-sized US re-
gional banks probably view a swap as a middle
ground between remaining caught in a cycle of debt
reschedulings and new money demands on the one
hand, and simply writing off the debt and taking an,
outright loss on the other. Accordingly, the smaller
banks free themselves from the pressure the large
money-center banks exert to participate in future
loans. Many debtors welcome the benefits of in-
creased foreign equity financing and relief from debt
servicing, although a number remain concerned that
the domestic monetary effects of swaps could aggra-
vate already difficult inflation problems.
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? Argentina has revised its previously restrictive and
lackluster swap program-for example, by dropping
a requirement that the investor match its swapped
proceeds with an equal amount of new funds-to
make the process more flexible and attractive to
foreign investors. Still, the US Embassy questions
the government's commitment to implement a suc-
cessful program.
? Brazil approved a new program in November 1987
for converting debt to equity either through auctions
or by way of a new bond scheme. Because the plan
to replace commercial bank debt with bonds is part
of the ongoing debt talks, the details of a swap
mechanism for this part of the program are still to
be negotiated between Brasilia and the banks.
? Venezuela has announced the framework of a debt-
equity swap program. Although a government com-
mission is still working on the details, the US
Embassy in Caracas believes the financial incentives
to investors will largely be offset by restrictions on
dividend repatriation and by disadvantageous ex-
change rates.
? Elsewhere in Latin America, Bolivia, Costa Rica,
the Dominican Republic, Honduras, Jamaica, and
Uruguay have announced that they are establishing
their own versions of a swap program.
The decisions by major US banks in the summer of
1987 to hike their loan-loss reserves probably will
somewhat expand the secondary markets for problem
loans to Latin America and accelerate growth of debt-
to-equity conversions in the region. For the first time,
according to financial experts, a number of large US
money-center banks will be able to write down sub-
stantial amounts of their own shaky loan exposures to
Latin America and convert them at near-market
value to equity stakes in the region. Previously, the
role of these major banks had been primarily confined
to that of intermediary, since non-US banks and
smaller US regional banks have provided nearly all of
the discounted loan funds for the swap markets. The
top US bank lender to Latin America publicly indi-
cated in June 1987 that it plans to convert as much as
$5 billion to equity over the next three years
Using another type of scheme, the Governments of
the largest Latin American economies, Mexico and
Brazil, have moved to tap foreign risk capital by
creating investment trusts-or closed-end mutual
funds-to facilitate foreign participation in local
stock markets. According to the financial press, one
such investment trust has been operating in Mexico
since early in the decade and has attracted many
foreign investors who seek the potentially high returns
on Mexican stocks but want to minimize the risks
associated with the high volatility of the stock prices.
The uncertainty caused by the recent Mexican stock
market crash, however, has temporarily damaged
foreign investor enthusiasm. The Brazilian Govern-
ment in 1987 approved a "Brazil Fund," which it
believes can bring in $150 million in new foreign
portfolio investments in the first year, but then post-
poned activation of the fund in the aftermath of the
global stock market upheaval in October. The fund
would permit foreign purchases of Brazilian stocks for
the first time and exempt foreign investors in the fund
from income taxes. The appeal of both Mexico's and
Brazil's funds probably will resurge eventually, when
the global stock market turmoil subsides and investor
wariness dissipates. Investment trusts have limited
potential elsewhere in Latin America because few
other countries have stock markets sufficiently broad
or well-developed to support these schemes.
Other Favorable Trends
In contrast to the beginning of the decade, when
foreign direct investment came predominantly from
the United States, many non-US-especially Japa-
nese-businesses are taking an increasingly active
interest in Latin America. Between 1980 and 1985,
Japan's total investment in Latin America expanded
150 percent, according to the financial press. A US
academic study noted in early 1987 that Japan has
seldom committed itself as strongly to investment in a
developing country outside of Asia as it did in Mexico
in the mid-1980s. This occurred because of, among
other things, low labor costs and the proximity of the
25X1
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large US market. I Japa-
nese firms also are studying new investment opportu-
nities in a wide range of industries in Brazil, already
by far the largest beneficiary of Japanese investment
in Latin America. In recent months, Japanese invest-
ment has slowed somewhat in both countries because
of political and economic uncertainty. Still, according
to US embassy reporting, Tokyo plans to encourage
increased Japanese investment in the region to com-
pensate for the financial impact of an anticipated
decline in Japan's demand for Latin America's ex-
ports
Foreign businesses increasingly are establishing ex-
port bases in Latin America to sell industrial goods to
home markets or other third countries-especially the
United State The
rising share of foreign investment devoted to produc-
tion for export reflects, among other things, a reliable
supply of skilled and moderately priced labor and
increased incentives extended by regional govern-
ments to businesses meeting export performance tar-
gets. Moreover, Mexico's export-oriented maquila-
doras have attracted substantial amounts of foreign
investment in the past few years. Foreign investors
have responded to the maquiladora program, origi-
nally set up by the Mexican Government 20 years ago
to expand employment along the US border, because
of current internationally competitive labor costs in
addition to the duty-free imports and other incentives
offered by the Mexicans. Other Latin governments,
including Brazil and Peru, have indicated they also
are considering the establishment of maquiladora-
style, export-oriented industrial zones.
Outlook
Although long-cultivated fears of foreign economic
domination and preferences for a major governmental
role in economic affairs will continue to limit expand-
ed openings to foreign businesses, we believe that
investment flows to Latin America gradually will
recover. Indeed, in our judgment, the projection of at
least one US investment counselor that foreign invest-
ment to the region may double from 1986 levels to
some $6.0 billion in the medium term-which we
define as-five years-is not without some foundation.
We expect, when final tallies are in, total 1987
investment receipts will amount to some $3.5 billion,
about 15 percent above 1986.
Figure 2
Cumulative Foreign Direct Investment
by Country of Origin, Yearend 1985 a
Other
12.5
United States
48.5
a Based on official statistics for Brazil, Chile, Colombia, and
Mexico, which collectively accounted for more than 75 percent of
Latin America's total receipts of foreign direct investment.
Latin American economic growth probably will in-
crease moderately, thereby attracting rising flows of
investment. In late 1987, Data Resources Institute
(DRI) and Wharton Economic Forecasting Associates
(WEFA) forecast 3-percent average annual growth
rates for the Latin American countries collectively-
revised down from earlier projections of 3.5 percent
because of the effects of the recent global stock
market plunge. Although the new projected 3-percent 25X1
growth would be only one-half the region's 6-percent
annual pace of the 1970s, it would be more than
double the average rate registered during 1981-86.
Despite strenuous resistance by hardcore nationalists,
Latin American governments probably will maintain
their recent, more liberal and flexible, policy stances
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with respect to restraints on foreign investment as
foreign capital becomes increasingly critical to sustain
regional growth:
Embassy in Mexico.
? In Mexico, the more accommodating government
attitude toward foreign businesses and the popular
maquiladora program suggest a continuing rise in
investment receipts. While de la Madrid's term of
office expires in December 1988, his likely succes-
sor, the ruling party candidate Carlos Salinas, prob-
ably will continue his essentially pragmatic and
conservative economic policies, according to the US
? The steps taken in the past 18 months by Colombia,
the Dominican Republic, Honduras, Venezuela, and
Trinidad-Tobago to liberalize restrictions on invest-
ment will make their domestic markets more attrac-
tive to foreign investors.
Moreover, we agree with academic analyses suggest-
ing that some recently installed civilian governments
in the region may become more willing to undertake
the needed structural adjustments to put their econo-
mies on firmer footings as their fledgling democracies
mature and their political bases broaden, or as their
leaders gain greater self-confidence in economic man-
agement. Some early signs include:
? In October 1987, nearly four years into his adminis-
tration, Argentina's Alfonsin won the praise of
foreign businessmen for his courage and commit-
ment to economic reform when he announced ad-
justment measures to trim the public-sector deficit.
Opposition from the recently strengthened Peronist
Party has diluted the package by blocking some
significant fiscal elements.
sy reporting.
? The civilian Governments of Honduras and Uru-
guay that took over from the military regimes in the
mid-1980s increasingly are implementing gradual
economic adjustment steps, according to US embas-
Even in Brazil, some resurgence of direct investment
flows probably will occur sometime in 1988 or 1989
after revised investment ground rules are clarified in
an approved new constitution
7 25X6
According to the US Embassy in
Brasilia, some of the existing proposals for increased
controls will probably be deleted or diluted through
the upcoming plenary vote in the constituent assembly
while others probably will not. If, on balance, only
some of the less damaging investment restrictions
survive to be incorporated in the constitution, we
believe many foreign investors will view Brazil as an
attractive investment market over the medium to long
term.
Finally, US financial analysts have suggested that
Latin governments, creditor banks, and multinational
corporations probably will expand their use of imagi-
native financial schemes to foster foreign investment.
Conversions of debt for equity in Latin America may
continue to grow, in their judgment, because of the
decisions of major international banks to augment
considerably their loan-loss reserves. In addition, they
point out that foreign businesses probably will make
increasing use of quasi-equity instruments-including
production or revenue sharing through a variety of
contract forms such as joint ventures, risk-service
contracts, and management or licensing agreements.
Through such schemes, Latin American governments
may obtain risk capital, including technology and
know-how, without allowing foreign control of local
economic activities.
Although we believe an increase in aggregate invest-
ment flows to Latin America is likely, we do not
minimize the potential for an erosion of the willing-
ness or ability of foreign companies to build up their
Latin American investment capital. The failure of
Latin American economies to grow at the level of the
DRI and WEFA forecasts, for example, would have a
deleterious effect on investment inflows as would
continuing assaults on world stock prices, which
would reduce the capital resources in industrialized
countries available for investment in Latin America.
Moreover, the recent improvements in Latin govern-
ment attitudes toward foreign direct investment could
dissipate and render a significant expansion of invest-
ment flows less likely. Acrimonious confrontations
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Table 4
Latin America: External Financing Needs and
Foreign Direct Investment (FDI)
Current Account Amortization Total FDI FDI
Deficit (percent of total)
Sources: I D B Economic and Social Progress in Latin America,
1987 (historical data) and DRI Latin American Review, Second
Quarter 1987 (projections for 1988-91).
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between Latin American governments and the indus-
tralized world over debt, trade, or other irritants in
their relations could stoke the fires of nationalism and
erode domestic support for foreign investment. Policy
shifts away from promoting greater foreign invest-
ments could occur sometime in the next few years in
one or more key Latin countries:
? Some Mexican businessmen fear that PRI candi-
date Carlos Salinas-who has a thin track record on
which to base an assessment with confidence-may
prove to be substantially more populist than de la
Madrid in his policy leanings, including a disposi-
tion to limit foreign investment.
? Argentina's Alfonsin could give in to pressures from
the populist Peronist opposition party and shift to a
more nationalistic stance if his current moderate
policies lead to severe domestic economic
deterioration.
? In Brazil, there is a chance that the constituent
assembly either will not agree on a new constitution
or will approve one that contains highly xenophobic
investment provisions, thereby leading to serious
national turmoil and the flight of foreign capital.
Deteriorating security conditions resulting from ter-
rorism and insurgency violence could discourage new
inflows of investment to some countries, including
Colombia and Peru. Colombia, especially, has been
one of the region's largest beneficiaries of foreign
direct investment in this decade because of its attrac-
tiveness to foreign business stemming from the gov-
ernment's good record in managing the economy and
its relatively liberal investment regulations, and the
country's rich and low-cost mineral fuel resources.
Sharply escalating insurgent violence and sabotage of
foreign oil and other facilities could deter a number of
otherwise interested foreign companies.
Even the doubling of foreign direct investment to
some $6.0 billion by 1991, while helping Latin debtors
meet their continuing large requirements for foreign
financing, would offer no more than a minor palliative
to their persistent and onerous debt difficulties. To
put projected direct investment flows of this magni-
tude in historical perspective, they:
? Fall short of the previous peak level of 10 years
earlier even in nominal terms.
? Would probably amount to about one-half of 198 l's
total in real terms.
? Would be equivalent to only 0.5 percent of total
Latin American GDP in 1991 compared with 1.2
percent in 1981.
Viewed against projections of Latin America's finan-
cial requirements by the International Monetary
Fund and DRI forecasting service, our expected in-
flows of foreign investment would contribute only one
quarter of the region's external capital needs (see
table 4). Because Latin debtors will continue to face
substantial financial gaps in spite of rising flows of
investment, those that are sufficiently creditworthy
probably will have to supplement their investment
receipts with additional major borrowings. Others
that found themselves unable to obtain substantial
new loans would be faced with having to slash imports
still further. Latin America's financial difficulties
would be compounded considerably should our more
pessimistic scenario come to pass and regional foreign
direct investment stagnate at current levels. The
financial gaps of some debtors would grow dangerous-
ly large and threaten to plunge these countries into
prolonged stagnation. Also, with respect to a few
billion US dollars of yearly debt-for-equity swaps,
these transactions pale against the region's $400
billion debt outstanding and will have little impact on
the debt servicing burdens
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Appendix
Latin America:
Foreign Investment Regulatory Controls
No sectors are off limits, but
central bank approval is re-
quired for investment in de-
fense, some public services,
mass media, energy, insurance,
financial entities, and if invest-
ment is over $20 millionor it
involves acquisition of a local
company worth over $10 mil-
lion. Antipollution decrees limit
investment in Buenos Aires.
All foreign investments and re-
investments must be registered
with the central bank. Certain
sectors are reserved for Brazil-
ian nationals including the in-
formation media and petroleum
exploration and refining. For-
eign investors also are subject to
restrictions in other sectors such
as banking, informatics, petro-
chemicals, and mining.
The only industry closed to for-
eign investment is petroleum,
although risk contracts are as-
signed. Also, there are no per-
centage restrictions on foreign
holdings. Investments over $5
million or in the media or public
sectors are subject to approval
by the Foreign Investment
Committee.
New foreign investment law lib-
eralized previously strict rules
of the Andean Pact. Most sec-
tors now are open to foreign
investors, although all invest-
ment still must be approved and
registered. Only foreign compa-
nies wishing to benefit from
Andean trade preferences need
to divest to mixed (51-percent
local equity) or national (80-
percent local equity) status.
Incentives granted only if in-
vestment is important to nation-
al interest.
Foreign investors may qualify
for special investment incen-
tives by the government-in-
eluding tax credit or import
duty concessions-only if they
agree to maintain a certain lev-
el of exports or if they establish
operations in certain underde-
veloped regions of the country,
such as the northeast or the
Amazon.
Incentives are available for in-
vestment in certain regions and
in sectors vital to the country's
development.
Foreign investors are eligible
for export incentives and special
import regimes for inputs used
in export products.
Dividends remitted abroad are
taxed at 17.5 percent. There is
no limit on amounts, but an
excess profits tax of 15 to 25
percent applies to remittances
above 12 percent of registered
capital. A tax of 45 percent
applies to 60 to 100 percent of
the amount of remittances of
royalties and fees. All remit-
tances must be made through
BONEX-government bond
system.
Dividend remittances are sub-
ject to 25-percent withholding
tax. Although there is no limit
on the amount that can be repa-
triated, net remittances above
12 percent of total registered
capital are subject to stiff sup-
plementary taxes of 40 to 60
percent. Also, remittances of
royalties and fees are limited to
I to 5 percent of gross sales.
There are no restrictions on re-
mittances, although intentions
to remit profits more often than
annually must be defended by
audited statements. An income
tax of 40 percent applies to
dividends remitted abroad. Re-
mittances of royalties and fees
are subject to a 40 percent
withholding tax and central
bank approval.
Currently, remittances are lim-
ited to 25 percent of capital
base and subject to a tax of 30
percent, in most cases. Higher
remittances may be permitted
in special cases. Royalties and
fees must be registered and
their tax ranges from 40 to 52
percent.
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Latin America:
Foreign Investment Regulatory Controls (continued)
All foreign capital must be reg-
istered with the central bank.
Foreign firms do not enjoy the
same easy access to domestic
credit facilities as do local
enterprises.
Foreign investment prohibited
in utilities, forestry, communi-
cations, and domestic
transportation.
Foreign investment is meant to
complement local investment,
so the majority of a firm's equi-
ty must be Mexican controlled,
with exceptions on a case-by-
case basis. All projects are ap-
proved and regulated by a gov-
ernment commission. Foreign
investors are barred from cer-
tain activities in the energy,
mining, banking, and transport
sectors.
Sectors closed to foreign invest-
ment include retail trade, radio,
and certain professional activi-
ties; public utilities must have a
local majority ownership. No
government approval is re-
quired for other sectors, al-
though a license must be
obtained.
Foreign investment must be au-
thorized in advance and regis-
tered by the government. Sec-
tors considered essential to
Peru's economy and sovereignty
are closed to foreign investors.
Investments in export-oriented
activities are exempt from cus-
toms duties and sales or profits
taxes. Also, firms located in
free zones do not have to pay
duties on remittances.
Several industrial free zones
provide exemption from income
tax, customs duties, and curren-
cy controls when goods are ex-
ported. To solicit mining con-
cessions, foreign firms must
establish Dominican companies.
Tax, financing, and export in-
centives are available for com-
panies that set up in the coastal
or frontier zones; also, for prior-
ity industries such as agroin-
dustry, machinery, and elec-
tronic equipment.
Companies located in the free
zone are exempt from import
and export duties and are ac-
corded special low-income
taxes.
Foreign companies are allowed
to exceed normal profit remit-
tance ceiling if they meet re-
quirements of increasing ex-
ports, increased use of local
inputs, or developing certain
geographical areas. Firms that
become mixed or national can
get tariff breaks and long-term
domestic financing.
No restrictions on remittances.
Dividends are subject to 15 per-
cent withholding tax. Royalties
and fees are taxed at 20
percent.
Profit remittances cannot ex-
ceed annually 25 percent of the
registered investment base, and
are subject to 20-percent with-
holding tax free zone opera-
tions are exempt. Payments of
royalties by a subsidiary to its
parent company are prohibited.
All contracts for fees must be
approved, and the withholding
tax is 20 percent.
Provided a firm is registered
and meets certain legal and tax
requirements, profits can be re-
mitted abroad taxed at 55
percent. Royalties and fees re-
mitted under registered con-
tracts are subject to a withhold-
ing tax of 21 percent, as well as
some foreign exchange
restrictions.
Remittances abroad are not
limited in any way. Profits re-
mitted are taxed 10 percent; for
royalties and fees the tax is 20
to 50 percent.
Since July 1986 a two-year
freeze on remittances has been
in effect. Under the Andean
Pact rules which normally hold
sway, remittances may not be
more than 20 percent of capital
base. Branch profits are subject
to a 15.4-percent withholding
tax, as well as a 35-percent
corporate income tax. Royalties
and fees must be approved and
registered.
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Latin America:
Foreign Investment Regulatory Controls (continued)
No enterprise can be totally for-
eign owned, and the govern-
ment favors joint ventures with
majority ownerships held by do-
mestic interests. All sectors are
open to private enterprise ex-
cept public utilities.
Some industries-including
public utilities and services,
port facilities, railroads, and in-
surance-are closed to foreign
and local firms. Foreign inves-
tors must register their invest-
ment to obtain government
guarantees of repatriation and
convertibility, but are then un-
able to obtain medium- and
long-term internal credit.
Several sectors are barred to
foreign firms including petro-
leum, some petrochemicals, iron
ore, and other natural re-
sources. Firms investing in oth-
er sectors such as public, profes-
sional, and financial services
must be. controlled by 80 per-
cent national interests. All in-
vestments must be registered
with the country's investment
agency.
Foreign investors active in
pioneer industries sometimes
are accorded exemption from
income tax or import duties for
five to nine years. Exporters are
allowed to deduct from taxable
profits part of their sales to non-
Caribbean markets.
Companies involved in activities
declared to be of national inter-
est are eligible for special credit
assistance and tax concessions.
Firms that locate in designated
free-trade zones are awarded
tax exemptions.
Some priority development sec-
tors are exempt from the trans-
formation rules and ceilings on
remittances: tourism, agricul-
ture, agroindustry, electronics,
informatics, and biotechnology.
Exemptions may also be ob-
tained if 80 percent of produc-
tion is exported outside the An-
dean market or if operations are
within free zones.
Central bank regulates and ap-
proves repatriation and pay-
ment of royalties and fees. Divi-
dend tax is up to 25 percent.
Royalties and fees are taxed
between 5 and 30 percent.
There is an industry and com-
merce tax of 30 percent on re-
mitted dividends-may be
waived if they are taxed abroad.
Profits not remitted after two
years are considered capital-
ized. The 30-percent tax also
applies to royalties and fee pay-
ments remitted abroad.
Profit remittances cannot ex-
ceed 20 percent of registered
capital plus a percentage equal
to the current LIBOR rate. The
remittance tax is 20 percent.
Royalties and fee payments are
prohibited between parent com-
panies and their subsidiaries.
Approved contracts with nonaf-
filiated are taxed from 18 to 50
percent.
Declassified in Part - Sanitized Copy Approved for Release 2012/09/04: CIA-RDP89S01449R000100090001-9
 Declassified in Part - Sanitized Copy Approved for Release 2012/09/04: CIA-RDP89S01449R000100090001-9
IJG~ 1 %A
Secret
Declassified in Part - Sanitized Copy Approved for Release 2012/09/04: CIA-RDP89S01449R000100090001-9