INTELLIGENCE MEMORANDUM

• Document Type: CREST
• Collection: General CIA Records
• Document Number (FOIA) /ESDN (CREST): CIA-RDP85T00875R001700030014-2
• Release Decision: RIPPUB
• Original Classification: S
• Document Page Count: 16
• Document Creation Date: December 22, 2016
• Document Release Date: May 19, 2010
• Sequence Number: 14
• Publication Date: January 1, 1972
• Content Type: IM

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Secret
DIRECTORATE OF
INTELLIGENCE
Intelligence Memorandum
Chile's Foreign Exchange Crunch
DOCUMENT SERVICES BRANCH
FILE COPY
DONUT DESTROY
Secret
ER IM 7214
January 1972
Copy No. 7 6
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WARNING
This document contains in&:rmution affecting the national
defense of the United Status, within the meaning of Title
18, sections 793 and 791, of the US Code, as amended.
Its transmission or revelation of its contents to or re-
ceipt by an unauthorized person is prohibited by law.
GROUP I
[xct.vDtD x11011 AUTOMATIC
rO)N NC 111AD1Nt1 AND
D,r:1.AFs1rIrA T1ON
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CENTRAL INTELLIGENCE AGENCY
Directorate of Intelligence
January 1972
INTELLIGENCE MEMORANDUM
CHILE'S FOREIGN EXCHANGE CRUNCH
Summary
1. President Salvador Allende is facing his first major economic crisis
since taking office in November 1970. Net foreign reserves, which stood
at a record $378 million when he was elected, plummeted by the end of
197! to $45 million - about two weeks' imports at current levels. The
Allende administration has further tightened exchange controls and assumed
a virtual monopoly over export and import transactions. In November,
Allende called for a renegotiation of Chile's large foreign debt, which totals
some $2.3 billion (including about $1.4 billion to the United States), and
stopped payments to most foreign creditors.
2. Chile's foreign exchange crunch derives both from a shortfall in
export receipts and from inflated imports. Lower world prices and
production difficulties after government takeover of the copper mines
brought a 20% drop in copper export earnings in 1971. At the same time,
import requirements rose as a result of government income redistribution
policies that produced a consumer spending spree. Although consumer goods
production was raised by bringing into use idle capacity, this source of
additional supplies has become exhausted, and industrial goods imports have
increased. An even greater increase has occurred in food imports, as land
reform policies have disrupted food output. The worsening political and
economic atmosphere produced a reversal in capital flows from a large net
surplus to a $100 million deficit, despite the cutoff in US copper company
remittances abroad. By late 1971, shortages of food and manufactured goods
were increasingly apparent even though government import policy was aimed
primarily at filling politically embarrassing gaps between supply and demand.
Note: This memorandum was prepared by the Office of Economic Research
and coordinated within the Directorate of Intelligence.
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3. Chile will. continue to face serious balance-of-payments difficulties
in the next year or so, even if it succeeds in obtaining substantial debt
relief in upcoming negotiations with its creditors. In 1972, imports almost
certainly will not be significantly above last year's inadeouate level, and
they may be cut significantly. Stagnant or reduced import capacity will
force Allende to choose between placating the Chilean consumer and making
badly needed investments in the economy. He cannot do both, and shortfalls
of either type will carry political costs.
4. Chile's traditionally weak balance-of-payments performance
improved greatly during the Frei administration. Copper sales, some
70%-80% of export earnings, more than doubled between 1964 and 1970.
Although imports and profit remittances increased even faster than exports,
the current account deficit was more than covered by large capital inflows.
US Loans and grants averaged more than $100 million a year during 1965-70,
and a copper industry expansion program brought in an additional $447
million during the period.
5. The large capital inflows of the Frei period were accompanied
by a rapid increase in external debt, which soared from less than $1 billion
in 1964 to some $2.3 billion in 1970. This jump was predominantly the
result of new borrowing, but the government's purchase of controlling
interests in the principal copper mines in 1967 and 1969 was also a factor.
The Frei administration expected that rising export earnings resulting from
the copper expansion program would allow Chile to cope with the increased
debt service burden.
Ingredients of the Foreign Exchange Crisis
Copper Situation
6. With Allende's election it was a foregone conclusion that the US
share of Chile's copper industry would be nationalized, and there were
doubts that adequate compensation would be paid. Allende promised
compensation, however, and a tedious verification of the companies' assets
and liabilities was undertaken. Nevertheless, on 11 October 1971 the
comptroller general announced that the two largest US companies not only
would receive no compensation but in fact owed some $378 million, which,
because of constitutional limitations, the state would not try to collect.
By Chilean calculations, the companies had taken $744 million in excess
profits during 1954-70. Because the alleged excess profits exceed the total
government-assessed value of the properties, Santiago currently is even
refusing to make payments on that part of the mines purchased by the
Frei government.
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7. Chile took over the copper mines at an ideal time from the point
of view of capital flows. Gross investment inflows under the copper
expansion program - then nearly completed - were scheduled to decline
from an average of $150 ;pillion annually during 1968-70 to less than $20
million in 1971. At the same time, the outflow in profit remittances,
depreciation, and copper debt payments were scheduled to increase from
$135 million to $255 million.* Nationalization automatically cut off all
copper profit remittances, and the decision not to pay compensation and
to suspend payments on the equity share purchased by Frei further reduced
capital outflows.
8. The copper nationalization, however, came at a difficult time from
the technical point of view. At the time of the takeover, new facilities
were starting up and technical difficulties were at their greatest. Early last
year, when the mines were still under company management, production
shortfalls were becoming evident, and these worsened considerably in
subsequent months under government control. In 1971, production
increased by only 4% - a shr..;. contrast with a prediction by the State
Copper Corporation (CODELCO) of a 16.6% rise and with the companies'
original 26% goal. Even the 4% gain was possible only because two new
mines i ire into production. Output at the two largest mines, Chuquicamata
and El Teniente, decreased by 7.5%. The Chilean government now predicts
that production levels planned for 1973 will not be reached until 1975-76.
Although CODELCO blames the production shortfalls on the companies'
mistakes in design - and this assessment may be partly justified - most
of the shortfall apparently is the result of government mismanagement, the
exodus of many trained technicians, and a drop in labor discipline and
morale. The companies probably could have eliminated the technical
problems and reached planned output within one year; it is possible that
the Chilean government, even with substantial Soviet aid, will not be able
to reach this goal at all.
9. The decline in average world copper prices - from 64 ? per pound
in 1970 to about 500 per pound in 1971 - has also hurt Chile's foreign
exchange position. Had prices remained the sante, earnings - even with the
production shortfall - would have amounted to about $900 million in 1971.
Because of the price dec'ine, copper earnings probably were no more than
$720 mill-un.
Rising Import Requirements
10. Certain import requirements have increased substantially as a
direct result of government policies, and total imports increased 1'.J% in
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1971. After taking office, Allende acted quickly to redeem political promises
by freezing prices and by raising wages an average of about 45%. The
resulting increase in real wages led to a sharp rise in manufacturing output,
as excess capacity was put to use. However, because of the government's
antagonistic stand on private enterprise - manifested in the widespread
seizure of both domestic and foreign firms - little or no new capacity was
being generated. Moreover, agricultural production was inhibited by the
government's accelerated efforts at agrarian reform and illegal land seizures
by peasants. Shortages of both food and manufactured goods soon began
to appear, and the government's only remedy was to increase imports at
a time when exports were falling sharply.
Chile: Trade Balance
11. These pressures caused a marked change in import composition
(see Table 1). Imports of food and beverages rose by more than 57% in
1971, and their share of total imports jumped from 17% to 24%. In contrast,
machinery and accessories fell from 26% to 19% of the total, partly because
of the near-cessation of foreign copper investment. Imports of durable
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Table 1
Chile: Import Composition
Million US $
1969
1970 of
1971 b/
Food and beverages
150
173
Unfinished products
105
106
For household consumption
33
29
28
For industrial consumption
72
77
116
Finished products
44
67
127
For household consumption
29
40
88
For industrial consumption
16
17
39
Raw industrial materials
233
235
275
Unfinished
24
25
30
Finished
209
210
245
Combustibles and lubricants
56
78
111
Machinery and accessories
269
265
218
Machines
203
203
149
Parts and accessories
66
62
69
Transport equipment
136
105
145
Vehicles
4
2
4
Equipment
83
57
74
Parts and accessories
49
46
67
Consumer goods
73
93
99
Durable
36
52
49
Nondurable
37
41
50
11
72
6
928
1J021
1,125
a. Preliminary.
b. Estimated.
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consumer goods declined moderately because of government restrictions,
while those of nondurable consumer goods rose by 22%. By year's end,
imports of all categories of conaLmer goods were rising.
Debt Repayment and Other Capital Flows
12. Chile's net external debt rose from $2.3 billion in November 1970,
when Allende took office, to an estimated $2.7 bi.:lion (about $300 per
capita) by the end of 1971. Scheduled debt servicing payments average
about $373 million annually for the next five years, and the heaviest
payments, averaging $412 million (43% of estimated 1971 export earnings),
are due in 1972-74.
13. Outflows of capital have exceeded inflows every month since
Allende's election, and in 1971 Chile's capital account registered a deficit
for the first time in recent history. Although the lessened inflow is partly
a result of the near-completion of the copper expansion program, the
worsening economic and political atmosphere is much more important.
Immediately after Allende's election victory and before he took office,
short-term capital flows, which had been positive during most of 1970,
became strongly negative. Direct investment has come to a standstill and
new borrowing, whether public or private, has declined sharply.
14. US banks, which still have substantial lines of credit outstanding
to Chilean state corporations, are reducing these as rapidly as possible, and
no new credit lines are being granted. Allende alleges that Chile already
has lost as much as $190 million in short-term bank credit, but this figure
probably is exaggerated. West European and Japanese credit lines, never
very important, are now mostly overdrawn, and it is unlikely that they
will be increased substantially. As an exception to the general trend, eight
Argentine banks recently granted a $25 million credit line to the Chilean
Agricultural Commercial Enterprise to import agricultural products,
principally meat, from Argentina.
15. Despite the "wait-and-see" attitude exhibited in most West
European countries with regard to extending untied loans and making direct
investments, the government-owned Pacific Steel Company has been able
to obtain some $100 million in funds from European consortiums for an
expansion program. Although details are lacking, the loan "package" appears
to be made up largely of suppliers' credits for the purchase of European
equipment. This type of arrangement continues to interest European and
Japanese exporters as a means of increasing their share of the Chilean
market. US suppliers, on the other hand, show little inclination to provide
such credits, and the Export-Import Bank (Eximbank) has stopped financing
US exports to Chile.
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16. Despite continued resistance by both Chilean industry and the
military to a shift to Communist equipment and technology, Soviet and
East European assistance clearly has been growing and seems headed for
further expansion. Numerous technical missions have arrived in Chile in
recent months to do feasibility studies on a wide variety of projects to
be undertaken with Communist aid. Since Foreign Minister Almeyda's
mission to Moscow and East European capitals in May-June 1971, long-term
credit agreements involving more than $134 million are known to have been
signed, bringing to $188 million total Communist commitments to Chile.
In late 1971, Moscow also provided $50 million in bank credits which will
enable the Chileans to help meet their short-term commercial obligations.
Allende's Reaction to the Crisis
Foreign Exchange and Import Controls
17. In an effort to reduce the foreign exchange drain, Allende has
established a complex system of multiple exchange rates and various
currency restrictions. Under Frei, there were two basic exchange rates: the
bankers' rate for trade and the brokers' rate for other transactions. Under
Allende, there are now four different bankers' rates, ranging from 12.2
escudos to the dollar for exports and for food and petroleum imports to
25 escudos to the dollar for imports of luxury items. Technically, there
remains a single brokers' rate, which was recently raised from 14 to
28 escudos to the dollar - a 50% currency devaluation for the transactions
affected. In practice, new foreign exchange taxes have created three brokers'
rates: a 28 escudo rate for foreign tourists, a 38 escudo rate for payments
to foreign creditors, and a 43 escudo rate for Chileans traveling abroad
and for payment of foreign royalty and licensing fees. In addition, the
amount of foreign currency a Chilean may take out of the country has
been further restricted. All foreign currency must be bought and sold
through the Central Bank, which is thus able to exercise close control of
exciange transactions.
18. The Allende government directly controls imports by private
business through a prohibitive (10,000%) prior deposit requirement on about
75% of all imports. The government has stated its inte;ition to extend these
controls gradually to most other imports. These restrictions have resulted
in a virtual import monopoly for government agencies, which are exempt
from the requirement. About 80% of exports also are controlled directly
through various state marketing orgatd-ations.
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Foreign Debt Default and Renegotiation
19. The seriousness of the foreign exchange crunch was officially
recognized on 9 November 1971 when Allende announced that Chile would
seek to renegotiate its debt repayment obligations.* Three days later,
Santiago suspended debt service payments except for those due on certain
short-term obligations to foreign suppliers and banks and $400,000 (;f
interest due in 1971 on loans from the US Agency for International
Development. The suspension was followed by the formal presentation of
a memorandum to the 'US government by the Chilean ambassador in
Washington. In this memorandum, Chile requested a three-year (1972-74)
moratorium, with deferred payments being distributed over the following
ten years.
20. Santiago made a similar presentation to a group of US banks on
14 December, but softened its stand somewhat that same day. The new
proposal allowed for "token payments" to the banks during the three-year
grace period and reduced the deferred payment period to seven years. In
late January the two principal US banks presented a counter-proposal,
presently under consideration by the other creditor banks and by Santiago,
that provides for a payment of 5% of the principal in 1972 and in 1973,
10% in 1974, 15% in 1975, 10% in June 19 7 6, and 55% in December
1976. If Chile is unable to meet this last "balloon" payment, the proposal
permits a substantial extension involving a 10%n payment in December 1976
and 15% annually for the next three years. Interest rates during the first
five years will be 1-3/4% above the prevailing London Eurodollar rate and
2% above this rate during the additional three years. If agreed upon, the
new arrangement would require Chile to pay less than half of the debts
due to these banks during the remainder of Allende's presidential term,
scheduled to end in November 1976. The banks' proposal probably reflects
their belief that a fairly generous compromise is necessary in view of Chile's
evident insolvency and is preferable to no payment at all.
21. The United States is the creditor nation that will be most affected
by the proposed renegotiation. Of Chile's net external public debt of $2.3
billion at the end of 1970, some 61% (or $1.4 billion) was owed to this
country, compared with less than 27% owed to all other countries and
about 12% owed to international organizations. The other most important
creditor nations are Italy, West Germany, France, Spain, United Kingdom,
Belgium, and Japan. Should the three-year moratorium be granted, European
countries will bear almost as large a burden as the United States. Most
of the debt contracted with Europeans consists of short- and medium-term
* This statement was later "clarified" to include only that portion of the debt
incurred before Allende came to power.
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suppliers' credits, much of which will fall due during 1972-74. Thus, only
44% of payments that would be affected by the moratorium are scheduled
to go to the United States, while 41-1/2% would go to other countries
and 14-1/2% to international organizations (see Table 2).
22. Although the Chilean government originally stated that it was not
requesting renegotiation of any part of the debt associated with the copper
program, debts resulting from US bank loans to the copper companies were
included in the renegotiation discussions with New York banks in December.
It is possible that Chile also plans to renegotiate loans from the Eximbank
and other third-party creditor? for the copper program at the meeting in
Paris. As was to be expected, Santiago has removed from current
consideration any payments on debts owed directly to the US copper
companies. Some $80 million, which Kennecott received from the Frei
government for the sale of a 51%-interest in its mine and reloaned to Chili
for the expansion program, is not being repaid because it was allegedly
"improperly used." Santiago also has refused payme-,it on the $153 million
still outstanding to Anaconda under the Frei purch~ise agreement, pending
review of the case by a Chilean court that norma.;ly is responsive to the
government's desires.
23. Chile's stance at meetings with US private bankers has indicated
a desire for a quick settlement in order to influence European creditors,
who are traditionally more difficult for a Latin American country to deal
with. The British in particular are expected to take a harder line at the
Paris talks. The first session on 3 February probably will be followed by
a two-week period during which officials of the creditor nations go home,
digest the written material, and work out positions. Upon returning to Paris,
the creditors will meet with Chile and the International Monetary Fund
for further negotiations.
Prospects and Options
24. Even if it is successful in obtaining most of its renegotiation goals,
Chile is likely to face very severe balance-of-payments problems during the
next year or so. Under the best of foreseeable circumstances, Chilean
imports in 1972 probably will not exceed $1,150 million - a mere 2%0
more than last year's inadequate level (see Table 3). Under relatively
unfavorable but still plausible conditions - and assuming no further
drawdown on scant foreign exchange reserves - imports threaten to be as
much as one-third below the 1971 level. Even an intermediate import level
of something like $950 million would leave supply seriously out of balance
with demand and pose difficult adjustment problems for the Allende
government.
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Distribution of Debts Due During the Requested
Moratorium Period (1972-74), by Creditor
Creditor Percent
._~...~
United States 43.9
Export-Import Bank 20.5
US banks 10.8
Agency for International
Development 3.9
Braden (Kennecott Corporation) 3.5
PL 480 0.9
Other private 4.3
International organizations 14.5
Inter-American Development Bank 6.7
International Monetary Fund 4.1
International Bank for
Reconstruction and Development 3.0
International Financial
Corporation 0.5
International Development
Association 0.2
Rest of world
Italy
West Germany
France
Spain
United Kingdom
Belgium
Japan
Other
Total
7.5
6.0
5.6
3:8
3.8
3.5
2.3
9.1
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25. A marked increase in copper production and prices could raise
import capacity above $1,150 million, but such a rise is highly unlikely.
By its own admission, the Chilean government is three years behind targeted
copper production, and new technical and labor problems are arising faster
than they are being solved. World copper prices may improve slightly in
response to the reinvigoration of the US economy, but there is little chance
that they will approach 1970 levels in the near future. Moreover, export
availabilities for fruit nd other agricultural items are apt to decline further,
and there is little reason to expect exports of nontraditional industrial
products to rise.
26. Chile's import capability in 1972 will depend most heavily on
its ability to attract new foreign capital. Total net direct investment flows
can be expected to be zero at best, and no new US credits of any kind
are likely under foreseeable circumstances. On the other hand, it is likely
that Allende will pay virtually nothing to US companies and as little as
possible to the US government. As long as such a move does not frighten
potential Japanese and West European creditors, he has little to lose. The
decision to undertake foreign debt renegotiation, nevertheless, has subjected
Chile's creditworthiness to closer worldwide scrutiny, and many creditors
probably will decide that Chile's future ability -- or willingness -- to repay
new loans is questionable. Western Europe and Japan will continue to
provide some suppliers' credits in an effort to increase their shares of the
Chilean import market, but these credits are unlikely to exceed $50 million
in 1972.
27. Soviet and East European aid will probably increase. With Cuba
as an example to be avoided, however, both Allende and the Soviets want
to limit the degree of Chilean dependence, and thus far virtually nothing
has been drawn on the large project loans and suppliers' credits already
provided. A Soviet decision to bail Chile out with more hard currency credits
and food and petroleum supplies or an effective Chilean decision to shift
to Communist area machinery and technology could significantly raise
assistance flows in a relatively short period. On balance, however, it is
doubtful that Communist assistance will add to Chile's import capacity by
more than $150 million this year.
28. Even if imports can be maintained at 1971 levels or somewhat
higher, Chile will not be able to fulfill its requirements for both consumer
and industrial goods. Shortfalls of either type will carry heavy political costs.
The government's initial populist measures have reinforced the average
Chilean's penchant for good living, and he will not willingly sacrifice his
standard of living in the interest of a socialist revolution. Moreover, at a
time when imports of almost all consumer goods are rising rapidly, a need
for increased capital goods imports is also being felt. The political
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importance of maintaining output and employment - largely dependent on
imported machinery and raw materials - is equal to that of maintaining
living standards.
29. It is doubtful that Chile can obtain the foreign exchange to pursue
either of these goals effectively; to do both would be impossible. To buy
time in which to consolidate his political position, Allende will have to
avoid increasingly apparent shortages and rationing of any kind in the
months ahead. Thus he will probably opt to favor consumer demand at
the expense of industrial outp'it and growth. Clearly, such a policy will
be merely a short-term measure that could exacerbate his difficulties in
eventually coming to grips with Chile's fundamental economic problems.
30. Economic problems in themselves are not likely to bring about
the government's downfall, but they will significantly increase Allende's
political difficulties. In the face of increasing popular dissatisfaction and
recent election losses, Allende's supporters already are torn between
accommodation and radicalization - extremes that Allende prefers to avoid.
It remains to be seen if his political adroitness will be sufficient to permit
him to steer a course between repression on the one hand and dilution
of his "irreversible revolution" on the other. Allende realizes that the one
issue that could possibly unite the Chilean people and lead to a voluntary
acceptance of necessary belt-tightening is that of US "economic aggression."
Using the United States as a scapegoat may well be the only good card
in Allende's hand, and he will take advantage of any opportunity to play
it.
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