Sample: D&B Country Report Chile

D&B Country Report Chile
Country Risk Services Dun & Bradstreet Limited 1

Contents

Country Risk Analyst
Fraser McGruer 01494 422690
Email: mcgruerf@dnb.com

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This D&B Country Report was
prepared in July 2006.
Global Economic Outlook 2
Country Risk Indicator DB2b 3
Key Information 4
Executive Summary 5
Political Risk 5
Macroeconomic Risk 5
External Economic Risk 6
Commercial Risk 6
Political Risk 7
Recent Developments 7
Political Environment 8
Socio-Political Risk 10
External Political Risk 11
Political Risk Outlook 11
Macroeconomic Risk 12
Short-Term Economic Performance 12
Components of Growth 13
Monetary Environment 16
Long-Term Economic Potential 19
Population 20
Technological Progress 20
Investment 20
Long-Term Economic Outlook 21
External Economic Risk 22
Balance of Payments Performance 22
Current Account 22
Export Profile 24
Import Profile 24
Financial and Capital Account 25
Foreign Debt and Default Risk 27
Foreign Exchange Reserves 28
Exchange Rate Risk 29
Trade Environment 31
Trade Overview 31
Current Account Exchange Regulations 32
Tariff Barriers 32
Non-Tariff Barriers 33
Commercial Risk 35
Credit Risk 35
Financial Sector Risk 36
Corruption 37
Other Commercial Risks 38
Commercial Risk Outlook 38
Investment Environment 40
Investment Overview 40
Capital Account Exchange Regulations 40
Foreign Direct Investment Environment 40
Portfolio Investment 42
Additional Sources of Information 43
Glossary 44
Country Risk Indicator Definition 46
SAMPLE

Global Economic Outlook
Real GDP growth forecast
World, %
2006
3.3
Interest rates and oil price
US interest rate, %
Jun. 2006
5.00
US, % 3.1 ECB interest rate, % 2.75
Euroland, % 2.0 Japan interest rate, % 0.10
Japan, % 2.7 Oil price (Brent crude), USD p/b 67.7

%
0.0
1.0
2.0
3.0
4.0
5.0
6.0
2
0
0
0
2
0
0
1
2
0
0
2
2
0
0
3
2
0
0
4
2
0
0
5
e
2
0
0
6
f
2
0
0
7
f
Asia/Pacific
Middle East & Africa
Europe
Latin America
North America
World
Sources: International Monetary Fund; D&B

World Growth
We expect the world economy to grow by 3.3% in
2006 on an exchange-rate-based weighting. The
main risk facing the global economy is the
imbalance between a savings overhang in much of
Asia and the level of external indebtedness in the
US. If these imbalances unwind in a disorderly way,
this could impede world economic growth.
Positively, the growth differential between the US
and Western Europe (the two largest regional blocs)
will narrow in 2006 and 2007, with Europe
recovering and US consumer spending slowing over
that period. The slowdown in US growth will also
drag down global economic activity slightly in
2007.

% (at month-end)
1.0
2.0
3.0
4.0
5.0
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7.0
8.0
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N
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-
0
7
M
a
r
M
a
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J
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l
Actual US interest rate
Forecast US interest rate
Actual ECB interest rate
Forecast ECB interest rate
Sources: US Federal Reserve; European Central
Bank; D&B

US and Euroland Interest Rates
US: With no moderation in the core inflation rate in
May, it now appears likely that the Federal Reserve
will raise rates by a further 25 basis points to 5.25%
at its meeting in late June. Beyond this, a further
rise is possible, although the Federal Reserve will
be increasingly aware about the risk of over-
extending its current tightening phase to the
potential detriment of economic growth.
Euroland: The ECB is likely to continue to tighten
monetary policy gradually, even after its 25 basis
point rise in the main policy rate to 2.75% on 8
June. Strengthening demand in the euro-zone has
started to affect core inflation, while oil prices
continue to push headline rates up. Brisk money and
credit growth also call for further tightening.

45
50
55
60
65
70
75
J
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-
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5
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N
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M
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Actual price
Forecast price
USD/b (ave.)
Source: D&B

Oil Price (Brent Crude)
Oil prices again broke USD70 per barrel (/b) in
early June after easing back in mid-May. Tight
production and refinery margins have maintained
upward pressure on prices. This should ease as
there is increasing evidence of a slowdown in global
demand growth and on 31 May OPEC confirmed it
would not cut production levels. In early June Irans
Supreme Leader shook oil markets when he said oil
flows from the Gulf would be at risk if the US made
the wrong move over Irans nuclear programme:
this came after the two sides had seemed closer to
resolving the issue, thereby easing pressure on
prices. D&B is maintaining its price forecast for
2006 at USD63.5/b.

SAMPLE

Country Risk Indicator DB2b
For Country Risk Indicator Definition see page 46

Low Risk
Low degree of uncertainty associated with expected
returns. However, country-wide factors may result in
higher volatility of returns at a future date.

The DB indicator is a comparative, cross-border
assessment of the risk of doing business in a country. The
indicator seeks to encapsulate the risk that country-wide
factors pose to the predictability of export payments and
investment returns over a time horizon of two years.

Overall Outlook
D&Bs risk rating of DB2b for Chile reflects the countrys sound
macroeconomic fundamentals, buoyant external sector, strong regulatory
environment and entrenched democratic politics.

Positive Risk Factors
+ The political risk level in Chile is well below regional standards. Since taking
office in March 2006, Michelle Bachelet (Chiles first female president) has
performed reasonably well, as reflected in her high public approval ratings.
+ The short-term economic risk outlook is broadly favourable, we forecast
robust (albeit moderating) real GDP growth of 5.4% and 5.1% in 2006 and
2007 respectively.
+ While there are some upside risks to inflation, we expect the monetary
authorities to be largely successful in controlling the price level: after rising to
3.5% in 2006, average inflation is forecast to ease to 2.7% in 2007
+ Chiles external economic profile is among the best in Latin America,
underpinned by a competitive export sector, favourable current account
dynamics, a relatively stable currency and manageable external debt levels.
+ High, albeit moderating copper prices are forecast to help sustain current
account surpluses equivalent to 1.3% and 0.5% of GDP in 2006 and 2007
respectively.
+ Successive Chilean governments have signed numerous free-trade agreements
with major markets and real import tariffs are at all-time lows.

Negative Risk Factors
Despite trade diversification, Chiles economy remains heavily exposed to
changes in the international copper price. A sharper-than expected decline in
the price of copper could place pressure on the current account, reduce the
fiscal surplus and place downward pressure on the currency.
Although Chile has achieved the Millennium Development Goal of cutting the
incidence of poverty in half, the country still has the worlds 12th most
unequal income distribution. The new Bachelet government must seek to
address social inequality, especially in human capital, if Chile is to improve its
risk rating.
Economic growth could decline in a less measured manner than our forecast if
the global economy slows more quickly than expected, leading to a larger than
expected decline in the price of copper.
Although upside risks to inflation will require continued monetary tightening,
the authorities will have to remain wary of the risk of becoming overly
restrictive.
Regional Risk
Indicators
Canada DB1c
USA DB1c
Chile DB2b
Trin. & Tob. DB2d
Mexico DB3a
Costa Rica DB3c
Brazil DB3d
Panama DB4a
Colombia DB4b
El Salvador DB4b
Peru DB4b
Uruguay DB4c
Dominican Rep. DB4d
Jamaica DB4d
Guatemala DB5a
Argentina DB5b
Venezuela DB5d
Honduras DB6a
Bolivia DB6b
Ecuador DB6b
Paraguay DB6b
Nicaragua DB6c
Cuba DB6d
End-2003 DB2b
End-2004 DB2b
End-2005 DB2b
Comparative Risk
Indicators
Iceland DB2b
Mauritius DB2b
New Zealand DB2b
Indicator History
Chile's Risk
SAMPLE

Key Information
Economic and Development Information
2003 2004 2005 2006f 2007f
GDP
CLP bn 50,954 57,906 64,549 71,349 78,149
USD bn 73.7 95.0 115.2 132.1 140.8
Breakdown of GDP
Agriculture (%) 14.9 14.7 14.4 14.4 14.4
Industry (%) 24.0 23.9 24.0 24.0 24.0
Services (%) 61.1 61.4 61.6 61.6 61.6
Economic indicators
Real GDP growth (% change) 3.9 6.2 6.3 5.4 5.1
Inflation, annual average (%) 2.8 1.1 3.1 3.5 2.7
Government balance (% GDP) -0.4 2.1 4.7 5.5 2.7
Unemployment, annual average (%) 8.5 8.8 8.1 8.0 7.8
Current account balance (% GDP) -1.3 1.7 0.6 1.3 0.5
Long-term real GDP growth potential, annual average, 2006-15: 5.0-5.5%
Development indicators Argentina Brazil Chile Mexico US
Population, 2005 (m) 39.2 180.6 16.1 105.3 294.9
Population, 2015 (m) 42.8 200.9 17.8 120.6 318.0
Population, 2050 (m) 53.0 247.6 21.6 162.9 354.2
Adult literacy (%) 96.5 84.0 95.2 90.1 99.0
GDP per capita (USD) 7,460 3580 4,590 5,070 34,100
GDP per capita (USD PPP) 12,050 7,300 9,100 8,790 34,100
Life expectancy (years) 73.6 67.5 75.0 72.4 78.1
Internet hosts (per 10,000 people) 47.3 39.0 82.3 50.6 2420.0
Dependency ratio, 2005 0.59 0.51 0.50 0.61 0.51
Political Information
Head of state & government President Michelle Bachelet Jeria
Political system Multiparty democracy
Present constitution adopted 1980
Ruling coalition Concertacion Coalition
Last elections Presidential: December 2005; Congressional: December 2005
Next elections Presidential: December 2009; Congressional: December 2009
Miscellaneous Information
Religion Roman Catholic
Capital (population) Santiago (4.8m)
Timezone GMT -4 hours
Sources: Central Bank of Chile; World Bank, World Development Report; D&B
SAMPLE

Executive Summary
Political Risk
The political risk level in Chile is well below regional standards. The presidential
election on 11 December 2005 was inconclusive as none of the four candidates
received an absolute majority. Michelle Bachelet, a moderate socialist of the
Concertacion coalition, won 53.49% of the vote to defeat Sebastian Pinera, a centre-
right candidate from the Alianza por Chile coalition in a further runoff election
among the top two candidates on 15 January 2006. As a result, she succeeded
President Ricardo Lagos on 11 March 2006 for a period of four years. Bachelets
inauguration meant that Chile had a female president for the first time in its history
and the prospect of a fourth successive term in office for the centre-left Concertacion
coalition.

Bachelet appears to have performed reasonably well during the early stages of her
tenure, as evidenced by a 65% approval rate in a poll released by the Corporacion
CERC at the end of May 2006. Positively, the overall political environment and
Bachelets policy efforts are likely to be aided by the fact that the Concertacion
alliance has also won majorities in both the lower and upper houses of parliament for
the first time. Bachelet has generally conformed to expectations in terms of pursuing
the orthodox and prudent economic policies of her predecessor, allied with a greater
focus on expanded social reform programs. Key areas of her social reform agenda
include: education; health; pensions; reduced income inequality; increasing
employment opportunities for women and young people; and ongoing constitutional
reforms (to rectify Pinochet-era laws).
Macroeconomic Risk
While remaining generally buoyant, Chiles economic growth slowed to 5.1% in Q1
2006, from 5.8% in Q4 2005. Although continuing as the main driver of economic
growth, domestic demand growth slowed to 8.3% year on year from 10.1% in Q4
2005. This moderate slowdown in domestic demand was partly attributable to high
international oil prices and higher interest rates which had a negative impact on
private consumption. From the supply side perspective, total economic output was
adversely affected by a contraction in the agricultural sector due to unfavourable
climatic conditions and reduced output of non-traditional crops.

Going forward, we expect the pattern of moderately slower economic growth to be
repeated in subsequent quarters, resulting in forecast real GDP growth of 5.4% in
2006 as whole. More specifically, domestic demand is expected to be constrained by
tighter monetary conditions while the external environment will become somewhat
less favourable due to slower economic growth in key trade partner nations and
reduced market prices for copper. In 2007, real GDP growth is forecast to slow
further to 5.1% due to the continued measured deceleration in domestic and external
demand conditions.

In the early part of 2006, the headline rate of inflation stood close the top of the
central banks targeted range of 2-4%. Accordingly, despite a pause in May and
June, the bank indicated that additional increments would be necessary in coming
months. Therefore, D&B forecasts that the policy rate will stand at 5.5% by the end
of 2006. Aided by the associated moderation in domestic demand, we expect the
central bank to be largely successful in its efforts to control inflation expectations
and to prevent the emergence of significant wage cost pressures. Indeed, lower
inflation and slowing domestic demand should facilitate a switch to an easing bias in
early 2007.

SAMPLE

External Economic Risk
Chiles external accounts are among the most stable in Latin America. In recent
years this performance has been underpinned particularly by the cyclical and
possibly structural rise in the price of copper, Chiles most important export item.
Going forward, the overall external economic outlook will remain broadly
favourable. In Q1 2006, increased copper receipts helped the current account surplus
to increase by 17.8% year on year to USD588m. More recent monthly data has
shown that copper revenue in the first five months of 2006 stood at USD11.6bn,
nearly double the USD6.6bn during the same period of 2005. While, import growth
has also been strong (increasing by 24.7% year on year in Q1), we are forecasting a
significantly increased trade surplus in 2006 and an expansion in Chiles current
account surplus to around 1.3% of GDP.

Looking further ahead to 2007, the outlook is necessarily more uncertain. We
anticipate a moderate easing in the pace of global economic growth, with a
concomitant reduction in the price of copper. This is consistent with the Chilean
central banks own forecast of reduction in the average price of copper in 2007.
Indeed in D&Bs view, the USD8,800 per tonne all-time high price which was
reached on 11 May, will remain the high point throughout the two-year forecast
period (as of mid-June 2006, the price of copper had fallen by around 20% from this
level, albeit remaining over 50% higher from the end of 2005). Given lower average
copper prices, and the continuation of relatively robust demand conditions (which
will help to support import growth) we are forecasting a reduction in the overall
current account surplus to around 0.5% of GDP in 2007.

The major risk to this still relatively benign scenario is a larger-than-expected
contraction in global demand (something we feel is most likely to originate from a
sharper-than-anticipated slowdown in US consumer expenditure), resulting in a more
severe fall in copper prices than presently expected. On the currency, we expect the
Chilean peso to remain broadly stable in the second half of 2006, before a moderate
3% depreciation in 2007. However, as for the current account, the major risk to our
relatively positive outlook is a larger than-expected contraction in copper prices,
which could result in a larger depreciation in the peso.
Commercial Risk
D&B believes that solid domestic demand and investment, and robust export growth
will drive overall economic growth. Credit conditions will remain broadly favourable
in the two-year forecast period as firms seek to expand output to meet export and
internal demand. Healthy revenue and profit growth will also help to support
payments performance. Despite forecast higher interest rates and inflation, credit
conditions will remain buoyant and overall trading risks when dealing with Chile are
minimal.

Meanwhile, conditions in the financial sector are good, with regulation and
transparency in line with international norms. More reform over the short to medium
term will further strengthen the system. Reform of the copyright law should also be a
priority before 2008 (part of Chiles free-trade deal with the US) as Chile could
otherwise face legal action for widespread breaches of the law.

Finally, corruption in Chile is clearly not as widespread as in the rest of the region. A
general political consensus against corruption and new laws designed to minimise
the chance for corruption to occur should help to safeguard generally Chiles clean
reputation.
SAMPLE

Political Risk
Key Point: The political risk level in Chile is well below regional standards.
Since taking office in March 2006, Michelle Bachelet, Chiles first female
president has performed reasonably well, as reflected in her relatively high
public approval ratings.
Recent Developments
Chiles centre-left Concertacion Alliance of Parties for Democracy (comprising four
political parties) has held uninterrupted power since the country returned to
democratic government in 1989. Ricardo Lagos of the Party for Democracy (PPD)
was president between January 2000 and 2006, when he was replaced by Michelle
Bachelet.

Despite fierce inter-party competition, the Concertacion Alliance won re-election in
the 2001 Congressional elections, albeit with a vulnerable majority. Lagos
administration was dogged by scandals throughout the first half of its government.
However, in the latter part of his tenure, Lagos steadily regained much of his lost
popularity due to his deft handling of corruption crises within the Concertacion and
the countrys increasingly robust economic performance. These factors helped the
Concertacions campaign efforts in the lead up to the December 2005 Congressional
and Presidential polls.
Presidential election December 2005 - January 2006

The presidential election on 11 December 2005 was inconclusive as none of the four
candidates received an absolute majority. Bachelet, a moderate socialist of the
Concertacion coalition, won 53.5% of the vote to defeat Sebastian Pinera, a centre-
right candidate from the Alianza por Chile coalition in a further runoff election
among the top two candidates on 15 January 2006. As a result, she succeeded Lagos
on 11 March 2006 for a period of four years; in September 2005, Congress had
reformed the constitution to reduce the length of the presidential term to four years
from six years previously. Bachelets inauguration meant that Chile had a female
president for the first time in its history and the prospect of a fourth successive term
in office for the centre left Concertacion coalition.
Table 1
Results of 2005/06 Presidential Election
Candidate First round, % of vote Second round, % of vote
Michelle Bachelet (PS/CPD) 46.0 53.5
Sebastian Pinera (RN/APC) 25.4 46.5
Joaquin Lavin (PH/JPM) 23.2
Tomas Hirsch Goldschmidt (UDI) 5.4
Source: Ministry of the Interior, http://www.elecciones.gov.cl

In D&Bs view, Bachelets victory bodes well for continued political stability in
Chile, and the ongoing normalisation of the politics following the divisions created
in the Pinochet era. Indeed, one of the most significant changes in Chile's political
landscape was the appearance of two presidential candidates from the right.
Previously, the two conservative parties, the RN and the UDI had combined forces in
the Allianza por Chile. However, in May 2005, RN leader Sebastian Pinera broke
with the coalition, announcing that he would run separately rather than back the
Union's candidate Joaquin Lavin, who had lost the last presidential contest by a slim
margin.
SAMPLE

Table 2
Party Standings Following December 2005 Congressional Elections
Party Chamber of Senate
Deputies (seats)
(seats)
Concertacion Coalition 65 20
Of which: Christian Democratic Party (PDC) 20 7
Party for Democracy (PPD) 21 3
Socialist Party (PS) 15 8
Radical Social Democrats (PRSD) 7 2
Alianza por Chile Coalition 54 17
Of which: Democratic Independent Union (UDI) 33 9
National Renewal (RN) 19 8
Independents List D 2 -
Independent (off pact) 2 1
Total 120 38
Source: Ministry of the Interior, http://www.elecciones.gov.cl
The split on the right, which helped Bachelet greatly, reflected Pinera's calculation
that a party with less attachment to the Pinochet-era and more modern type of
conservatism could be more successful. Pineras victory over Lavin in the first phase
of the election appeared to strongly vindicate this view. Although frustrated by
Pinera's decision to run independently, Lavin later pledged his support to Pinera
immediately after the elections, effectively reconstituting the coalition.

Indeed, one of the notable features of the latest presidential election was the main
opposition National Renovation Partys (Pineras party) efforts to appeal to the
centre ground by openly criticising the legacy of Democratic Independent Union,
which is rooted in base of supporters form the Pinochet period.
Political Environment
Bachelet appears to have performed reasonably well during the early stage of her
tenure, as evidenced by a 65% approval rate in a poll released by the Corporacion
CERC at the end of May 2006. Positively, the overall political environment and
Bachelets policy efforts are likely to be aided by the fact that (for the first time,) the
Concertacion alliance has majorities in both the lower and upper houses of
parliament. In terms of policy, Bachelet has generally conformed to expectations in
terms of pursuing the orthodox and prudent economic policies of her predecessor,
allied with a greater focus on expanded social reform programs. Key areas of her
social reform agenda include: education; health; pensions; reduced income
inequality; increasing employment opportunities for women and young people; and
ongoing constitutional reforms (to amend Pinochet-era laws).

On her first day in office, Bachelet announced the first of 36 measures (see Policy
Agenda) targeted for her first 100 days in office including: free health care for all
patients older than 60 through the national health-insurance system (previously, only
patients older than 65 enjoyed this benefit); and the creation of a special commission
to investigate pension reforms including members from the opposition as well as
from the government. Significant pension reforms proposals are likely to emerge in
2007. The key issue with respect to pensions is that more than half of the
beneficiaries in the current privatised system are expected to reach retirement age
without sufficient assets to purchase the state guaranteed minimum annuity. Potential
changes to the system could include fiscal incentives for greater contributions and
measures to increase competition among plan sponsors to lower management costs.
Positively, Concertacions control over both houses of Congress and the generally
consensual approach to policy making should help the passage of proposed reforms.
SAMPLE

Nevertheless, Bachelets ability to implement her manifesto pledge of reforming the
binomial electoral system for congressional elections remains unclear.

Since taking office, Bachelet has faced little in the way of serious political
challenges. However, there were large high school demonstrations and strike action
between May to early June 2006, with students demanding increased funding for
public schools. Nevertheless, the standoff appeared to have been resolved by June,
when Bachelet offered various concessions including nearly USD200m in funding
for repairs to hundreds of dilapidated schools and benefits including thousands of
free school lunches and free entrance exams.
Political System
The Executive: Constitutional reforms passed in September 2005 reduced the length
of the presidential term to four years from six previously. Reforms also reduced the
power of the presidency by limiting its capacity to control the congressional agenda
and by allowing the Chamber of Deputies greater powers to supervise executive
decisions. Additionally, the reforms also reduced the political influence of the
military by giving the president the power to dismiss military commanders and by
reducing the powers of the military-dominated National Security Council.

The Legislature: Legislative power lies in a bicameral Congress comprising a lower
house (Chamber of Deputies) of 120 members elected nationally for a four-year term
and an upper house (Senate) of 38 elected senators (the 2005 constitutional reforms
abolished all unelected Senate seats). Senators are elected for a maximum term of
eight years. The two major political coalitions fractured during the run-up to the
2005 presidential election. Nevertheless, the differences between ex-coalition
members and between coalitions are not large. This tends to moderate parties
sectoral political demands.

The Judiciary: The judiciary was once subservient to the military junta, so judicial
reform was an important policy priority for the post-dictatorship administration as
part of overall efforts to democratise the countrys political institutions. The power
of the Supreme Court was strengthened and its role expanded to ensure that the
executive and legislature were accountable.
Policy Agenda
D&B has no concerns over economic policy following the recent presidential
election: monetary and fiscal policy will remain prudent, with the Bachelet
administration subscribing to the previous governments principle of a structural 1%
surplus on the central public accounts, which will support Chiles credibility in
international markets. In addition, the independent central bank will continue to have
inflation targeting and exchange rate stability as its key focuses. In addition, during
an address to nation, on 21 May Bachelet articulated 4 key transformations that her
administration was seeking to achieve during her term:

1. Pension reform: key specific areas include: incorporating the self-employed
into the scheme; refining the systems minimum guarantees; introducing
more gender equality; encouraging more competition and transparency; and
increasing the profitability of the funds.

2. Quality in education: including reform of pre-school education (seen as a
key originating source of later inequalities); more resources for children
coming from less well-off backgrounds; priority support for schools in more
densely populated areas.

3. Innovation development: including increasing productivity through greater
innovation; introducing new products and adding technological value to
exports; increasing expenditure on R&D to 1% of GDP by 2010.
SAMPLE


4. Housing and urban development: including a focus on higher quality
housing construction and the reduction of segregation by social class;
increased environmental enhancement efforts.
Socio-Political Risk
Internal Stability
Following the transition to democracy in 1989, the rule of law has been established
and successive governments have reinstated widespread respect for human rights as
an important policy objective. The previous Lagos government sought to reconcile
the families of the victims of the 1973-89 dictatorship (represented by the Group of
Families of the Detained-Disappeared, AFDD) and alleged perpetrators, but pressure
to deal with cases of alleged human rights violations remains considerable and
finding evidence against perpetrators is exceedingly difficult. Since 1990, there have
been eight attempts at reaching a political or legislative solution to nearly 1,200
forced disappearances. The government continues to look for ways of encouraging
former officers to provide the information that will help to locate the disappeared.
Prosecutors have managed to exploit loopholes in the 1978 amnesty law and are
currently charging several retired officers for kidnapping.

On the whole, there are no major internal security concerns, with interest groups
seeking to lobby parliament through democratic means. Nevertheless, high rates of
poverty (around 20% of the population live in poverty and Chile has a very unequal
distribution of income) and unemployment mean that common crime rates are
relatively high. Organised crime and money laundering is present, albeit less
widespread than in some other Latin American nations with weaker political and
legislative systems.
Interest Groups
The Military: The military played a major role in shaping the countrys recent
history. However, Lagos accelerated the reduction of its power by limiting the
military budget. The military is now subservient to the countrys executive and no
longer influences the governments policy agenda as it did during the Pinochet era.

The Catholic Church: As in many Latin American countries, the Catholic Church is
an important political player. Pinochet actively and unsuccessfully sought Church
support during his period in office, although during military rule, the Church, guided
by an ethos of Christian social justice, sought to defend human rights and provided
shelter for some of the persecuted. The Church continues to represent the under-
privileged and plays an important role in education through Catholic universities.

Business Groups: The main business groups are the Society for the Promotion of
Manufacturing (SOFOFA) and the Confederation for Production and Commerce.
SOFOFA is generally supportive of government policy and at times has an input into
policy-making.
Labour Relations
Industrial strife is minimal in Chile, partly reflecting the repression of unions during
the military era. Union membership is still limited and most wage bargaining is
conducted at company level. Nevertheless, since the late 1990s when democracy
became more entrenched, the public sector labour unions (allied to the ruling
Concertacion) have become more vocal, seeking concessions from the government in
terms of welfare spending and labour legislation. Chiles ports have been
intermittently hit by disruptive strike action ahead of privatisation.
SAMPLE

External Political Risk
The democratic governments of the 1990s worked hard to reintegrate Chile into the
world and end its status as an international pariah. Over the last decade, foreign
relations have been increasingly entwined with the governments desire to develop
trading relations. The country joined the Asia Pacific Economic Co-operation
(APEC) forum in November 1994 and in 1995 became an associate member of
Mercosur, the trade group that links Argentina, Brazil, Paraguay and Uruguay
(Bolivia, Peru and Venezuela are also associate members).

The previous Lagos government suggested that Chile would not enter the Free-Trade
Area of the Americas unilaterally but would act in unison with other Mercosur
members. Meanwhile, in recent years Chile has signed a number of bilateral trade
treaties, most notably with the EU, the US and South Korea.

Elsewhere, in mid-2004, Peru and Chile clashed over borders created by the 1929
Treaty. Both Peru and Chile suggested that they had the military capability to deal
with any threat; Chile is presently upgrading its naval strength. However, we believe
that the issue arose from Peru-Bolivia talks aimed at providing the latter with Pacific
Ocean access along the Peru-Chile border. We believe that no military conflagration
will result between the two countries and Chile remains committed to finding
practicable ways to offer Bolivia access to the Pacific Ocean. Bachelet has stated her
willingness to debate all aspects of bilateral relations, including the conditions
necessary to facilitate access to the Pacific for Bolivia.

The recent election of Evo Morales as president of Bolivia is not expected have a
detrimental impact on bilateral relations with Chile. Indeed, there is a possibility that
relations could improve with the recent political changes in the two countries.
Positively, Bachelets inauguration was attended by Morales (in exchange of the visit
Lagos had paid to Morales' inauguration). During their meeting, Morales expressed
his desire for improved relations with Chile and Bachelet reciprocated by pledging
the same, including a desire to re-establish diplomatic relations with Bolivia.
Political Risk Outlook
The political risk level in Chile is well below regional standards. The presidential
election on 11 December 2005 was inconclusive as none of the four candidates
received an absolute majority. Bachelet, a moderate socialist of the Concertacion
coalition, won 53.49% of the vote to defeat Pinera, a centre-right candidate from the
Alianza por Chile coalition in a further runoff election among the top two candidates
on 15 January 2006. As a result, she succeeded Lagos on 11 March 2006 for a
period of four years. Bachelets inauguration meant that Chile had a female president
for the first time in its history and the prospect of a fourth successive term in office
for the centre-left Concertacion coalition.

Although probably too early judge, Bachelet appears to have performed reasonably
well during the early stage of her tenure, as evidenced by a 65% approval rate in a
poll released by the Corporacion CERC at the end of May 2006. Positively, the
overall political environment and Bachelets policy efforts are likely to be aided by
the fact that (for the first time,) her Concertacion alliance has majorities in both the
lower and upper houses of parliament. In terms of policy itself, Bachelet has
generally conformed to expectations in terms of pursuing the orthodox and prudent
economic policies of her predecessor, allied with a greater focus on expanded social
reform programs. Key areas of her social reform agenda include: education; health;
pensions; reduced income inequality; increasing employment opportunities for
women and young people; and ongoing constitutional reforms (to amend Pinochet-
era laws).
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Macroeconomic Risk
Key Point: The short-term economic outlook remains broadly favourable.
However, moderate slowdowns in domestic and external demand are
forecast to result in lower real GDP growth of 5.4% and 5.1% in 2006 and
2007 respectively.
Short-Term Economic Performance
Chiles economic successes over the past 20 years reflect sound and consistent
policy measures based on trade and exchange rate flexibility and, in recent years,
inflation targeting and fiscal prudence. After a recession in 1999 (when real GDP fell
by 0.8%), economic growth averaged an unimpressive 3.5% in the next four years.
However, the rate of expansion accelerated considerably in 2004 with real GDP
growth of 6.2%, due in large part to higher copper prices that were more than double
end of 2002 levels. In 2005, the continued rise in copper prices and robust demand
conditions led to continued economic buoyancy and slightly faster real GDP growth
of 6.3%.
Chart 1
Yearly GDP Growth Contribution by Demand
%
-8
-6
-4
-2
0
2
4
6
8
10
12
14
1997 1998 1999 2000 2001 2002 2003 2004 2005
Private consumption Gross fixed capital formation
Change in inventories Government consumption
Net exports Real GDP growth
Source: Banco Central de Chile, Boletin Mensual, http://www.bcentral.cl
2006, from 5.8% in Q4 2005. Although continuing as the main driver of economic
private consumption. From the supply-side perspective, total economic output was

tighter monetary conditions (see Interest rates), while the external environment
(see External Economic Risk) will become somewhat less favourable due to
slower economic growth in key trade partner nations and reduced market prices for
copper. In 2007, real GDP growth is forecast to slow further to 5.1% of GDP due to
the continued measured deceleration in domestic and external demand conditions.
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Components of Growth
Table 3
Contribution to Growth
2003 2004 2005
Real growth rate (%):
Private consumption 4.2 6.1 8.2
Gross fixed capital formation 5.7 11.7 24.7
Government consumption 2.4 6.1 4.5
Exports 6.5 11.8 6.1
Imports 9.7 18.0 20.4
Real GDP 3.9 6.2 6.3
Share of GDP (%):
Change in inventories 1.1 1.7 1.4
Net exports 0.9 -1.0 -5.8
Contribution to real GDP growth (percentage point):
Change in inventories 0.5 0.8 -0.3
Net exports -0.9 -1.9 -5.2
Private Consumption
Private consumption increased in real year-on-year terms from 2000 to 2004. The
low interest rate environment (see Monetary Environment) buttressed private
consumption of consumer durables, in particular. In 2005, a decline in the
unemployment rate and increased real disposable income growth (the government
increased the minimum wage by 6.25% in June 2005, more than double the rate of
inflation) enabled private consumption growth to accelerate to 8.2% from 6.1% in
the previous year.

Private consumption growth slowed to by 7.3% in Q1 2006 year on year, against
8.6% in Q4 2005. This moderate slowdown was attributable to slightly higher
unemployment, higher interest rates and a slower rate of real income expansion.
Going forward, this trend is expected to persist in subsequent quarters resulting in
slower forecast private consumption growth of 5.9% in 2006. In 2007, the same
factors are expected to reduce real GDP growth further to 5.4%. Although the
overall outlook for private consumption is broadly stable, D&B remains concerned
over the economys insufficient potential for permanent job creation. Seasonal
employment (based on the output calendar in the agriculture sector) continues to
account for a sizeable section of the workforce, leading to wide fluctuations in the
unemployment rate from winter to summer.
Gross Fixed Capital Formation
Over the period 1998-2002, investment spending, which represents around 21% of
total GDP, was poor by Chilean standards. Investment spending fell by an average
1.8% in each year. This weakness in investment spending was partly attributable to
domestic and foreign business sectors lack of confidence in the Lagos government
ability to implement consistent, business and investment-friendly policies. At the
same time as cutting interest rates, the government formulated populist labour market
and healthcare reforms, and devised plans for a royalty tax on mining companies.
SAMPLE

The weak external environment in 1999-2002 also affected domestic business
confidence; Chilean companies with significant investments in Brazil and Argentina
saw their profits slashed and cut their investment plans accordingly.

Investment spending picked up significantly in 2003 and 2004, rising by 5.7% and
11.7% in each year respectively. The dramatic rise in the export sectors seen in these
two years encouraged investment in the export industries. At the same time,
monetary policy was loose, which stimulated commercial lending greatly. FDI into
Chile also increased significantly as investors recognised Chile as a relatively low
risk emerging markets with large exposure to the natural resources sector (especially
copper). In 2005, fixed investment growth surged to 24.7%, as economic buoyancy,
relatively low real interest rates and the continued growth in copper prices, spurred
business confidence.

In Q1 2006, fixed investment slowed to 10.2% year on year from 19.7% in Q4 2005.
Partly, this sharp slowdown was attributable a high base of comparison in 2005:
fixed investment grew in excess of 25% during the first three quarters of 2005.
However, this was also the result of less favourable monetary conditions and the
expectation of slower economic growth in the second half of 2006 on the part of
businesses. In D&Bs view, these same factors will constrain investment growth in
subsequent quarters. Nonetheless overall fixed investment is forecast to grow by a
healthy 7.1% in 2006, slowing further to 5.4% in 2007 as the copper price eases.

Government Consumption
In general, successive governments have shown a commitment to prudent fiscal
policy. The preceding Lagos government made a concerted attempt to reallocate
spending to social priorities, in the context of reduced spending overall, which
helped to ensure a government deficit of just 0.4% of GDP in 2003 and a surplus of
2.1% of GDP in 2004. Positively, Bachelet has pledged to maintain the preceding
governments rule of maintaining an average 1% budget surplus for every five-year
period. Meanwhile, high copper prices have fed the Copper Stabilisation Fund,
which receives surplus earnings when the copper price is above USD0.96 per pound
and transfers holdings to the Treasury when the world price falls below USD0.96 per
pound. The government also uses accrued surpluses to selectively prepay
government debt.
Chart 3
Government Balance
-12
-10
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-4
-2
0
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2
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f
Chile Argentina Brazil Mexico
% of GDP
Sources: Ministry of Finance, http://www.minhda.cl; D&B
SAMPLE

Positively, in 2005 the budget surplus increased further to 4.7% of GDP, as surging
copper related revenues, increased total revenues and real expenditure growth was
limited to just 6.5%. Going forward, the governments 2006 budget forecasts a
reduced surplus of around 2.2% of GDP. However, this forecast is based on the
highly conservative forecast that total copper revenues will fall by around 30% due
to lower prices. However, as of mid-June 2006 the price of copper was around 50%
higher than the end of 2005. Consequently, a significant increase in copper related
revenue is more likely, and D&B forecasts an increased fiscal surplus of around
5.5% of GDP in 2006. In 2007, lower copper prices are expected to contribute to a
reduced fiscal surplus of 2.7% of GDP.
Copper Royalty Tax
As the copper industry remains a huge source of income for the state, the preceding
Lagos government first proposed the introduction of a royalty tax of 3% in early
2004. The proposal eventually won congressional support in May 2005, after two
years of congressional debate and nearly a year after the government first proposed
the Royalty Bill. The 2005 Royalty Law created a tax of 5% on the operating profits
of mining groups with an aggregate annual output of more than 50,000 tonnes of fine
copper equivalent. The new tax has been applied from the start of 2006 and is
expected to yield more than USD150m per year. The royalty tax forms part of the
governments broader plan to improve tax receipts, often hindered by evasion and
the almost constant reduction in import tariffs as free-trade deals come into force.
Increasing receipts will form an integral strand in funding anti-poverty policies over
the short to medium term.
Net Exports
With overseas trade accounting for a much larger proportion of GDP in Chile than
Brazil or Argentina for instance, net exports have been an important source of GDP
growth. One of the major determinants of whether net exports positively contribute
to GDP or detract from it is the international price of copper. Copper prices have
been on an upward trend since 2000, driven by Chinas growing demand for the
metal as well as improved access for Chilean copper in the EU and the US.
However, high copper prices are by no means a guarantor of positive growth
contributions from the external sector. Indeed, in recent years there have been
sizeable negative contributions from the external sector because exports growth,
while strong, has tended to fall a long way short of import growth.
Chart 4
Export and Import Growth
-15
-10
-5
0
5
10
15
20
25
1997 1998 1999 2000 2001 2002 2003 2004 2005
Exports Imports
y/y % change
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On the debit side, Chile is vulnerable to a large and sustained rise in international
fuel prices, a factor which has supported very strong import growth in recent years.
In addition, the relative price of consumer imports is expected to continue to fall
given the rapid liberalisation of trade tariffs, thereby fuelling consumer demand for
imported goods. Real tariffs on products imported into Chile fell to a record low of
1.5% in July 2004. As in recent years, we expect import growth to continue
outpacing the growth in imports during the two-year forecast period. Therefore, we
expect that net exports will detract from GDP growth in both 2006 and in 2007.

Monetary Environment
Inflation
The central bank operates an inflation target within a range of 3% plus or minus 1%
(i.e. 2-4%), and the monetary authorities have had considerable success in reducing
and containing inflation within this range. Chiles inflation performance compares
favourably with that of its regional counterparts, with the rate generally falling since
the early 1990s. Low price inflation during 2000-03 was partly reflective of subdued
domestic demand conditions and excess spare capacity in industry that allowed the
monetary authorities to reduce interest rates in a bid to stimulate GDP growth. In
2004, despite a significant pick up in domestic demand, average annual inflation was
registered at just 1.1%. As such, the absence of price pressures could be linked to the
availability of ample spare capacity and a strong peso (which helped to control the
cost imported goods).
Chart 5
Consumer Price Inflation
-10
0
10
20
30
40
50
1
9
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f
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7
f
Chile Argentina
Brazil Mexico
annual average, %
Sources: Banco Central de Chile, http://www.bcentral.cl; D&B
In 2005, average inflation increased significantly to 3.1%, albeit still well within the
central banks targeted range of 2-4%. This increase was in line with robust demand
conditions, the steady reduction in industrial spare capacity and increased energy
costs (reflecting higher international oil prices). Positively, in the early part of 2006,
although nearer to the central banks target range, inflation appeared to be largely
under control, with a 3.7% year-on-year increase in the headline rate in May, down
from 3.8% in the previous month. In 2006 as a whole D&B forecasts a slightly
higher average inflation rate of 3.5%, declining to 2.7% in 2007, as oil prices ease
and domestic demand moderates further.
Money Supply
Interest rates have generally been adjusted in response to GDP trends, while money
supply has acted passively (although some credit limits are used). The central bank
SAMPLE

sets an offer rate, which is effectively the target for the daily inter-bank rate, in real
terms (as a premium over the Unidad de Fomento, an inflation index).
Chart 6
Money Supply
y/y % change
-5
0
5
10
15
20
25
30
35
J
a
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M1A M2A M7
Interest Rates
The authorities monetary stimulus to February 2004 (interest rates fell to 1.75%)
spurred the rising trend in private consumption. However, with the subsequent rise in
domestic demand and the concomitant rise in inflationary pressures, the central bank
switched to a tightening bias in September 2005, raising its policy by 25 basis points
increments. Continued improvement in domestic demand and the inflationary impact
of high oil prices enabled the bank to raise rates further in subsequent months (in 25
basis point increments) until the end of 2005, when rates stood at 4.5%.

In the first half of 2006, the tightening bias was maintained with the policy rates
rising to 5.0% in April. However, with the likelihood that rates were in the vicinity of
the neutral region and evidence of slowing economic growth, the bank held rates
steady at the 5% level in May and June 2006. However, in its accompanying
statements the bank continued to point out that, in view of continuing inflationary
pressures, additional increments would still be necessary in the coming months.
Accordingly, we expect the policy rate to stand at 5.5% by the end of 2006, ahead of
a switch to an easing bias in early 2007.

SAMPLE

Chart 7
Interest Rates
%
0
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a
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p
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A
p
r
Source: International Monetary Fund, International Financial Statistics
Short-Term Growth Forecast
2006, from 5.8% in Q4 2005. Although it remains the main driver of economic
private consumption. From the supply side perspective, total economic output was
Table 4
Short-Term Economic Forecasts
Forecast 2006f 2007f
Real growth rate (%):
Private consumption 5.9 5.4
Gross fixed capital formation 7.1 5.4
Government consumption 5.0 6.0
Exports 6.5 4.9
Imports 8.4 6.1
Real GDP 5.4 5.1
Contribution to real GDP growth (percentage point):
Private consumption 3.8 3.5
Gross fixed capital formation 2.1 1.6
Change in inventories 0.2 0.2
Government consumption 0.5 0.6
Net exports -1.2 -0.8
Inflation, annual average (%) 3.5 2.7
Interest rate (policy rate, %) 5.50 4.50
Source: D&B
tighter monetary conditions while the external environment will become somewhat
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less favourable due to slower economic growth in key trade partner nations and
reduced market prices for copper. In 2007, real GDP growth is forecast to slow
further to 5.1% of GDP due to the continued measured deceleration in domestic and
external demand conditions.

In the early part of 2006, the headline rate of inflation stood close the top of the
central banks targeted range of 2-4%. Accordingly, despite a pause in May and
June, the bank indicated that additional increments would be necessary in coming
months. Therefore, D&B forecasts that the policy will rate will stand at 5.5% by the
end of 2006. Aided by the associated moderation in domestic demand, we expect the
central bank to be largely successful in its efforts to control inflation expectations
and to prevent the emergence of significant wage cost pressures. Indeed, lower
inflation and slowing domestic should facilitate a switch to an easing bias in early
2007.
Long-Term Economic Potential
Economic growth has generally been impressive, with healthy economic returns
during the past two decades, and the country is now the most developed in the
region. Growth has been stimulated by numerous factors, including sound
macroeconomic management and structural reforms initiated by the Pinochet regime.
The rapid growth of the world economy (driven by the US) allowed Chile to benefit
from fast export growth during the 1990s.

Trade liberalisation, privatisation and social security reforms date back to the 1970s
and early 1980s. These reforms have helped to promote private initiative, with the
public sector playing a relatively small role. The countrys relatively long history of
structural reform has helped to create a modern industrial base and infrastructure.
The country has a well developed and dynamic services sector and a flexible, albeit
small, manufacturing sector, dominated by processed primary goods, particularly
food and drink products, cellulose, paper products and chemicals. Efforts to diversify
the economy have yielded mixed results and Chile continues to rely on the primary
sector, notably agriculture, forestry, fisheries, and mining and quarrying.
Consequently, the economy is vulnerable to changes in commodity prices and
external demand for these goods. This exposure can have additional effects on the
economy given the importance of the primary sector as a source of employment and
its significant linkages with the rest of the economy, including the processing
industries.

Primary sector crops include traditional wheat, oats, maize, potatoes, sugar beet and
rice, as well as new market garden vegetable crops. Since the early 1970s, Chile has
been a major exporter of a wide range of fruit, taking advantage of the countrys
diverse topography (for example, the grape season is unusually long, spanning from
November to April). A well-developed agro-processing industry has also added
value to the production of these agricultural goods. Nevertheless, some restructuring
will be necessary in the medium term, particularly as the volume of world
agricultural trade rises. The amalgamation of small producers will allow exploitation
of economies of scale and productivity gains.

Chile has the worlds largest known copper deposits and is regarded as the most
efficient producer. Copper production was boosted in the 1990s by the opening of
new facilities, including La Escondida; the worlds third largest copper mine.
However, the volatility of copper prices has often undermined the fiscal and external
accounts. In the past 30 years, the price of copper has fluctuated between USD0.24
and USD1.60 per pound, often doubling and halving over two- or three-year periods,
with severe consequences for macroeconomic stability. With global economic
growth expected to be relatively sound (albeit declining) over the two-year forecast
period, we believe that prices will remain positive for Chilean producers. The new
royalty tax on mining companies had been expected to stem foreign investment
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initially. However, given the record high earnings for mining companies during 2005
(as commodity prices continued to reach record highs), investment into Chile
continues to remain attractive for these mining companies.
Population
Chiles population is estimated at 16.1m in 2005. Average annual population growth
was down marginally from 1.25% during 1990 to 2000, to 1.1% during 2001-2005.
The population is also relatively young. In 1995, 29.5% of the population was under
14 (although this is below the regional average of 33.8%). The UN expects
population growth to slow to 0.7% in 2020-25. This trend is predicated on a fall in
the crude birth and reproduction rate given increased participation of women in the
labour market and improving healthcare provision (which will also engender a fall in
the infant mortality rate).

Slower population growth will lead to a reduction in the dependency ratio to 2015,
when, according to the UN, the ratio will fall to a low of 0.48. This favourable
demographic trend will reduce the burden on scarce fiscal resources such as housing,
education and healthcare. However, the increase in the workforce will put greater
pressure on job creation, necessitating greater efforts to reduce structural
unemployment and initiatives to improve labour market flexibility. After 2015, a rise
in the number of people over 65 (as well as improved basic health) will raise the
dependency ratio once again.

The quality of human capital is relatively high, reflecting the countrys good level of
economic development and the governments continued emphasis on improving
social provision. The UN Human Development Index places Chile in the high
human development category, and Chile has achieved the UN Millennium
Development Goal to cut extreme poverty in half ten years ahead of schedule (the
only Latin America country to do so). Increased public spending on healthcare
provision, rising incomes, and improved diet and sanitation have extended life
expectancy to the level of many developed countries. Education has also been a
policy priority, reflected in a sustained rise in education spending over the past
decade. Consequently, enrolment rates are high, particularly at the primary and
secondary levels, and the literacy rate is 95.2%.

However, Chile still has the 12th worst distribution of wealth in the world. Large
disparities in the distribution of education across different income groups persist,
with poorer children in some regions having reduced access to education, which
limits their income earning capacity.
Technological Progress
Chiles relatively long history of trade liberalisation, deregulation and privatisation
has helped to modernise the economy and promote competitive pressures.
Privatisation has encouraged restructuring and investment in new, more efficient
(mainly imported) technologies, as well as introducing progressive managerial and
organisational practices. This has produced a modern economic infrastructure and an
efficient primary sector, albeit one exposed to weather patterns.
Investment
The domestic savings rate is relatively high by regional standards. This is partly due
to entrenched macroeconomic stability since the 1982 recession, most notably low
inflation, rising incomes, successive budget surpluses and a strong banking system.
Significantly, Chiles high savings rate is often considered a consequence of pension
reforms introduced in 1980, which implemented a private pension system. However,
recent assessments have dampened enthusiasm for the reforms, particularly given a
decline in the savings rate in the mid-1990s. Nevertheless, the pensions reforms have
contributed to a deepening of the financial markets, as well as reducing potential
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fiscal liabilities in the long term (in the medium term, the government must pay out
the contributions made under the old state system) and raising a general awareness of
the need to save.

Demographic shifts will result in a rise in savings over the next five years, although
as the dependency ratio increases, domestic savings will come under pressure.
Moreover, Chiles usually high domestic investment rate is not fully financed by
domestic savings. Hence, domestic investment financing needs are met using foreign
capital, underpinning previous current account deficits and are likely to continue to
do so (see External Economic Risk).
Long-Term Economic Outlook
D&B expects Chiles annual real GDP growth to average 5.0-5.5% over the coming
decade. Macroeconomic stability and a strong spirit of free enterprise and
competition will help to underpin growth. Like many Latin American nations,
Chilean demographic trends will be favourable in the early part of the 21st century.
However, the window of opportunity created by a decline in the dependency ratio
(which will have a positive effect on savings) is relatively small. The new Bachelet
government must push savings vehicles, such as private pensions, and make
regulatory changes that allow private pension funds more freedom in financial
markets.

Moreover, additional investment in skills and vocational training will be necessary to
ensure further productivity gains. The public education system remains in need of
modernisation and a large body of structural unemployment must be reduced before
the working population begins to rise. Finally, although successive governments
have been successful in diversifying the economy, copper still accounts for a
significant proportion of GDP, and as such, represents a degree of risk to Chiles
relatively stable economy.
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External Economic Risk
Key Point: Higher copper prices will continue to underpin Chiles external
economic performance over the two-year forecast period. However, we
forecast a reduced current account surplus in 2007 due to an expected
moderation in global demand and reduction in the market price of copper.
Balance of Payments Performance
Chiles external accounts are among the most stable in Latin America and the trade
sector is traditionally the driver of Chilean economic growth. Manageable current
account deficits have generally been financed by sizeable surpluses on the financial
and capital account (a result of healthy FDI flows), leading to frequent balance of
payments surpluses. In the last two years current account surpluses deficits have
been replaced by small surpluses due largely to the spectacular increase in the price
of copper, Chiles key export category.
Chart 8
Balance of Payments
USD bn
-15
-10
-5
0
5
10
15
1996 1997 1998 1999 2000 2001 2002 2003 2004 2005
Trade balance Services balance
Income Current transfers
Financial & capital account Errors & omissions
Overall balance
Source: Central Bank of Chile http://www.bcentral.cl

We believe that the balance of payments will remain favourable over the two-year
forecast period, with high international copper prices offsetting the increase in
import costs caused by strong domestic demand and bullish oil prices. Foreign
investment should remain stable over the short to medium term, especially as copper
prices are high and economic fundamentals are sound. Profit remittances, especially
from the mining industry, will continue to see money leave on the income account.
Current Account
Chile has registered a trade surplus in every year since 1999. The trade sector is the
traditional engine of the countrys economic growth. Exports are dominated by
copper, which accounts for almost half of all receipts. However, the trade surplus is
often offset by sizeable deficits on the income and services balances, reflecting the
repatriation of profits on investment (mainly from companies in the mining industry)
and, over the last few years at least, a decline in tourist visits.

SAMPLE

Since 2004, the current account has experienced significant improvement, due
largely to the remarkable growth in the price of copper which has resulted in a
similarly impressive expansion in the merchandise trade surplus. In 2004, a doubling
of copper exports contributed to a 249% surge in the trade surplus to USD9.2bn
from USD3.69bn previously. However, the remarkable performance of the mining
sector also saw foreign investors withdraw their profits and income on investments in
the sector, leading to a record USD8.0bn deficit in the income account. Nonetheless,
the trade effect dominated, enabling Chile to record an overall current account
surplus of USD1.6bn (around 1.7% of GDP) its first surplus in more than six years.

In 2005, reflecting strong global demand and the associated uptrend in the price of
copper, total goods exports grew by 25.9%. However, strong domestic demand
conditions and the continued rise in international oil prices meant that imports grew
by an even larger 32.0% in 2005. Consequently, the overall trade surplus expanded
by a relatively modest 10.6% to USD10.2bn, a smaller rate of expansion than the
32.8% increase in the income deficit to USD10.6bn. Despite this, a 61.1% surge in
the current transfers surplus helped to maintain a small overall current account
surplus of USD0.7bn, equivalent to around 0.6% of GDP.
Chart 9
Current Account Balance
% of GDP
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-4
-2
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2
4
6
8
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9
6
1
9
9
7
1
9
9
8
1
9
9
9
2
0
0
0
2
0
0
1
2
0
0
2
2
0
0
3
2
0
0
4
2
0
0
5
e
2
0
0
6
f
2
0
0
7
f
Chile Argentina Brazil Mexico
Sources: Central Bank of Chile, http://www.bcentral.cl; Central Bank of Brazil; Central Bank of
Mexico; D&B
Outlook
In Q1 2006, Chiles current account surplus increased by 17.8% year on year to
USD588m. This increase was largely attributable to the continued rise in the market
price of copper which helped to increase total exports by 24.4% year on year in the
same period. More recent monthly data has shown that Chiles copper revenue in the
first five months of 2006 stood at USD11.6bn, nearly double the USD6.6bn during
the same period of 2005. While, import growth has also been strong (increasing by
24.7% year-on year in Q1), we forecast a significantly increased trade surplus in
2006 and an expansion in Chiles current account surplus to around 1.3% of GDP.
Looking ahead to 2007, the outlook is necessarily more uncertain. However, we
Indeed in D&Bs view, the international price of copper will remain at a high level
throughout the two-year forecast period, albeit below the USD8,800 per tonne all-
time record high reached on 11 May 2006: as of mid-June 2006, the price of copper
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had fallen by around 20% from this level, albeit remaining 50% higher than the end
of 2005 level. Due to lower average copper prices, and the continuation of relatively
robust demand conditions (which will help to support import growth) we forecast a
reduction in the overall current account surplus to around 0.5% of GDP in 2007. The
major risk to this still relatively benign scenario, is a greater-than-expected
contraction in global demand (most likely to originate in a sharper-than-anticipated
slowdown in US consumer expenditure), resulting in a more severe contraction in
copper prices than presently expected.
Export Profile
Chiles export profile is more varied than that of many of its regional counterparts
both in terms of export products and the geographical distribution of trade. Export
diversification has seen forestry and fishing exports increase in importance; several
non-traditional exports have also grown strongly in the past decade, with notable
examples including the fresh fruit and wine industries and the industrial sector
(mainly food and drink, processed fishmeal and forestry products). However, copper
remains the single most important source of foreign sales; Chile is the worlds largest
producer and sales account for around 40% of total export revenues in most years
(47.0% of total exports in 2005).
Table 5
Principal Exports
USD bn 2001 2002 2003 2004 2005
Minerals 7.3 7.1 8.8 16.7 22.6
Of which: copper 6.5 6.3 7.8 14.5 18.3
Agriculture, forestry & fishing 1.7 1.8 2.1 2.3 2.5
Industrial 8.0 8.1 9.4 11.8 13.8
Total 17.0 17.1 20.3 30.8 38.9
Source: Banco Central de Chile, Boletin Mensual
Traditionally, Chiles trading relations have been broad enough to offset adverse
weather or economic conditions in any given location that might otherwise
undermine Chiles overall economic performance. Successive Chilean governments
have signed bilateral and multilateral free-trade agreements (FTAs) that have
expanded Chilean market access and reduced the cost of doing trade with Chile.
Chile now has duty-free access to over 50% of the global marketplace and is seeking
further FTAs in Asia. In addition, in August 2004, Chile and China began feasibility
studies for a free-trade deal. Annual trade between the two countries is worth
USD3bn.
Table 6
Exports by Destination
Country 2004 (% of total) 2005 (% of total)
US 15.6 15.8
Japan 11.9 11.5
China 10.2 11.1
South Korea 5.9 5.7
Brazil 4.5 4.4
Mexico 4.1 4.0
France 4.0 3.5
Taiwan 3.1 3.2
Sources: Banco Central de Chile, Boletin Mensual; International Monetary Fund, Direction of
Trade Statistics
Import Profile
During economic expansions, Chile imports growing levels of consumer,
intermediate and capital goods to meet expanding domestic consumer and industrial
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demand. Capital goods import growth tends to be driven by substantial investment in
infrastructure, often associated with mining and, in previous years, privatisation. In
2005, imports increased by 32.0% to USD30.1bn. The most significant growth rate
was recorded in capital and intermediate goods, which increased by 54.3% and
26.9% year-on-year respectively in 2005. This reflected both a surge in fixed capital
investment (see Gross Fixed Capital Formation) and the continued rise in
international oil prices (Chile is a net oil importer).
Table 7
Principal Imports
USD bn 2001 2002 2003 2004 2005
Capital goods 3.5 3.5 3.6 4.6 7.1
Consumer goods 2.9 2.8 2.9 3.7 4.6
Intermediate goods 10.0 9.6 10.9 14.5 18.4
Total 16.4 15.9 17.4 22.7 30.1
Chilean import suppliers are geographically varied. Reflecting Chiles participation
in the regions largest trade bloc (Mercosur), imports are primarily sourced from
Latin America. The US is also a major seller, a trend cemented by a bilateral trade
deal that came into effect in January 2004. Asia was the second largest source of
imports reflecting the purchase of components for the maquila industries.
Table 8
Imports by Source
Country 2004 (% of total) 2005 (% of total)
US 13.8 14.6
Argentina 16.5 14.5
Brazil 11.1 11.6
China 7.4 7.7
Germany 3.4 3.7
Peru 2.9 3.6
South Korea 2.8 3.3
Japan 3.2 3.1
Source: International Monetary Fund, Direction of Trade Statistics
Financial and Capital Account
Healthy net FDI and portfolio inflows sustained a surplus on Chiles financial
account in the 1990s, securing balance of payments sustainability. With increasing
economic stability, Chilean investment overseas has increased considerably with the
Chilean private sector investing in Argentina, Brazil and in the US. Moreover,
Chilean pension funds were encouraged to invest abroad as limits to their foreign
interests were eased.

Chiles financial and capital account recorded surpluses during 2000-03 before
falling into deficit in 2004. While total investment inflow grew during 2004
(particularly FDI), there was also a sizeable deficit on the short term flow account
as Chilean banks provided trade credits to the US. In 2005, there was a reduction in
net FDI from the previous years elevated level. However, a marked reversal in the
other investment account to a small surplus from a deficit of USD4.2bn in the
previous year, helped to return the financial and capital account to an overall surplus
of USD0.4bn from a deficit of USD2.0bn in 2004.
Foreign Direct Investment Flows
Net inflows of FDI accelerated sharply in the mid-1990s, rising to USD6.2bn in
1999. Most of this fixed investment was in the utilities and service sectors and came
from Spanish and US investors. From 2000 to 2003, net FDI was fairly stable
averaging USD2.5bn annually. However, there was a significant upturn in FDI in
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2004, rising to USD5.6bn. This surge in investment was largely linked to the boom
in the global copper industry, which encouraged investment aimed at raising the
capacity of the industry. In 2005, net FDI remained robust, although it declined by
19.9% from the previous years elevated level to USD4.5bn, due to a combination
increased outflows and reduced inflows.
Chart 10
Net Foreign Direct Investment
USD bn
0.0
1.0
2.0
3.0
4.0
5.0
6.0
7.0
1996 1997 1998 1999 2000 2001 2002 2003 2004 2005
Aside from the mining sector, key beneficiaries of FDI in Chile have been the
transport and telecommunications sectors, while the major sources of FDI have been
Spain, the US and Italy. Going forward, Chile will remain an attractive FDI location
due to its large reserves of copper and its sound economic fundamentals, stable
regulatory environment and minimal trade tariffs.
Equities
Following the sharp increase in credit risk during 1998-99, a result of the
deteriorating global trading environment, conditions began to pick up in 2000. Part
of this improvement reflected healthier macroeconomic conditions. However,
legislative changes also encouraged credit growth. Where local businesses used to be
restricted to American Depository Receipts (ADR) listings in the US, new legislation
gave them more freedom in the way they financed themselves. This reduced
borrowing costs, as companies were permitted to raise equity in international
markets. The main beneficiaries of this change were second-tier companies, which
lacked the capital base to list in New York, internet start-ups and small groups
aspiring to public offerings on the NASDAQ. Larger foreign-owned companies are
now free to raise equity in their home markets.

D&B believes that economic conditions in Chile are generally favourable. This will
buoy domestic investment (and many Chilean companies will access money through
the stock market) and buttress overseas investor confidence in the Chilean market.
Indeed, the general stock price index (IGPA) rose, virtually uninterrupted, from
January 2003, to peak around the 10,200 level in October 2005. This two-and-a-half-
year trend reflected the upturn in international copper prices, robust domestic
economic output and a strengthening of the peso. After briefly falling to the 9200
level in late 2005, the IGPA index resumed its uptrend in the following year, rising
to a new record high level around the 10300 level in May 2006.

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Going forward, the Chilean stockmarket will continue to be supported by the
countrys generally sound economic fundamentals. However, in D&Bs view the
capacity for further significant gains could be limited due to moderating economic
growth, and less favourable monetary conditions. In addition, like all emerging
markets which have benefited greatly from increasing foreign investment in recent
years, the possibility of a sudden increase in risk aversion can not be discounted. In
particular, foreign investor sentiment could be negatively affected if benchmark US
interest rates have to rise by more than initially expected.
Debt
During the last ten years, more than USD2.0bn has been collected by the local sector
through capital increases and bond floats. This reflects the increasing use of both the
equity market and also debt creation as a means of funding investment. In emerging
market terms, Chile remains a solid performer (although not as lucrative as Mexico
or Brazil). When sentiment turns against emerging markets, Chilean private debt
tends to become less attractive; however, given relatively high sovereign ratings,
public debt issues tend to do relatively well even when conditions are not ideal.

We do not believe that there will be any significant public debt offerings over the
two-year forecast period due to the strength of copper prices (and hence the public
purse); however, companies dedicated to mass consumption will undergo a constant
process of expansion and are likely to tap the debt market.
Bank Lending
Chile has a sustainable international bank balance compared with other countries in
the region. Total bank debt reached USD21.3bn at the end of 2005, marginally
higher than the level of bank debt for the previous year. 50.3% of all debt is short
term, down marginally on 2004, 40.7% of all loans have a maturity date over two
years. We do not consider bank lending to constitute a significant risk; we believe
that lending will remain moderate over the medium to long term as the Chilean
financial sector strengthens and the public sector moves away from bank debt in
favour of issuing debt on the domestic and international bond markets.

Table 9
Maturity and Sectoral Distribution of Bank Lending to Chile
USD m 2001 2002 2003 2004 2005
Maturities:
Up to & including one year 8,346 10,158 10,470 10,422 10,827
Over one year & up to two years 2,222 1,106 1,481 854 663
Over two years 8,768 8,802 8,195 8,193 8,655
Unallocated 592 719 1,295 1,053 6,031
Total 19,928 20,785 21,441 20,522 21,258
Sectors:
Banks 2,018 3,095 4,863 4,522 3,423
Public sector 1,315 1,723 2,433 2,224 3,453
Non-bank private sector 16,592 15,964 14,145 13,775 11,761
Unallocated 3 3 0 1
Total 19,928 20,785 21,441 20,522 21,258
Source: Bank for International Settlements, International Banking and Financial Market
Developments
Foreign Debt and Default Risk
Slow economic growth, low tax collection and low copper prices forced the
authorities to issue USD1bn worth of debt in January 2003. However, the subsequent
rebound in Chiles external sector has allowed the external accounts to rank among
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the most manageable in the region. The countrys debt stock poses no threat to
economic stability. The IMF is generally supportive of the governments debt
management strategy, supporting the central banks initiatives to deepen domestic
financial markets by introducing long-term peso-denominated bonds.
Table 10
Debt Indicators
USD bn 2001 2002 2003 2004 2005
Total 38.5 40.5 43.1 43.3 44.8
Of which: general government 2.9 3.6 4.6 4.7 4.0
monetary authorities 0.0 0.0 0.0 0.0 0.0
banks 2.5 3.8 5.4 6.3 7.3
other sectors 28.2 28.3 28.8 28.0 29.5
direct investment: inter-business loans 4.9 4.8 4.2 4.2 4.0
External debt (% of GDP) 56.2 60.2 58.4 45.6 38.9

Some 79% of external indebtedness is held by the private sector; only an estimated
USD9.4bn was held by the public sector in 2005. Moreover, the majority of Chiles
external liabilities are long term with short-term external debt comprising just 16.1%
of total external debt in 2005. Positively, gross external debt as a proportion of GDP
has declined significantly in recent years, falling from 60.2% of GDP in 2002 to less
than 40% of GDP in 2005. As the growth rate of new external debt is likely to
remain below the GDP growth rate, we expect this favourable trend to be maintained
in the two-year forecast period.
Foreign Exchange Reserves
Chiles reserve balance has been fairly stable over the last few years, ending 2005 at
USD17.0bn, against USD16.0bn in 2004 and USD15.9bn in 2003. By the end of
June 2006, reserves had increased further to USD17.9bn (covering around 5.7
months of imports of goods and services). Reserves have funded the governments
debt management strategy of paying off expensive debt to minimise the ripples
emanating from emerging market crises, such as the collapse of the Argentine
economy, and as a means of reducing holdings of US dollar-denominated debt.
Table 11
Foreign Exchange Reserves
USD bn
0
5
10
15
20
25
1
9
9
6
1
9
9
7
1
9
9
8
1
9
9
9
2
0
0
0
2
0
0
1
2
0
0
2
2
0
0
3
2
0
0
4
2
0
0
5
Sources: International Monetary Fund, International Financial Statistics; Banco Central de
Chile, Boletin Mensual
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Exchange Rate Risk
After devaluation in 1982 (following the abandonment of the fixed peg to the US
dollar in 1981), Chiles exchange rate policy was conducted through a crawling peg
whereby a central reference rate of the peso was gradually devalued against the US
dollar. In 1992, the reference rate was set against a basket of currencies comprising
the US dollar, Japanese yen and euro. In an effort to boost exports and make
economic policy more flexible, the authorities floated the peso on 2 September 1999.
Chart 11
Chilean Peso:US Dollar Exchange Rate (Inverted Scale)
CLP:USD, average
300
400
500
600
700
800
1996 1997 1998 1999 2000 2001 2002 2003 2004 2005
Source: International Monetary Fund, International Financial Statistics

The rate of depreciation of the peso against the US dollar accelerated almost
continually for seven quarters from January 2000. As Chiles terms of trade
improved in late 2003 and 2004, contributing to an appreciation of the peso (Chiles
peso appreciated in real and nominal terms during 2004), the central bank refused to
intervene. This reluctance to intervene has bolstered market confidence in Chiles
monetary authorities and in the permanence of the floating exchange rate regime.

The Chilean peso appreciated by around 8% to CLP514.5:USD in 2005.
Accelerating global demand (particularly Chinese demand) for copper was the main
driver for the pesos appreciation during this period. To the disappointment of
exporters whose competitiveness was reduced by the pesos rise, the authorities did
not intervene to lower the exchange rate over the year. In 2006, market sentiment
changed, with the peso depreciating by more than 6% to the CLP550:USD (from the
end 2005 level) by mid-June 2006. This change in direction was precipitated by a
number of factors, including: higher US interest rates; lower copper prices (which
fell by around 20% from their May 2006 all-time peak of USD8,800 per tonne); and
a generalised re-evaluation of emerging market risks (i.e. increased risk aversion,
something which was also partly linked to availability of higher US cash rates).

We expect the peso to be largely stable in the second half of 2006, based on the
assumption that US Federal Reserve is close to ending its extended phase of
monetary tightening sometime during the second half of 2006. More stable US
interest rates, in tandem with a slightly more elongated tightening period from the
Chilean central bank (see Interest Rates) should help to support the peso. In 2007,
based on the assumption lower copper prices, and slower domestic economic growth
we are forecasting moderate 3% deprecation in the peso to the CLP570:USD level
by the end of the year. The major risk to this relatively benign scenario is a larger
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than-expected fall in the copper price, which could result in a larger depreciation in
the peso.

External Economic Risk Outlook

Chiles external accounts are among the most stable in Latin America. In recent
years this performance has been underpinned particularly by the cyclical and
possibly secular rise in the price of copper, Chiles most important export item.
Going forward, Chiles overall external economic outlook will remain broadly
favourable. In Q1 2006, increased copper receipts helped Chiles current account
surplus to increase by 17.8% year on year to USD588m. More recent monthly data
has shown that Chiles copper revenue in the first five months of 2006 stood at
USD11.6bn, nearly double the USD6.6bn during the same period of 2005. While,
import growth has also been strong (increasing by 24.7% year on year in Q1), we are
forecasting a significantly increased trade surplus in 2006 and an expansion in
Chiles current account surplus to around 1.3% of GDP.

Looking further ahead to 2007, the outlook is necessarily more uncertain. We
Indeed in D&Bs view, the USD8,800 per tonne all-time high price which was
reached on 11 May will remain the commoditys high throughout the two-year
forecast period: as of mid-June 2006, the price of copper had fallen by around 20%
from this level, albeit remaining 50% higher than the end of 2005 level). Due to
lower average copper prices, and the continuation of relatively robust demand
conditions (which will help to support import growth), we forecast a reduction in the
overall current account surplus to around 0.5% of GDP in 2007.
Table 12
External Economic Forecast
% of GDP 2006f 2007f
Current account balance 1.3 0.5
Financial & capital account balance 1.0 0.6
Overall balance of payments 2.3 1.1
Import cover (months) 5.7 5.5
Source: D&B
The major risk to this still relatively benign scenario, is a sharper-than-expected
contraction in global demand (something we feel is most likely to originate from a
sharper-than-anticipated slowdown in US consumer expenditure), resulting in a more
severe decline in copper prices than presently expected. On the currency, we expect
the Chilean peso to remain broadly stable in the second half of 2006, before a
moderate 3% depreciation in 2007. However, as for the current account, the major
risk to this relatively benign scenario is a larger than-expected contraction in copper
prices, which could result in a larger depreciation in the peso.
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Trade Environment
Key Point: The Chilean government is committed to a liberal trade regime.
Free-trade agreements with the most major markets, including the US, have
all been signed in recent years.
Trade Overview
Chile has an open trade regime having liberalised its trade in the 1970s. Since then,
governments have actively sought to promote trade ties; as such, the dynamic growth
of Chiles economy since 1990 has largely been export-led. Trade deals have mainly
been on a bilateral basis, but also through associate membership of Mercosur. The
favourable trading environment means that Chile is the most open economy in South
America. Indeed, real tariffs on products imported into Chile fell to a record low of
1.5% in July 2004. We expect Chile to continue negotiations on further free-trade
deals over the two-year forecast period (most notably with China). Most recently, in
June 2005 a free-trade agreement (FTA) was signed with Panama.
Relations with the EU
Chile agreed an FTA with the EU, its second largest export market after the US, in
June 2002 and the agreement came into force in January 2003. The deal appears to
have resolved the issue of agricultural trade (which has consistently caused EU-
Mercosur free-trade talks to stall), and EU companies can now form joint ventures
with Chilean companies. Their output enjoys barrier-free entry into both markets.
Relations with Europe (Non EU)
Chile signed a free-trade pact with the European Free-Trade Association (EFTA),
which includes Norway, Switzerland, Iceland and Liechtenstein, in June 2003, giving
around 90% of Chilean exports to the EFTA immediate free access.
Relations with the US
The government began talks with the US in December 2000 regarding entry to the
North American Free-Trade Area (NAFTA) for Chilean exports. Early expectations
were for talks to conclude by the close of 2001. However, negotiations were
postponed and then suspended in June 2002. Free-trade negotiations resumed in
early 2003, and in July the US Congress voted to accept Chile as a free-trade partner
from January 2004. Under the deal, more than 85% of bilateral trade in consumer
and industrial productions became tariff free immediately, with most remaining
tariffs eliminated within four years. Since the bilateral deal came into effect, real
tariffs on US imports have slipped from 2.0% to 1.3%. The agreement requires that
each country enforces its own labour standards. The deal also reintroduces the US
generalised system of preferences (GSP), which expired in September 2001, and
which gives favourable tariff treatment to 16% of Chiles total exports to the US.
The main export benefits are methanol, wood, refined copper and vegetable seeds.
Mercosur
Chile became an associate member of Mercosur in 1995. Argentina, Brazil,
Paraguay and Uruguay are full members, while Bolivia, Peru and Venezuela are the
other associate members. In 2001, President Ricardo Lagos Escobar announced that
Chile would apply for full membership; however, this is unlikely to be achieved as
there remain a number of fundamental differences between Chile and the Mercosur
economies. In economic terms, Chile has already reached free-trade deals with the
EU and the US, reducing the need for Chile to join Mercosur. Furthermore,
Mercosurs tariff levels are much higher than those of Chile. In political terms,
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Chilean politicians have embraced free trade whereas those in Brazil and Argentina
(in particular) are more indifferent. It would be impossible for Chile to become a full
member of Mercosur without undermining its free-trade philosophy.
Relations with Asia
Chile is developing relations with economies in the Far East. Chile became a
member of the Asia Pacific Economic Co-operation (APEC) forum in 1994 and the
Chilean authorities recently negotiated an FTA with South Korea. It was the first
such agreement between an Asian and Latin American economy. South Korea hopes
to use the agreement as a springboard to increase investment and trade within the
region as a whole: Chile currently runs a trade surplus with South Korea. Chile and
China began talks over an FTA during the APEC summit, held in November 2004.
Following five rounds of talks, an agreement was signed in November 2005 and
awaits Congressional ratification. Chile has also held preliminary free-trade deal
talks with India and Japan.
Current Account Exchange Regulations
The central bank is responsible for implementing exchange control policy. Since
2001, import declarations issued by the National Customs Service have been
required to purchase foreign exchange in the formal exchange market. The
requirement for a central bank-issued import report was eliminated from 2001.
Tariff Barriers
The previous government was committed to reducing tariff barriers and enacted an
across-the-board cut in tariffs to 10% in 1999. The Lagos administration maintained
this stance dropping the tariff by a percentage point per year, to 6% in 2003.
However, there are some exceptions: used goods have a tariff of 16.5% (second-
hand cars are not permitted), while computer goods enter duty-free. While the
weighted mean tariff is 7%, there are many discounts due to bilateral FTAs with
many countries or by special discounts on specific imports, such as computer-related
goods.
Chart 12
Weighted Mean Tariffs for All Products, 2004
1

0 2 4 6 8 10 12 14
Argentina
Venezuela
Ecuador
Colombia
Brazil
Bolivia
Chile
Uruguay
Mexico
US
%
Note:
1
Data for Bolivia and Uruguay are for 2001; data for Venezuela are for 2000.
Source: World Bank, World Development Indicators
Following the entry into force of the FTA between Chile and South Korea in April
2003, duties on imports from South Korea dropped 4.5 percentage points to 1.6%,
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fuelling a general tariff decrease. Since the bilateral agreement between Chile and
the US came into effect in January 2004, real tariffs on US imports have fallen from
2.0% to 1.3%. Real tariffs on all products imported into Chile fell to a record low of
1.5% in July 2004.

The maximum tariff on most goods is 25%. Flour, vegetable oil and wheat have a
tariff set at 31.5% in accordance with WTO requirements, and the tariff on sugar
imports was raised to 98% in July 2002 (a move backed by the WTO). Nonetheless,
tariffs are sometimes subject to change; for example, tariffs on wheat were increased
to protect the domestic industry from falling international prices. The government
imposes minimum customs valuations on agricultural imports for the same reason. A
few items are exempted from the present tariff regime. Exemptions include tariffs
negotiated with Latin American Integration Association (LAIA) countries and under
a number of bilateral trade agreements.

Non-Tariff Barriers
All imports require a licence, largely as a means of registering imports. Although
these are granted as routine for most goods; pharmaceuticals and weapons are
subject to tighter licensing requirements. A registration certificate is also needed for
goods over USD3,000. The import of used passenger and cargo transportation is
prohibited. Exceptions are ambulances, armoured cars, public road cleaning vehicles
and cement-making vehicles. These goods pay 11% import duty plus VAT. Other
non-tariff barriers include strict animal and phytosanitary requirements, often
designed to protect domestic food-producing industries. Nevertheless, numerous
controls on agricultural goods (including wheat and various fruits) have been lifted.
Similar licensing, registration, phytosanitary and quality controls are imposed on
exports.
Documentation
Bill of Lading: Original plus two copies usually required. Should show gross weight
of each item, made out to order. To order bills of lading are legally recognised in
Chile.

Certificate of Origin: Not needed unless specifically required.

Commercial Invoice: The invoice should be prepared in a minimum of four copies.
Those covering automobiles should be the invoices of the manufacturer or an
authorised dealer. The commercial invoice should contain a detailed and specific
description of the goods, giving the net, legal and gross weights, the free on board
(f.o.b.) value of the merchandise, unit price of each item, date of insurance covering
shipment (if applicable) and other usual particulars of such documents. Although
Notarisation or Chamber of Commerce certification is not required, a sworn
statement of declaration of origin, in English or Spanish, in a prescribed text is
required.

Consular Fee: As fees are payable at destination, all original documents should be
sent to the importer. Fees are collected on commercial invoices, bills of lading or air
waybills.

Import Licence: Imports valued over USD3,000 must be covered by a registration
certificate (informe de importacion) issued by the central bank.

Insurance Certificate: This should follow the importers instructions.

Marking of Goods: Country of origin must be shown in most cases. The importers
name should also be shown on canned foods and consumer goods.

SAMPLE

Packing Lists: This should be issued in accordance with the importers request.

Samples: Samples of negligible value are subject to special duty.

US Shippers Export Declaration: Required if the value is more than USD2,500.
SAMPLE

Commercial Risk
Key Point: A broadly favourable economic outlook based on continuing
strength in the export sector and a rebound in domestic demand should
support the improving trend in commercial risks.
Credit Risk
During 2000-02, when credit conditions were relatively weak, (reflecting poor
domestic and global demand and low world commodity prices), Chilean firms
postponed investments. However, copper prices and global demand for Chilean
exports (especially from the large number of countries with free-trade agreements
with Chile) began to rise from 2003. This improving trend encouraged investment
and a recovery in payments performance.
Chart 13
Late Payment Trends
20
25
30
35
40
45
50
55
60
65
Q
3
-
0
0
Q
1
-
0
1
Q
3
Q
1
-
0
2
Q
3
Q
1
-
0
3
Q
3
Q
1
-
0
4
Q
3
Q
1
-
0
5
Q
3
Q
1
-
0
6
% of payments made in excess of 30 days over terms
Source: D&B
In 2004 and 2005, the improvements in credit risk were largely associated with firms
in the export and related industries. However, D&B believes that this trend
broadened in 2005 as the economic recovery began to encompass businesses serving
the domestic sectors.
Payments Experience
Payments made by Chilean corporations are relatively slow, with some 42.2% of
firms making payments 30 days beyond terms in Q1 2005; 14.3% of businesses paid
90 days or more beyond terms. In the same period, 57.0% of payments were made
promptly. D&B does not expect to see a significant improvement in payments
performance during the two-year forecast period. While we expect overall economic
conditions to remain favourable, the monetary environment is becoming more
restrictive, which may prove problematic for some firms. Importantly, given the
liberal terms on which most trade with Chile is done, firms have the room to pay late
(unlike trade on more stringent terms).

Usual Terms: D&B recommends that exporters use sight drafts in transactions with
Chilean firms. Trade terms tend to be more liberal for Chile than for many other
Latin American countries.

SAMPLE

Usual Terms

Minimum Terms Sight Draft
Recommended Terms Sight Draft
Usual Terms 30-60 days

Transfer Risk: The transfer situation is generally favourable, aided by ample foreign
exchange liquidity (see Foreign Debt and Default Risk) and limited bank delays
owing to a sound and competitive banking system. Import cover (for goods and
services), at 5.7 months in 2005 and an estimated 5.0 months in 2006, is well beyond
the IMF recommended minimum of 3.0 months.

Transfer Situation

Local Delays 1-2 months
Foreign Exchange/Bank Delays 1-2 month
Import Cover 5.0 months

Export Credit Agencies: The level of cover offered to businesses involved in
transactions with Chilean firms compares favourably with cover offered on trade
with other countries in the region, reflecting a stable macroeconomic and political
climate.

Export Credit Agencies

US Eximbank Full cover available
Atradius Full cover available
ECGD Full cover available
Euler Hermes UK Full short-term cover available

Financial Sector Risk
Restructuring during the 1990s has helped to produce a robust banking sector that
remains relatively resilient to the kind of turmoil prevalent elsewhere in Latin
America. The mergers and acquisitions that occurred after the 1980s debt crisis also
had a positive impact. Moreover, the banking superintendency tightly supervises the
banking system with extensive disclosure requirements, which makes the system very
transparent. Following the November 1997 banking law, regulations were brought
into line with the capital-risk adequacy and lending guidelines recommended by the
Bank of International Settlements (BIS). Chiles long-debated tender law was signed
onto the statute books in 2000. The law requires that any merger and acquisition that
leaves a single institution with more than 15% of market share needs special
approval from the banking superintendency. The institution also has to demonstrate a
capital adequacy ratio of at least 10% compared with the Basel Committee
requirement of 8%. These reforms followed Spanish BSCHs acquisition of Banco
Santiago, which left it in control of the countrys two largest banks (BSCH also
controls Banco Santander Chile) and with around 28% of the countrys loan market.
SAMPLE

Table 13
Top Seven Chilean Banks, July 2005
Bank Tier One Total Pre-tax Return on
captial assets profit/loss assets
(USDm) (USDm) (USDm) (%)
Banco Santander Chile 1,488 21,600 437 2.0
Banco de Chile 932 17,200 305 1.8
Corp Banca 665 5,600 102 1.8
Banco del Estado de Chile 661 15,400 150 1.0
Banco de Credito & Inversiones 602 12,300 191 1.6
BBVA Banco BHIF 396 5,700 59 1.0
Banco del Desarrollo 231 2,800 43 1.5
Source: The Banker
In recent years the IMF has praised the countrys regulation of its financial system
and welcomed the authorities intention to tighten regulation further, especially to
reduce risks in the insurance industry and strengthen regulation and supervision of
the securities industry. The Fund has also seen room to improve anti-money
laundering legislation and laws aimed at combating the financing of terrorism
legislation. The IMF has also suggested that there is scope for improving financial
system efficiency. It suggested that investment restrictions on pension funds could be
liberalised to take advantage of economies of scale and increased competition.

The IMF has also highlighted the need for the regulatory system to adapt to the
increasing sophistication of financial markets, where distinctions between entities
had become more blurred, by moving to a high-quality risk-based regulatory system
that would take into account the interconnections between different components of
the financial system. It also noted that there was room to further improve competition
regarding the financing of small- and medium-sized enterprises. Changes aimed at
fulfilling these recommendations are currently on the legislative agenda (contained
within the Capital Markets II draft law) and should take effect over the short to
medium term.

Corruption
Measuring what is corruption and what is local business culture is a difficult task.
However, Transparency Internationals survey of corruption perceptions gives some
idea of the relative level of corruption between countries. Each country is given a
corruption perception rating between 0.0, which represents the highest level of
perceived corruption, and 10.0, which represents the lowest level. The 2005
Corruption Perceptions Index shows Chile as the least corrupt country in Latin
America. Chiles score was 7.3 in 2005, compared with 7.4 in 2003 and 2004.
Significantly, there was no major change in Chiles corruption rating between 2005
and 2003 even though the government and the main opposition coalition suffered
from a corruption scandal in 2003. We attribute this confidence in transparency to
the governments quick handling of the affair: legislation was rapidly introduced to
reduce the room for further public sector corruption. We believe that fighting
corruption is a political priority in Chile and will continue to be legislated against
over the medium term.

SAMPLE

Chart 14
Corruption Perceptions for Selected Countries, 2005
0.0=most corrupt 10.0=least corrupt
0.0 1.0 2.0 3.0 4.0 5.0 6.0 7.0 8.0
Venezuela
Ecuador
Bolivia
Argentina
Mexico
Brazil
Trinidad
Colombia
Uruguay
Chile
Source: Transparency International, Corruption Perceptions Index

Other Commercial Risks
Intellectual Property Rights
Chile is a member of the World Intellectual Property Organisation (WIPO) and party
to the Paris, Berne and Rome Conventions. It also signed the WIPO Copyright and
Performance and Phonograms treaties in April 2001, both of which came into effect
in 2002. Chiles Trade Related Aspects of International Property Rights (TRIPS)
obligations came into effect on 1 January 2000.

Although Chiles intellectual property laws, promulgated in 1991, provide protection
for industrial patents and are generally compatible with international norms, patent
protection remains insufficient by international standards. The current laws do not
provide adequate protection for confidential test data. Patent approval remains slow,
with the approval time averaging over four years. In addition, copyright and
trademark enforcement is still weak.

It is estimated that two-thirds of the software programmes used in Chile have been
copied illegally, costing the industry USD200m. The level of piracy is worrying
considering that Chile promised to make changes to its copyright laws (before 2008)
when it signed its free-trade agreement with the US at the start of 2004. If the
Chilean authorities do not start to make changes soon, they may find themselves
subject to legal action for non-compliance with the treaty. However, D&B believes
that Chile will make the necessary changes prior to 2008 and that legal action over
the next year or two would be premature.
Commercial Risk Outlook
D&B believes that solid domestic demand and investment, and robust export growth
will drive overall economic growth. Credit conditions will remain broadly favourable
in the two-year forecast period as firms seek to expand output to meet export and
internal demand. Healthy revenue and profit growth will also help to support
payments performance. Despite forecast higher interest rates and inflation, credit
conditions will remain buoyant and overall trading risks when dealing with Chile are
minimal.
SAMPLE

Meanwhile, conditions in the financial sector are good, with regulation and
transparency in line with international norms. More reform over the short to medium
term will further strengthen the system. Reform of the copyright law should also be a
priority before 2008 (part of Chiles free-trade deal with the US) as Chile could
otherwise face legal action for widespread breaches of the law.

Finally, corruption in Chile is clearly not as widespread as in the rest of the region. A
general political consensus against corruption and new laws designed to minimise
the chance for corruption to occur should help to safeguard generally Chiles clean
reputation.
SAMPLE

Investment Environment
Key Point: Chile welcomes foreign investment into large areas of the
economy, and the removal of capital controls should boost overall investment
levels. Sound economic fundamentals and a relatively transparent regulatory
environment make Chile an attractive investment location.
Investment Overview
Chile has one of the most liberal and transparent foreign investment regimes in Latin
America. Foreign participation through inward investment is encouraged as a means
of sustaining long-term economic growth and development. Such investment enables
existing and potential resources to be more efficiently utilised. It also creates the
conditions needed for structural economic diversification through greater access to
new technology. The Chilean foreign investment supervisory authority is the Comite
de Inversiones Extranjeras (CIE), which authorises most investments.

Foreign firms are generally treated on a par with local companies. There are no
limitations regarding foreign share ownership in a Chilean company, except in the
media and hydrocarbon industries. However, there are some restrictions. Investments
over USD5m, or those proposed in state-controlled industries, require the approval
of the whole committee. For other cases, the CIE executive committee has approval
powers.
Capital Account Exchange Regulations
The central bank lifted the last remaining controls on international capital flows in
April 2001. The changes eliminated the following requirements: that investors secure
central bank authorisation for capital inflows related to loans, portfolio investment
and FDI; that authorisation be sought for capital outflows related to capital gains
dividends and other benefits; and the reserve requirement, which obliged investors to
deposit a portion of their investment with the central bank for up to one year.
Foreign Direct Investment Environment
Foreign Investment Laws
Decree Law 600 (DL600), introduced in 1974 and since subject to various
modifications, specifically encourages FDI in order to underpin development and
technological flows. DL600 specifically prohibits discrimination against FDI.

Under DL600, all applications for investment must be lodged with the Foreign
Investment Committee. Profits and capital can be repatriated immediately. Following
reform in 1997, the minimum investment allowed under DL600 was increased to
USD1m from USD25,000 (technology, machinery and equipment are exempt).
Equity now has to be at least 50% of the investment (rather than 30%), with the
remainder as debt. Exemptions to reserve requirements were also tightened.
Investments below USD100,000 (rather than USD200,000) are now exempt.
Investment Incentives
Various investment incentives are available in certain sectors, including the
petroleum and nuclear industries (particularly on imported machinery). There are
also investment incentives according to region, which are designed to promote
development in some of the less developed areas of the country.
SAMPLE

Free-Trade Zones
There are free-trade zones at the ports of Arica, Iquique and Punta Arenas.
Companies located in a free-trade zone are exempt from corporate income tax, VAT
and duties on imported inputs and parts.
Taxation
During 2001, a new law governing corporate tax rates was issued. Accordingly, this
increased the corporate tax rate from 15% to 17% over a three-year period to 2004.
If corporate profits are distributed abroad, the withholding tax rate is 35%, with a
credit for the tax previously paid on undistributed profits (the amount of the credit
will depend on the tax rate paid by the profits distributed, 15.0%, 16.0% or 16.5%).
Profits distributed to persons in Chile are subject to a progressive rate applicable to
the recipient of the distribution. Profits distributed to legal entities domiciled or
resident in Chile are not subject to income tax.

Capital gains are treated as normal income. Dividends paid by a resident company to
resident shareholders are not taxable, although those paid to non-residents are
subject to a 35% withholding tax (subject to a credit). Interest paid on loans from
abroad is also subject to a 35% withholding tax. If the loan is granted by a foreign or
international bank or financial institution that rate is 4%. VAT is levied at 18%
(exports are exempt). Various municipal and real estate taxes are also levied.
Chart 15
Corporate Tax Rates in Selected Countries, 2005
0 5 10 15 20 25 30 35 40 45
US
Canada
Ecuador
Argentina
Colombia
Mexico
Brazil
Uruguay
Bolivia
Chile
%
Source: KPMG, Corporate Tax Survey

Double taxation and tax evasion agreements have been signed with numerous
countries including Argentina, Canada and Mexico, although there is no agreement
with the US. There have been some encouraging moves regarding the tax treatment
of foreign investors. Capital gains tax on portfolio foreign investment was lowered to
15% from 35% in 2002. However, a reduction in dividend tax, which is levied at
35%, is unlikely, given the governments need to minimise the fiscal deficit.
Company Organisation
There are seven basic forms of company organisation in Chile:

Corporation (Sociedad Anonima, S.A.): There are two forms of corporations:
open and closed. Open corporations are quoted on the stock exchange. When
SAMPLE

they have less than 500 shareholders, 100 shareholders or more must hold at
least 10% of the capital. Open corporations must publish their financial
statement annually. Closed corporations must have a minimum of two
shareholders. They are not submitted to any of the above requirements and are
used for small ventures.
Sociedad de Responsabilidad Limitada (S.R.L): Limited liability company.
Branch of a Foreign Corporation (Agencia): Branches of foreign companies
must be registered with a Chilean notary. They must produce documents relative
to the legal existence of the company in its country of origin and a copy of its
bylaws. Power of attorney must also be given to the agent representing the
company in Chile. A copy of the branchs annual accounts must be published in
a local newspaper within four months of the end of the financial year.
Sociedad Colectiva: General partnership.
Limited Partnership (Sociedad en Comandita): These are most favoured in
cases of association, either of persons or of corporations. The liability of each
partner is limited to the amount of his initial investment. The parties are legally
bound once a partnership deed has been drawn. Partnerships are under no
obligation to publish any financial statements.
Asociacion o Cuentas en Participacion: Silent partnership joint venture.
Empresario Individua: Sole proprietorship.

The most common forms of association selected by foreign investors (apart from
branches) are corporations and limited partnerships.
Portfolio Investment
The Santiago Stock Exchange is Chiles only stock exchange. The main stock market
index is the General Stock Price Index (IGPA), which consists of most of the stocks
quoted on the Santiago exchange. The IPSA index is a selective price stock
exchange and includes the 40 most actively traded stocks on the exchange. The
INTER 10 index reflects the main Chilean stocks that are quoted in foreign exchange
markets and also have a major local presence. It is made up of the ten stocks with the
biggest market value, which have also issued American Depository Receipts.
Investors wishing to buy or sell shares on the exchange do so via a brokers bureau.
Transactions are executed by brokers or through a daily auction system.
SAMPLE

Additional Sources of Information

Banco Central de Chile
Agustinas 1180
Casilla Postal 967
Santiago, Chile
Tel: (562) 670 2000
Fax: (562) 670 2099
http://www.bcentral.cl
Chilean-American Chamber of
Commerce
Avenida Kennedy 5735, Oficina 201
Torre Poniente
Las Condes
Santiago, Chile
Tel: (562) 290 9700
Fax: (562) 212 0515
http://www.amchamchile.cl

Corporacion Nacional del Cobre
de Chile (Codelco)
Huerfanos 1270, Casilla 150-D
Santiago, Chile
Tel: (562) 690 3000
http://www.codelco.com
US Embassy in Chile
Av. Andres Bello 2800
Las Condes
Santiago, Chile
Tel: (562) 232 2600
Fax: (562) 330 3710
http://www.usembassy.cl

ProChile
6100 Wilshire Blvd., Suite 1260
Los Angeles
CA 90048, USA
Tel: (213) 932 7200
Fax: (213) 932 7204
http://www.chileinfo.com
North American-Chilean
Chamber of Commerce Inc
220 E 81st Street
New York, NY 10028
USA
Tel: (212) 288.5691

US Department of Commerce
Trade Information Center
International Trade Administration
14th and Constitution Ave, NW
Washington, DC 20230
Tel: 800-USA-TRADE
Fax: (202) 482.4726
http://www.ita.doc.gov
Chilean Trade Bureau
510 W Sixth Street, Suite 1204
Los Angeles
CA 90014, USA
Tel: (213) 624.6302

Credit Information
D&B provides information relating to over 100m companies worldwide. Visit
www.dnb.com for details. Additional information relevant to country risk can also be
found in the following services:
International Risk & Payment Review: Provides timely economic, political and
commercial information and analysis on 132 countries. Available as a subscription-
based internet service (www.dnbcountryrisk.com) and monthly update journal, the
IRPR carries essential information on payment terms and delays. It also includes the
unique D&B Country Risk Indicator to help monitor changing market conditions.

Exporters Encyclopaedia: Information on 220 world markets to help customers
decide where they can safely and profitably do business. Data provided include key
contacts, transportation information, legislation affecting export commerce and tips
on foreign business travel. Published annually in August plus ad hoc updates,
English Language Edition.
SAMPLE

Glossary
Balance of payments The sum of payments made to all other nations less the sum of
external receipts.
Basis point One one-hundredth of a percentage point.
CAD Cash against documents: On payment, the buyer receives the
documents that give access to the purchased goods.
CiA Cash in advance: The buyer pays the seller before shipment is
effected.
CIS Commonwealth of Independent States (Armenia, Azerbaijan,
Belarus, Georgia, Kazakhstan, Kyrgyz Republic, Moldova, Russia,
Tajikistan, Ukraine and Uzbekistan)
CLC Confirmed letter of credit: A letter of credit in which payment is
guaranteed by the opening bank in the buyers country and by
another bank.
CPI Consumer price index
Current account balance Part of the balance of payments that records a nations exports and
imports of goods and services, and income and transfer payments.
CWP Claims waiting period: The time between when the covered risk
materialises and the earliest time when indemnification of a claim
can take place.
DSR Debt service ratio: Annual interest and principal payments on a
countrys external debts as a percentage of exports of goods and
services.
ECB European Central Bank
ECGD Export Credits Guarantee Department (UK)
EU European Union
Eximbank Export Import Bank (US)
FDI Foreign direct investment: Investment in productive assets by a
company incorporated in a foreign country.
Fitch Fitch Ratings
FX Foreign exchange
G7 Group of Seven industrial nations (Canada, France, Germany, Italy,
Japan, UK and US)
G8 Group of Eight industrial nations (G7 plus Russia)
GDP Gross domestic product: The value of goods and services produced
within an economy.
GNP Gross national product: GDP plus net income from abroad.
Government balance The balance of government expenditure and receipts.
SAMPLE

HIPC Heavily Indebted Poor Countries initiative: A framework for
creditors to provide debt relief to the poorest and most heavily
indebted countries.
IMF International Monetary Fund
Import cover The amount of official FX reserves a country has in relation to the
average monthly value of imported goods and services.
Inflation The increase in prices over a given period.
IT Information technology
LC Letter of credit: A guarantee of payment to a seller from a buyers
bank. Payment is conditional on named documents being presented
by specific dates.
Moodys Moodys Investors Service
MP Member of parliament
NATO North Atlantic Treaty Organisation
NGO Non-governmental organisation
Nominal effective exchange rate The weighted average exchange rate of the local currency vis--vis a
basket of foreign currencies.
OA Open account: credit extended that is not supported by a note,
mortgage or other formal written evidence of indebtedness.
OECD Organisation for Economic Co-operation & Development
OPEC Organisation of Petroleum Exporting Countries
Q1; Q2; Q3; Q4 First, second, third and fourth quarter
R&D Research and development
Real effective exchange rate The nominal effective exchange rate adjusted for inflation
differentials with the countrys trading partners.
Real GDP GDP adjusted for inflation
S&P Standard & Poors
SD Sight draft: A draft or bill that is payable on demand or on
presentation.
STIPP Short-Term Insurance Pilot Program (US): Provides short-term
cover to buy US goods in countries where Eximbank is otherwise
not open for medium-term financing in the public or private sector.
Terms of trade The ratio of the index of export prices to the index of import prices.
A rising ratio indicates improving terms of trade.
UN United Nations
VAT Value-added tax: A consumption tax levied at each stage of
production based on the value added to the product at that stage.
WTO World Trade Organisation
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Country Risk Indicator Definition

D&Bs Country Risk Indicator provides a comparative, cross-border assessment of the risk of doing
business in a country. The indicator seeks to encapsulate the risk that country-wide factors pose to the
predictability of export payments and investment returns over a time horizon of two years. The risk
indicator comprises a composite index of four over-arching country risk categories:

Political risk - internal and external security situation, policy competency and consistency,
and other such factors that determine whether a country fosters an enabling
business environment;

Macroeconomic risk - the inflation rate, government balance, money supply growth and all such
macroeconomic factors that determine whether a country is able to deliver
sustainable economic growth and a commensurate expansion in business
opportunities;

External economic risk - the current account balance, capital flows, foreign exchange reserves, size of
external debt and all such factors that determine whether a country can
generate enough foreign exchange to meet its trade and foreign investment
liabilities;

Commercial risk - the sanctity of contract, judicial competence, regulatory transparency, degree
of systemic corruption, and other such factors that determine whether the
business environment facilitates the conduct of commercial transactions.

The DB risk indicator is divided into seven bands, ranging from DB1 through DB7. Each band is
subdivided into quartiles (a-d), with an a designation representing slightly less risk than a b designation
and so on. Only the DB7 indicator is not divided into quartiles.

Indicator Meaning Explanation

DB1 Lowest risk Lowest degree of uncertainty associated with expected returns, such as export
payments, and foreign debt and equity servicing.

DB2 Low risk Low degree of uncertainty associated with expected returns. However,
country-wide factors may result in higher volatility of returns at a future date.

DB3 Slight risk Enough uncertainty over expected returns to warrant close monitoring of
country risk. Customers should actively manage their risk exposures.

DB4 Moderate risk Significant uncertainty over expected returns. Risk-averse customers are
advised to protect against potential losses.

DB5 High risk Considerable uncertainty associated with expected returns. Businesses are
advised to limit their exposure and/or select high-return transactions only.

DB6 Very high risk Expected returns subject to large degree of volatility. A very high expected
return is required to compensate for the additional risk or the cost of hedging
such risk.

DB7 Highest risk Returns are almost impossible to predict with any accuracy. Business
infrastructure has, in effect, broken down.
SAMPLE

Sample: D&B Country Report Chile

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