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UV0921

CHILE: A CHANGED JUNGLE FOR


THE LATIN AMERICAN TIGER (ABRIDGED)
In June 1998, Carlos Massad, president of Banco Central de Chile (the central bank of
Chile), was evaluating the Chilean economic situation. After a decade of spectacular economic
performance with average annual growth rates of more than 7% (Exhibit 1), Chile had earned the
name Latin American Tiger in reference to the fast-growing tiger economies in East Asia (Hong
Kong, Singapore, South Korea, and Taiwan).
Chile was facing one of the biggest challenges since the collapse of its financial system in
1982. Somewhat ironically, the 1997 crisis plaguing those same namesake tigers, which resulted in
sharp currency devaluations and severe economic contractions in East Asia, had greatly increased
the risk premium for investing in other emerging markets. Investors, who once willingly poured
billions of dollars into emerging markets, were now avoiding them indiscriminately. They were
choosing instead to park their money in safe havens such as the United States. This sudden
withdrawal or stopping of foreign investment was now causing severe economic difficulties in other
emerging economies that were dependent on foreign investment for economic development and
threatened to ignite a new round of financial crises. Perhaps most worrisome, the next round of
crises could be much closer to home. (See Exhibit 2 for Chiles balance of payments.)
For many years, Chile could rely on its abundant natural resources, most notably copper,
forestry, and fishery, to provide the country with the hard currency needed to import equipment and
technology (Exhibits 3 and 4). But the weakened economies in Asia had depressed the world
demand for commodities. The price of copper had fallen to its lowest level since 1988 (Exhibit 5).
The combination of capital flight and weakened exports had started to slow down production in
Chile (Exhibit 6) and to drain the countrys foreign exchange reserves (Exhibit 2). Massad had to
come up with a strategy to reverse the deterioration in Chiles balance of payments and prevent a
major crisis. While the economic institutions and policies implemented since the early 1990s had
worked well for Chile, the global economic environment had changed drastically in the last couple
of years. Should Chile change course? If so, in what direction?

This abridged case was prepared by Jose Joaquin Matte (MBA 02), under the supervision of Wei Li, Professor of
Business Administration. The authors gratefully acknowledge the financial assistance of Dardens Batten Institute. It was
written as a basis for class discussion rather than to illustrate effective or ineffective handling of an administrative
situation. Copyright 2002 by the University of Virginia Darden School Foundation, Charlottesville, VA. All
rights reserved. To order copies, send an e-mail to sales@dardenbusinesspublishing.com. No part of this publication may
be reproduced, stored in a retrieval system, used in a spreadsheet, or transmitted in any form or by any means
electronic, mechanical, photocopying, recording, or otherwisewithout the permission of the Darden School
Foundation. Rev. 3/08.

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The Dilemma of the Early 1990sControls on Capital Inflows


The early 1990s saw a sharp increase in capital flows into most emerging economies in the
Western Hemisphere. Chile was no exception (Exhibit 2). These inflows created a dilemma for the
central bank: In order to achieve its internal objectivethe inflation targetthe central bank needed
to keep interest rates sufficiently high. They were often higher in Chile than abroad to dampen
aggregate demand. (See Exhibit 7 for time-series plot of a Chilean benchmark short-term real
interest rate.) The interest rate differential needed to control aggregate demand, and inflation gave
rise to incentives for interest-arbitrage capital inflows. This put upward pressure on the exchange
rate. There was, therefore, the risk that high interest rates needed to control inflation would cause a
rise in even larger capital inflows and a further appreciation of the real exchange rate (RER)
(Exhibit 8). The appreciation in RER would in turn cause deterioration in Chiles export
competitiveness and make the economy more vulnerable to external shocks, therefore compromising
the central banks external objective of maintaining a competitive and stable exchange rate. The
dilemma was how to control inflation through a tight monetary policy without damaging Chilean
export competitiveness.
Initially, the Chilean central bank responded to the capital inflows with foreign exchange
intervention to slow the pace of currency appreciation. Later, the central bank also tried to offset the
inflows by removing some existing restrictions on capital outflows. But this created a somewhat
perverse reaction as investors responded to lowered barriers to capital outflow by committing more
capital to Chile.
In June 1991, the central bank introduced controls on capital inflows: a 20% Unremunerated
Reserve Requirement (URR) on foreign loans and foreign investment in fixed-income securities.
Under the URR, a foreign investor who bought short-term debt securities in Chile or held deposits in
Chilean banks was required to deposit 20% of the investment in a non-interest-earning account at the
central bank for one year. The requirement to hold non-interest-earning deposits for one year meant
that the financial burdenthe foregone earningsdecreased as the term of the investment
lengthened. The second element of the capital controls was the imposition of a minimum holding
period of one year for foreign direct investments forbidding foreign investors from withdrawing their
direct investments within one year.
The objective of the URR was to favor equity over debt financing and long-term financing
over short-term financing and allow the operation of a tight monetary policy without resulting in
large [BOP] account imbalances.1 The URR was expected to discourage short-term inflows without
affecting long-term foreign investments. Between 1991 and 1997, the rate of the URR was
increased, and its coverage extended (Exhibit 9).

Le Fort and Budnevich, 1996.

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Exchange Rate Policy


A crawling peg exchange rate system was introduced in 1985 by Finance Minister Hernan
Bchi. The peso was allowed to trade against the U.S. dollar in a band around the target exchange
rate set by the central bank. The central bank intervened if the market rate threatened to move
outside the band. The trading band was set initially at 3% around the target rate and was raised to
5% in 1989. The exchange rate policy aimed to contain excessive volatility in the market value of
the peso and to maintain competitiveness of Chilean exports on international markets. Because the
consumer price inflation had been running at a much higher rate in Chile than in the United States,
the central bank used frequent and small devaluations of the target nominal exchange rate to keep
the real exchange rate at a competitive level.
After the introduction of the URR, and in response to continuing capital inflows and
escalating pressure on the peso, the central bank used the crawling peg system to allow an orderly
and gradual appreciation of the currency in real terms. This was usually done by keeping the target
nominal exchange rate devaluing at a slower rate on average than the prevailing inflation. To
introduce more exchange rate flexibility, the central bank also widened the trading band to 10% in
1992, and 12.5% in 1997. Throughout the 1990s, the central bank kept a restrictive monetary
policy in order to reduce the inflation inertia in the economy. See Exhibit 8 for charts on nominal
and real exchange rates.
Trade Policy
Since the 1970s, Chile had opted for unilateral trade liberalization, producing one of the most
transparent trade regimes in the world. With only a few exceptions, a single- and low-import tariff
rate had been in effect since the 1970s. The authorities preserved this policy and further
complemented it in the 1990s with a series of both multilateral and bilateral trade agreements.
Chile signed its first free trade agreement with Mexico in 1991. The agreement incorporated
a program for further tariff reductions that culminated in 1998 with tariff-free trade between the two
countries, except for a short list of goods and services. Following the agreement with Mexico, Chile
signed, in 1993, a trade agreement with Venezuela and another one with Colombia. Both agreements
established tariff-reduction programs culminating in tariff-free trade for most traded goods and
services in 1997. Additional bilateral trade agreements were signed with Ecuador (1994) and Peru
(1998).
In 1994, Chile was invited to attend the inaugural summit meeting for the North American
Free Trade Agreement (NAFTA) meeting. It was hoped that Chile would join the United States,
Canada, and Mexico as a member of NAFTA. Support for NAFTAs expansion was dramatically
reduced following the Mexican peso devaluation in 1995 and growing trade imbalances among
NAFTA partners. Nevertheless, the Chilean incorporation into the NAFTA received a push forward
when Chile signed a free trade agreement with Canada in November 1996. This agreement became
operational in June 1997 with immediate free trade for 80% of bilateral trade and a program to

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UV0921

reduce the tariffs to zero within six years (except for some agricultural products). In 1997, the
Clinton administration failed to secure fast-track negotiating power from the U.S. Congress,2
delaying indefinitely Chiles chances to join the NAFTA.
In June 1996, Chile signed an association agreement with Mercosur, the Latin American
common market that included Argentina, Brazil, Paraguay, and Uruguay. The agreement consisted
of 40% reduction of tariffs for most traded products. Further tariffs cuts were expected to reach 70%
by 2002 and 100% by 2004.3 These trade arrangements further strengthened Chiles trade links with
its Latin American neighbors, in particular with Argentina and Brazil (Exhibit 3).
In 1996, Chile signed a framework agreement on economic cooperation with the European
Union. This agreement replaced a more restrictive one signed in 1990 and included cooperative
programs in areas such as customs, investments, environmental regulations, intellectual property,
and telecommunications. In early 1998, Chile and the European Commission agreed to a negotiation
schedule toward a free trade area that would be operational in 2005.
Overall, Chile had maintained a liberal, transparent trade regime since the free market
reforms in the 1970s. The government had a clear preference for concluding free trade agreements
that did not inhibit its own freedom to undertake further unilateral reforms. Chiles main trade policy
instrument was the uniform tariff that was introduced in the late 1970s. In December 1997, the tariff
was 11%, and further reductions to 7% or 8% had been sent to the Congress for approval. Despite an
increased emphasis on regional agreements since 1990, the authorities sought to continue the process
of unilateral liberalization by further reducing tariffs.
Chiles trade balance was highly dependent on primary goods, including copper, fruits,
forestry, and fishery products. About 10% of Chiles exports were manufactured goods, mainly
processed from natural resources. Despite export diversification efforts, Chile continued to be highly
dependent upon copper, and the economy remained sensitive to fluctuations in world copper prices.
To cope with the resulting volatility of export income, the Chilean government operated a
stabilization fund out of its copper revenues.
Reliance on Commodities
Chile had the largest reserves of copper in the world, accounting for 28% of the worlds
proven and economically viable reserves (Exhibit 4). Copper production was even more
concentrated: Chile produced 34% of the world output. Copper, therefore, played a very important
role in the Chilean economy. It represented nearly 40% of all Chilean exports (Exhibit 3). The
mining sector as a whole represented 50% of all the exports and 8% of the GDP. As with any other
2

A U.S. president with fast-track negotiating power was authorized by Congress to negotiate a free trade agreement
with a foreign country. Congress could only approve or disapprove the negotiated agreement but had no authority in
modifying it.
3
Investing Licensing and Trading in Chile. The Economist Intelligence Unit.

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UV0921

commodity, the price of copper was very volatile and subject to wide swings in the short run
(Exhibit 5). Inventories, as well as international market conditions, drove the world market price of
copper. As shown in Exhibit 4, Europe, Asia, and North America were the main consumers of
copper. Given the extensive use of copper in the construction, automotive, and telecommunications
industries, an increasing share was used in Japan and other Asian countries, making the region the
most dynamic copper market in recent years.
Investment Link to Neighboring Countries
Chilean companies had been active investors themselves in Latin America. Because Chile
was the first country to undertake mass privatizations of state-owned assets, many privatized
companies in Chile had extensive experience with postprivatization enterprise restructuring. When
Argentina, Brazil, and other Latin American countries started to privatize their state-owned firms,
Chilean firms had a competitive advantage in restructuring and better access to Chilean and
international financial markets for financing. Between 1990 and 1995, Chileans made more than
USD5.5 billion in direct investment in Argentina, USD1.9 billion in Peru, and USD415 million in
Brazil. Economic weakness in neighboring countries would have an immediate impact on the
Chilean economy.
Taking Action
In June 1998, Carlos Massad was evaluating the Chilean economic situation. Structural
reforms such as trade liberalization and privatization, combined with macroeconomic policies on
exchange rates, inflation, and partial capital controls, had paid off handsomely. Nevertheless, the
Asian financial crisis could present serious challenges to other emerging market countries, including
Chile. The next domino to fall could be a Latin American country. The Brazilian real had been under
pressure since December 1997. While the Brazilian government had skillfully averted an immediate
devaluation, Massad knew that Chile had to prepare for the worst as investors continued to flee
emerging markets and commodity prices continued to be weak.
Massad had to devise a strategy to minimize the potential for harm due to the ripple effects
emanating from the Asian crisis. In the past, the Chilean central bank focused more attention on
controlling inflation and on stabilizing the exchange rate. Should the central bank continue to focus
on price stability in the changed global economic environment? Or should its policies focus more on
economic growth and employment?
Acting independently, the Chilean central bank had decided to pursue a restrictive monetary
policy by increasing the benchmark 90-day interest rate from a 6.5% real rate to 7% in January 1998,
and to 8.5% in February in an effort to make investment in Chile more attractive (Exhibit 7). But
would this be enough? Massad had to consider the overall state of the Chilean economy, commodity
prices, and investor confidence in emerging markets in general and in Chile in particular. Facing a
new interdependent world, he felt that he had to act quickly and forcefully.

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What should he do that would avert a crisis and at the same time make Chile an attractive
market for international trade and investment?

21.0%
38.9%
27.1%

Growth in monetary base


Growth in M1
Growth in M2

Source: IMF

12.5

19.9%
7.9%

Inflation rate
Unemployment rate

Population (millions)

62,334
6.6%

64%
11%
19%
3%
3%

As % of GDP
Private consumption
Government consumption
Gross fixed investment
Increase/decrease in stocks
Net exports

GDP at 1986 prices


Real GDP growth

238

19,069
-1,614
17,455

GDP
Net Factors Inc/payments abroad
GNP

Exchange rate (pesos/dollar)

12,205
2,075
3,703
539
5,772
5,224

Private consumption
Government consumption
Gross fixed investment
Increase/decrease in stocks
Exports of goods and services
Imports of goods and services

1987

12.8

46.5%
22.5%
31.2%

14.7%
6.3%

66,892
7.3%

60%
10%
20%
2%
7%

247

23,912
-1,958
21,954

14,325
2,478
4,855
589
8,265
6,602

1988

13.0

17.2%
35.2%
23.5%

17.0%
5.3%

73,956
10.6%

60%
10%
24%
2%
5%

297

24,795
-1,793
23,003

14,910
2,501
5,845
391
8,897
7,749

1989

13.1

23.3%
23.6%
28.1%

26.0%
5.6%

76,690
3.7%

62%
10%
23%
2%
3%

337

27,446
-1,592
25,854

16,979
2,677
6,352
541
9,502
8,604

1990

13.3

44.7%
23.9%
23.3%

21.8%
5.3%

82,802
8.0%

63%
10%
20%
3%
4%

375

32,279
-1,826
30,453

20,436
3,120
6,434
845
10,702
9,259

1991

13.5

26.3%
22.5%
23.4%

15.4%
4.4%

92,969
12.3%

65%
10%
22%
1%
1%

382

39,718
-1,821
37,897

25,877
3,842
8,906
549
12,174
11,631

1992

13.8

21.2%
24.0%
11.3%

12.7%
4.5%

99,464
7.0%

66%
10%
25%
2%
-2%

431

41,701
-1,600
40,101

27,484
4,184
10,392
660
11,468
12,487

1993

14.0

16.2%
9.9%
25.8%

11.4%
7.9%

105,141
5.7%

65%
10%
23%
1%
1%

404

52,947
-2,654
50,293

34,223
5,267
12,325
434
15,515
14,817

1994

Chilean Economy (in millions of U.S. dollars, except as noted)

CHILE: A CHANGED JUNGLE FOR


THE LATIN AMERICAN TIGER (ABRIDGED)

Exhibit 1

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65%
10%
25%
2%
-2%

425

66,518
-2,714
63,804

43,323
6,867
16,565
1,314
19,004
20,555

1996

65%
11%
25%
2%
-3%

440

71,775
-2,570
69,205

46,645
7,548
18,290
1,252
20,186
22,146

1997

14.2

22.2%
27.0%
19.6%

8.2%
7.3%

14.4

16.2%
20.6%
16.3%

7.4%
6.4%

14.6

20.2%
15.2%
9.6%

6.1%
6.1%

116,315 124,938 134,174


10.6%
7.4%
7.4%

63%
10%
24%
2%
2%

407

63,556
-2,718
60,839

39,759
6,247
15,172
1,220
19,416
18,258

1995

UV0921

519
-519
-548
-21
50
3,629
366
5,430
5,064

Overall Balance

Financing
Reserve assets
Use of funds and credit loans
Exceptional financing

International reserves (1)


Government surplus / deficit (-)
Government revenues
Government spending

Source: IMF

(1): Excludes gold reserves


- Annualized data on quarterly information

-33

Errors and Omissions

1,241
1,277
83
-119

-690
1,483
8,078
-6,595
-2,173
-460
-1,940
226

Current Account
Trade balance
Exports (f.o.b.)
Imports (f.o.b.)
Services and transfers
Services
Income
Transfers

Capital and Financial Account


Foreign direct investments
Portfolio investment
Other capital (net)

1989

Balance of Payments

6,068
220
5,692
5,471

-2,323
-2,121
-209
8

2,323

-50

2,857
654
361
1,843

-484
1,284
8,373
-7,089
-1,768
-228
-1,737
198

1990

7,041
496
7,210
6,714

-1,257
-1,049
-197
-11

1,257

392

964
696
189
79

-99
1,485
8,942
-7,456
-1,584
33
-1,928
312

1991

9,168
906
9,142
8,236

-2,547
-2,344
-203
0

2,547

373

3,132
537
458
2,137

-958
722
10,007
-9,285
-1,680
-177
-1,881
378

1992

9,640
827
9,692
8,865

-428
-170
-249
-9

428

-13

2,995
600
730
1,665

-2,554
-990
9,199
-10,189
-1,565
-228
-1,656
320

1993

13,088
896
11,951
11,055

-3,151
-2,918
-210
-22

3,151

-558

5,294
1,672
908
2,713

-1,585
732
11,604
-10,872
-2,317
-149
-2,499
331

1994

14,140
1,640
14,133
12,493

-1,139
-740
-298
-101

1,139

132

2,357
2,205
34
118

-1,350
1,381
16,025
-14,644
-2,731
-324
-2,714
307

1995

14,833
1,548
15,610
14,062

-2,504
-1,107
0
-1,397

2,504

-651

6,665
3,446
1,100
2,119

-3,510
-1,091
15,405
-16,496
-2,419
-260
-2,666
507

1996

16,017
3,676
18,084
14,408

-6,812
-6,812
0
0

6,812

-3,224

8,623
1,584
3,140
3,899

1,413
2,784
18,772
-15,988
-1,371
664
-2,643
608

1997Q1

Balance of Payments (in millions of U.S. dollars, except as noted)

CHILE: A CHANGED JUNGLE FOR


THE LATIN AMERICAN TIGER (ABRIDGED)

Exhibit 2

-8-

17,017
664
16,366
15,702

-3,469
-3,469
0
0

3,469

-3,108

8,894
3,924
3,024
1,946

-2,316
420
17,284
-16,864
-2,736
-388
-2,912
564

1997Q2

17,585
1,622
17,459
15,836

-2,589
-2,589
0
0

2,589

-1,970

10,511
4,908
1,936
3,667

-5,952
-3,624
15,320
-18,944
-2,328
-328
-2,564
564

1997Q3

17,306
34
18,086
18,052

132
132
0
0

-132

6,530

1,394
3,000
1,360
-2,966

-8,056
-5,812
15,276
-21,088
-2,244
236
-2,828
348

1997Q4

16,465
2,757
17,725
14,968

3,345
3,345
0
0

-3,345

-3,029

3,360
3,664
-156
-148

-3,676
-2,536
15,916
-18,452
-1,140
332
-1,748
276

1998Q1

UV0921

UV0921

-9Exhibit 3
CHILE: A CHANGED JUNGLE FOR
THE LATIN AMERICAN TIGER (ABRIDGED)
International Trade
1987

1988

1989

1990

1991

1992

1993

1994

1995

1996

1997

United States
Japan
United Kingdom
Brazil
Others

22.4%
11.0%
9.5%
6.2%
50.9%

19.3%
12.2%
11.3%
5.1%
52.1%

17.7%
13.6%
11.1%
6.1%
51.5%

Copper
Fresh fruit
Fish meal
Cellullose
Others

42.8% 48.4% 49.8% 45.5% 40.5% 38.8% 35.3% 36.6% 40.5% 39.1% 41.1%
10.2% 8.3% 6.7% 8.5% 10.5% 9.7% 9.2% 8.0% 7.0% 7.8% 7.2%
6.9% 6.5% 6.3% 4.5% 5.2% 5.4% 4.0% 3.9% 3.9% 3.9% 3.3%
5.1% 4.4% 4.0% 5.1% 5.0% 6.8% 6.7% 8.0% 9.6% 6.5% 5.8%
35.0% 32.4% 33.2% 36.4% 38.8% 39.3% 44.8% 43.5% 39.0% 42.7% 42.6%

Exports
17.4% 17.6% 16.3% 17.6% 17.3% 14.4% 16.6% 15.9%
16.2% 18.4% 16.9% 16.0% 17.0% 17.7% 16.2% 15.7%
11.0% 7.8% 6.0% 5.2% 5.0% 5.1% 4.8% 4.4%
6.5% 4.5% 5.6% 5.9% 4.5% 6.5% 5.8% 6.2%
48.9% 51.7% 55.2% 55.3% 56.2% 56.3% 56.6% 57.8%

Imports
United States
Argentina
Japan
Brazil
Source: Datastream

19.2% 19.7% 18.6% 17.7% 19.3% 19.5% 22.3% 22.3% 23.9% 23.1% 22.0%
9.6% 7.7% 10.2% 7.6% 7.9% 9.5% 7.9% 8.5% 6.4% 5.3% 9.3%
9.4% 10.9% 9.7% 7.5% 8.5% 9.8% 9.5% 8.5% 7.5% 6.0% 5.4%
4.0% 5.5% 5.5% 6.5% 6.7% 6.2% 5.2% 8.1% 8.7% 9.2% 6.3%

UV0921

-10Exhibit 4
CHILE: A CHANGED JUNGLE FOR
THE LATIN AMERICAN TIGER (ABRIDGED)
Copper Reserves (in millions of tons)
Basic Reserves Percentage of
Reserves
Percentage of
(1)
Total Reserves
(2)
Total Reserves
Chile
163
25.9%
88
27.5%
United States
90
14.3%
45
14.1%
China
37
5.9%
18
5.6%
Poland
36
5.7%
20
6.3%
Zambia
34
5.4%
12
3.8%
Russia
30
4.8%
20
6.3%
Congo (Kinshasa)
30
4.8%
10
3.1%
Mexico
27
4.3%
15
4.7%
Peru
24
3.8%
7
2.2%
Canada
23
3.7%
10
3.1%
Australia
23
3.7%
7
2.2%
Other countries
113
17.9%
68
21.3%
Total
630
320
(1): Basic Reserves include all known reserves
(2): Reserves include only reserves which are economically viable
Source: U.S. Geological Survey, Mineral Commodities Summaries (January 1998)

Consumption by Region
Consumption per region (%)

1992

1993

1994

1995

1996

1997

Europe
Germany
France
Italy
United Kingdom
Other Europe

39%
10
5
5
3
16

33%
8
4
4
3
14

33%
9
4
4
3
13

33%
9
4
4
3
13

31%
8
4
4
3
12

31%
8
4
4
3
12

Asia
Japan
China
Taiwan
South Korea
Other Asia

34%
13
8
4
3
6

37%
13
9
4
4
7

35%
12
7
5
4
7

37%
12
9
5
4
7

38%
12
9
4
5
8

38%
11
9
4
5
9

Americas
United States
Canada
Mexico
Other America

25%
20
1
1
3

28%
21
2
2
3

30%
23
2
2
3

27%
21
2
1
3

28%
21
2
2
3

28%
21
2
2
3

1%

1%

1%

1%

1%

1%

Africa
Oceania
Total
Source: IMF

1%

1%

1%

2%

2%

2%

100%

100%

100%

100%

100%

100%

UV0921

-11Exhibit 5
CHILE: A CHANGED JUNGLE FOR
THE LATIN AMERICAN TIGER (ABRIDGED)
Copper Price
Copper Price - Grade A3
(USD per metric ton @ Dec 97 prices - using GDP deflator)
4500

4000

3500

3000

2500

2000

1500
1/1/1987

5/15/1988

Source: DataStream.

9/27/1989

2/9/1991

6/23/1992

11/5/1993

3/20/1995

8/1/1996

12/14/1997

UV0921

-12Exhibit 6
CHILE: A CHANGED JUNGLE FOR
THE LATIN AMERICAN TIGER (ABRIDGED)
IMACEC Index of Monthly Economic Activity

IMACEC Activity Index - Monthly Change


2.00%

1.50%

1.00%

0.50%

-0.50%

The IMACEC Index measured more than 90% of the components of the GDP.
Source: Banco Central de Chile

Jan-98

Jul-97

Jan-97

Jul-96

Jan-96

Jul-95

Jan-95

Jul-94

Jan-94

Jul-93

Jan-93

Jul-92

Jan-92

Jul-91

Jan-91

Jul-90

Jan-90

Jul-89

Jan-89

Jul-88

Jan-88

Jul-87

Jan-87

Jul-86

Jan-86

0.00%

UV0921

-13Exhibit 7
CHILE: A CHANGED JUNGLE FOR
THE LATIN AMERICAN TIGER (ABRIDGED)
Interest Rates
90-day real Interest Rate
(Middle Rate - Real Rate)
14%

12%

10%

8%

6%

4%

2%

0%
1/1/1994

7/20/1994

2/5/1995

Source: Banco Central de Chile.

8/24/1995

3/11/1996

9/27/1996

4/15/1997

11/1/1997

5/20/1998

UV0921

-14Exhibit 8
CHILE: A CHANGED JUNGLE FOR
THE LATIN AMERICAN TIGER (ABRIDGED)
Exchange Rate
Chilean Nominal Exchange Rate
(pesos per USD)
500
450
400
350
300
250
200
150
100
Jan-87

May-88

Sep-89

Feb-91

Jun-92

Nov-93

Mar-95

Aug-96

Dec-97

Source: DataStream

USD Billions

Real Exchange Rate and Foreign Exchange Reserves (Chile, 1987-1998)


140.00

20.00
18.00

130.00
16.00
120.00

14.00
12.00

Foreign Exchange Reserves (left scale)

110.00

10.00
100.00

8.00
6.00
4.00
2.00

90.00

Real Effective Exchange Rate (right scale)


(increase in index value represents
real appreciation)

70.00

19
8

7M
19 1
87
M
19 7
88
M
19 1
88
M
19 7
89
M
19 1
89
M
19 7
90
M
19 1
90
M
19 7
91
M
19 1
91
M
19 7
92
M
19 1
92
M
19 7
93
M
19 1
93
M
19 7
94
M
19 1
94
M
19 7
95
M
19 1
95
M
19 7
96
M
19 1
96
M
19 7
97
M
19 1
97
M
19 7
98
M
1

0.00

80.00

Note: 1997M1 means January 1997 (month 1). Source: IMF.

UV0921

-15Exhibit 9
CHILE: A CHANGED JUNGLE FOR
THE LATIN AMERICAN TIGER (ABRIDGED)
Changes in the URR
Date

Measure

Motivation

Jun 1991

20% URR was introduced for all new credit inflows. 20%
of the credit inflows was required to be posted with the
central bank in a non-interest-bearing account. The holding
period varied from 90 days to one year depending on the
maturity of the debt.

To discourage short-term inflows


in favor of equity and long-term
financing to increase flexibility of
monetary policy

Jan 1992

20% URR extended to foreign currency deposits with To close the deposit loophole
proportional holding period

May 1992

URR was raised to 30% for bank credit lines. The holding To increase the cost on foreign
period was set at one year regardless of loan maturity.
borrowings; unify duration to
facilitate enforcement

Aug 1992

URR was raised to 30% on all foreign borrowing, foreign To close a loophole and increase
investments in Chilean debt securities and foreign deposits the cost of implied tax on foreign
in Chile.
borrowings

Jan 1995

Holding currency limited to USD only.

Jul 1995

URR extended to secondary ADR offerings


To close a loophole
(ADR = American Depository Receipt, representing
ownership in the shares of a non-U.S. company listed on
U.S. financial markets)

Dec 1995

Foreign borrowing to be used externally was exempt of To facilitate global operations of


URR
Chilean companies

Oct 1996

FDI committee would consider for approval productive A relaxation of URR


projects only. Approved FDI would be exempt of URR

Dec 1996

Foreign borrowing < USD200,000 (USD500,000 in a year) Further relaxation


exempt of URR

Mar 1997

Foreign borrowing < USD100,000 (USD100,000 in a year)


exempt of URR

Source: Jos De Gregorio, Sebastian Edwards, Rodrigo O. Valds, NBER Working Paper 7645 (2000).