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DE RUEHSG #0813/01 2492101
ZNR UUUUU ZZH
R 052101Z SEP 08
FM AMEMBASSY SANTIAGO
TO RUEHC/SECSTATE WASHDC 3679
INFO RUEHAC/AMEMBASSY ASUNCION 3518
RUEHBO/AMEMBASSY BOGOTA 2083
RUEHBU/AMEMBASSY BUENOS AIRES 1030
RUEHBR/AMEMBASSY BRASILIA 0409
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RUEATRS/DEPT OF TREASURY WASHDC

UNCLAS SANTIAGO 000813 
 
SENSITIVE 
 
SIPDIS 
 
STATE FOR WHA/BSC, WHA/EPSC, EEB/IFD, INR/IAA 
 
E.O. 12958: N/A 
TAGS: EFIN ECON EINV PGOV PREL OVIP CI
SUBJECT: FEDERAL RESERVE BOARD GOVERNOR KROSZNER A HIT IN CHILE 
 
¶1. (SBU) SUMMARY: Federal Reserve Board Governor Randall Kroszner 
presented the keynote address at a Central Bank-hosted conference 
for representatives of the banking and financial sector in Santiago 
on August 29.  In his first visit to Chile, Kroszner also met with 
influential business entrepreneurs, academics, financial experts, 
and current and former Central Bank and government ministers.  While 
discussions often focused on the state of the U.S. economy, Governor 
Kroszner also spoke about the challenges facing the U.S. financial 
system, risk management, and the effects of the housing and sub 
prime crisis.  His Chilean interlocutors expressed their concerns 
over increasing inflation, skyrocketing fuel costs, labor market 
inflexibility, and the need to improve education in Chile.  END 
SUMMARY. 
 
In High Demand 
-------------- 
 
¶2. (U) During a packed five-day program (August 26-31), Federal 
Reserved Board Governor Randall Kroszner met with Central Bank 
President Jose De Gregorio, Codelco CEO Jose Pablo Arellano, Finance 
Minister Andres Velasco, Bank Superintendent Gustavo Arriagada, 
former Central Bank President Vittorio Corbo, and representatives 
from private banks and the banking association.  At a luncheon 
hosted by the Ambassador, Kroszner discussed the global economy and 
Chile's performance with former Finance Minister Eduardo Aninat, 
University of Chile Economics and Business Dean Felipe Morande (also 
advisor to Presidential candidate Sebastian Pinera), Adolfo Ibanez 
University Rector Andres Benitez, former Finance Minister Carlos 
Caceres, and Celfin Capital brokerage board president Juan Andres 
Camus. 
 
¶3. (U) Several institutions held events in Fed Governor Kroszner's 
honor.  In addition to its conference, the Central Bank hosted two 
events, one with Central Bank Board Members and a second with 
financial sector regulators and key Central Bank managers.  AmCham 
and Banco de Chile organized a dinner with influential private 
sector and bank representatives.  A 16-year professor at the 
University of Chicago, Governor Kroszner attended a gathering with 
prominent Chilean Alumni and a private dinner with business magnate 
Alvaro Saieh (who has a PhD from the University of Chicago).  The 
Fed Governor also visited the Santiago Stock Exchange and reviewed 
the salmon industry in southern Puerto Montt, the wine sector in 
central Casablanca valley, and El Teniente mine -- the world's 
largest underground copper mine -- near Rancagua, south of 
Santiago. 
 
Central Bank: Pressure To Liberalize Energy Exploration 
--------------------------------------------- ---------- 
 
¶4. (SBU) In a courtesy call with Central Bank President Jose De 
Gregorio, Governor Kroszner expressed his thanks for the invitation 
to speak in Chile and the two discussed the upcoming central bank 
conference in Argentina.  De Gregorio made reference to Chile's 
energy concerns, noting that there was increasing political pressure 
on the GOC to liberalize rules governing energy exploration. 
Normally, investors working with the government are required to use 
a process called "L600," which allows for contracts between the 
state and private companies.  However, because of environmental 
sensitivities, oil drilling is excluded from the L600 process and 
requires special (and thus more complex and restrictive) 
documentation.  However, as Chile's energy costs escalate, and 
efforts to diversify energy gather steam, there has been a push to 
make the process easier. 
 
CODELCO:  Copper Prices Will Stay High 
-------------------------------------- 
 
¶5. (SBU) Governor Kroszner met with CEO Jose Pablo Arellano of the 
national, state-owned copper company, CODELCO.  Arellano believed 
copper production would remain unable to respond to demand pressures 
in the near term, which augured for sustained high copper prices. 
He said despite current weakness in world demand, in 2007, copper 
production had fallen short of what was promised by 900,000 tons. 
Short-term capacity in copper production was limited but had been 
overestimated by many experts, leading in part to the dramatic 
increase in copper prices.  In addition, changes made in supply 
(such as new mines, or increased productivity) were often associated 
with long lag times (up to 12 years in many cases).  China had 
accounted for almost all of the demand expansion since 2002, and was 
an aggressive consumer of Chilean copper products.  However, unlike 
in Africa, Chinese companies had not yet sought direct equity in 
copper producing companies in Chile. 
 
Finance Minister Velasco:  Econ 101 
----------------------------------- 
 
¶6. (SBU) Governor Kroszner's meeting with Finance Minister Andres 
Velasco was a reunion of two friends who were fellow academics. 
They grilled each other on the theories and models underlying 
current global macroeconomic trends (e.g., price model for oil). 
Ambassador Simons joined the banter, noting in the last five years, 
there had been no dramatic change in the global supply of oil in the 
ground, but prices had risen considerably.  The main factors were an 
inability to solve political risks associated with supplies and an 
inelasticity of demand in countries such as China and India, where 
fuel is subsidized.  Velasco noted the GOC had provided a cushion 
for consumers on fuel costs, but the price had increased 40% in the 
last month alone.  Argentina had a contract to sell Chile 18 mcm of 
gas per day, but reneged, which the Ministry estimated cost Chile 
one percent of GDP per year for the last three years. 
 
¶7. (SBU) Velasco noted Chile enjoyed a public surplus of almost 
seven percent of GDP.  The Finance Ministry wanted to use the 
surplus to pay down remaining debts, but there was very little left. 
 The Ministry had already recapitalized the Central Bank, which had 
acquired debt during the banking crisis of the 1980's.  It was now 
examining repaying debt from Chile's transition to privatized 
pension funds. 
 
¶8. (SBU) Velasco also explained the budget approval process in Chile 
was easier than in the U.S.:  1) Congress could not originate a bill 
for expenditure without the Ministry's sponsorship; 2) the Finance 
Ministry was required to submit the budget by September 30, but if a 
fully approved and amended budget was not passed by the Congress 
before November 30, the Ministry's original submission would 
automatically become law.  Velasco added that Chile's Sovereign 
Wealth Funds' investment rules were quite conservative and easy to 
sell to Chile's strong export lobby, because they realized intense 
domestic investment risked exchange rate appreciation. 
 
Former Central Banker: Next Team Will Do Better 
--------------------------------------------- -- 
 
¶9. (SBU) In an office call with Vittorio Corbo, an old friend and 
former Central Bank President, Kroszner exchanged opinions on the 
global economy.  Corbo also expanded on Chile's recent economic 
difficulties.  He highlighted inflationary pressures and the 38% 
rise in energy costs over the last 12 months.  He expressed relief 
there is consensus across the political spectrum on the need to curb 
inflation, which has increased to nearly 10 percent. 
 
¶10.  (SBU) Corbo praised Finance Minister Velasco for following 
sound fiscal policies.  He noted that despite national elections in 
2009, the GOC is planning to decrease fiscal spending from nearly 
10% of GDP to around 6% over the next year.  This runs counter to 
what many would expect prior to an electoral campaign.  To help 
reduce inflation, interest rates are being increased gradually and 
could approach 10% by the end of 2008, he estimated. 
 
¶11. (SBU) Corbo was critical of Minister of Labor Osvaldo Andrade, 
claiming he is pursuing policies that are akin to those in the 1950s 
and do not contribute to increased investment.  The Minister has not 
promoted a labor regime that facilitates the hiring and firing of 
workers.  Corbo argued that the high severance pay schemes, for 
example, needed to be eliminated, which would help increase 
salaries.  The former Central Bank President indicated that the next 
government, whether headed by Sebastian Pinera or former President 
Lagos, would do a better job overall. 
 
Chile's Economic Constraints 
---------------------------- 
 
¶12. (SBU) The Ambassador hosted a lunch at the residence for 
Governor Kroszner on August 28 with top economists.  While much of 
the conversation focused on the U.S. economy and international 
financial markets, the Chilean guests expressed several concerns 
about Chile's current path.  Felipe Morande, a Pinera advisor, 
expressed alarm over inflationary pressures from excessive 
government spending, spiraling energy costs, and a lack of new GOC 
thinking. 
 
¶13. (SBU) Eduardo Aninat identified energy, education, and the labor 
market as three crucial areas that hinder Chile's advancement in the 
world market.  Fuel costs have skyrocketed because Chile has no 
independent source of energy and Argentina failed to abide by 
natural gas supply contracts.  On education, he noted Chileans lack 
English language and technical skills necessary to excel in the 
modern work force.  Aninat stated that the labor force needed to be 
more flexible, facilitating the hiring and firing of workers.  Stock 
broker Juan Andres Camus agreed.  He said that when investors 
examine whether to pursue a project, they need to know the costs of 
getting out.  The costs associated with terminating employees are 
too high in Chile, he emphasized. 
 
¶14. (SBU) Former Finance Minister Carlos Caseres lamented that Chile 
had lost an opportunity to take advantage of high commodity prices, 
in particular for copper.  He noted that levels of productivity had 
decreased 3-4%, inflation is rising, and economic growth is slowing. 
 He argued that the current government is generally pursuing 
successful public policies implemented in the past (i.e., from the 
Pinochet regime), but is not doing it out of conviction. 
 
When EF Hutton Speaks... 
------------------------ 
 
¶15. (SBU) Comment:  Chilean officials and members of the private 
sector expressed great appreciation for the opportunity to exchange 
views with Governor Kroszner.  When he spoke about the state of the 
U.S. economy, the housing slowdown, and difficulties with financial 
securities, his Chilean interlocutors listened attentively.  At the 
Ambassador's event, for example, one former Finance Minister took 
copious notes.  The visit proved highly productive and helped 
reinforce the close bilateral relations we enjoy with GOC contacts 
and the private sector. 
 
SIMONS