The January election of billionaire Sebastián Piñera as Chile’s first conservative president since right-wing dictator Augusto Pinochet stepped down in 1990 was a political earthquake. No one suspected that the country would be hit by the real thing only a month later, though. The massive temblor, which at 8.8 on the Richter scale was the fifth-most-powerful ever recorded, claimed nearly 500 lives. The quake and its subsequent tsunami destroyed more than 200,000 homes, one out of three schools, one third of all hospital beds, some 200 bridges and key sections of the country’s highway system.
For Piñera, who ended 20 years of center-left government by promising to reinvigorate the economy and raise living standards sharply, the disaster threatened to wreck his plans even before he and his team took office in March. “In economic terms the cost was $30 billion, or 17 percent of our GDP,” the president tells Institutional Investor in an interview at his office in the presidential palace, La Moneda. By comparison, he adds, “the total damage from Katrina was less than 0.1 percent of the U.S. GDP.”
Six months after the devastating quake, Chile — and Piñera — are coping with the catastrophe far better than almost anyone would have imagined. On a recent 200-mile drive south from Santiago, through some of the worst-hit areas, there is remarkably little evidence of the destructive impact. The transportation network is largely restored, every schoolchild is back in class (albeit many in makeshift structures) and, unlike in Haiti, hardly anyone in Chile is homeless. The government has built some 70,000 temporary wooden homes and plans to permanently replace destroyed housing within a year.
The economy, meanwhile, has been anything but devastated. Reconstruction after the earthquake has stimulated Chile’s biggest growth spurt in years. Economic output surged by 6.5 percent in the second quarter from a year earlier, compared with 1.5 percent in the first quarter. The Ministry of Finance forecasts that growth will average nearly 5 percent this year — a far cry from initial predictions that the quake would cause output to contract by 1.5 percent. Foreign direct investment increased nearly 50 percent in the first four months of this year, to $5.7 billion, the most of any nation in Latin America, according to the United Nations Conference on Trade and Development.
“Our immediate priority was dealing with the quake victims and starting the recovery process, but we did not set aside our growth plans,” says Finance Minister Felipe Larraín, whose 12th-story office in downtown Santiago still bears cracks in its walls from the disaster. “We decided to move ahead with both agendas.”
The question now is whether the government can build on the postquake momentum and recapture the economic vitality that Chile demonstrated from 1986 to 1997, when the market liberalizations of the Pinochet era reached their full flower and growth averaged 7.5 percent a year. By contrast, growth averaged a more sluggish 3.5 percent after 1997 as investment slumped.
For Piñera the solution is to inject into the economy the same kind of entrepreneurial spirit he has exhibited in his career. The 60-year-old president holds a Ph.D. in economics from Harvard University and boasts a successful track record as an investor, whose holdings included the television station Chilevisión and a 27 percent stake in Chile’s Lan Airlines. (He sold off the airline stake and is in the process of divesting his Chilevisión shares.) During his campaign he vowed to promote policies to encourage investment, boost productivity and wages and cut red tape for business: In short, a can-do conservative government after years of center-left coalition rule that had turned dull and sclerotic. His program aims to boost growth to an average of 6 percent during his four-year term and pave the way for Chile, with 17 million inhabitants, to become the first Latin American country to join the ranks of developed nations by 2018. “Piñera promised change,” says Patricio Navia, a Chilean political analyst at New York University. “And he has brought into his cabinet a team of people with a lot of business experience and management expertise.”
In economic terms, Piñera harks back to an earlier era when Chile was a lonely bastion of laissez-faire policies in a continent known for state intervention in the economy. During Pinochet’s reign the government privatized hundreds of businesses, introduced mandatory private pension plans to supplant social security, reduced trade barriers and opened the country up to foreign investment. “Chile was clearly the economic pioneer,” says Claudio Loser, a senior fellow at the Inter-American Dialogue, a Washington, D.C.–based think tank. “And today, Chile is gradually becoming a developed country.”
Over the past decade much of Latin America has adopted a similar range of policies, helping to transform the region into one of the world’s fastest-growing areas. Growth across Latin America is expected to average 4.5 percent this year, according to the World Bank. The dynamism of the broader Latin American economy as well as deepening trade relationships with Asian countries such as China, the biggest buyer of Chile’s copper, are key factors supporting the country’s robust recovery this year.
In other respects, Piñera represents a break from the past. The new president went further than his center-left predecessors in his handling of the sensitive issue of human rights abuses committed during the Pinochet era, from 1973 to 1990. In July he surprised Chileans on both the right and the left by rejecting an appeal from the powerful Catholic Church hierarchy to grant a blanket amnesty to more than 60 former military and police officers serving sentences for human rights violations, including torture and murder. “I wanted to deliver a strong message that we will protect human rights — for everybody and in every circumstance,” says Piñera. Still, divisions over the Pinochet legacy are never far from the surface, and critics say Piñera hasn’t laid the issue to rest. “There is a long way to go — several hundred more people should be brought to justice,” says José Zalaquett, Chile’s leading human rights lawyer.
On a personal level, Piñera brings to the presidency a hyperkinetic style that sometimes grates on both opponents and supporters. In a bid to reach out to quake victims, Piñera spent a night in a sleeping bag at one victim’s home, only to have critics dismiss the visit as a populist stunt by a mogul who owns one of Santiago’s plushest residences. And when the president insisted that his cabinet ministers travel around the country dressed in red jackets for greater visibility, the media lampooned them as looking like pizza delivery boys. “Chileans expect a certain dignity from their president,” says Raúl Sohr, a center-left political commentator and novelist.
In the end, though, Piñera will be judged by how well his government revives and sustains economic growth. The early results are encouraging, but the government has much work to do to promote a vigorous and lasting recovery. The earthquake caused an estimated $30 billion in losses, including some $21 billion in infrastructure damage and $9 billion in lost output and emergency costs. Insurance will pay for a little more than two thirds of the costs, leaving a reconstruction bill that the government estimates at $8.4 billion.
In theory the government could cover that amount out of Chile’s $10.8 billion Economic and Social Stabilization Fund, a sovereign wealth fund financed by a levy on foreign sales of copper, the country’s largest export. The center-left government of former president Michelle Bachelet withdrew $9 billion from the fund in 2008–’09 for stimulus and welfare spending to soften the impact of the global recession on Chile, which suffered a 1.5 percent contraction in GDP last year. But drawing on the fund, which is invested abroad, produced a large inflow of capital that contributed to a 20 percent surge in the peso against the dollar in 2009. Repeating that process “could provoke a massive appreciation of the currency and endanger thousands of small businesses in agriculture and industry that depend on a competitive exchange rate,” says Larraín.
Instead, the government has decided to finance earthquake reconstruction by selling bonds and raising business taxes. With an Aa3 credit rating from Moody’s Investors Service for its sovereign bonds, a minuscule 6 percent debt-to-GDP ratio and fiscal surpluses that averaged 6 percent of GDP over the past four years, the government has no problem drawing upon the markets at home and abroad. In July, Chile tapped the global market to issue $1 billion in ten-year bonds priced to yield just 90 basis points more than comparable U.S. Treasuries, well below a spread of 150 basis points paid by Brazil for a similar issue earlier this year. The government also sold $500 million worth of ten-year peso bonds domestically, with a rate of 5.5 percent.
The government is also asking business to help finance reconstruction. It hiked the corporate tax rate from 17 percent to 20 percent, a rate that will prevail until the quake crisis is deemed over, says Larraín. More controversially, the government is seeking to collect up to $1 billion in additional royalties from mining companies. Congress rejected the proposal, but Piñera has vowed to reintroduce it in modified form, putting the government on a collision course with the country’s most powerful business sector. “It would have been better to issue more government debt in order not to increase business taxes,” says Alberto Ramos, a New York–based senior economist at Goldman, Sachs & Co. “I mean, why raise taxes when the debt ratio is so low and there is access to low-interest loans abroad?”
The financial system, which is almost entirely in private hands, has proved as resilient as the public sector in coping with the earthquake. At the time of the disaster, Chilean banks were just emerging from the global financial meltdown and their earnings were beginning to recover. Net income for the banking system dropped a modest 11.4 percent in 2009 as interest income dipped and loan-loss provisions rose 30 percent. “This is a financial system that already came through a stress exercise because of the global crisis,” says Jeanne Del Casino, a Latin American–banking analyst at Moody’s in New York. “With economic growth dropping sharply, the banks did much less lending, so they weren’t as exposed when the earthquake struck.”
Mauricio Larraín, CEO of Spanish banking giant Santander’s Chilean subsidiary, the country’s largest bank, with a 20.3 percent share of the loan market and 18.4 percent of savings, sees nothing but growth ahead. In the first half of this year, Santander Chile boosted its net income by 4.2 percent from a year earlier, to $398 million. The bank expects loans to grow by 15 percent in the second half and predicts earnings will grow by at least 50 percent in the next three to four years. “Yes, the bank is well managed, but let’s face it, Chilean banking is living in a very favorable environment,” says Larraín, who is not related to Finance minister Larraín.
Chile’s 75 percent private-sector loan-to-GDP ratio is already the highest in Latin America, and well above Brazil’s 58 percent and Mexico’s 24 percent. By the end of President Piñera’s term, in 2014, Santander predicts Chile’s ratio will reach 90 percent, close to the 100 percent–plus levels prevailing in the U.S. and Western Europe. The biggest loan growth will be among small and medium-size companies and middle-class retail clients. “They are very profitable market segments and have much greater growth potential than corporate and high-income retail clients,” says Mauricio Larraín.
The biggest complaint of the commercial banks is the competition from new rivals launched by local department stores. After a mere dozen years’ existence, the three department store banks — Falabella, París and Ripley — claim more than 40 percent of consumer lending, thanks to the voluminous credit data they gather from their shopping clients. Traditional banks insist the playing field isn’t level, because they are obliged to publicly disclose the total debts of their business and retail clients, while department store banks aren’t required to report any shopping debts incurred by their customers. “We would like to see a financial reform that creates equal obligations on client disclosure,” says Santander’s Larraín.
But such pleas are unlikely to move the Piñera government. The intense competition between commercial and department store banks has been a boon for consumers, helping to make Chilean loan rates the lowest in Latin America. Annual interest rates on Chilean retail loans averaged only 5.03 percent in June, compared with 9.5 percent in Mexico and 15.29 percent in Brazil.
The government would like to see similar market forces invade the cozy, high-profit world of the AFPs — administradoras de fondos de pensiones, or pension fund administrators. The six private pension funds have $115 billion in assets under management, the equivalent of 65.1 percent of Chile’s GDP — just under the 67.1 percent average for private pension funds in the other countries in the Organization for Economic Cooperation and Development. In 2009 the AFPs surpassed all of their OECD peers, with a 24.8 percent return on their investments, according to OECD statistics.
Critics, however, have long accused the AFPs of overcharging for their services. In addition to paying a mandatory 10 percent of gross monthly wages into an AFP, workers pay an additional 2.5 to 3 percent of income to cover management fees and life and disability insurance. “The Piñera government will probably focus on encouraging more competition among the AFPs in order to reduce contributors’ fees,” says Axel Christensen, head of asset manager BlackRock’s office in Chile and a former investment manager for Cuprum, a leading AFP. The June start-up of Modelo, the first new AFP in more than a decade, provides a glimmer of hope. Offering cheaper rates than the six established funds, Modelo is aimed at Chileans just entering the workforce, who by law must be assigned to the AFP charging the lowest fees — unless they insist on choosing another fund.
Although Piñera has steered clear of controversy with the financial sector, he has become embroiled in conflict with the powerful mining industry, an unlikely adversary for a conservative government. Mining, mainly of copper, is by far Chile’s largest business, accounting for 20 percent of GDP. Mining company profits last year reached $11.4 billion — more than twice as much as those of the next two largest business sectors, electricity and banking, combined. To help pay for the postearthquake reconstruction, Piñera asked the mining sector to agree to a temporary increase in its royalties over the next three years from the current 4 to 5 percent to a new band of 4 to 9 percent (the exact level is linked to lows and highs in the price of copper). The formula would raise as much as an additional $1 billion in mining taxes. To soften the blow the government promised to extend the current royalty levels on mining from 2018, as negotiated by the previous center-left government, until 2025. “There is a political angle here,” says Ramos, the Goldman Sachs economist. “This is a center-right government whose intentions are second-guessed by the center-left opposition, and it is trying to show that there are no sacred cows when it comes to taxing those who can afford to pay.”
But the Piñera plan pleased nobody. Unwilling to be viewed as less populist than the new government, the opposition gathered enough support in Congress to reject the proposal in July on the grounds that it was too generous to the mining companies. The mining companies, meanwhile, were angered by what they viewed as a reopening of the royalty issue, which they thought had been put to rest after arduous negotiations with the previous government in 2005. “Changing the rules for any business sector isn’t a good idea, but it can be especially damaging when it involves such an important sector as mining,” says Gonzalo Menéndez, senior director of the Luksic Group, majority owner of Antofagasta, Chile’s third-largest mining company, after state-owned Codelco and BHP Billiton, the Anglo-Australian giant.
Last year, Antofagasta produced 442,500 tons of copper in cathode and concentrate forms; net income fell 45 percent, to $1.6 billion. In 2011 its copper production will reach almost 700,000 tons, along with 220,000 ounces of gold, with the opening of a new mine, La Esperanza, which the company began work on in the midst of the global crisis in 2008. “We were the only major mining group in the world to go ahead with its investment plans even during the collapse of Lehman Brothers,” asserts Menéndez.
Having demonstrated that kind of risk-taking and financial strength in a time of great crisis, Antofagasta is unlikely to convince the government that it would be hurt by higher royalties to pay for quake reconstruction. Piñera makes it clear he expects the mining companies will eventually back down. “People always tend to complain in order to improve their negotiating position,” says the president, recalling his own experiences cutting business deals.
A far larger and longer-term economic challenge facing the new government in its efforts to raise the country to developed-nation status will be stimulating the creation of more value-added industries with higher-paying jobs. Chile’s per capita GDP of $14,500 on a purchasing-power parity basis is less than half the $34,000 median among nations with a similar Aa credit rating, and pockets of deep poverty persist in the country. After steady progress under center-left governments, the poverty rate fell from 40 percent in 1990 to 13.7 percent in 2006. But in the following three years, much to the dismay of center-left politicians, the rate climbed back to 15.1 percent as investment and productivity levels slumped.
To reverse the trends in productivity and investment, Piñera’s government is proposing an ambitious program under which 6 million of the country’s total 7 million workers will be retrained over the next four years. The retraining would be done by their private-sector employers with the aid of government subsidies in the form of bonuses and vouchers. But the government has not yet estimated the costs involved. And the program smacks of state guidance long alien to the Chilean economic model. “This isn’t an industrial policy,” insists Finance Minister Larraín. “We are not trying to pick winners. Let the private sector pick the businesses it wants to expand.”
The most successful Chilean businesses have managed to climb the value chain by finding ways to compete in markets at home and abroad, rather than by simply retraining their work forces. Consider the country’s leading vintner, Viña Concha y Toro. Nationalized by the Socialist government of former president Salvador Allende, Concha y Toro was returned to its owners, the Guilisasti family, after the Pinochet coup in 1973. The family helped the business grow rapidly by exploiting a variety of market niches and encouraging consumers to gravitate from $5 bottles of everyday wine to higher-quality vintages at $10 and $20 a bottle. Today, Concha y Toro’s 19 labels account for one third of the domestic market and close to 40 percent of Chilean wine exports. The company, the seventh-largest wine producer in the world, boosted net income by 42.3 percent last year, to 50.1 billion pesos ($97.4 million); revenues were up 10.1 percent, at 354.7 billion pesos. The Guilisastis hold a controlling 41.7 percent stake, with 18.1 percent of shares owned by Chile’s private pension funds and the remainder in the hands of other investors.
Concha y Toro was hit hard by the earthquake, which destroyed vats and bottles holding 10 percent of its wine stock, roughly the same level of losses suffered by the rest of the industry. It could have been worse. “All our assets were insured,” says Blanca Bustamante, the company’s head of investor relations. “And even though we had to stop operations for ten days, we were able to resume just in time for the harvest.” By late July fermentation vats and casks had been repaired or replaced, and a drive through several vineyards in the quake-stricken provinces of Colchagua and Maule, south of Santiago, showed little sign of damage.
Meeting market challenges can be a lot tougher than overcoming natural catastrophes, though. The explosive growth over the past decade of the Yellow Tail brand, owned by Australia’s Casella Wines, knocked Concha y Toro from its top perch to second place among foreign wine imports in the United States. “Yellow Tail was like a tidal wave,” concedes Bustamante.
The company aims to increase sales by at least 10 percent a year by means of price discipline and more imaginative export marketing — such as a recent agreement to use players from Manchester United, soccer’s most recognizable team, to advertise its brands. CEO Eduardo Guilisasti says the company is enjoying its fastest growth in Asia, currently its fourth-largest export market, after Europe, Latin America and the U.S. “Also, an increasing proportion of revenues and profits will come from our premium brands,” predicts Guilisasti.
Whether the new government’s push for more jobs, productivity and value-added goods and services will result in more companies like Concha y Toro remains to be seen. But Piñera has no doubt he won the presidency because of his entrepreneurial background, and he promises to use that experience to revitalize the economy. “I want to bring back those years of the fat cows, when everybody talked about the Chilean miracle,” he says.
