Tackling the Greek debt problem, a look at the Chilean experience

Greece continues to remain in limbo, with the ECB opposing a debt restructuring while some of the financially stronger European countries are favoring it.  The stumbling blocks seem to be fears of contagion, the impact on European banks, doubts as where Greek economic recovery would come from and implementation risks.  This reminds me of Latin America in the 1980s when policy makers were trying to pick to right time to devalue: the answer was, and remains, that such time doesn’t exist.

As decision makers dither, the financial conditions in Europe are only getting worse.  At prevailing yields, Greece couldn’t borrow long term if it wanted to.  The discount at which Greek debt is traded indicates that investors believe that a large “haircut” is inevitable.  We are fast approaching the moment when fears and rational expectations meet.

All parties would be well advised to consider the case of Chile in the 1980s, when that country was faced with massive financial and economic problems.  Not only did it solve them (without any help from multilateral agencies such as the MF or the World Bank or from the international banking community), it emerged, and remains to this day, the healthiest economy in the region.

The first element of the solution was to tackle the budget gap with old fashioned cost control.  As this was not sufficient, the government also embarked on a program of privatizations, with a twist. 

It is important to note that these privatizations were not rushed as the decision was made to bring the candidates back to financial health first.  This had several benefits: getting a higher price for these assets, establishing a good track record and winning lasting support for free markets from a large segment of the population.  Helping ordinary people become shareholders, often referred to as capitalismo popular, worked as follows.  Some of the largest state enterprises were sold to both strategic corporate investors and the public at large.  Because these enterprises had healthy finances, they could commit to pay substantial minimum dividends for a period of several years.  The public was offered low interest financing to buy into these privatizations, with the minimum dividends set at a level that was sufficient to pay the interest due on the financing and then some. 

To make significant reductions in the external debt, the government created two programs, one for existing foreign creditors (Chapter XIX) and another for Chilean residents (Chapter XVIII).  These programs allowed for the purchase of foreign debt at a discount.  Non-residents were allowed to remit the principal value of their investment after ten years.  Residents were not. 

If the external debt that was swapped for local pesos had been issued by the State, the discount was non-negotiable, otherwise it was up to the parties to negotiate it.  Typically, bank debt was swapped at a discount of around 25%.  As the program progressed, and the economy started to recover, the discount shrank.

   

To my knowledge, this swap program has been one of the most successful voluntary debt exchanges ever.  It helped reduced eligible foreign debt by US$ 7 billion out of a total of US$ 20 billion.  It helped local firms repay their external debts, and foreigners participate in privatizations or new projects.  It had two important corollary benefits: (1) rebuilding foreign investor confidence as the program was rigorously but fairly and consistently executed, and (2) serving as a crucial pump primer for new large strategic investments; large multinationals would often fund their initial capex using Chapter XIX rules and then follow up with entirely fresh foreign resources.  As a senior executive with a large US multinational at the time, I can testify as to how well this program worked.

None of these efforts would have brought about a lasting recovery unless Chile had been able to boost its exports.  I say exports because the Chilean population being small and not well off, it couldn’t offer a big enough market for above average economic growth.  Again, unlike many countries that had focused on import substitution, Chile took a strategic approach to exports by focusing on its comparative advantages.

It is ironic that ITT played a crucial, albeit indirect, role in this.  When it exited Chile, a small portion of its capital was unregistered with the Central Bank and therefore couldn’t be repatriated.  These were the days of capital controls.  ITT decided then to use these monies to seed what became the Fundacion Chile.

Over the years, Fundacion Chile acted as a catalyst in many of the important strategic development efforts of the country.  Besides acting as a think tank, the Fundacion educated would-be entrepreneurs and provide seed capital (literally).  The first major endeavor was the creation of a strong forestry sector.  This was followed by the creation of a fruit growing industry geared to exports which was fully operational by the mid-1980s.  The next major effort was the creation of the salmon farming industry. 

Each of these strategic projects was built on sustainable competitive advantages (fast growing pine trees, season inversion in the southern hemisphere and phytosanitary conditions provided by the Pacific and the Andes, cold pure waters of the southern Pacific); each developed into a multi-billion dollar industry.

Times are different, but Chile and Greece have much in common, such as small size, eccentric locations, excessive indebtedness, difficulties in obtaining outside financial assistance.

So the experience of Chile is very useful for solving Greece’s problems.  It shows that creditors will subscribe to a debt reduction program if it offers sufficient guarantees and has good chances of success.  It shows that governments must secure the backing of a large portion of the population by ensuring that both sacrifices and benefits are shared among all parties.  Finally, it shows that even a small country can find and exploit its competitive advantages.