There are few more emblematic legal constructs in
emerging market finance than the Chilean DL600.
What Michael Phelps is to swimming, the Decree Law 600 is to foreign
direct investments: both defined an era and both set very high bars for their
successors.
It is thus very significant that former president
Michelle Bachelet, now the leading candidate to return to that office, proposed
to eliminate the DL600. Apparently, this
would be part of a set of new policies, such as raising corporate income taxes,
to generate more public revenues to finance greater social expenditures.
I have observed for a few years now that a sort of
frugality fatigue is setting in Chile.
Chile was the first, and for decades, the only Latin American country to
embrace an economic model based on budgetary equilibrium, personal financial
responsibility and free enterprise. The
first signs lassitude started to appear after twenty years of effort.
One important area of friction has been the private
pension system. Another more recent has
been education. In my view, a major
factor in the sentiment shift has been the change in regional politics. Center-left moderates such as F. H. Cardoso
in Brazil (1995-2003) and R. Lagos in Chile (2000-2006) and center-right A.
Uribe in Colombia (2002-2010) have been replaced by N. and C. Kirchner in
Argentina (2003- present), H. Chavez and N. Maduro in Venezuela (1999-
present); these new populist regimes have actively promoted government
interventionism, budgetary laxity and public sector expansion. Even Brazil, under presidents Lula (2003-2011)
and Rousseff (2004-present), has returned
to greater government activism in economic affairs. Virtue is difficult enough to preserve, but
all the more so when temptation is all around.
The DL600 was promulgated in 1974 by the military
junta (probably another feature which doesn’t endear it to President Bachelet)
and has been a landmark piece of legislation. Besides its symbolic importance
which cannot be underestimated, its success stems from its unique features:
·
Foreign investments instrumented via
DL600 are approved via a contract between the investor and the
State. The strength of a contract is
that its terms cannot be amended except by mutual consent of the parties. No such protection exist under general
legislation;
·
The DL600 guarantees a fixed corporate
income tax rate of 42%[1]
for a period of 10 years, extendable for a total of 20 years; it also fixes the
mining royalty tax for 10 years;
·
Other guarantees include
non-discrimination vis-à-vis local companies, access to foreign exchange and
freedom to remit dividends and capital (after one year), freezing of the accounting
for such items as depreciation and accumulated losses.
In a country where
mining is the single biggest economic activity (and thus where capital
investments are both very large and long-term), the assurance that the
conditions under which one invests will not change is very valuable. The success of DL600 can be measured by three
numbers: $51 billion of foreign direct investments in 10 years in a country
with a GDP of $164 billion[2].
It is debatable whether
Chile would get tangible financial benefits from abolishing DL600. If anything, it would signal that a
Bachelet-led government would want to preserve the right to change FDI taxation,
a rather worrying sign. It would also
reduce some of the competitive edge that Chile has had compared to such rivals
as Peru. Finally, it would send a not so
subtle signal that budgetary discipline would be under greater threat since the
government would open the way to higher taxation.
Perhaps it takes a
foreign perspective to fully appreciate the value of the DL600. From mine, I found that while other countries
often presented more favorable terms for FDI, Chile generally won thanks to the
stability of its institutional framework.
DL600, if abrogated, will be missed.
[1] This compares
with an effective tax rate of 35% assuming (1) all net profits are paid out in
the form of dividends and (2) the foreign investor chooses not to avail himself
of the terms of the Decree Law 600.
[2] It is
important to remember that by far the biggest mining entity in Chile is
state-owned CODELCO whose investments are thus considered local and outside the
DL600.
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