IV. Fiscal stabilization funds, 1983-2005

4.1 Copper price compensation fund38

4.1.1 Origin

The Copper Price Compensation Fund (CPCF) arises from the application of a clause contemplated in point 1(a) of Annex 4 of the loan agreement IBRD No 2625 CH from 25.10.85, designated as Structural Adjustment (SAL), signed by the Republic of Chile and the International Bank for Reconstruction and Development. Therefore, its origin and maintenance do not proceed from a law that mandated its application.

4.1.2 Characteristics

The CPCF is composed of currency deposits made by the Republic’s General Treasury in Chile’s Central Bank, which incorporates them to its international reserves.

In order to make such deposits, the Republic’s General Treasury gets the resources from the transfers that the Treasury receives from the National Copper Corporation (Codelco), both for surplus and for income tax.

The CPCF is based only on the copper exports carried out by Codelco, which is a state-owned company with its own equity and with a special set of financial, budget and tax regulations.

4.1.3 Elements

a. Benchmark price

It is made up of a long-term price of refined copper (minus a corresponding discount) determined by a committee of experts according to the procedures established by the Ministry of Finance, which refers to the expected future long-term price in the commodity world market.

b. Discount

It is equal to the difference between the observed LME price (of a pound of refined grade A copper) and the FOB price obtained by Codelco (products sold mixture).

c. London Metal Exchange price

It corresponds to the cash price at which a pound of copper is traded at the London Metal Exchange.

d. FOB price

It is equal to the cash price obtained by foreign sales made by the corporation.

4.1.4 Operation

In 1985, it operated according to what was established in the Ordinary Order No 1561, in which it was set forth that its primary objective was to comply with the agreements negotiated with the IBRD.

As from June 2005, the operation of the CPCF was subjected to modifications, which were made formal by Ordinary Order No 425. The purpose of such modifications is to adjust the CPCF to the present fiscal rule determined by the structural balance39.

The CPCF takes into account quarterly balances of Codelco’s foreign sales, with which deposits or drafts from the CPCF are determined.

Under the present fiscal policy rule, the expenditure expansion is determined by the behavior of structural income, which in turn depends on the evolution of tendential GDP, long-term copper price and additional income coming from structural changes in the sources of fiscal financing.

a. Deposits

Deposits will be made into the CPCF when the FOB price is higher than the benchmark price.

FOB price > benchmark price

For this purpose, the following weighting table is used:

i) 0.0% for the first 4 US$c/Lb difference.

ii) 50% for the following 6 US$c/Lb difference.

iii) 100% for everything that exceeds the previous 10 US$c/Lb.

CPCF deposits = (FOB price - benchmark price) according to weighting x physical foreign quarterly sales x 22.0462 factor

b. Drafts

Drafts will be made into the CPCF when the FOB price is lower than the benchmark price, according to the same previous weighting table.

FOB price < benchmark price.

CPCF draft = (FOB price - benchmark price) according to weighting x physical foreign quarterly sales x 22.0462 factor

4.1.5 What should be done with the Copper Reserved Law and the fiscal surplus?40

The Copper Reserved Law is not fair since it forces 10% of Codelco income to go to a reserved budget of the armed forces. The law also establishes a guaranteed floor of 220 million dollars minimum given annually to the armed forces.

If copper price falls dramatically and the sales value is lower than 220 million, the Treasury must make up for the difference, taking it from other State’s expenditure programs.

If, on the other hand, the copper price goes up, all additional income goes automatically to the reserved budget of the above-mentioned institutions. In other words, the law fixes a minimum but not a maximum, contrary to what happens to the rest of the public sector, through the Copper price compensation fund, in which a top price is established beyond which additional resources should be saved for years with lower economic growth.

In fact, the same principle is applied to all State income, not only of copper, from the moment in which the structural surplus rule equal to 1% of expenditure was established. Why use a different criterion for defense expenditure? As it is a matter of investments, they should be assessed with technical criteria and in keeping with the strategic definitions required by a sound defense and security policy of the country.

According to some economists, the Copper Reserved Law is one of the anachronisms of the Chilean economic institutionalism. In recent years, economy has been increasingly opened, banking as well as capital market legislation has been modernized, the laws which regulate trademark rights, free competition, the water code and fishing have been updated, and numerous other actions have been passed by Congress, most of them devoted to modernize institutions and make public affairs more transparent.

The Senate Finance Committee, which since 2004 operates on a permanent basis, has worked together with the Ministry of Finance to consolidate a solid and reliable budget system, which nowadays is a world-wide leader in transparency and professionalism, which has been recognized by international agencies such as the OECD, IMF and others.

Therefore, an initiative to revoke the so-called Copper Reserved Law and to arrange for the item “armed forces investments” to be included in the budget should not be a source of mistrust, because it would contribute to strengthen transparency and, thus, public trust in the armed forces. An attempt would be made to apply similar evaluation standards to all State’s investment budgets, modernizing the exercises of strategic programming of investments that armed institutes may require in the future.

The bottom objective is two-folded: transparency and to guarantee regional security with appropriate expenditure on defense.

A complementary discussion relates to what to do with the savings generated by a high copper price during the last two years.

So far, similarly to the government’s general savings, they have been used to reduce the country’s public debt. Uninterruptedly since 1990, the three governments of national unity have prepaid public debt, which constituted 100% of the country’s GDP by the mid-eighties. Nowadays, it has been reduced and it represents no more than 10% of the GDP, one of the lowest in the world.

How much more can or must public debt be reduced?

Nowadays the Treasury is remarkably shielded in case of sudden increases in international interest rates. That’s why the surplus could be oriented in terms of investments in the future, which would contribute to a greater growth and, therefore, to a greater expected tax collection, so that the observable fiscal deficit to date would automatically reduce in time. Italy argues the same with respect to great public investments in infrastructure41.

Chile’s Budget Director suggested at the 2005 budget discussion that part of the fiscal surplus should go to a cumulative fund, in such a way that the State can guarantee those people who in the future do not reach a minimum pension a reasonable floor in their pension when they retire from the labor force.

This proposal’s value is that is gives a social sense to the present fiscal surplus. It is not a matter of saving for the sake of it, nor is it an excessively conservative bias in fiscal policy, but the point is that conditions would be created so that future generations are better off when they reach old age42.

The same could be argued with respect to the creation of a fund to promote first-rate education, which would widen the younger generations’ productive capacity.

It is possible now to explore these paths because the country as a whole has given evidence for two decades of knowing how to manage public resources with prudence and with no concession to populism.

As a result of the unexpected fiscal surplus produced by the increase in copper price in international markets, other proposals have appeared regarding the most appropriate use of the bigger number of resources that will be available to the State.

In this regard, an option has been suggested that concerns the debt that the Treasury has with Chile’s Central Bank (CHCB), an institution which submits a general balance characterized by showing a long position in foreign currency and, on the other hand, a short position in national currency.

The position regarding foreign currency follows basically from holding international reserves, while the position in local currency follows from the issuance of instruments. This makes the general balance to be exposed to exchange rate fluctuations, the inflation rate and the differential between the interest rates at which it invests its reserves and the interest rate at which it issues its papers (the rate at which it effectively places its papers, not the coupon rate). Additionally, the operating expenses of the CHCB should be taken into account.

On the other hand, it should be noted that, from the point of view of cash flow, the relevant variables are the reserves net change in foreign currency due to foreign currency net purchase, net interests paid and earned, net write-down of internal assets and liabilities and operating costs43.

Exchange fluctuations affect the state of results but have no impact on the cash flow. The net position in foreign currency reaches about US$ 13,800 million. National currency liabilities with effect on accounting results represent the equivalent to US$ 17,700 million.

In simple terms, the balance of the CHCB has a chronic tendency of losses, with the subsequent equity deterioration.

The relevance of this situation on the appropriate management of the monetary policy and the Central Bank functions are outside the scope of the present analysis. Nevertheless, it should be noted that the literature on the subject does not reveal the presence of conflicts or difficulties.

From the point of view of the CHCB there are two options to be considered: prepayment of debt and/or capital contributions.

From the point of view of the balance, the second option is more attractive since it generates operational net positive income.

The first option may be less attractive if the cash resources received are invested in less profitable instruments than the net income which it receives now, which is a likely situation because the Treasury could be interested in prepaying the most expensive debt (which yields a LIBOR rate plus 0.5).

The Treasury should pay the debt that it arbitrarily imposed on Chile’s Central Bank when it should have been absorbed by the Treasury. This is the cheapest debt.

Anyway, what should be highlighted is that said prepayment does not represent a significant change for the CHCB’s cash-box situation or a greater change in its general balance, since the net debt it has with the Treasury, US$ 5,700 million up to December 31st, 2004, equals many times the resources that would be available.

However, the same resources, contributed as capital, would benefit the Central Bank more. It is true in the short run, but in the long run the loss of capital will be repeated if present mismatches cannot be eliminated. The Central Bank should seek to eliminate such mismatches. That was why the issuing institute started to issue papers in dollar, or readjustable in dollars, in past years.

The payment of the fiscal debt would contribute to eliminate rate mismatches. This is the time to think imaginatively about how yesterday’s and today’s prudence can become an investment in quality of life and better opportunities for future generations.

Notes

38  Taken and summarized from: Copper price compensation fund. Government of Chile, Ministry of Finance, Office of the Budget, August 2005.