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Chile cuts $2.3 billion of red ink by turning debt into investment

By Tyler BridgesSpecial to The Christian Science Monitor / December 10, 1987



Santiago, Chile

Chile has reduced its foreign debt by $2.3 billion through debt-equity swaps, making it Latin America's most aggressive user of a transaction that the Reagan administration and International Monetary Fund say could play a significant role in making the region's debt burden manageable. Other Latin American countries, notably Mexico, Ecuador, and Brazil, have permitted debt-equity swaps. These involve the sale of a bank's loan at a discount. The buyer of the loan, say a multinational company, converts the proceeds into the debtor's currency and invests in the ownership of business in the debtor country at something approaching the original value of the loan. The difference is made up by the local central bank.

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But no Latin American country has done as many deals or promoted their use as enthusiastically as Chile. The country's debt is now $19 billion, with private banks holding $13 billion of that.

President Augusto Pinochet began permitting the complex transactions two years ago as part of his government's pro-business economic policies, which have included removing many restrictions on foreign investment. Government officials and bankers say that the swaps reduce Chile's foreign debt while increasing investment in the country at the same time.

``Everybody wins with debt-equity swaps,'' says Geert Geisterfer, a Citibank vice-president here. ``Countries get new investment and reduce their foreign debt. Companies get to make an investment at a discount. We're convinced it's a very good deal for Latin America and Chile.''

Not everybody agrees, however. Some socialist economists and businessmen say the deals give an unfair advantage to foreign investors over Chilean investors, because converting debt notes into pesos at a discount allows them to make investments more cheaply.

Latin America's debt crisis created the market for debt-equity swaps. When countries told banks it would be years before they could pay off debts, many banks, especially smaller ones, began looking for ways to unload the debt notes.

The thinking was that it was better to sell the debt at less than full value to another investor today rather than hold the note and wait for promised repayment at least several years from now.

A market was created where banks could buy and sell countries' debt at a discount, with the rate depending on how able the country was seen in making debt payments. Each dollar of debt from countries such as Chile, Venezuela, and Mexico, which have relatively strong economies, is available for 50 to 60 cents, while debt of South America's poorest nation, Bolivia, is traded for 10 to 15 cents per dollar.

The discount rate in almost all Latin American countries had been 30 to 50 percent higher before Brazil declared a debt moratorium earlier this year, and major US banks set aside billions of dollars in reserve to cover losses from nonpayment.

While banks in all countries seek to sell at a discount the debt notes they hold to reduce or end involvement in Latin America's debt crisis, Chile has attracted more interest from investors looking to buy the debt and convert into a local investment through a debt-equity swap.

Businessmen and bankers say the country's free-market economic policies and economic stability are the reasons. ``In other countries, resources aren't allocated through the market, and liquidity is created by having the central bank print money,'' says David Gallagher, managing director of Asset-Chile, which brokers debt-equity swaps.

``Chile has taken the trouble to create a free-market system, and capital markets here are big enough that you can tap the market for domestic liquidity rather than the central bank.''

Because debt-equity swaps turn debt into investment overnight, many countries fear the transactions could spur inflation. Indeed, Mexico suspended its debt-equity swap program in early November because of inflation worries.

Businessmen and bankers here, however, say the government's careful economic management minimizes the chance that debt-equity swaps could inflame Chile's 20 percent inflation rate.

Francisco Garces, international director of the central bank, says about $800 million of Chilean debt has been turned into investment so far in 1987 and expects $500 million more to be converted before the end of the year. He says the government is projecting $800 million to $1 billion in debt-equity swaps next year.

Mr. Garces says that the central bank, which must approve all debt-equity swap arrangements, is processing applications more slowly than before to ensure that proposed investments will generate foreign exchange and create wealth.

The New Zealand company Carter Holt Harvey carried out the biggest debt-equity swap, buying $160 million of Chilean debt last year which it then converted into pesos and invested in the forestry industry.

Citibank has three projects, pending central bank approval, whereby it would buy $30 million worth of its own debt at the current market discount of 55 cents on the dollar and then invest the money in export-oriented companies. Bankers Trust purchased a reported $60 million worth of debt that it used to buy shares of Chilean pension and insurance companies.

American Express did one debt-equity swap to buy a stake in Soquimich, a company the government recently privatized. Security Pacific Bank has also carried out several debt-equity swaps.