Chile - Savings are crucial to Santiago's salvation

Intense takeover activity in the electricity sector, foreigner-friendly changes to capital controls and monetary easing by the central bank may have helped save the Santiago Stock Exchange from extinction last year.

Average daily volumes traded on Chile's exchange had faded from $46 million a day in 1995 to $17.7 million in 1998 but scrambled back up to around $25million in 1999, fuelled by Endesa of Spain's bold $3.6 billion takeover of Endesa (Chile) and Enersis, the country's two largest electricity companies, and helped by the partial flotation of the main water utilities.

This spate of action in the energy and utilities sectors provided short-term relief for the 37 member brokers and pushed the bourse's full-year profits up 59%, to $7.4 million. However, it also sucked liquidity from two of the most heavily traded shares in Latin America.

Nonetheless, according to Wall Street analysts, Chile is still among the most liquid markets in the region and the country has one of the highest ratios of market capitalization to GDP.

A recent study by US investment bank Salomon Smith Barney shows that Chile is the second-cheapest stock market in Latin America in terms of the impact of, say, a $2 million trade on the final total price of a basket of high-capitalization stocks. Such a play in Chilean shares will shift the total price 68 basis points, compared with 42bp in Mexico, 81bp in Brazil, 191bp in Argentina and 554bp in Brazil.

According to its designers, this model is really a test of depth and volatility. However, the reality is that the Chilean stock exchange owes a lot of its apparent liquidity to the depth of the American depository receipt market in New York, where daily average volume in the 27 Chilean shares in 1998, for example, was $36.9 million, more than double total turnover at home.

Chilean ADRs account for about 60% of the Latin American market, and a typical foreign investor in Chilean equities will hold at least 70% in the New York-traded instruments.

In contrast, back in Santiago, most of the 254 companies listed on the local bolsa are tightly controlled by family groups or multinationals. Most are rarely, if ever, traded and initial public offerings are a rarity. In this respect Chile resembles the other major Latin American stockmarkets.

Of the 40 stocks that make up the main Ipsa index, only those with ADRs are seriously covered by the international investment banks.

Santiago brokers have partly blamed the country's framework of strict capital controls for fading turnover on the home market, but now look forward to seeing the elimination of the rule under which foreign portfolio investors have to leave their capital in the country for at least a year.

This move, expected soon after the new administration of president-elect Ricardo Lagos is sworn in on March 11, follows the effective elimination in 1998 of the encaje (lock-in), under which a percentage of foreigners' investments were left as security with the central bank.

Central bank officials today happily admit that these measures are redundant at a time when the fixed-rate market - with base interest rates at 5.25% - is hardly about to attract speculative abuse, and the currency is stable.

More important, the monetary authorities have had to take steps to attract capital inflows to top up the levels lowered by the relaxation of foreign investment controls on the country's $34 billion private pension system.

The eight fund administrators (AFPs), currently have close to 16% of the total pool invested in foreign stocks and bonds, against less than 5% 18 months ago. The ceiling will soon be raised to 20% and there is pressure on the bank to set it even higher at 30% before too long.

Another recent move designed to create business for Santiago brokers was the creation of an offshore market, where Chileans and foreigners can invest in non-Chilean mutual funds, share certificates and Chilean ADRs without incurring the 15% capital gains tax on profits. For foreign investors, the new market also allows them to escape from the one-year rule.

The first to list on the market, which formally kicked off on February 15, was American Skandia Advisor Funds, through a Chilean incorporated subsidiary working with Larrain Vial, Chile's biggest broker.

Some analysts say all these initiatives, while benefiting sentiment, will have only a marginal impact on trading volumes.

Walter Molano, head of research at BCP Securities in Greenwich, Connecticut, says Chile's declining savings-to-GDP ratio is putting a strain on its capital markets.

"In a country where the savings are sufficient to cover the investment needs of the public and corporate sectors, the bolsa is the perfect vehicle for channeling these resources from one side to the other," he says. "The problem in Chile is a macroeconomic one - the savings rate has been slipping since the golden age of the late 1980s and the early 1990s."

The relative liquidity of the Chilean market makes it cheap in terms of the impact of large transactions, but capital gains tax of 15% for foreigners (and up to 48% for Chilean investors) make it ultimately expensive compared with Brazil, Argentina and Mexico, according to a study by the International Finance Corporation.

Brokers' charges and exchange fees, however, are low at about 0.5% each, plus 17% value-added tax on this. A transaction worth, say $100, will cost the individual about $101.17. Traders are pressuring the government to follow Brazil's recent lead and eliminate the 15% tax on stock market profits.

Given the wafer-thin margins and waning volumes, life on the Santiago bolsa is a game of survival for some of the smaller brokers. Each of the member firms has paid around $680,000 for a share in the exchange. Apart from the right to trade shares and the full range of derivatives and fixed-rate instruments, this participation also entitles the brokers to an annual dividend, which in 1998 was about $98,000, and can be a useful supplementary income.

"When there's no business around, some of these guys almost live off the dividend," said the chief executive of one member broker in Santiago.