UPDATE 2-Chile President replaces Foreign, Defense ministers

Thu Mar 12, 2009 4:36pm EDT

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(Updates with Foxley comment, details)

SANTIAGO, March 12 (Reuters) - Chilean President Michelle Bachelet said on Thursday she was replacing her foreign and defense ministers, as her ruling coalition heads into the toughest election battle in two decades amid a global financial crisis.

Foreign Minister Alejandro Foxley had resigned his cabinet post to rejoin a think-tank and will be replaced by the country's ambassador to the United States, Mariano Fernandez, Bachelet said.

Foxley's exit comes days after he became embroiled in controversy in neighboring Peru, with which Chile has a long-standing border dispute, for criticizing Peruvian politicians who opposed a new free-trade pact between the two countries.

In Lima, Peruvian Prime Minister Yehude Simon said Foxley's exit would help improve bilateral relations, which have been volatile since war in the late 19th century.

Bachelet said Foxley's decision to step down had been discussed "some time ago".

She added she was appointing Government Minister and spokesman Francisco Vidal as defense minister, replacing Jose Goni, who will take up the role of ambassador to the United States.

"The times ahead, as we have said, will be tough and will be decisive in successfully facing the economic crisis and its impact on Chile and to make good on pledges to the people," Bachelet said in a televised address at the presidential palace, paying tribute to both outgoing ministers.

"It is our duty to make the maximum effort to ensure these dreams become reality," she added.

Lagging in the polls, Bachelet's ruling center-left coalition faces a tough fight to retain its two-decade grip on power in a presidential election due later this year thatanalysts expect to be a close call.

Center-right billionaire businessman Sebastian Pinera, who lost a 2006 election run-off to Bachelet, is leading the field according to opinion polls.

Former President Eduardo Frei has emerged as the main hope of the leftist alliance that has ruled since the end of Chile's 1973-1990 dictatorship. Bachelet cannot run for re-election.

However, with Chile's economy widely regarded as one of the most stable in Latin America, and lauded for fiscal prudence, few expect major policy changes whoever wins. (Reporting by Rodrigo Martinez, Manuel Farias, Bianca Frigiani in Santiago and Teresa Cespedes in Lima, Writing by Simon Gardner, editing by Philip Barbara)

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