INTERNATIONAL ECONOMIC & ENERGY WEEKLY

• Document Type: CREST
• Collection: General CIA Records
• Document Number (FOIA) /ESDN (CREST): CIA-RDP84-00898R000100110002-2
• Release Decision: RIPPUB
• Original Classification: S
• Document Page Count: 46
• Document Creation Date: December 22, 2016
• Document Release Date: February 14, 2011
• Sequence Number: 2
• Publication Date: March 18, 1983
• Content Type: REPORT

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Intelligence
Weekly
International
Economic & Energy
DI IEEW 83-011
18 March 1983
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International
Economic & Energy
Weekly
iii Synopsis
1 Perspective-OPEC: Awaiting the Market's Verdict
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3 Briefs Energy
International Trade, Technology, and Finance
National Developments
15 World Economy: Fallout From Recession
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21 World Economy: Moving Into Recover
y
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29 United Kingdom: Protectionist Trends
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35 United Kingdom: The Election Budget
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39 Financially Troubled Oil Exporters Adjusting to Price Decline[
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Comments and queries regarding this publication are welcome. They may be
directed t irectorate of Intelligence, 25X1
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International
Economic & Energy
Weekly
Synopsis
Perspective-OPEC: Awaiting the Market's Verdict
The longest ministerial meeting in OPEC's history ended in London this week
with the unprecedented decision to lower official oil prices by $5 per barrel.
Should the agreement survive the coming weeks of non-OPEC price cuts and
destocking, the key to further success will rest with a rebound in consumption.
World Economy: Fallout From Recession 25X1
The worldwide economic slump of the last three years had created unprece-
dented problems in the postwar period. In the OECD, unemployment rose by
record numbers; industrial capacity use fell to extremely low levels; and
business failures surpassed all previous postwar peaks in most major OECD
countries. In the LDCs, the recession slashed export earnings, contributing
significantly to their debt problems, and forced a record 30 of them into IMF-
mandated austerity programs. More favorably, the recession led to a surpris-
ingly marked slowdown in world inflation rates. 25X1
World Economy: Moving Into Recovery) 25X1
After three years of slump, the world economy appears on the verge of
recovery. We believe that world economic growth in 1983 could be stronger
than foreseen in many recent forecasts.
United Kingdom: Protectionist Trends 25X1
Trade protectionism is increasing in the United Kingdom despite Prime
Minister Thatcher's vocal public support for and philosophical commitment to
free market economic policies 25X1
United Kingdom: The Election Budget
The new British budget announced on 15 March may have been the last
chance for Prime Minister Thatcher's Conservative government to convince
voters that it has delivered on its promises. It will have little impact on
unemployment or on domestic growth but may be enough to keep Thatcher in
office for another term.
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Financially Troubled Oil Exporters Adjusting to Price Decline
A further slide in oil prices will exacerbate the financial difficulties of a
number of LDC oil producers, particularly Egypt, Indonesia, Mexico, Nigeria,
and Venezuela. With foreign reserves down to a month or two of imports in
some cases and with limited capability to borrow from Western banks, the
falloff in oJ*l revenues will necessitate t ugh and politically unpopular austerity
measures.
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International
Economic & Energy
Weekly
The longest ministerial meeting in OPEC's history ended in London this week
with the unprecedented decision to lower official oil prices by $5 per barrel.
The most important points of the new agreement are:
? The official price of Arab Light, OPEC's benchmark crude oil, was lowered
to $29 per barrel.
? An overall production ceiling of 17.5 million b/d was set as an average for
the rest of the year.
? Individual production quotas were allocated to all members except Saudi
Arabia, which will act as a "swing" producer to balance supply and demand.
? Price differentials established a year ago will be retained, except for Nigeria,
which will be allowed to maintain an advantageous $1 price differential over
the marker crude.
Perspective OPEC: Awaiting the Market's Verdict
The oil ministers agreed that the new prices were to be considered as floors,
and the individual country allocations as ceilings. Price discounting and the
dumping of oil onto the spot market were also forbidden.
The intense pressures on OPEC to adjust prices were the result of falling oil
consumption and company efforts to reduce inventories. Free World oil
consumption this winter fell about 6 percent below year-earlier levels as
relatively warm weather-about 15 percent warmer than normal-pushed
heating oil use about 1 million b/d below expected levels. As a result, oil
companies were left with stocks well in excess of their needs and, combined
with expectations of lower prices, caused a sizable inventory liquidation of
about 4 million b/d in early 1983. Inventory liquidation and reduced
consumption pushed demand for OPEC oil down to the 15 million b/d level in
recent weeks. Market weakness was further intensified by reports of increased
Soviet exports to Western Europe in recent months.
Given current market conditions, OPEC's new overall ceiling is about 2.5
million b/d in excess of demand. Most of this is being absorbed by Saudi Ara-
bia, whose current production is under 3 million b/d. Much uncertainty
surrounds the willingness of certain members to observe the new ceilings and
the apparent room for cheating in the agreement. Because the quotas are for
production only, some members can still raise sales by exporting from stocks.
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Two members that ignored last year's quotas-Iran and Libya-are currently
producing a combined 300,000 b/d above their assigned ceilings and their
adherence to the new accord is in doubt. Venezuela, however, apparently has
enough oil in storage to meet its export goals for the year while producing
within the new ceiling. At the same time, members facing serious revenue
problems, such as Nigeria and Indonesia, are producing a combined 500,000
b/d below their quotas and would like to produce more.
Nigeria will come under severe pressure to cut prices again if sales fail to in-
crease or if North Sea producers adjust prices downward as several market ob-
servers expect. Lagos has already threatened to match any North Sea price
cut. Price cuts by other non-OPEC producers would also add downward
pressure and fuel market expectations of a downward price spiral. Mexico
lowered its prices $2 to $3.50 per barrel following the OPEC meeting, and the
Soviet Union can be expected to remain competitive to ensure hard currency
sales.
The main near-term factors heavily influencing the fate of the agreement are
market psychology and Saudi willingness to bear the brunt of the likely
downard pressure on demand. Both these factors pose considerable
uncertainties:
? Most observers believe the agreement lacks credibility under present market
conditions. If this attitude continues, as seems likely for at least a few weeks,
companies will continue to unload stocks and keep OPEC production well
below 17.5 million b/d.
? The Saudis achieved the price cut they apparently have desired for several
months, and Riyadh's willingness to play the role of swing producer may
underpin the agreement. Saudi output, however, is already below 3 million
b/d and they may have little room or desire to go much lower.
Should the agreement survive the coming weeks of non-OPEC price cuts and
destocking, the key to further success will rest with a rebound in consumption.
There are no signs yet that the decline in oil use has bottomed out, and there is
little hope that it will until a sustained economic recovery gets under way in
OECD countries.
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Energy
Mexican Oil We believe Mexico City's recent oil price cut was not large enough and came
Price Cut too late to allow Mexico to restore its export volume. On 14 March, Pemex cut
light oil prices $3.50 per barrel to match the new $29 OPEC benchmark, while
it cut its heavy oil $2 per barrel to $23 per barrel; Mexico's new average oil
price stands at $26 per barrel compared with an earlier level of $28.75.
Because Mexico deferred lowering oil prices so long, exports fell one-third in
February and another, one-third during the first nine days in March
To regain its earlier export level, we believe Mexico
would have to cut average oil export prices another $1 to $2 per barrel.
Ottawa Considers Faced with a shrinking share of the US market and the prospect that falling oil
Reducing Gas prices may cut that share even more, Ottawa is considering an adjustment in
Export Price the price of Canada's natural gas exports. The current price of $4.94 per
thousand cubic feet could be cut by 40-60 cents. Although a decision has not
yet been made, Ottawa is under considerable pressure from the gas-producing
provinces to take some action to prevent a further decline in Canada's gas
exports, currently less than half of the authorized volumes. A reduction in the
Canadian export price could force a similar cut by Mexico in the price of its
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Iranian Oilfield Itwo production platforms in the 25X1
Damage o~ w oilfield suffered extensive damage as a result of an Iraqi attack on
1 March. Both platforms are blowing oil and on fire. A third platform received
some minor damage as a result of the attack, which also sank an Iranian
workboat, killing 11 people. Another well on a fourth platform in the Nowruz
oilfield has been leaking crude at a rate of about 1,500 b/d for more than a
month. The large oil slick that has formed is creating a potential threat to wa-
ter supplies in Kuwait, Saudi Arabia, Bahrain, and Qatar. Some of the
approximately 85 desalination plants serving these countries may have to be
shut down if the slick reaches the plants' water inlets. Water shortages lasting
up to several weeks could result. Because of the risk of further Iraqi attacks, no
attempt will be made to extinguish the fires and stop the flow of oil until Bagh-
dad provides some guarantee that it will not interfere with the work.
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Polish and South According to the state coal trading company, Weglokoks, Poland intends to
African Coal Export export 33 million tons of coal in 1983, with 20 million tons earmarked for
Plans Western markets to earn hard currency. Last year, exports totaled 28.5 million
tons-15.5 million tons to the West and 13 million tons to socialist countries.
South Africa plans a 17-percent rise in exports this year to 32 million tons. In
1982 South African shipments declined for the first time in over a decade,
largely because of increased competition from Polish exports. Although we
believe projections for both countries will prove optimistic because of sluggish
worldwide demand and coal transportation problems in Poland, US suppliers 25X1
nevertheless will face fierce competition in the world coal market.
Indonesian Loan (Jakarta has signed a loan agreement with
Agreement for the US Export-Import Bank to help finance expansion of Indonesia's Cilacap
Refinery Expansion oil refinery on the southern coast of Java. The loan-$292.5 million with 11-
percent annual interest-will be repaid over 10 years. The Japanese reportedly
will put up an additional $300 million for the project. The planned expansion
of Cilacap's refining capacity from about 90,000 b/d to some 300,000 b/d by
the end of the year will bring total refining capacity to about 550,000 b/d,
enough to meet current domestic requirements of 485,000 b/d. With this
expansion and completion of planned expansion of the Balikpapan refinery and
Dumai hydrocracking facility, Jakarta will be able to meet all of the country's
growing domestic requirements, making processing deals it currently has with
Singapore refiners unnecessary.
Cameroonian We estimate Cameroon's oil production will average over 120,000 b/d this
Petroleum Plans year, up almost 20 percent from 1982 levels. Lokele field, operated by the US
for 1983 company Pecten, was brought on stream at 5,000 b/d in early February and
was the first of several small fields that will be placed in production this year.
Oil exports should average some 90,000 b/d, netting revenues close to $1
billion if Cameroon's 1983 average export price maintains its historical parity
with the OPEC benchmark. about 70 develop-
ment and exploration wells will be drilled this year, compared with 86 in 1982.
The French company Elf is the only operator with a firm exploration drilling
program for 1983. Gulf Oil has not had a drilling program since 1981 because
of the soft oil market and negotiating difficulties with the Cameroonian
Government over contract renewals. Last week the company formally notified
the Ministry of Mines and Energy that it would seek international arbitration
to settle the yearlong dispute.
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International Trade, Technology, and Finance
EC Exchange Rate A realignment of the exchange rates of the eight currencies in the European
Realignment Expected Monetary System may come as early as this weekend. For most of the past
three weeks, the Belgian and French francs have been at the bottom of the
range allowed against the West Germany mark under the EMS. According to
the financial press, the French, West German, and Belgian central banks spent
more than $1 billion in that period to support the exchange rate. Despite
denials that a realignment is imminent, the French Finance Ministry reported-
ly prepared a study of the economic impact of an 8-percent devaluation of the
franc against the mark. West German Chancellor Kohl's election victory and
the trouncing of the left in the French municipal elections last week have
further strengthened the mark and weakened the franc. Moreover, speculation
about a realignment has increased pressure on the exchange rates.
Brussels, Paris, and Bonn have been resisting a realignment. The Belgian
Government imposed capital controls last Monday, which strengthened the
Belgian franc against the mark. The Belgians and the French fear the
inflationary impact of a devaluation. The West Germans believe that a more
expensive mark would harm exports at a time of double-digit unemployment
rates. At a minimum, the three governments all want to put off a realignment
until after cabinet changes in France and West Germany. Pressure on the
foreign exchange markets, however, probably will force their hands. When the
realignment comes, the French may effectively devalue the franc by as much
as 10 percent against the mark. The West Germans may revalue the mark, a
move that would be equivalent to devaluing the other currencies. The
Belgians-and possibly the Italians, Irish, Dutch, and Danes-also may
MITI Efforts To In a belated effort to slow Japanese penetration of US machine tool markets,
Restrain Machine Tool MITI now intends to enforce its export cartel's floor price on machine tools,
Exports to the the action to result in
United States substantial price increases for Japanese machine tools sold in the US market.
Established in 1978 to head off US dumping charges, the cartel sets a base
price for Japanese machine tool exports, but it has been ignored by Japanese
MITI efforts to restrain machine tool exports probably will have little
immediate effect on Japanese sales if US demand recovers, because Japanese
firms are sitting on huge US inventories of machine tools. The buildup
occurred when demand plummeted in the US market in 1981-82. In one recent
example, the president of the Japanese Machine Tool Builders Association
said that Japanese manufacturers had 3,000 unsold numerically controlled
devalue their currencies, but by a smaller amount.
(NC) lathes in the United States in November 1982.
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Japanese firms had a nine-month supply of NC machine tools in
US warehouses in January. the Japanese
plan to lower prices to unload these machines if demand recovers sufficiently
in 1983.
LDCs Deemphasize The Nonaligned Summit, held in New Delhi earlier this month, downplayed
Global Negotiations Global Negotiations-the long-stalled Third World proposal for comprehen-
sive reform of international economic institutions such as the IMF, the World
Bank, and GATT-and emphasized instead the idea of piecemeal internation-
al economic change. The LDCs probably will directly pursue such reforms as
the relaxation of IMF conditionality and an increase in the World Bank's
lending capacity. They are likely to employ their new strategy at UNCTAD
VI, the North-South conference scheduled for June in Yugoslavia.
West German Turbine The West German firm AEG-Kanis is to supply rotor parts for Soviet-
Parts for Soviet manufactured, 25-megawatt turbines, some of which may be intended for the
Pipeline gas export pipeline to Western Europe.
IBy late February
AEG reportedly had begun ordering forgings and was buying machine tools,
using development funds provided the company by the state government of
North Rhine-Westphalia during the US embargo on oil and gas equipment to
the USSR. By seeking West German help, the Soviets appear to acknowledge
they are having problems producing the turbines. Although the press in the
USSR has announced the successful testing and the start of serial production
of the turbines in Leningrad, the plant there could either be having trouble
with the first batch or be unable to produce enough units. Production of 12 to
17 turbines was scheduled for 1983, and the media have claimed some units
were to be used on the export pipeline.
Japan Reschedules Japanese creditors have agreed in principle to reschedule North Korean debt
North Korean Debt payments due through 1985, according to Japanese press reports. Under the
new agreement, payments of approximately $102 million in principal will be
deferred until 1986-89; Pyongyang, however, will continue to make semiannu-
al interest payments on its $255 million debt. North Korea remains in default
on debts amounting to $1.3 billion owed other Western creditors, mainly
European banks. While North Korea is not actively seeking a resolution of
default because of its severe hard currency shortage, it is attempting to
preserve trade relations with Tokyo. Japan is North Korea's largest Western
trading partner and is the most likely source of advanced technology and
equipment the North needs to modernize its industry.
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GNP-may not be reached. According to press reports, some officials estimate
that the deficit could rise to about $57 billion unless Rome comes up with ad-
ditonal spending cuts or revenue. Although the government already has
approved several measures to keep the deficit in line, including higher
transportation fees and tax increases, these measures have been offset to a
large extent by a reduction in income tax rates to correct for "bracket creep,"
part of the government's concessions in a January labor accord. Rome is
considering additonal measures including cuts in politically sensitive social
programs and further tax increases. In addition, the government is considering
limiting the drop in administered oil product prices and applying the additional
revenues, as it did last year, to Italy's financially troubled electric utility.
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Saudi Restrictions Saudi Arabia is restricting imports from Lebanon, apparently because of
on Imports From unhappiness with Lebanon's handling of Palestinian issues as well as concern
Lebanon that Israeli goods have entered Arab markets via Lebanon. The US Embassy
in Beirut has obtained a circular allegedly issued by Riyadh prohibiting
temporarily the importation of certain foods and manufactured items from
Lebanon and requiring strict inspection and an acceptable certificate of origin
on all other goods from there. The letter cited concern that Israeli goods have
circumvented the Arab boycott by being transshipped through Lebanon.
Contradictory claims by the Lebanese and the Saudis make it difficult to
assess the impact of Saudi restrictions. The US Liaison Office in Riyadh
reports that customs officials and Lebanese merchants in Saudi Arabia are
playing down the effect. The Lebanese claim, however, that the restrictions are
having a devastating impact on their exports.
British Bank
in Trouble
National Developments
Developed Countries
will have to determine the extent of difficulties that Hambros faces.
their interbank deposits with Hambros because of its poor financial outlook-a
number of British and Norwegian banks are major depositors. Hambros is a
small but well-known international bank with 1982 assets of about $2.5 billion;
it has been one of the major banks involved in oil tanker financing. Both the
drop in demand for oil and poor real estate investments were cited as causes for
Hambros's problems. In considering any rescue effort, the Bank of England
Many international banks reportedly have cut
Hambros does fail, the interbank market may react further and cut deposits 1
with those banks exposed to Hambros. 25X1 25X1
Continued Italian New Italian budget estimates indicate that Rome's goal of holding this year's
Budget Austerity deficit to last year's level of $52 billion-about 15 percent of estimated
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a worsening balance-of-payments situation, and higher inflation.
Social spending cuts will be the most difficult austerity measure to take. Rome
already has modified earlier proposals for lower social security and health
benefits in the face of strong labor union opposition. If the ruling coalition be-
comes deadlocked over the issue, Socialist party leader Craxi may use the
crisis to force early elections. The government could avoid a protracted debate
by resorting to revenue measures to keep the budget in line. We believe,
however, that even if Rome adopts new austerity measures, sluggish GNP
growth this year, government concessions on the labor accord, and high
interest payments on the national debt will result in an expansion of the deficit,
Closer Scrutiny by With many Western banks under increasing strain because of their large
Tokyo of Overseas lending to LDCs, the Japanese Government is imposing new guidelines on
Commercial Loans domestic banks and has indicated that it will be monitoring their overseas
lending more closely. According to the US Embassy, a Ministry of Finance of-
ficial has acknowledged that Japan has decided to improve collection of
country exposure data and require a higher proportion of long-term deposits as
funding for long-term loans. Other changes under study include a limit on
banks' holdings of foreign currency assets and the creation of a reserve for bad
debts on overseas lending. Under certain circumstances, banks will be allowed
to exceed the current ceiling of 20 percent of equity on a bank's medium- and
long-term loans to any one foreign country. This would permit Japanese banks
to participate in refinancing packages for LDCs where heavy exposure already
exists; such an exception already has been made in the case of Mexico.
Estimated Japanese Private
Overseas Loans Outstanding a
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Total loans
58.44
LDCs (Continued)
LDCs
29.30
OPEC
4.60
Latin America
17.42
Venezuela
1.75
Mexico
5.98
Indonesia
0.99
Brazil
5.83
Algeria
0.78
Argentina
2.09
Ecuador
0.39
Panama
1.53
Nigeria
0.34
Asia
5.15
Communist countries
3.81
South Korea
1.86
East Germany
0.96
Hong Kong
0.88
Hungary
0.81
Philippines
0.87
Poland
0.55
Africa
2.06
USSR
0.19
Liberia
1.46
a Medium- and long-term loans by Japanese banks and insurance
companies as of the end of September 1982.
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The level of Japanese overseas lending has grown rapidly since 1980 when the
government began liberalizing foreign exchange laws. According to a Japanese
business newspaper, medium- and long-term offshore loans totaled about $58.4
billion by the end of September 1982, up $11.6 billion from the year before,
but we cannot judge the accuracy of the data. In addition, short-term loans
have increased substantially, particularly in 1982, as banks tried to avoid the
20 percent of equity guideline and short-term credits seemed less risky. We do
not believe the new MOF guidelines will bring about any significant reduction
in Japanese medium- and long-term lending, although some private banks
reportedly are reluctant to increase their short-term exposure in Latin
Australia's Economic The economy continues to deteriorate with unemployment in February
Situation Worsens reaching 9.6 percent compared with 9.2 percent in January. In addition, the
projected budget deficit for the fiscal year beginning July 1983 has been
revised upward from $5 billion to $8 billion. As a result, Prime Minister
Hawke suggests the Labor government will reassess its economic program and
may not be able to follow through on campaign promises to stimulate the
economy, including a proposal to cut taxes. Hawke may also extend the
current wage freeze, scheduled to end in June, to the end of this year and has
called for a week-long summit of government, business, and union officials to
try to deal with the economic situation.
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Mexican Debt Mexican financial authorities are drafting schemes to encourage Mexican
Developments companies to reschedule debts held by foreign creditors, according to US
Embassy reporting. To handle financing for private debt, FICORCA, a new
government trust funds was formed on 11 March. Although financial details
have not yet been made public, the US Embassy reports that FICORCA will
finance foreign exchange obligations at about one-third below the current
controlled exchange rate if a foreign creditor is willing to reschedule the
private debt over six to eight years. In addition, to take some pressure off busi-
nesses, the government has announced a new subsidy in the form of three-year
credits for one-fourth the interest obligations incurred by the firm from 5
August 1982 to 31 January 1983.
Because little progress on private debt rescheduling has been made, private-
sector debt arrearages are increasing. Since August, because of the lack of
exchange at the subsidized rates offered by the government, interest payments
of only about $60 million have been paid on more than $1 billion past due by
the private sector. Another $1 billion in debt principal is currently past due.
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Under these circumstances, many commercial banks have begun classifying
the writing off private-sector Mexican loans. Alfa Industries of Monterrey-
the largest private sector firm in Mexico-is an example of a Mexican firm
under great pressure. Some creditors are challenging Alfa's debt rescheduling
discussions because they want to declare the company in default and attach its
assets. Other Alfa creditors may have to spend as much as $75 million to buy
out the hardliners, avoid default, and prevent the implementation of more
complicated cross-default clauses.
Argentina Backing According to US Embassy reports, Argentina apparently intends to breach
Away From Austerity agreements with foreign public and private lenders by imposing price controls
on essential goods, postponing public-service rate hikes, and reducing interest
rates. They also reportedly plan to approach the IMF to renegotiate their
three-month-old agreement, made public only recently. One cabinet member
has already resigned in anticipation of the policy shift, and other officials
probably will follow. Foreign lenders will probably not make new loans, which
could prompt the Argentines to unilaterally suspend debt payments. Lack of
fresh funds will prevent economic recovery and fuel inflation, which so far this
year is running well over 200 percent.
Jamaica Considers The weak world aluminum market and producer threats to scale down their
Lowering Bauxite Jamaican operations have prompted Kingston to consider bauxite tax modifi-
Taxes cations before the 1974 levy expires in December. Possible adjustments include
more favorable tax rates for alumina producers and other production and
investment incentives. Kingston is anxious to rekindle investor interest in
modernization and expansion. US suppliers have steadily shifted to non-
Caribbean sources, but Jamaica still contributes about 30 percent of the
bauxite and alumina required for US aluminum consumption. Nonetheless,
Kingston will resist any immediate slash in bauxite tax receipts that could
cause Jamaica to overshoot its budget deficit target under the IMF program.
Any reduction in the cost of Jamaican bauxite would make it difficult for
Suriname to sustain its recent demand for higher bauxite taxes.
Grenadian Claims According to Embassy reporting, the Grenadian economy appears to have
Belie Economic stagnated in 1982, despite Deputy Prime Minister Coard's claim of 5.5 percent
Troubles real growth. Continued low world prices will keep key export earners-
nutmeg, mace, and bananas-from providing much relief. In addition, the
probable move from Grenada of the US-run medical school, which contributes
about 20 percent of the country's foreign exchange receipts, will be an
economic blow. Many local businessmen predict an economic decline as
Cuban-assisted construction on the Port Salines airport nears completion and
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associated loan repayments begin to come due over the next few years.
Grenadian officials have publicly voiced optimism that better flight connec-
tions will reverse the 10-year decline in tourism, but hotels are not expected to
expand sufficiently to support a large tourist influx. Without larger Soviet
Bloc support, public spending to offset poor private-sector performance will
become much harder to sustain.
Problems in Recently implemented government regulations designed to reorganize Sudan's
'Restructuring foreign exchange market have halted private foreign exchange transactions
Sudan's Foreign and could curtail the few imports that are privately financed unless the
Currency Market government corrects the situation soon. Khartoum on 7 March ordered
commercial banks to replace licensed private traders in the free foreign
exchange market. The free market is necessary to generate badly needed
foreign exchange for private transactions, and the government prefers a
regulated to a black market. The central bank, however, has issued contradic-
tory regulations and has so far failed to authorize foreign banks to operate in
the new market. Unless swiftly resolved, the present confusion will further
tarnish Sudan's business reputation, already poor because of foreign debt
problems.
Kinshasa Trims In an attempt to strengthen its case for a one-year standby loan from the IMF,
Budget Deficit To Zaire recently announced a budget for 1983 that projects a deficit exactly
Secure IMF Loan equal to the amount-$420 million-that the Fund has indicated would be
tolerable, according to the US Embassy in Kinshasa. By deferring all public
spending except for salaries, Zaire reportedly has achieved surpluses during
the first two months of 1983 and has remained well within suggested IMF
budget targets. We believe that Kinshasa will find it increasingly difficult to
stay within the budget as spending pressures mount later this year. Even if
Zaire secures an IMF agreement and Paris Club debt rescheduling, the
government's ability to live within the budget will depend largely on export
revenues and foreign aid.
Kenyan Financial Kenya continues to experience severe financial difficulties that could jeopar-
Problems dize access to vital Western aid. Nairobi's most immediate problem is to
reduce its budget deficit by nearly $80 million to meet IMF targets by the end
of this month. In addition, Embassy reporting indicates that Nairobi's efforts
to conserve scarce foreign exchange-currently enough for about a month's
imports-have substantially reduced business and international trade activity,
major sources of revenue. Kenya's deteriorating financial situation raises
questions about Nairobi's ability to secure enough assistance to cover this
year's projected current account deficit of $375 million. Failure to meet IMF
conditions probably would prompt Western donors to hold off until Nairobi
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indicates a greater determination to restore financial order. Western countries
may decide to withhold funds in any case if Kenya goes ahead with plans to
use aid money currently on hand for unauthorized purposes. President Moi
already is under growing public pressure for his handling of the economy and
cannot afford additional cuts in imports associated with the loss of aid.
Thailand Seeks Thai Government and World Bank officials are negotiating the details of the
Second Structural $175 million loan, which is intended to enable the Thai economy to be more
Adjustment Loan competitive internationally. Bangkok largely met conditions attached to its
first structural adjustment loan, $150 million, granted last year. The govern-
ment eased export and import restrictions slightly, implemented new tax
measures, and raised energy prices to near-market levels. Conditions for the
new loan, especially further tariff reductions and tax increases, will be harder
to meet. Proposed increases in bus and rail fares, which Bangkok earlier
promised the World Bank, are being reconsidered because of public opposition.
These price hikes probably will be a point of contention in the current
negotiations
1983 Singapore The 1983 budget introduced in Parliament early this month continues efforts
Budget to move the city-state into knowledge-intensive manufacturing and service
industries and to compensate for slower export growth. Spending in the fiscal
year that begins 1 April will be 18 percent higher than last year and
emphasizes housing construction and infrastructure projects-such as industri-
al parks and the first phase of a $2.5 billion rapid-transit system. The
government policy to encourage wider use of computers in manufacturing will
be spurred by permitting full depreciation of computer purchases in one year.
In an effort to improve Singapore's competitiveness against other international
financial centers, especially Hong Kong, banks will receive a five-year tax
holiday on all income from loans syndicated abroad.
Possible Chinese Several US firms report that business with China has declined since mid-
Retaliation in Textile January. At that time, Beijing announced it would stop new purchases of US
Trade With the synthetic fibers, cotton, and soybeans because of the failure of bilateral textile
United States trade talks. Although trade officials in Beijing say that only those three
products are officially affected, some businessmen believe there has been a
shift away from imports of other US products such as machinery and
equipment and chemicals. Chinese buyers have implied to textile machinery
sales representatives that they will no longer exclusively buy US-origin
equipment and that foreign-made equipment must be included in any pur-
chase.
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Secret
We believe there may be a modest effort under way to nudge the United States
into offering China more favorable textile trade terms. In many of the product
categories experiencing sales declines, however, China already has surplus
inventories or can obtain better quality products or lower prices elsewhere.
Beijing may reduce purchases of some manufactures, but we expect continued
grain trade and an overall increase in US exports of machinery and equipment
to China. US businesses with countertrade contracts with China-the US
firms supply equipment and assistance to Chinese textile mills in return for
products-may be the hardest hit by the textile impasse. With relatively strict
quotas on US imports of Chinese-origin textile goods, these firms now must
sell their products in the less-lucrative international market. One US trading
firm estimates that its combined losses from reduced fiber sales, decreased
business opportunities in China, and losses on sales of Chinese fabrics and
apparel will result in a decline of $100 million-20 percent of 1982 sales-in
projected 1983 earnings.
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Secret
World Economy: Fallout From Recession
The worldwide economic slump of the last three
years has created unprecedented problems in the
postwar period. In the OECD, unemployment rose
by record numbers; industrial capacity use fell to
extremely low levels; and business failures sur-
passed all previous postwar peaks in most major
OECD countries. In the LDCs, the recession
slashed export earnings, contributed significantly to
their debt problems, and forced a record 30 of them
into IMF-mandated austerity programs. More fa-
vorably, the recession led to a surprisingly marked
slowdown in world inflation rates.
Demand management policies generally fostered
the declines in world economic activity over the
past three years. As they focused on the goal of
lowering inflation, most OECD governments put in
place exceptionally tight fiscal policies in 1980-82.
Central banks generally pursued tighter monetary
policies as well.
The Worldwide Slump in GNP
Over the last three years, the world economy
experienced its worst slump since the end of World
War II. In 1980-82, OECD real GNP rose a scant
2 percent; LDC real output increased at about a
2-percent annual rate, compared with a 6-percent
pace in the last half of the 1970s.'
The slump was unprecedentedly broad:
? Among the Big Seven OECD countries, only
Japan recorded cumulative growth greater than
1.5 percent a year in 1980-82; despite a slight
rebound, the UK's real GNP last year remained
lower than in 1978.
' Historical data presented in this article were obtained primarily
from OECD and IMF statistical publications; estimates for 1982
World Real GNP Growth
-1 1976-79a 80 81 82 -1 1976-79a 80 81 82
aAverage annual.
? Unlike the 1974-75 recession, the downturn se-
verely affected the smaller OECD countries. In
1981-82 seven of these countries-Belgium,
Greece, Iceland, Luxembourg, the Netherlands,
Sweden, and Switzerland-recorded cumulative
GNP declines; only Turkey managed greater
than 2-percent growth for the two years.
? The LDCs-both OPEC and non-OPEC-expe-
rienced the worst growth performances in over 30
years. OPEC real GNP grew only 2 percent
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The Recession's Impact on LDCs
The world recession has had far-reaching impacts
on the Third World. It has depressed growth to the
lowest levels in the postwar period, slashed export
earnings, caused unemployment to soar, and creat-
ed major international financial problems. More-
over, it has not provided a reduction in inflation.
The strength of the adverse effects on LDCs is in
marked contrast to their success in insulating
themselves from the 1974-75 recession.
The chief differences between now and 1974-75 lie
in the international economic arena. In 1974-75 the
Third World countries were able to finance eco-
nomic expansion at rates more rapid than that
possible with domestic resources because they had
easy access to foreign funds. OPEC used its oil
surplus to finance its expansion; the non-OPEC
LDCs used increased borrowings from commercial
banks to cover their needs.
The reverse of this situation has been true in this
recession. The OPEC surplus is gone, constraining
OPEC members' ability to expand their own econ-
omies. In addition, the indebtedness of the non-
OPEC LDCs has become so large that concerns
about their creditworthiness have forced many to
reduce their rates of economic expansion. Many
have had to implement formal austerity programs
in response to IMF mandates.
Key LDCs Operating Under IMF-Mandated Austerity
Programs
Bangladesh
Bangladesh
Argentina
Guyana
Costa Rica
Bangladesh
Honduras
Guyana
Brazil
Jamaica
Honduras
Chile
Kenya
India
Costa Rica
Liberia
Ivory Coast
Guyana
Madagascar
Jamaica
Honduras
Malawi
Kenya
India
Morocco
Liberia
Ivory Coast
Pakistan
Madagascar
Jamaica
Panama
Malawi
Kenya
Sudan
Morocco
Liberia
Uruguay
Pakistan
Madagascar
Panama
Malawi
Senegal
Mexico
Sierra Leone
Morocco
Sudan
Pakistan
Thailand
Panama
Togo
Peru
Uganda
Philippines
Uruguay
Senegal
Zaire
Sierra Leone
Zambia
Sudan
Zimbabwe
Thailand
Togo
Uganda
Uruguay
Zambia
Zimbabwe
during 1981-82 with a number of OPEC mem-
bers experiencing declines in real output. In the Increased Unemployment. OECD out-of-work to-
non-OPEC Third World, the 0.7-percent growth tals rose by 11 million persons in 1980-82, nearly
estimated for 1982, was dramatically lower than double the jump that occurred in 1974-75. More
any annual growth performance since 1950. than 30 million persons are now jobless in the
OECD, nearly 9 percent of the labor force.
Impacts of the Recession
The impacts of the recession on the OECD econo-
mies were strong and mostly negative. Unemploy-
ment and business failures skyrocketed; only on the
inflation front was there a significant positive
Western Europe was particularly hard hit. A cut in
West European labor usage-in part a response to
increases in real wages in the late 1970s-com-
bined with rapid labor force growth to push jobless-
ness up by 2.5 million even during the expansion
effect.
Secret 16
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World Economy: Changes in Real GNP
Percent OECD: Unemployment
Million persons
3.9
1.2
1.5
-0.4 19.1 21.3
24.7
30.2
5.2
4.4
3.2
2.5 1.2 1.1
1.3
1.4
3.8
0.5
3.8
-4.8 0.8 0.9
0.9
1.3
Western Europe
3.3
1.4
-0.2
0.2 Western Europe 10.4 11.5
13.8
16.2
West Germany
3.9
1.9
0.2
-1.1 West Germany 0.8 0.9
1.3
1.8
France
3.8
1.1
0.2
1.6 France 1.4 1.5
1.7
2.0
United Kingdom
2.5
-2.0
-2.0
0.5 United Kingdom 1.3 1.7
2.6
2.9
Italy
3.8
3.9
-0.2
0.7 Italy 1.7 1.7
1.9
2.1
LDCs
5.7
4.6
1.8
0.9
Non-OPEC
5.6
5.7
3.1
0.7
Argentina
2.0
-1.6
-6.0
-7.0
Brazil
6.5
8.0
-2.0
0.0
India
0.4
7.5
4.6
-0.5
Mexico
6.2
8.3
8.1
1.0 since the series has been recorded, business liqui-
Singapore
12.6
10.2
12.5
13.4 dations in 1982 were at the highest levels since
South Korea
10.4
-6.2
6.4
6.0 the 1930s.
5.8
2.0
-1.4
1.2
Indonesia
6.9
7.0
7.6
6.5 ? In West Germany, 1982 capacity usage was 5
Nigeria
5.9
3.7
-2.4
-11.0 percentage points below the 1975 low point; at
Saudi Arabia
9.5
10.9
8.1
5.2 the same time, business failures, including some
Venezuela
4.8
-1.2
1.0
0.4 large prominent firms, hit postwar record levels.
a Average annual percent change.
b Estimated.
years of 1976-79. Since 1979 an additional 6
million West Europeans have joined the unem-
ployed ranks, pushing the overall unemployment
rate past the 9-percent mark
Depressed Manufacturing. Capacity utilization in
the Big Seven manufacturing sectors fell to record
low levels. Revenue losses, combined with high
finance charges, to push many firms to the point of
bankruptcy.
? In the United States, where manufacturing ca-
pacity utilization has fallen to the lowest point
? Even in Japan, where the recession has been
mildest and capacity utilization remains the high- 7Fx1
est, bankruptcies have risen sharply. 25X1
Drop in Inflation. The prolonged slump in real
economic activity did lead to a rapid slowdown in
world inflation. At about 8 percent, OECD con-
sumer price increases in 1982 showed a remarkable
turnaround from 1980 when OECD consumer 25X1
prices rose by 13 percent, the worst record of the
postwar period except for 1974.
The shift in inflationary trends was even more
pronounced in commodity markets. World oil
prices stagnated, agricultural and metallic raw
material prices dropped over one-fifth, and prices
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8.8
6.2
8.4
Western Europe
West Germany
France
United Kingdom
Italy
LDCs
Non-OPEC
OPEC
3.7
9.7
15.5
31.5
38.3
Percent OECD: Changes in Hourly Earnings Percent
in Manufacturing
12.9
10.6
8.4
13.5
10.3
6.2
8.0
4.9
2.6
10.1
12.5
10.8
15.1
13.3
10.9
5.5
5.9
5.3
13.6
13.4
12.0
18.0
11.9
8.6
21.2
19.5
16.4
35.9
30.0
53.8
42.7
35.6
59.7
17.6
16.7
19.0
Oil
14.1
65.3
11.8
-2.7
Food
0.5
34.0
-13.9
-20.9
Agricultural raw
materials
13.9
4.1
-9.8
-13.8
a Average annual percent change.
b Estimated.
8.4
9.9
6.6
12.6
12.1
9.2
12.2
10.8
5.2
4.4
14.8
14.5
13.6
16.3
13.2
11.0
22.4
23.7
17.8
a Average annual percent change.
b Estimated.
cost increases in the Big Seven OECD countries
have remained above 7 percent, down only about a
percentage point from the average pace of the
1970s and a full 5 percentage points above the rate
of unit labor cost increases in the 1960s.
of world-traded food items were off one-third.
Except for food, where downward price pressures
have emanated chiefly from high levels of produc-
tion, the recession has played a key role in com-
modity price declines
OECD wage increases also moderated substantial-
ly. In Western Europe, rises in hourly earnings fell
to only 11 percent last year, well below the
14-percent-a-year pace of the 1970s and fairly close
to the 9-percent increases of the 1960s. Japan also
has achieved a marked slowing of wage gains
Recession-induced slowdowns in productivity
growth, however, have limited the impact of favor-
able wage settlements on business costs. Unit labor
Secret
18 March 1983
Government demand management policies general-
ly fostered rather than counteracted the decline in
world economic activity, over the past three years
as the political response to a decade of rampant
inflation led to strong commitments to end the
price spiral. In the Big Seven OECD countries, for
example:
? The Thatcher government implemented extreme-
ly contractionary fiscal policies, actually moving
the budget toward surplus even in the face of a
three-year decline in real output. According to
OECD estimates, London's discretionary shifts in
fiscal policy were more contractionary than in
any other Big Seven country. London's monetary
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OECD: Changes in Money Supply
Monetary
Base
M1
M2
Monetary
Base
M 1
M2
OECD
10.2
9.8
11.7
5.5
6.8
12.1
United States
8.1
7.6
8.6
3.8
4.7
7.1
Japan
9.9
9.3
12.4
4.6
4.9
8.8
Canada
10.4
4.8
16.7
4.6
7.6
13.6
Western Europe
12.5
12.4
13.9
6.4
8.8
12.8
West Germany
8.9
8.0
9.2
2.7
2.5
5.2
France
9.2
10.3
13.8
13.2
11.5
10.8
United Kingdom
11.2
14.5
11.9 c
2.0
10.1
14.6 c
Italy
19.8
22.3
21.4
13.7
10.1
10.3
a Average annual percent change.
b Estimated.
c Sterling M3 definition of the money supply.
policy in 1980-82 was mixed. Growth rates of
narrowly defined monetary aggregates, such as
the monetary base and M1, were reined in sharp-
ly. On the other hand, broader definitions of the
money supply, such as sterling M3, grew more
rapidly, largely because of technical factors and
institutional shifts similar to the recent changes
in the US financial sector.
? Japan's demand management policies were gen-
erally contractionary on both the monetary and
fiscal fronts. Despite a steady slowing of real
domestic economic activity, the budget deficit as
a share of GNP declined in 1980-81 only to
rebound last year. The chief cause of the increase
in the 1982 deficit was an unexpectedly large
shortfall in tax revenues. Concurrently, expansion
of Japan's monetary aggregates was reined in
sharply.
? The OECD estimates that the discretionary
tightening of Canadian fiscal policy was exceeded
only by the United Kingdom and Japan's. Otta-
wa's monetary policy also generally was tighter in
1980-82 than in the 1970s.
? Ever fearful of inflation, Bonn also engaged in
essentially contractionary demand management
policies over the past three years. Despite a drop
in GNP of 1.1 percent last year, West Germany's
government budget deficit remained at a constant
4 percent of GNP. In addition, the Bundesbank
slowed growth of credit. In 1980-82, M2 in-
creased 4 percentage points less per year than in
1976-79; growth of M1 and the monetary base
dropped even more.
? France shifted to expansionary policies with the
coming to power of President Mitterrand in May
1981; the subsequent acceleration of French in-
flation, deterioration of competitiveness, and de-
preciation of the franc, however, forced a shift to
contraction.
? In Italy, the budget deficit increased more in
1980-82 than in any Big Seven country except
Canada and the United States. With shaky coali-
tion governments unable to chart a clear fiscal
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Big Seven:
Changes in Government Budget Balances, 1979-82 a
Actual
Change
Effect of
Changes in
Economic
Activity
Effect of
Increased
Interest
Payments
Estimated
Discretionary
Change
Big Seven
-2.3
-3.0
-0.8
1.5
United States
-4.3
-3.5
-0.6
-0.2
Japan
1.5
-0.7
-1.2
3.4
-1.4
-2.8
-0.7
2.1
-2.2
-2.5
-0.9
1.2
United Kingdom
1.1
-4.4
-0.5
6.0
Italy
-2.9
-2.3
-1.8
1.2
Canada
-4.4
-5.7
-1.3
2.6
Big Seven: Change in Percent of GNP
Government Budget a
Big Seven
2.5
-2.3
United States
4.7
-4.3
Japan
-2.1
1.5
Canada
0.5
-4.4
Western Europe b
2.1
-1.3
West Germany
2.8
-1.4
France
1.5
-2.2
United Kingdom
1.5
1.1
a OECD estimates.
b Big Four only.
course, the Bank of Italy battled inflation by
substantially slowing the growth of all three
monetary aggregates.
? The United States followed the least contraction-
ary fiscal policies in 1980-82. According to esti-
Secret
18 March 1983
mates by the OECD, it was the only major
OECD country to engage in discretionary shifts
in fiscal policy that have been expansionary. On
the other hand, monetary policy was quite tight,
with all major monetary aggregates expanding
considerably more slowly in 1980-82 than in the
previous four years.
Fiscal and monetary policy in the smaller OECD
countries also was generally tight. The weighted
average budget deficit for Australia, Austria, Bel-
gium, Denmark, the Netherlands, Norway, and
Sweden increased by only 1.3 percent of GNP
during 1981-82, despite real GNP growth that
averaged only 0.4 percent a year. During 1974-75
these countries swung into deficit by a degree equal
to nearly 3 percent of their GNP. Monetary policy
also was tightened, with more than half of the
Small Seventeen-including larger countries such
as Spain, Sweden, the Netherlands, and Belgium-
recording reductions in the growth of their broadly
defined money stocks between 1976-79 and 1980-
82
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World Economy: Moving Into Recovery I
After three years of slump, the world economy
appears on the verge of recovery. There are a
number of obstacles to a strong rebound, but we
believe world economic growth in 1983 could be
stronger than foreseen in many recent forecasts. To
some extent, the recovery path will depend on the
demand management policy stances of OECD gov-
ernments. At present, both fiscal and monetary
policies are tight in most countries; some relax-
ation-particularly of monetary policy-may be
needed to support a more rapid recovery.
Signs the Slump Is Over
A number of signs have emerged that indicate the
1980-82 world recession has bottomed out. In the
OECD:
? According to the IMF data, OECD-wide indus-
trial production stopped declining in late 1982;
even where decline continued, notably in some
West European countries, the pace slowed from
that of earlier months.'
? According to both the OECD Secretariat and the
US Conference Board, leading indicators of in-
dustrial production are up for recent months in
most OECD countries.
In the LDCs, sketchy, end-of-1982 data indicate
that their domestic situations are not as close to
recovery as are those in the OECD. On the other
hand, the "free-falls" their economies were in
during much of 1982 may be nearing an end.
'This article provides an overview of the factors that will play
important roles in 1983 world economic trends; a forthcoming
intelligence assessment will provide greater detail on our expecta-
tions on the course of recovery, particularly in the OECD countries.
Z Data presented in this article were obtained primarily from OECD
and IMF statistical publications.
Industrial Production
Index: 1975=100
116
114 1981 1982
a Seasonally adjusted.
Underlying Factors
The bottoming out of the slump is attributable to a
number of influences. One key factor has been the
greater-than-expected slowdown in world inflation
that the recession triggered. While wage gains have 25X1
also been pulled down, the decline in price inflation
has been greater in a number of key OECD
countries. As a result, real wages rose in 1982 for
the first time in three years; it appears that much of
the increase occurred later in the year. This im-
provement in real wages is enabling consumers to
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increase their real expenditures. At the same time,
the leveling off of unemployment in some countries
probably is increasing their willingness to do sor-
A second factor in the turnaround has been the fall
in oil payments from the OECD and non-OPEC
LDCs to OPEC-a decline that conservation and
substitution have caused to far outpace the drop
that would has been dictated by the world recession
alone. In 1982 these payments to OPEC by the rest
of the world declined by $60 billion; the so-called
Low-Absorbers of OPEC-chiefly the Persian Gulf
states-shouldered more than $40 billion of the
decline. This shift in world spending flows is, in
effect, leaving additional spending power equal to
between 0.5 and 1 percent of world GNP in the
hands of Western and non-OPEC LDC businesses
and consumers-groups with a much higher pro-
pensity to spend than the OPEC countries.
A third factor that seems to have played some role
in the bottoming out has been a relaxation of
monetary policy in three of the Big Seven OECD
countries:
? In the United States the Federal Reserve's dis-
count rate has been cut from 14 percent in late
1981 to 8.5 percent; growth of the primary
monetary aggregates has accelerated to or above
the high end of the Fed's target range for mone-
tary expansion.
? In West Germany the central bank money stock
has recently has been allowed to grow at the
upper end of the Bundesbank 4-7 percent target
range; in 1981 its growth was held to the low end
of that range. Concurrently, the Lombard rate
has been cut from 7.5 to 5 percent.
? In the United Kingdom, sterling M3-the money
stock definition traditionally used in the Bank of
England's policy formulations-has increased
more rapidly in recent months, but the govern-
ment claims that this is due to technical factors
rather than a change in policy.
Secret
18 March 1983
Speed of Recovery
The speed of the recovery will depend on a variety
of influences. A number of factors are likely to hold
it back:
? Stock Adjustment. Stock overhangs in Japan and
Western Europe likely will retard first-half 1983
production gains as business relies on inventories
to meet increases in demand. In Japan, stock-
building accelerated last year despite slower
growth of final demand. Of the four largest West
European countries, only in the United Kingdom
were stocks actually drawn down; in West Ger-
many and France, stockbuilding accelerated
sharply.
? Structural Problems in Industry. The depressing
effect of slack capacity on business investment is
compounded by structural problems. The produc-
tion declines in many old-line industries, most
notably iron and steel, have been so severe that
disinvestment in these sectors may offset invest-
ment rebounds in stronger industries.
? No LDC Import Growth. Imports by LDCs can-
not be counted on to provide impetus to OECD
growth as in the 1975-76 recovery. The wide-
spread financial problems in these countries re-
sulted in a 1-percent drop in import volume last
year after 9-percent growth in 1981. Continua-
tion of the debt problems and the impact of IMF-
mandated austerity programs are expected to
lead to, at best, no import volume growth again
this year. We estimate that the zero import
volume increases in the LDCs, instead of a more
typical 5-percent expansion of imports, will cost
the OECD between 0.5 and 1.0 percentage point
in growth.
? High Long-Term Interest Rates. Long-term in-
terest rates remain high, depressing both business
fixed investment and household investment ex-
penditures. While short-term rates have fallen,
the trend in longer term rates is more important
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Secret
Big Seven Countries: Long-Term Interest Rates
Nominal Rate
Three-year Inflation Rate
Positive Real Interest Rates
0
0
0
0
5 5
I I I I I I I I I I I I I I I I I I I I
0 1973 74 75 76 77 78 79 80 81 82 0 1973 74 75 76 77 78 79 80 81 82
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 -2 1976-79a 1980 1981 1982b 1982b
a Average annual rate. 1st half 2nd half
b over same half of 1981.
for major fixed investment decisions such as
installation of plant and equipment or housing
construction. In several of the major OECD
countries, real long-term rates are down only
slightly from the 1982 peak.
An additional constraint on recovery in 1983 may
be the recent spread of protectionist measures. The
impact of this factor on the world economy is
difficult to quantify, but, because world economic
expansion has depended heavily on increasing
trade, protectionism probably is providing an addi-
tional small hurdle to recovery.
Finally, OECD fiscal policies have remained tight.
Except for France, Italy, and Canada, the fiscal
policies of the Big Seven are designed to trim
government deficits.
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F
Some Positive Signs
The presence of these negative influences probably
will prevent a robust world economic recovery of
the 1975-76 variety, when OECD real GNP in-
creased at more than a 5-percent annual rate in the
first 18 months of recovery. There are, however,
some positive signs:
? First, the US economy seems to be coming off the
mark faster than expected late last year. In its
December 1982 Economic Outlook, for instance,
the OECD called for 2-percent first-half 1983
growth in the United States. The Department of
Commerce now estimates a 4-percent growth rate
in the first quarter, and Data Resources Incorpo-
rated calls for essentially as strong growth in the
second quarter.
? A second encouraging factor is the slide in oil
prices. Energy-producing sectors-and their in-
vestment spending-will be depressed by continu-
ing oil price declines, but most other sectors will
benefit. We estimate that each $1 drop in
OPEC's oil price leaves $6 billion in the hands of
non-OPEC consumers and businesses.
Government Policy Options
A third factor that could help boost growth would
be a further shift in demand management policies
in key OECD countries, as occurred in the mid-
1970s. Looser fiscal policy is not considered by
most OECD governments to be economically or
politically practical Japan, the United Kingdom,
and a few small West European countries, never-
theless, may have room to adopt more expansionary
fiscal measures.' Moreover, some relaxation of
monetary policy is likely, particularly if US interest
rates decline further.
25X1
^
25X1
25X1
I
25X1
25X1
25X1'
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secret
World Economy: Government Policies
in the Mid-1970s
By early 1975 the OECD economies had sunk to
depths akin to, although not as severe as, those
currently being experienced. Demand management
policies during 1974-75 were tight on both the
fiscal and monetary fronts:
? In 1974 the combined government budget deficits
of the Big Seven countries widened by only 0.7
percent of GNP, despite just 0.7 percent real
growth. In the two largest economies-the Unit-
ed States and Japan-the tightness of fiscal
policy was more pronounced than for the OECD
as a whole.
? OECD monetary policy also turned tighter in
1974 as money stock expansion rates were cut
sharply from the rapid pace of 1971-73.
Expansionary Policies in 1975-76
These contractionary policies were significantly
modified during 1975 and 1976. Budget deficits
were allowed to increase sharply in 1975 and
remain high in 1976 even though economic recov-
ery proceeded rapidly. More rapid expansion of
demand also was supported by a looser monetary
policy in most OECD countries.
The strongest shifts to expansionary policies were
in the United States-where money supplies grew
at about double the 1974 rate and the 1975-76
budget deficits ran about 3 percent of GNP higher
than in 1974. West Germany also allowed a sub-
stantial rise in money stock growth and budget
deficits~
Response to Stimulus: Growth and Inflation
The policy modifications of 1975-76 coincided
with a reversal of real output trends. OECD real
output rose at more than a 5 -percent pace in late
1975 and 1976. Nearly all OECD countries shared
in this rebound. Moreover, the growth slump in the
non-OPEC LDCs bottomed out and was reversed
in the OPEC countries.
The initial inflation costs of the robust economic
recovery were low. OECD inflation continued to
decelerate through the end of 1976; 20 of the 24
OECD countries had lower inflation in late 1976
than they did at the trough of the 1974-75 reces-
sion
Several factors combined to provide the decelera-
tion of inflation:
? Continued slack in world oil markets kept oil
prices steady.
? Nonoil commodity prices also increased only
moderately.
? Most important, inflationary pressures from the
wage side diminished considerably. Despite the
onset of recovery, wage increases remained mod-
erate as a result of still-high unemployment; the
sharp gains in productivity that occurred as the
economies rebounded also held down price pres-
sures.
Despite the continued steady expansion of world
economic activity in the intervening years, it was
not until 1979 that there was a major reaccelera-
tion of global inflation pressures brought on by:
? Continuation of expansionary policies as capaci-
ty output levels were approached. .
? Spillover impacts from US inflation.
? The initial impacts of Oil Shock II.
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World Economy:
Changes in Real GNP and Prices
Real GNP
6.1
Consumer prices
7.8
United States
Real GNP
8.8
-1.0
2.3
5.3
5.3
5.0
5.1
Consumer prices
11.7
24.5
11.8
9.3
8.1
3.8
3.6
Canada
Real GNP
8.9
7.1
4.5
6.5
6.3
4.7
5.1
Consumer prices
20.9
30.1
31.6
42.3
29.1
24.1
31.1
OPEC
Real GNP
12.1
9.1
3.9
10.1
8.2
1.1
4.0
Consumer prices
13.2
19.0
21.3
18.9
12.2
18.7
11.9
Non-OPEC
Oil
15.0
233.0
-2.4
6.8
9.4
0.4
44.4
Food
54.0
60.2
-21.2
-18.4
-3.7
14.0
14.1
Agricultural raw materials
79.2
-3.6
-19.7
24.2
3.2
7.6
22.0
Metals
46.9
24.9
-19.4
6.0
7.4
5.5
29.8
Secret 26
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Secret
OECD: Money Supply and Budget Deficits
1973
1974
1975
1976
1977
1978
1979
Budget deficit (percent of GNP)
0
-0.7
-5.4
-3.0
M2 (percent change)
14.0
10.8
11.9
13.6
United States
Budget deficit (percent of GNP)
0.5
-0.2
-4.2
-2.1
M2 (percent change)
6.6
4.7
9.0
11.4
Japan
Budget deficit (percent of GNP)
0.5
0.4
-2.7
-3.7
-3.8
-5.5
-4.8
M2 (percent change)
22.2
12.6
12.6
15.1
11.5
12.1
11.0
Western Europe b
Budget deficit (percent of GNP)
-0.9
-2.1
-5.5
-3.9
-3.0
-3.9
-3.4
M2 (percent change)
17.1
14.7
13.8
14.6
12.8
14.4
13.7
West Germany
Budget deficit (percent of GNP)
1.2
-1.4
-5.7
-3.6
-2.4
-2.6
-2.9
M2 (percent change)
10.5
7.1
9.4
10.1
8.6
10.0
8.2
France
Budget deficit (percent of GNP)
0.9
0.6
-2.2
-0.5
-0.8
-1.8
-0.7
M2 (percent change)
14.2
17.2
15.0
16.0
12.4
13.5
13.4
United Kingdom
Budget deficit (perce
nt of GNP)
-2.7
-3.7
-4.6
-4.9
-3.1
-4.3
-3.1
M2 (percent change)
c
27.2 -
10.2
10.8
9.4
10.3
15.2
12.7
Italy
Budget deficit (perce
nt of GNP)
-5.8
-5.4
-11.7
-9.0
-8.0
-9.7
-9.3
M2 (percent change)
20.9
20.0
20.9
22.0
21.4
23.0
19.1
Budget deficit (percent of GNP)
1.0
1.9
-2.4
-1.7
-2.6
-3.1
-1.9
M2 (percent change)
15.6
24.2
14.4
19.0
15.3
14.0
18.7
a Big Seven only for budget deficit.
b Big Four only for budget deficit.
c Sterling M3 balances.
27 Secret
18 March 1983
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Implications
The benefits of something more than flat or mini-
mal real GNP growth this year would be wide-
spread. The most important benefit likely to come
from more rapid growth will occur in the debt-
troubled LDCs. Each 1-percentage-point increase
in OECD real GNP will add $5 billion to LDC
export earnings and, in turn, reduce financing
needs. While credit relief for many LDCs is neces-
sary in the short run, their debt problems can be
solved over the longer run only through increased
world demand for their products. 25X1
Secret 28
18 March 1983
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Secret
United Kingdom: Protectionist Trends
Trade protectionism is increasing in the United
Kingdom despite Prime Minister Thatcher's vocal
public support for and philosophical commitment to
free market economic policies. Rising unemploy-
ment, increased import penetration, a considerable
contraction of the UK's industrial base, and a
deteriorating trade surplus has boosted public pres-
sure for the government to take a more interven-
tionist stand on trade. In the 1970s-before
Thatcher took office-nontariff barriers became
the main impediment to trade. While Thatcher has
been less willing to impose restrictions on foreign
goods and services, she has recently been forced by
a still sluggish economy and a fast-approaching
national election to take measures aimed at "pre-
serving British jobs." Additional measures are like-
ly even should Thatcher win-as expected-be-
cause growth will remain below past levels and high
unemployment will continue
Thatcher's government has been an outspoken ad-
vocate of free trade since it took office in May
1979. It has pledged to reduce subsidies to industry
and return publicly owned firms to private control
as part of its effort to promote competition and
efficiency. Chancellor of the Exchequer Howe and
Trade Minister Peter Rees have, for the most part,
resisted labor union, business, and opposition party
calls for significant increases in trade restrictions.
In elaborating the UK's position on GATT, Trade
Minister Rees has stated that London supports:
? A consensus on reducing protectionism that-
although stopping short of the US proposal for an
immediate standstill-would significantly liberal-
ize trade in manufactures.
? A study on reducing trade barriers in the newly
industrializing countries (NICs).
? Limited and selective safeguard measures and
increased transparency of voluntary restraint and
industry-to-industry arrangements.
? Negotiations on agriculture including proposals
to bring the Common Agricultural Policy of the
European Community under GATT.
? New efforts at liberalizing trade in services.
Despite the Thatcher government's public stance,
there are a large number of trade-distorting policies
used by the United Kingdom. According to a recent
report by the quasi-official National Institute of
Economic and Social Research, 48 percent of total
trade was subject to some form of government
management in 1980 versus 36 percent in 1974.
The 1980 average for the EC was 45 percent, and
only Italy, with 52 percent of its trade subject to
some form of management, was higher than the
United Kingdom. Perhaps most significant, the
study found that over 17 percent of British manu-
factured goods were subject to restrictions in 1980
versus 0.2 percent in 1974.
In part, nontariff controls on trade were an inevita-
ble result of the increased role of the government in
economic and industrial management which took
place in the years before Thatcher came to power.
They were also a response to the decline in domes-
tic and foreign sales of traditional industries as
tariff walls were reduced under successive rounds
of the GATT. The recession and rising unemploy-
ment have slowed Thatcher's effort to reduce subsi-
dies, especially for many nationalized firms in
traditional industries, keeping the level of managed
trade high despite her philosophical commitment to
free trade. However, she has thus far resisted the
more extreme protectionist measures demanded by
the opposition.
Secret
DI IEEW 83-011
18 March 1983
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United Kingdom: Key Sectors Subject to Protectionism
Sector
Target
Employment
(Percent Change
May 79-Sep 82)
Output (Percent
Change May 79-
Dec 82)
Percent Change in
Imports as a Share
of the Domestic
Market May 79-
Sep 82
Japan
Eastern Europe
European Com-
munity
-53
-38
25
Coal
Eastern Europe
United States
- 10
0
-6
Shipbuilding
Japan
NICs
-33
-8
-54 a
-7
19
Autos
Japan
Spain
-52
-36
15
Textiles, clothing,
footwear
Japan
NICs
United States
-13
-11
10
Agriculture
United States
European Com-
munity
-7
0
-6
Electronics,
computers
Japan
NICs
-12
-14
27
Machine tools
Japan
NICs
United States
-28
-16
15
Legal, financial
services
European
Community
United States
-8
NA
NA
Engineering
consulting
services
Japan
-2
NA
NA
a Change is the result of replacement of ships lost during the
Falklands crisis.
Secret
18 March 1983
Examples of Protectionist
Measures
Government ownership, $720 mil-
lion subsidy in FY 1982, licensing-
marketing agreements.
Government ownership, govern-
ment purchasing policies, $1.5 bil-
lion subsidy in FY 1982.
Government ownership, govern-
ment purchasing policies, $140 mil-
lion subsidy in FY 1982.
Government ownership, govern-
ment procurement policy, $900 mil-
lion subsidy.
Government ownership, $540 mil-
lion subsidy in FY 1982, Japan
limited to 11 percent of the market,
voluntary export restraints (quota).
High government participation, li-
censing and labeling restrictions.
Health and safety standards,
labeling requirements, marketing
board, buy national campaign, CAP
(EC) tariffs and quotas.
Heavy government participation,
Large subsidies, buy national,
VERs on TVs and VTRs.
Growing subsidies, VER, buy na-
tional campaign.
Licensing restrictions on banking,
insurance, and legal services.
Subsidy to domestic design and
engineering firms.
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necrer
The United Kingdom draws a substantial degree of
protection from its membership in the European
Community. Community tariffs on some sensitive
products, such as autos (10 percent) and semicon-
ductors (17 percent), are relatively high. Variable
import levies on agricultural products under the
Common Agricultural Policy, however, are less
beneficial to the the United Kingdom as a small
food producer than they are to other member
states. The UK also looks to the Community for
protection against imports of foreign steel, textiles,
coal, and electronic goods (TVs, VTRs, stereos)-
commodities coming principally from Japan and
the NICs. British automakers have led the fight for
more stringent EC controls on Japanese cars and
trucks and on autos from Spain. London is also
pushing for a producer agreement on aircraft with
the European Community.
The United Kingdom's. most important trade pro-
tection measures are not formal barriers to foreign
imports, however; rather, they are business subsi-
dies, to both private and state firms. Tax subsidy
rates on British manufactures, as a percent of asset
prices, rose from an average 7.3 percent in 1973 to
10.9 percent in 1980 and 13.1 percent in 1981.
Industrial subsidies and grants, including those to
nationalized industries, accounted for 41.6 percent
of government spending and 17.8 percent of GNP
in FY 1982/83. Direct subsidies to private industry
alone accounted for 4 percent of GNP last year.C
London also provides subsidized export financing
through the Export Credits Guarantee Department
(ECGD). Under this plan, British banks provide
export credits in exchange for unconditional repay-
ment guarantees, interest rate subsidies, and limit-
ed portfolio refinancing by the government. Be-
tween 80 percent and 100 percent of long-term
contract values are supported under the program. A
recent British Treasury report questions the cost-
effectiveness of official subsidies to capital goods
exports (10 percent of total exports) and suggests
they be discontinued. Trade Secretary, Lord
Cockfield, however, opposes the Treasury position.
as well as US. proposals fore a flexible system on
export credit interest rates.
Nationalized firms enjoy virtual domestic monopo-
lies in the steel, coal, shipbuilding, aerospace, and
auto industries. The government also has a large
stake in the chemical, computer, telecommunica-
tions, and petrochemical sectors. State firms gener-
ally are not subject to constraints on expenditure,
research, development, or expansion and are often .
guaranteed sales to other government-owned firms
regardless of price.. Government-owned electrical
plants, for example, are forced to buy coal from
government-owned National Coal Board mines
even though subsidized domestic prices are higher
than import prices; the costs are passed on to
consumers.
Government policies on purchasing, licensing, la-
beling, and standards.also act to restrict entryof
foreign goods. British state companies do most of
their purchasing in the United Kingdom; three
domestic. companies, for example, supply 60 per-
cent of British telecommunications purchases. Lo-
cal governments were encouraged to "buy nation-
al" on computer purchases in 1982 from the
25-percent government-owned computer, -manufac-
turer ICL. The United Kingdom has also expanded
the domestic and export powers of its agricultural
marketing organization. Health, safety, and label-
ing standards have been used to keep out milk, . -
poultry, and some alcoholic beverages from the EC:
Licensing practices have.been used to restrict or
ban imports of foreign services such as banking and
insurance. The French claim that the United King-
dom uses customs regulations and reduced. customs
entry points to slow imports.
Quantitative restrictions are increasingly being
used to reduce import penetration by Japan and the
NICs. Japanese auto imports are held to 11 percent
of the.British market under a voluntary. agreement.-
Color television sets, picture tubes, video.tape ,
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recorders, machine tools, motorcycles, and forklift
trucks are also covered by voluntary export agree-
ments (VERs) between the British and the Japa-
nese.
Rising Protectionist Pressures
The key factor behind the rise in protectionist
pressures is the decline in manufacturing employ-
ment. A protracted recession, tight monetary poli-
cies, loss of export market shares, and import
penetration contributed to a loss of 2.7 million jobs
in industry between 1974 and 1982; of these, nearly
2 million were lost after Thatcher took office.
Unemployment now stands at 3 million adult work-
ers or 13 percent of the labor force.
Some industries have been hit even harder. Em-
ployment in the steel and auto sectors is half the
1979 level, and one-third of the workers in the
shipbuilding industries have been laid off over the
period. Sales of British machine tools are now 55
percent below their 1975 level, and imports now
account for 40 percent of domestic sales compared
with 28 percent in 1975. Japan has increased its
share of the UK market more than 8 percentage
points. Meanwhile, jobs in the industry are down
nearly 30 percent.
Unions and trade associations like the Confedera-
tion of British Industry, which represents 300,000
British employers, want the government to increase
aid to industries and take action to keep out foreign
goods. Automakers and the unions want a quota on
auto imports from Spain, and shipbuilding unions
are pushing for more government aid, a scrap-and-
build program, and financial incentives for pur-
chasers of British-built ships. Steel and coal work-
ers are demanding new subsidies to keep open
plants and mines that are no longer competitive.
Thatcher's political opponents-with an eye to an
election some time between June 1983 and May
1984-have made protectionism a key part of their
programs. Most radical has been the proposal by
Secret
18 March 1983
Labor's shadow Chancellor of the Exchequer Peter
Shore which calls for a mixture of devaluation and
protectionism to reinforce a major reflationary
program. The plan includes a 30-percent devalua-
tion over two years, renationalization of British
industry, and strict planning of production and
trade. The Social Democratic-Liberal Alliance has
stated a preference for a less radical plan calling
for increased subsidies and trade constraints only in
especially hard-hit sectors.
Thatcher has been forced to take a more pragmatic
approach toward protectionism with an early elec-
tion possible and unemployment still at record
levels. Some of the government's most recent ac-
tions on trade clearly have been taken to show its
concern about unemployment and thus attract
votes. The most notable instance is the subsidy that
accompanied London's December 1982 order to
British Steel Corporation to continue production at
all five of its plants, even though there is sufficient
demand to support only four integrated steel plants.
Major financial commitments have also been an-
nounced to support British production of high-
technology goods. A $25 million grant went to
British microchip manufacturer Inmos Internation-
al, and London has reiterated its support for com-
puter maker ICL by pressing local governments to
boost spending on British computer and office
equipment. The government has also told British
Leyland-the nationalized auto company-to hold
off its plans to shift to foreign suppliers. Another
plan under study would subsidize British suppliers
in order to match prices offered by foreign compa-
nies. In an effort to slow layoffs in the mines,
London also is applying new pressures on electricity
producers to buy more expensive domestic coal.
This new pragmatism represents a substantial shift
from Thatcher's earlier policies.
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Secret
One result of the increased pressure against Japa-
nese goods has been a substantial increase in
Japanese investment in the United Kingdom. Brit-
ain has allowed Japan to increase its direct invest-
ment in order to promote new employment even
though it will eventually mean additional cash flow
to Japan. Ten Japanese plants designed to produce
color TVs, VTRs, or stereos (creating several thou-
sand new jobs) have opened in the United Kingdom
at an increasing rate since the mid-1970s. Joint
ventures between British and Japanese auto and
machine toolmakers are also being explored.
Outlook and Impact on the United States
Pressures for protection are likely to rise because
current levels of unemployment are expected to
continue through the mid-1980s. A Thatcher vic-
tory at the polls, however, would probably result in
substantially lower levels of British protectionism
than under any other government. Under the
Tories, subsidies and government ownership of
industry would probably continue to be gradually
reduced and some progress toward trade liberaliza-
tion would be likely. A Labor government, on the
other hand, would sharply increase both protection-
ism and government control of industry. The Social
Democratic-Liberal Alliance would be in the mid-
dle applying new nontariff barriers only in specific
areas where import penetration is highest. Most of
the protectionism contemplated would be directed
against imports from Japan and the NICs.
Only minor pressure on US exports will come
directly from the United Kingdom. Most actions
against US goods will be carried out in the context
of the EC. Agricultural exports will be a prime area
of contention, although London believes the EC has
room to compromise in upcoming negotiations with
the United States.
Chemicals and high-technology goods are areas of
potential bilateral US-UK trade conflict. The
United Kingdom is intent on developing its domes-
tic industry and has already demonstrated its will-
ingness to increase financial support and employ
purchasing policies to aid in further expanding its
computer industry. Thatcher views high-technology
industries as important for developing the UK
service sector and providing long-term employment
growth as well as export earnings. To that end she
can be expected to argue for the protection of an
"infant industry." She will, however, join the
United States in pushing for liberalization of trade
in services because she believes Britain has a
competitive advantage in that area and will benefit
from increased trade flows
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United Kingdom: The Election Budget
The new British budget announced on 15 March
may have been the last chance for Prime Minister
Thatcher's Conservative government to convince
voters that it has delivered on its promises. Mixed
signals on an economic recovery, record levels of
unemployment, falling oil revenues, and a plum-
meting British pound have left the Tories vulnera-
ble to criticism on economic policy-with an elec-
tion widely expected this year, perhaps as early as
June. The budget takes a middle road between the
massive reflationary program called for by the
Labor Party and the relatively tight monetary and
fiscal policy mix the Tories have pursued since
taking office in May 1979. What little stimulus
there is will come from cutting personal taxes and
cosmetic trimming of business taxes. The budget
will have little impact on unemployment or on
domestic growth because of the expected increase
in imports. It may, nevertheless, provide enough of
a boost to keep Thatcher in office for another term.
The Economic Setting
The Tories came into office in May 1979 promising
to turn the economy around. To this end, they
introduced a Medium-Term Financial Strategy fo-
cused on cutting inflation, reducing the role of
government in the economy, and improving produc-
tivity and competitiveness. Their program called
for:
? Sustained reduction in money stock growth from
9 percent in 1980/81 to 6 percent in 1982/83.
? One-percent annual reduction in real budget
spending through 1984.
? A reduction in taxation, featuring a shift from
direct (income) to indirect (VAT) taxes to foster
competitiveness and investment.
? "Privatization" and reduced subsidies for govern-
ment-owned firms.
? A return to realistic wage bargaining.
The economic record that Thatcher would bring
into the election is mixed. Inflation, which peaked
at 22 percent in May 1980, now stands at 5.6
percent over a year earlier largely as a result of
lower wage demands. Unemployment, however, has
grown from 5.6 percent of the work force when
Thatcher took office to 12.9 percent. After three
years of stagnation, real GNP is turning upward
and is projected to rise 1.4 percent in 1983; on the
other hand, the trade and current accounts are
moving toward deficit.
The budget deficit has shown marked improve-
ment; last year the $14 billion deficit was nearly $3
billion below its target despite added expenses
stemming from the Falklands conflict, higher social
welfare payments to the unemployed, new subsidies
for failing industries, and less-than-expected oil
earnings. Taxes as a share of GDP have increased,
however, from 34.4 percent in 1979 to 40.1 percent
last year. Although productivity and competitive-
ness have improved markedly because of layoffs
and a 13-percent trade-weighted depreciation of
the pound since November 1982, key industries
such as steel, autos, shipbuilding, and textiles con-
tinue to lose ground. Moreover, Thatcher has been
forced to go slow on her privatization program
because she cannot find buyers for several of the
failing firms.
Falling oil prices are a mixed blessing for the
United Kingdom. Lower oil prices will slow returns
for the oil companies-which provided most of the
growth Britain experienced over the last three
years-and will cut government tax revenues. They
will also put downward pressure on the pound,
boost import prices and, in the short term, reduce
the trade surplus. On the export side, reduced
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Consumer Prices-
Unemployment Rate
Percent
Current Account- Trade
Balance
Billion #
Trade-Weighted Exchange
Rate
Index: 1975=100
Public Sector Borrowing
Requirement
Billion #
foreign sales of oil will be offset only after an
adjustment in exchange rates leads to improve-
ments in the price competitiveness of British manu-
factured goods. Rising import prices will cause new
domestic inflationary pressures, tending to offset
the deflationary benefits of reduced oil prices. The
domestic growth stimulus from a $5 per barrel drop
in oil prices will add no more than 0.4 percent to
real GNP growth from increased consumption.
London may be forced to reduce its taxes on oil
companies, however, in order to maintain an ade-
quate level of exploration and development and to
assure oil supplies for the 1990s.
Loosening the Reins
Aware that this will be the last full fiscal year
budget for the present Parliament regardless of
when the election takes place, Thatcher has used
the event to solidify her current lead in the polls. To
this end, she provided the maximum amount of
stimulus she could and still remain within her $12
billion target for the deficit. The cautiously expan-
sionary $182 billion budget seems to take into
account another cut in the price of North Sea oil
that is widely expected to come before April. Most
of the stimulus comes on the revenue side; about
$3.8 billion goes to cuts in personal income taxes
and an additional $585 million goes to reduce the
burden of National Insurance payroll taxes on
corporations. Child benefit payments are raised by
11 percent on the expenditure side. As expected,
the government raised excise duties on beer, wine,
liquor, cigarettes, gasoline, and vehicle sales slight-
ly less than the change in inflation over the past
Industrial Production,
Manufacturing
Index: 1975=100
a Seasonally adjusted annual rates.
b Estimated.
CTarget.
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18 March 1983
year.
Tight monetary targets-the keystone of Thatch-
er's economic program until now-will be eased.
This year's growth target for monetary aggregates
is to be 7 to 11 percent-the same as in the FY
1982 budget announcement but well above the 4 to
8 percent target called for in the original Medium-
Term Financial Strategy. The government has not
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confirmed that it will set the 13-percent target for
MI that had been suggested in a recent British
Treasury Department staff report.
The budget also contains significant tax relief for
companies engaged in exploration and development
in the North Sea. The recent decline in drilling
activity and the expected impact of falling oil prices
on company spending plans has apparently con-
vinced the government that tax relief is necessary if
the United Kingdom is to be assured of adequate
oil supplies in the 1990s. The advance petroleum
revenue tax has been cut from 20 to 15 percent
starting in July and there are plans to phase it out
altogether by the end of 1986. New fields devel-
oped after April 1982 will no longer be subject to
royalties, and the quantity of oil exempted from
petroleum revenue tax will be doubled.
Opposition Proposals
Although largely a paper exercise, the opposition
parties have announced their own proposals for the
economy in hopes of gaining some political ground.
Labor Party leader Michael Foot and shadow
Chancellor Peter Shore are calling for massive
reflation, a 30-percent devaluation of sterling, and
increased protection against foreign imports. Labor
wants to increase public spending by over $7.8
billion in order to reduce unemployment. Much of
the Labor program has been derived from the
Cambridge Policy Group, which holds that free
trade is not effective and claims that the United
States and the United Kingdom would be better off
with high tariffs used to subsidize wages. Labor has
taken the program further by proposing a devalua-
tion to make British exports more competitive and
to reduce imports. The Party also wants to increase
government control of the economy by reversing
Thatcher's privatization policies and instituting a
centralized planning framework for both produc-
tion and trade.
The Social Democratic-Liberal Alliance has pro-
posed a budget directed at creating new production
and jobs and steering a middle course between the
Tories and Labor. The Alliance proposes a $4.2
billion increase in borrowing-to $16.2 billion-to
support a 2.5-percent cut in indirect taxes (VAT), a
$1.3 billion increase in capital spending, $1.5 bil-
lion in tax relief to small business, and $2.1 billion
in special unemployment programs. It claims the
plan would create 465,000 additional jobs in FY
1983 and boost real GDP by over 1 percent. While
the Alliance admits the measures would be slightly
inflationary, it claims that the benefits from added
employment would far outweigh the costs of in-
creased inflation.
The budget may have some psychological impact
on voters, but it is unlikely to result in any substan-
tial improvement in unemployment by election
time. Thatcher currently leads in the polls and
there are already signs that a recovery is under
way. The government estimates that it costs
$35,000 to create one job and that the lag between
expenditure and employment may be as long as six
to nine months-barely enough time for an Octo-
ber 1983 election even if all goes well. Moreover,
the OECD estimates that unemployment will re-
main at current levels through 1985.
Political observers view the budget as Thatcher's
initial move to influence both the general election
and the important Darlington byelection, which
will take place on 24 March. The budget's political
purpose is to ensure Tory unity, to offer sufficient
tax concessions to consolidate the Conservatives'
lead in the polls, and to reassure business groups
allied to the party that the government is working
to ensure economic growth. At the same time,
Thatcher will be careful to maintain her reputation
as a strong leader who will not curry favor with the
voters at the expense of sound long-term recovery.
Opposition parties may face a quandary in attack-
ing the budget for making too many concessions to
Conservative interest groups while also accusing
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the government of not doing enough to stimulate
the economy and reduce unemployment. Most polls
show voter dissatisfaction with the government's
economic policy, but they also show that the voters
have little faith in the programs advocated by
Labor or the Social Democratic-Liberal Alliance.
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Financially Troubled Oil Exporters:
Adjusting to Price Decline
A further slide in oil prices will exacerbate the
financial difficulties of a number of LDC oil
producers, particularly Egypt, Indonesia, Mexico,
Nigeria, and Venezuela. With foreign reserves
down to a month or two of imports in some cases
and with limited capability to borrow from West-
ern banks, the falloff in oil revenues will necessitate
tough and politically unpopular austerity measures.
Resort to IMF assistance may also be in the cards
for some. Cuts in imports will fall heavily on the
OECD, which supplies nearly 85 percent of foreign
goods purchased by these countries.
Payments Impact of Oil Price Cuts
Current account prospects for the financially trou-
bled LDC oil exporters have markedly deteriorated
as a result of the decline in world oil prices.
? If the annual OPEC selling price were to fall to
$25 a barrel from last year's $33.50, the oil
export revenues of these five oil producers could
drop by $6-16 billion from last year's $60 billion
depending on the strength of the recovery in oil
demand. We estimate that under the most opti-
mistic production assumptions Mexico would be
most seriously affected, with oil export revenues
plummeting by 22 percent.
? If the OPEC price were to drop to $20 a barrel
for the year, oil revenues of the financially trou-
bled LDC oil exporters would dip to $35-44
billion.
Adjustments to Price Decline
and commercial bankers are reluctant to extend
new credits. Foreign exchange reserves have fallen
sharply in many cases, ruling out the possibility of
financing a large current account deficit through
reserve drawdowns. In our judgment, massive cuts
in imports will be the principal avenue for adjust-
ment, although four of the oil exporters could
finance part of the deficit through IMF loans.
The import cuts needed to offset decines in oil
prices would be substantial if prices continue to
drop throughout 1983. For instance, if the annual 25X1
OPEC selling price averaged $25 per barrel this
year, we estimate that the volume of imports for
the five countries would have to be reduced by a
minimum 15 percent to achieve the 1983 current
account balances expected at the end of last year.
? Mexico and Venezuela would have to cut imports
the most-24 percent in each case.
? The other three countries could hold the reduc-
tions to around 9 percent. At a price of $20 a
barrel, the volume of imports would have to be
slashed by an average 30 percent. Reductions of
this magnitude would lead to substantial declines
in other sectors of the economy, intensify social
problems in these countries, and probably lessen
this year's election chances of the ruling,parties in
Venezuela and make orderly elections more diffi-
cult in Nigeria
The OECD countries, particularly the United
States, would feel the effects of austerity measures. 25X1
In 1981 these five countries purchased around $70
billion in goods from the OECD-nearly 85 per-
cent of their total import bill. The United States
accounted for the bulk of Mexican purchases and
The financially troubled oil producers have few
options available for dealing with an oil price
decline. The creditworthiness of most has fallen,
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Financially Troubled Oil Producers: Geographical
Distribution of Imports, 1981
Egypt
Indonesia
Mexico
Nigeria
Venezuela
Total
8,782
13,520
29,132
18,776
11,493
OECD
6,335
9,463
27,396
15,536
9,869
United States
1,737
1,432
19,568
1,675
5,445
Japan
38
4,527
1,869
2,368
922
West Germany
897
1,253
1,625
2,382
552
France
833
322
711
1,865
399
United Kingdom
433
315
459
3,368
252
Italy
652
160
632
958
582
Canada
79
85
670
92
700
Small 17
1,666
1,369
1,862
2,828
1,017
64
1,127
39
16
10
Africa
69
143
43
134
54
Asia
301
2,062
282
1,726
292
Hong Kong
23
916
57
463
68
India
79
43
10
56
Singapore
65
42
242
19
South Korea
36
401
34
123
36
Middle East
59
10
25
76
13
Western Hemisphere
201
65
672
420
973
Brazil
103
42
440
299
186
USSR, East Europe
953
184
204
381
24
nearly 50 percent of Venezuelean imports. Japan
supplied one-third of Indonesian purchases; the Big
Four European countries provided 45 percent of
Nigeria's imports.
If oil prices fall sharply in 1983 Egypt would be
forced to try to borrow additional amounts in the
Eurodollar market and to impose much tougher
and politically risky austerity measures. We esti-
mate that for each $1 per barrel decline in the price
of oil Egypt stands to lose $150-200 million in
foreign exchange earnings from oil exports, Suez
Canal tolls, and worker remittances. Oil exports
now account for one-fourth of Egypt's total foreign
exchange earnings; the direct revenue losses from a
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18 March 1983
decline in oil prices to $25 could approach $750
million. Cairo probably would attempt to blunt the
impact of reduced earnings by seeking more US aid
for balance-of-payments support and by reducing
ambitious economic growth targets. The Egyptians
might be tempted to seek official aid from other
Arab states.
Since the end of last year, Indonesia's financial
outlook has deteriorated markedly because of the
decline in oil prices, the continuing soft market for
nonenergy raw materials, and the below-average
rice crop expected this year. While most analysts
earlier believed that Indonesia would be able to
cover its deficit for 1983 without having to resort to
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stiff domestic austerity measures, Djakarta could
be forced to take difficult steps if oil prices continue
to tumble. At $25 per barrel, imports would have to
be cut about 9 percent to hold the deficit to $8
billion even if oil demand picked up this year.
Djakarta to date has had no difficulty in lining up
foreign credits to finance its payments deficit.
However, the Indonesians are having to pay higher
interest rates and are displaying growing nervous-
ness over the availability of funds. International
bankers are becoming increasingly concerned over
their exposure; any further weakening in Indone-
sia's external accounts would intensify bankers'
fears.
Each $1 drop in oil prices costs Mexico $550
million; a continued slide in oil prices would neces-
sitate additional financial support or further auster-
ity measures. Without offsetting financing, a 25-
percent drop in oil prices, for instance, would entail
a minimum 25 percent reduction in real imports to
hold the current account deficit to $4.2 billion, the
amount projected under the IMF adjustment pro-
gram last fall. If Mexico misses its IMF targets by
wide margins and international bankers perceive
that de la Madrid's policies are off base, we believe
that the risk of losing international financing could
be significant.
Nigeria will have to substantially tighten current
restrictions on government spending and imports
since it is already in serious trouble with creditors;
foreign exchange reserves are low, borrowing ca-
pacity is limited, and arrearages are growing. At
$25 a barrel, imports would have to cut by almost
10 percent even if oil demand recovered in order to
hold the deficit at $5-6 billion. We believe that the
Shagari government would choose to cut spending
on capital equipment in order to keep consumer
items flowing in the country. This will hurt the
country's import-dependent manufacturing sector,
intensify the urban unemployment and force un-
popular economic reforms.
In our judgment,
Lagos will not turn to the IMF for assistance before
this summer's elections since such a move would be
cited by the opposition as tangible evidence the
present government is unable to handle the econo-
my. We believe Shagari will increasingly look to
the United States for financial assistance, citing
Nigeria's longstanding role as a reliable source of
US energy needs. 25X1
Venezuela will have to sharply curtail both public
spending and imports if oil prices continue to fall.
Caracas would have to reduce sensitive social pro-
grams and further curtail its domestic economic
development program. Public expenditures were 25X1
already slated to fall some 10 percent in nominal
terms this fiscal year even with no decline in the
price of oil. Venezuela's options are limited because
its creditworthiness has sharply deteriorated. The
government is attempting to restructure half of the
$19 billion public debt to a longer maturity, and
last month it imposed currency controls and a
three-tier exchange rate in an effort to stem capital
flight. 25X1
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