INTERNATIONAL ECONOMIC & ENERGY WEEKLY 17 JUNE 1983
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Publication Date:
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Intelligence
Weekly
International
Economic & Energy
-,Seef et-
DI IEEW 83-024
17 June 1983
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International
Economic & Energy
Weekly
iii Synopsis
1 Perspective-Eastern Europe: Still Looking to the West
5 Briefs Energy
International Trade, Technology, and Finance
National Developments
15 Romania: Progress in Tackling Financial Problems
21 Hungary: First Steps Toward Financial Recovery
27 Yugoslavia: Financial Outlook
Comments and queries regarding this publication are welcome. They may be
directed toQDirectorate of Intelligence,
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17 June 1983
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International
Economic & Energy
Weekly
Synopsis
Perspective-Eastern Europe: Still Looking to the West I 25X1
Eastern Europe faces difficult decisions as it deals with debt servicing
problems, the impact of austerity, and lagging productivity. The East Europe-
an regimes will continue to approach Western governments for credits and
assistance, in part because they recognize that the USSR is likely to be of little
help.
Romania: Progress in Tackling Financial Problems
Romania has made significant progress in recovering from its debt crisis.
Bucharest's determination to solve its debt problem led to deep slashes in
imports and a $3 billion turnaround in the hard currency trade account since
1981. For the longer term, substantial hurdles still must be overcome; financial
pressures are likely to require continued austerity, and Bucharest must begin
to deal with longstanding problems, especially productivity, competitiveness,
and economic management.
Hungary: First Steps Toward Financial Recovery) 25X1
The withdrawal of credit lines from Eastern Europe following the Polish and
Romanian debt crises brought Hungary to the brink of bankruptcy in early
1982. With only modest gains in Hungary's financial position expected this
year and growing repayments of medium- and long-term debt through 1985,
Budapest will remain on a financial tightrope.
Yugoslavia: Financial Outlook
Given the difficulties involved in arranging this years financial package, we
believe private lenders will not provide enough new loans to cover the
traditional large first-half financing requirement next year of $2 billion to $2.3
billion. By early 1984-or sooner if the financial package falls apart-some
Western creditors will probably try to press Belgrade to begin a formal
rescheduling of its debts.
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Bad weather, electricity shortages, and transportation tieups were the major
factors behind India's near zero economic growth last year. Although more
favorable weather would alleviate many of these problems, India's longer term
outlook is clouded by looming financial problems. ~ 25X1
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International
Economic & Energy
Weekly
Perspective Eastern Europe: Still Looking to the West
Eastern Europe faces difficult decisions as it deals with debt servicing
problems, the impact of austerity, and lagging productivity. Most of the
countries in the region must try to secure more Western assistance and at least
preserve current levels of Soviet economic support. They will need to gauge
how much more austerity they can impose and still maintain political stability,
and some may consider reforms to remove systemic obstacles to improved
economic performance.
The East European economies are still reeling under the impact of the credit
squeeze that began in 1980 and intensified in 1981 after Poland announced it
was unable to repay its debt. The situation turned more desperate in early
1982 as banks decided to reduce their exposure to the region. Thus, while the
financially troubled LDCs were able to increase their borrowing from banks
last year, Eastern Europe suffered a reduction in credit lines of about $5
billion.
As sources of credit dried up, reserves dwindled and rescheduling negotiations
dragged on, and most East European countries were forced into severe
adjustment programs. All of Eastern Europe, except Bulgaria, slashed hard
currency imports last year; the region ran its first hard currency trade surplus
in more than 20 years and brought its current account into balance. The
domestic cost of these policies, however, has been high:
? Annual growth of GNP for the region stagnated in 1982, compared with the
over 4-percent rate recorded in the 1970s. We expect that GNP growth will
show little if any increase this year.
? Investment dropped nearly 10 percent during 1981-82 and will show a
further decline this year.
? Per capita consumption is now declining in the region as a whole, probably
for the first time since the immediate post-World War II era.
? Consumer price hikes-once considered taboo by most of the regimes-are
now commonplace and, in some instances, steep.
Despite some progress in lowering the external deficit, the East European
regimes have done little to solve basic economic problems. Only two
CEMA countries-Hungary and Bulgaria-have embarked on fundamental
economic reforms, and there is general skepticism and resistance to the idea
among the leaderships in the region. The dilemma is that deeper reforms
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Eastern Europe
Soviet
Union
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would yield few benefits in the short run and would be difficult to implement
at a time when the regimes are coping with debt servicing problems. Moreover,
the regimes-many possibly facing succession struggles-also are prone to
factionalism between entrenched bureaucracies, which are split on the issue of
economic reform.
Eastern Europe's problems are further complicated by the potential for
political fallout from austerity and reform measures. For the most part, the
East European populations have quietly tolerated their repressive political
climate in exchange for gradual improvements in their economic well-being.
Even in the years when material rewards were meager, public reaction was
often mild, apparently because of confidence that improved living standards
were "just around the corner." Now the promise of a better future is suspect,
and consumers are no longer patient. The Polish story is well known, and the
situation there remains volatile. Romania has suffered through several sporad-
ic, and at times violent, outbursts.
The East European countries may be left with few options but to cut
consumption further. Continued reductions in investment over the next several
years threaten future growth, and the Soviets will continue to press their
Warsaw Pact allies to maintain-if not increase-real defense spending. As
pressure on consumers mounts, the outcome is uncertain but could lead to
greater repression in several countries.
In coping with the debt crisis, the CEMA members of Eastern Europe have
not been able to fall back on the USSR, which is coping with its own economic
difficulties. The Soviets actually have intensified the region's problems by
trimming concessionary oil deliveries in 1982 and by pressing more vigorously
for balanced trade. In the case of Hungary, Moscow contributed to Budapest's
1982 liquidity crisis by pulling hard currency from Hungarian banks. In
addition, the USSR and its East European allies are having problems in
setting up a CEMA summit that would deal with the economic malaise in the
Bloc. The East Europeans continue to resist Soviet pressures for increased
CEMA integration because they fear loss of both their political and economic
independence. Under the best circumstances, the East Europeans hope for no
further cuts in Soviet deliveries and no toughening in trade terms.
Some also hope for at least tacit approval from Moscow to experiment with
economic reforms. The debt crisis, the cool East-West political climate, and
the lack of help from the USSR suggest growing East European isolation.
Nevertheless, some regimes are trying to expand or at least protect their ties
with the West:
? Both Hungary and Yugoslavia have arranged emergency support from
Western banks, governments, and international financial institutions to try
to stave off formal rescheduling.
? Hungary approached the EC last month about establishing a trade pact
similar to those the Community has with Yugoslavia and Romania.
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? Romania arranged two years of debt relief from Western governments and
banks and recently settled its emigration disputes with the United States,
West Germany, and Israel in hopes of maintaining its preferential trade
status.
? Poland continues to push for IMF membership and for rescheduling
agreements; the leadership hopes the papal visit will lead to an easing of
Western sanctions.
Eastern Europe, similar to the financially troubled LDCs, is dependent on
Western economic recovery and assistance in dealing with likely payments
crises in the near term. Unlike some LDCs, however, the East European
countries will not stand to gain as much from recovery since they dragged their
feet on measures needed to make their exports competitive or to improve
economic performance. In addition, Western bankers are reluctant to increase
lending to the region. As a result, the East European regimes will continue to
approach Western governments for credits and assistance, in part because they
recognize that the USSR is likely to be of little help.
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Briefs
Energy
Major Delays in Drilling at the Urengoy gasfield during 1982 fell reportedly well short of
Soviet Gas Drilling planned targets. The number of new wells completed last year was signifi-
cantly below the number planned and may only have been slightly more than
the number completed in 1981. Urengoy is the USSR's largest producing gas
deposit, and virtually the entire planned increase in gas output in the current
five-year plan is to come from there.
The lags in well drilling have been caused primarily by the demands of the ex-
port pipeline construction program, which have overtaxed the West Siberian
Transportation Network and compounded delays in the production and
delivery of crucial drilling supplies. The shortfall, however, is unlikely to affect
production in the near term or threaten gas export obligations to Western
Europe in 1984. On the other hand, a shortfall in drilling for the third year in a
row could affect production in 1985. This could cause problems in meeting
both export and domestic requirements.
Polish Coal According to the Polish Press Agency, Poland exported approximately 13.6
Exports Up million tons of coal in the first five months of this year-27 percent above
year-earlier levels. Shipments to the West to earn hard currency are 23 percent
above the 1982 level. The Poles are regaining Western markets through price
concessions, barter arrangements, and pressure on some West European
governments to purchase Polish coal if they hope to receive payments on their
outstandin loans to Poland
This year Poland plans to export 35-37 million tons of
coal-7-9 million tons above the 1982 level, but because of depressed demand
and high stocks in Western Europe, we do not believe the Poles will be able to
achieve such a high export level.
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Japanese Contracts Several Japanese companies recently signed new long-term contracts with Iran
for Iranian Oil
All of Iran's previous
contracts with Japan, totaling some 250,000 barrels per day, will have expired
by next month.
Iran's production has slumped recently to about 2.1 million barrels per day, as
compared with about 2.6 million barrels per day in the first quarter and with
its OPEC quota of 2.4 million barrels. So far, Tehran has refused to give
discounts because its official price is competitive with world market prices for
comparable OPEC crudes. If the government is to sell enough oil to finance
the budget this year, however, it eventually may be forced to shave its price by
Crucial IMF
Negotiations
for Brazil
as much as $1 per barrel.
International Trade, Technology, and Finance
Intentions regarding other issues of key concern to the IMF remain in doubt.
Brazil has not yet provided a complete austerity package satisfactory to the
IMF, resulting in mounting fears of a financial crisis and a possible debt
moratorium. President Figueiredo last week warned that tougher economic
measures would be imposed soon. Brazilian officials have disclosed some parts
of the package, including increases in the price of petroleum products and
wheat, as well as reductions in credit subsidies for agriculture and exports.
government fears of social unrest have delayed
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17 June 1983
increased financial support from foreign banks.
completion o the pac age. meanwhile, Brazil has not yet been able to obtain
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The IMF is deeply concerned about Brazil's huge public-sector deficit and
triple-digit inflation. It almost certainly would be disappointed with the
government's unwillingness to slash state spending and to defer-at least
temporarily-the indexing of wages to inflation. Unless Brazil and the IMF
reconcile their differences quickly, a debt moratorium may be declared soon.
Some government officials believe such a step would force foreign banks to co-
operate in restructuring Brazil's debt.
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Israeli-Jordanian Meetings between Israeli and Jordanian water authorities have failed to
Dispute Over Water Use resolve water-use problems along the Yarmuk River, reemphasizing that
serious trouble could develop if the disagreements continue. Both Israel and
Jordan expressed concern about the other's plans for increasing
its use of water from the Yarmuk River basin. Jordan plans to begin
construction in September of additional diversion inlets from the Yarmuk
River to the East Ghor Canal in order to expand irrigation on the East Bank.
The Israeli Government says it will act to halt any Jordanian construction that
is undertaken without its prior agreement. Tel Aviv does not doubt Jordan's
willingness to continue providing Yarmuk River water for use in the Al
Adasiyah Triangle. It maintains, however, that unilateral regulation of the
river flow by Jordan would violate Israel's riparian rights.
Jordan is deeply concerned that Israel is drilling several wells on the north side
of the Yarmuk. Amman claims that the wells are in the same water source for-
mation that feeds Jordan's important Mukheiba well and that any Israeli
attempts to get water from this aquifer for use in the occupied Golan Heights
would violate international law. Israeli authorities say they will accumulate
test data from the wells to determine the water's origin, but they will not
discuss any plans for its use.
These two issues underscore Jordan's current inability to prevent Israel from
using a larger share of the Yarmuk basin's water. Unless agreement is reached
on Jordan's diversion plans, Amman will be likely to delay construction,
realizing that Israel would take action to stop the work. Jordan probably will
be able to meet its minimum requirements this summer because of the heavy
rains last winter, but in the longer run it needs to regulate the flow of the Yar-
muk River to provide water for irrigation and urban uses. Israel also has an in-
creasing need for water but benefits from the lack of regulation of the river's
flow because any water not used by Jordan enters Israeli territory.
Possible Soviet Moscow has tentatively approved $460 million in credits for development
Development Aid projects in Pakistan including $300 million worth of credits earmarked for a
for Pakistan power plant project This amount is well
below the $2 billion worth of long-term aid requested by Islamabad last
March, when a high-level Soviet economic delegation visited Pakistan. If such
aid is in fact forthcoming, it would represent a significant increase in Soviet
economic assistance to Pakistan.
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Boundary representation is
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Pretoria Pressuring South Africa has warned Botswana, Lesotho, and Swaziland that it will reduce
Neighboring Countries their share of receipts from the Southern African Customs Union (SACU) in
on Homelands September unless they accept South Africa's four so-called independent
homelands as new and coequal members of SACU. Pretoria apparently sees
SACU membership as a means of legitimizing the independent homelands,
which South Africa created as part of its "grand apartheid" scheme but which
have gained no international recognition. According to Foreign Minister
Botha, Pretoria's use of economic leverage is also aimed at underlining the
dependence of neighboring states on South Africa and prohibiting the
antiapartheid African National Congress from operating within the region._
SACU is currently composed of South Africa, Botswana, Lesotho, and
Swaziland. Pretoria collects duties on member countries' imports-most of
which pass through South Africa-and distributes shares based roughly on
their percentage of total SACU imports. Pretoria provides a hidden form of
foreign aid by allowing the other members-to inflate their shares by overstating
imports. SACU receipts in recent years have amounted to over 60 percent of
the government revenues of Lesotho and Swaziland and over 30 percent for
Botswana.
National Developments
Developed Countries
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Less Developed Countries
Zimbabwean Budget Zimbabwe's budget deficit during the fiscal year ending 30 June will
Deficit Clouds significantly exceed the target level agreed to by Harare as one of the
Future IMF Support conditions for receiving a $324 million IMF standby loan in March 1983. The
deficit totaled $700-800 million during the first half of the fiscal year, about
double the target level of 7 percent of GDP. Drought and the continuing deep
economic recession in Zimbabwe have held tax revenues far below original
budget projections despite increases in excise and sales taxes. The costly
campaign against dissidents in Matabeleland has been an unexpected drain on
resources.
In our judgment, Minister of Finance and Economic Planning Chidzero will
press for an extremely austere budget for the fiscal year beginning 1 July,
despite sharply rising requirements for drought relief and pressure to increase
spending on other social services. Although Chidzero's efforts will probably
assuage the IMF for now, continued overspending by Harare could eventually
induce the IMF to stop disbursements on the loan.
New Jamaican Prime Minister Seaga has failed to obtain a $150 million loan from Kuwaiti
Austerity Program investors, and he will now have to implement a new austerity program in
accordance with an agreement negotiated last month with the IMF. The
measures include additional cuts in government spending, shifts of virtually all
imports to the costly free-market foreign exchange rate, and further restric-
tions on government credit. Seaga told US Embassy officials on Saturday that
the new measures will disrupt his recovery program and "doom" his political
The stringent program is essential to maintain the support of the IMF, the
World Bank, and commercial lenders. The spending cuts will require major
changes in the budget, thereby opening Seaga to strong criticism from the
opposition. In the short term, moreover, inflation and already high unemploy-
ment are likely to rise, and the drive for increased export earnings will falter.
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Economic Protests in The government is beginning to meet public resistance to an IMF-mandated
Costa Rica austerity program. Widespread protest demonstrations and the prospect of
violence have forced the government to rescind a recent increase in utility
rates. Although President Monge is blaming Communist organizers, the US
Embassy believes that the protests have extensive popular support. Monge had
enjoyed substantial backing for his austerity policies, which are aimed at
reducing the pressures related to foreign exchange shortage. The demonstra-
tions mark the first time he has been attacked personally for poor leadership
on economic matters. Future protests are likely as the public becomes more op-
posed to the austerity measures, and the Communist Party may seek to exploit
the discontent.
Additional Stock Bankruptcies related to the Kuwaiti stock crash market soared from 69 to 305
Market Bankruptcies this past month and are likely soon to top 400. Some traders have been able to
in Kuwait strike deals with their creditors, but many have found creditors inflexible on
repayment terms. The Kuwaiti Government has provided almost $2 billion to
cover losses of insolvent traders, but it has become less generous with public
funds in recent weeks. Kuwait has begun to confiscate the assets of bankrupt
traders and to pay creditors with government bonds. Financial observers
believe the government will end up owning far more assets than it can manage
effectively.
Madagascar Despite considerable opposition within his government, socialist President
Liberalizing Ratsiraka has decided to push ahead on some initial steps to liberalize the
Its Economy economy designed in past to gain Western aid. He announced plans last month
to ease government controls on repatriation of foreign exchange and on
distribution of rice, the country's main dietary staple. Exporters will be
allowed to retain a portion of their foreign earnings for imports deemed
essential for their business operations. Approval, however, must be obtained
first from the Central Bank and will depend on the availability of funds. Rice
farmers will be permitted to sell directly to the private sector rather than
through inefficient government marketing channels. We agree with the US
Embassy's assessment that these policies impinge on politically influential
leftists in the government who already have indicated their intend to sabotage
the reforms. Ratsiraka's more immediate concern, however, is paving the way
for another IMF standby agreement after the current one expires this summer.
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Higher Priority for Moscow has announced several resolutions calling for more and higher quality
Consumer Sector in consumer goods, housing construction, and consumer services. According to
the USSR Pravda, the target for growth this year in light industry output has been raised
from 2.7 percent to 5.5 percent. In addition, two party Central Committee
departments have been reorganized to improve supervision in the agricultural,
food processing, light industry, and other consumer areas. General Secretary
Andropov's strong public endorsement of the national Food Program is
another indication of his desire to improve consumer welfare.
itnaropov is
determined to help the consumer and that a recent decision by the Politburo to
improve agriculture and light industry output would substantially increase
bilateral trade opportunities. investment in light 25X1
industry and the food processing industry will be accelerated at the ex
heavy-but not military-industries in the five-year plan for 1986-90. 25X1
Although these actions strengthen the apparent continuity between Brezhnev's
and Andropov's policies, it is not yet clear to what extent they will be backed
up by increasing the investment available for consumer goods production. A
substantial reallocation of resources is unlikely in the near term. The extra
production that is to come from light industry this year is to be achieved
through better discipline, greater efficiency, and better management. Any
major changes in allocations, as suggested by Sushkov, probably would not
occur before the 1986-90 period.
Bulgaria To Expand Party leader Zhivkov told the leadership early this month that he will
Economic Reforms introduce more economic reforms in 1984. He said declining quality of
industrial exports means the country has to import advanced technology,
particularly machinery from the West. He also said that prices of industrial
goods should reflect quality standards and that wages should take into account
the quality of the goods produced as well as volume of production. Zhivkov's
new stress on economic reforms comes at a time when most East European
leaders are waiting for the Soviets to chart the path they will take on the issue.
By urging industry to accelerate economic reforms, Zhivkov probably hopes to
repeat the success he had in applying incentives to agriculture in 1979.
Zhivkov this week was scheduled to visit Hungary, where he probably
conferred with party leader Kadar on Hungary's experience with economic
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Budapest Expands Budapest next month will implement a new regulation that simplifies the
Opportunities for process of applying to work abroad and expands the categories of citizens who
Work Abroad can do so. Hungarians have in principle had the right to work abroad since
1966, but only a relatively few privileged artists and professionals were able to
take advantage of it. Under the new law, employers and local officials will
have much more leeway to approve applications, and self-employed persons
and pensioners as well as employees of cooperatives and state enterprises will
be eligible. Permission normally will not be granted for a stay abroad of more
than five years, and the worker must deposit 20 precent of his earnings in the
National Bank, where they will be exchanged for forints.
A Hungarian party official told US Embassy representatives that the new
legislation is designed to give Hungarian workers increased exposure to
Western training and professional experience and to improve the morale of the
workforce. We believe, however, that Budapest views the program as an outlet
for some of its underemployed labor and as a chance to earn hard currency.
The decree probably will not lead to a dramatic outflow of Hungarian workers
in the near term because the government will be careful to prevent a drain of
skilled workers and because high unemployment rates in the West will limit
opportunities for Hungarians. The decree nonetheless sets Hungary farther
apart from its Warsaw Pact allies, both in its permissiveness and in its
recognition of the benefits of closer integration with the world economy.
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Romania: Progress in Tackling
Financial Problems
Romania has made significant progress in recover-
ing from its debt crisis. While Bucharest has had to
reschedule its debts due in 1982 and this year, it
vows to resume payments on time next year. Roma-
nia's plans for covering this year's financial needs
appear to be on track. Bucharest's determination to
solve its debt problem led to deep slashes in imports
and a $3 billion turnaround in the hard currency
trade account since 1980. Such an approach has
put a considerable burden on the domestic econo-
my. For the longer term, substantial hurdles still
must be overcome; financial pressures are likely to
require continued austerity, and Bucharest must
begin to deal with longstanding problems, especial-
ly productivity, competitiveness, and economic
management.
Payments Difficulties Emerge in 1981
Romania's serious financial difficulties began in
second-half 1981. Despite the approval of a $1.1
billion IMF standby credit in June 1981, Roma-
nia's financial situation deteriorated rapidly in the
second half of the year. The financial strategy
worked out with the IMF was to convert its
uncomfortably high level of short-term debt into
medium- and long-term debt and to rebuild Bucha-
rest's hard currency reserves. The flaw in this
strategy was its optimism about Romania's borrow-
ing prospects. Western banks not only refused to
convert short-term debt into medium- and long-
term debt, but Bucharest had to spend scarce hard
currency reserves to repay a large part of obliga-
tions coming due. Arrears to suppliers and banks
mounted to $1.1 billion by the end of the year,
leading the IMF to suspend credit drawings under
the standby arrangement and forcing Romania to
seek debt relief.
Financing Sources Fell Short in 1982
Bucharest's 1982 financing requirement totaled
$4.4 billion, primarily in principal payments and
arrearages overdue since 1981. Romania's midyear
expectation that it could come up with nearly $4.9
billion in debt relief and new credits was overly
optimistic, and Bucharest was unable to cover a
gap of $500-600 million at year's end. This gap
mainly reflects arrears to suppliers for which no
agreement was reached, and it also includes some
unrescheduled obligations to Paris Club members
overdue at the end of the year.
Rescheduling Agreements. After 11 months of
negotiations, Romania and Western banks signed 25X1
an agreement on 7 December to reschedule 80
percent of arrears from 1981 and principal pay-
ments due in 1982; the remaining 20 percent was to
be paid in two installments in January and March
1983.
Bucharest was able to secure
only $1.3 billion in debt relief from banks in 1982,
about $1 billion less than requested at the outset of
rescheduling talks. Firms had balked at the Roma-
nian request to convert their short-term loans into
six-and-a-half-year credits, and several banks man-
aged to obtain payments and avoid rescheduling.
Western governments began talks on debt relief
after the IMF restored Bucharest's access to draw-
ings under the standby arrangement in June. The
Paris Club quickly agreed to reschedule 80 percent
of principal and interest payments due in 1982 and
arrears from 1981, providing debt relief of $400
million. A key difference between the bank and
government agreements is that the Paris Club
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Agreement
Date of
Agreement
on Terms
Date of
Signature
1982 bank
agreement
February
1982
7 December
1982
1982 Paris
Club
agreement
June 1982
28 July 1982
1983 bank
February
20 June 1983
agreement
1983
1983 Paris
Club
agreement
18 May 1983
18 May 1983
Obligations
Covered
80 percent of
principal pay-
ments on all
debt, includ-
ing short
term.
80 percent of
principal and
interest pay-
ments on me-
dium- and
long-term
debt.
70 percent of
principal pay-
ments due in
1983 on medi-
um- and long-
term debt.
60 percent of
principal pay-
ments on me-
dium- and
long-term
debt.
Amount of Repayment
Debt Relief Terms
Interest Repayment
Rate Period
$1.3 billion LIBOR plus 1985-88 Unrescheduled
1.75 percent- principal paid in
age point January and
March 1983.
Agreement cov-
ered much less
than originally
planned because
suppliers and
many banks re-
fused to
participate.
$400 million Varies with 1985-88 FRG has not yet
creditor, gen- signed bilateral
erally 1 per- agreement.
centage point
above domes-
tic govern-
ment borrow-
ing rate.
$600 million LIBOR plus 10 percent of Amount not be-
1.75 percent- rescheduled ing rescheduled
age point amount due in due August-De-
1984; remain- cember 1983.
der to be paid
1987-89.
$130 million Varies with 1986-90 Of the 40 percent
creditor, gen- not rescheduled,
erally 1 per- 30 percent due
centage point within one month
above domes- of original due
tic govern- date, 10 percent
ment borrow- due on 30 No-
ing rate. vember 1983.
25X1
agreed to reschedule only medium- and long-term
debt and required that $260 million in short-term
credits be paid. Failure to pay these short-term
obligations delayed for months conclusion of bilat-
eral agreements with the 15 signators to the Paris
Club agreement.
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17 June 1983
Credit Problems. IMF data show that loans fell
$470 million short of the $1.7 billion target agreed
with the IMF early in the year:
? Short-term trade credits totaled $350 million-
nearly all from oil-exporting countries-some
$150 million less than planned.
? New medium- and long-term credits of $550
million were some $100 million less than
expected.
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Secret
In December, the IMF decided to allow Bucharest
to draw $330 million, despite loose ends such as
unsigned bilateral agreements with Paris Club
members, refusal by some banks to accept resched-
uling, and no agreement with suppliers.
External Account Surplus. The shortfall in financ-
ing forced Bucharest to cover its financing needs by
running a current account surplus of $655 mil-
lion-an improvement of $1.5 billion compared
with 1981. The $1.5 billion hard currency trade
surplus was achieved by cutting imports by one-
third. The import cuts intensified widespread short-
ages of food, gasoline, and other consumer goods.
In data presented to the IMF, Bucharest acknowl-
edged that payments-induced problems caused con-
sumption to fall after many years of rapid growth
in the 1960s and 1970s. In addition, the rate of
growth of industrial production fell to a postwar
low of 1 percent.
Improved Prospects for 1983
The 1983 financial picture looks much better than
last year. Based on incomplete and inconsistent
data supplied to the IMF and Western banks, our
estimates show that Bucharest has lined up most of
its financing requirements of $4.2-4.5 billion. The
shortfall of up to $500 million could be covered by
more credits, better trade performance, or some
easing in the IMF target for reserves. Improvement
stems mostly from Bucharest's crossing the hump
in its debt maturity structure. Nearly two-thirds of
the debt contracted through 1980 came due in
1981-82, and beginning this year the payments
schedule stretches out considerably. The improve-
ment would be greater were it not for the need to
cover overdue obligations from 1982. The picture
also looks bright because debt relief negotiations
appear to be proceeding well, and Bucharest's
credit needs are modest. The major uncertainties
are whether Bucharest can meet its ambitious trade
surplus target and can roll over its short-term debt.
If creditors are spooked by political problems in
Romania or by financial developments elsewhere
Romania: Projected Sources and Million US $
Uses of Financing in 1983
500 to 600
250
161
800
601
130
IBRD 250
Suppliers credits 145
Short-term oil credits 200
Rollover of short-term debt 850
Drawdown of IMF disbursement 316
191 to 467
and they choose to reduce further their short-term
exposure, Bucharest would have difficulty in meet-
ing its obligations.
Continued Trade Adjustment. Romania is holding
to its strategy of painful adjustment by forcing a
net flow of resources out of the economy. In a letter
to the IMF accompanying the review of the stand-
by arrangement in March, Finance Minister Gigea
pledged to meet tough external account targets
even at the expense of not fulfilling growth goals.
Bucharest projects a current account surplus of
$800 million on the strength of another huge trade
surplus of $1.6 billion, up $75 million compared
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17 June 1983
3,810 to 4,095
Payments under rescheduling 391
agreements
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c Actual.
d Target.
-2 1980 81 82a 82b 82c 83d
aSpring projection
b Fall projection.
with 1982. Not only will this target be difficult to
achieve, but perhaps risky as well, given the impact
on the economy of the adjustments already made.
Imports are set to rise by 6 percent to $5 billion-
still far below the 1980 peak of $8.1 billion. Plans
call for further reductions in imports of crude oil
and grain and substantial increases in imports of
machinery and equipment and metals. Bucharest
has told the IMF that the 6-percent growth rate
projected for exports will come from a 17-percent
increase in sales of refined petroleum products and
a 2-percent gain in nonoil exports.-The small
increase projected for nonoil exports should be
manageable, but the boost in exports of oil products
seems overly optimistic, given the soft energy mar-
ket and Romania's own energy problems.
Status of Rescheduling. Bucharest's effort to re-
schedule its 1983 debt to the banks appears to be
moving smoothly, especially compared with the
1982 negotiations. Creditors were uncertain about
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17 June 1983
whether debt relief would be needed this year, but
at the end of 1982 Bucharest informed its creditors
that payments due in 1983 would be suspended
pending conclusion of a rescheduling agreement. In
only their second negotiating session-held in early
February-Romania and the nine major Western
banks that led the 1982 rescheduling effort agreed
on tougher terms: only 70 percent of some $900
million in principal payments to banks is to be
rescheduled instead of the 80 percent in 1982, and
short-term debt is not covered. Moreover, all the
unrescheduled principal is due in the second half of
this year, and some of the rescheduled amount is
due next year
(creditors have responded favor-
ably to the terms, and the agreement is set to be
signed on 20 June. Several factors account for the
rapid progress this year:
? The amount to be rescheduled is less than half
the amount of debt relief from private creditors in
1982.
? Treatment of short-term bank debt is not an issue
because most of it was either paid or rescheduled
last year.
? Some of the banks most opposed to the 1982
agreement have little or no debt due this year.
The Paris Club got off to a slower start because of
Romania's continuing problems in wrapping up
bilateral accords with Western governments to
conclude the 1982 Paris Club agreement. On
18 May the Paris Club met and quickly agreed to
reschedule 60 percent of principal due this year on
medium- and long-term guaranteed credits. Al-
though Bucharest's original request last December
called for debt relief to cover 75 percent of 1983
principal and interest, the Romanian Finance Min-
ister readily accepted the terms.
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Credits. Romania expects to receive about $1
billion in new credits this year, two-thirds of which
are to come from the IMF and World Bank. The
IMF approved Romania's performance in the De-
cember 1982 and March. 1983 reviews of the three-
year standby arrangement and has continued to
disburse funds. The Fund continues to watch Ro-
mania's situation closely, however, and will conduct
further reviews in July and November. The pros-
pects now appear good that Bucharest will receive
the $400 million it has requested this year. A
World Bank team visited Romania early this year
to consider projects for financing. The Romanians
also hope to obtain $350 million in loans to finance
imports of oil and other raw materials. While
Romania's credit rating is still poor, Bucharest
should be able to obtain this modest amount of
credit.
Outlook for 1984 and Beyond
nian exports.
Assuming that Bucharest manages to cover most of
its 1983 financing requirement so that only small
amounts of arrearages are carried into 1984, con-
tinued gradual improvement in the financial situa-
tion is possible. We judge that Romania's financing
requirement next year is small enough-about $2.2
billion-that the goal of avoiding rescheduling can
be achieved. It is too early to predict this with
much confidence. According to IMF projections,
more than $2 billion in principal payments are due
next year including payments on short-term, debt.
The remainder of the financing requirement is
$200 million in credit extensions to support Roma-
Bucharest plans to cover $850 million of the re-
quirement by earning a current account surplus,
largely on the strength of a $1.7 billion trade
surplus, which we believe may be difficult to
achieve. If drawings this year proceed on schedule,
about $300 million will be available from the IMF
under the third and final year of the standby
arrangement. The Fund projects that another $400
million in loans will be provided by the IBRD and
suppliers. This projection for loans seems realistic,
Romania: Principal Due on Medium- Million US $
and Long-Term Debt
and Bucharest should have little trouble borrowing
success in dealing with its financial problems.F~ 25X1
this amount, especially if it demonstrates continued 25X1
The breathing space associated with the reschedul-
ing ends in 1985 when Bucharest must begin to
repay obligations rescheduled in 1981. By that time
the IMF standby arrangement also will have ex-
pired. Both of these factors will put pressure on the
regime to continue earning large trade surpluses in
order to cover external obligations and to deal with
underlying economic problems that hurt competi-
tiveness and continue to prevent sustainable and
balanced growth. On the other hand, it seems likely
that creditors will take into account Bucharest's
success in overcoming its debt woes and that access
to commercial credits should improve somewhat.
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Hungary: First Steps Toward
Financial Recovery
The withdrawal of credit lines from Eastern Europe
following the Polish and Romanian debt crises
brought Hungary to the brink of bankruptcy in
early 1982. Emergency loans provided by the Bank
for International Settlements (BIS) and the IMF
stanched the hemorrhaging of Hungary's hard
currency reserves and forestalled the need for
rescheduling. This gave Budapest time for remedial
action, but it did not correct fundamental weak-
nesses in the balance of payments. With only
modest gains in Hungary's financial position ex-
pected this year and growing repayments of medi-
um- and long-term debt through 1985, Budapest
will remain on a financial tightrope. To restore its
financial health, Hungary must:
? Slow the growth of domestic demand and run
current account surpluses.
? Lengthen the maturity structure of debt and
build up reserves in order to reduce its vulnerabil-
ity to the withdrawal of short-term credits.
? Implement reforms to improve efficiency and
export competitiveness.
In order to succeed, Hungary also needs a revival of
growth in its Western markets, falling international
interest rates, and increased lending by Western
banks that remain wary about increasing their
exposure in Eastern Europe.
The Hungarians were vulnerable to a loss in banker
confidence because of reliance on short-term bor-
rowing to cover their financing needs. The pullout
of $1.3 billion in short-term credits by Western,
OPEC, and CEMA banks; Hungary's inability to
roll over $200 million in maturing medium-term
credits; and a current account deficit of $200
million nearly exhausted Hungary's foreign ex-
change holdings in first-quarter 1982. Budapest
had to sell or put up as loan collateral nearly all of
its gold stock.
liquid reserves fell from $1.8 billion to less than
$400 million, or little more than one month's worth
of imports, during January-March. As a result, a
growing number of Western suppliers reported
delayed payments from Hungarian importers.
The Hungarians parlayed their good relations with
the West and their reputation as sound managers
into enough emergency support from Western gov-
ernments, the BIS, and the IMF to prevent a debt
rescheduling. The Hungarians argued that a finan-
cial crisis would undermine their economic reforms
and gratify those in the USSR and Eastern Europe
who want to tie Hungary more closely to the East.
This argument convinced West European central
banks and governments in April to provide $210
million in short-term bridge loans through the BIS
to shore up Hungary's reserves. The BIS indicated
that additional credits would be available later in
the year if Hungary made progress in negotiating a 25X1
standby agreement with the IMF. Several West
European governments also extended guaranteed
trade credits. This show of official Western support
and some arm-twisting by Western governments
convinced 14 commercial banks to arrange a $260
million loan for Hungary in August.
Although the regime temporized for several months
over the need to reduce imports, the BIS and IMF
pressured Budapest to tighten adjustment measures
in return for emergency loans.
L
During second-half 1982, the Hungarians
responded by raising prices and cutting subsidies on
some consumer goods and services, tightening do-
mestic credit, imposing controls on hard currency
imports, and devaluing the forint. The BIS lent
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Hungary: External Financial Indicatorsa
Legend
Current account balance
Interest
Amortization
another $300 million in September, and the IMF
approved $610 million in credits in December.
About one-third of the IMF funds were disbursed
immediately to repay the April BIS loan, and the
remainder is to be drawn this year. These loans and
a growing trade surplus enabled Hungary to meet
its debt service obligations, clear up its arrearages,
and redeem much of its collateralized gold. By the
end of 1982, Hungary had rebuilt its foreign
exchange reserves to nearly $1.2 billion.
The IMF and Hungary project that the country
will cover its $2.6 billion in debt repayments and
increase its reserves by $500 million with the help
of:
? A $600 million current account surplus.
? $250-300 million in trade credits (primarily
government-backed).
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17 June 1983
? $60-70 million in drawings on World Bank loans.
? $200-260 million in untied commercial bank
loans.
? $366 million in IMF credits.
? $1.6 billion in short-term borrowings.
The Hungarians hope to increase their trade sur-
plus from nearly $770 million to over $1.1 billion
and benefit from a $400 million decline in net
interest costs. Hungary does not envision a signifi-
cant lengthening of its debt's maturity structure
because Western banks remain reluctant to extend
medium-term loans. Nonetheless, the Hungarians
hope to reduce their vulnerability to a reduction in
short-term credits by use of more medium-term
trade credits in place of borrowing Eurodollar
deposits.
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Hungary: Financing Requirements
Financing requirement
4,160
Current account
balance
-79
Trade balance
766
Exports
4,876
Imports
4,110
Net interest
-976
Other
131
Repayments of
medium- and
long-term debt
843
Repayments of
short-term debt
2,849
Export credits, net
-179
Borrowing sources
3,271
Medium- and long-
term credits
1,154
Million US $ Hungary: Domestic Economic Indicators
1,142 1,015
5,252 5,125
4,110 4,110
-580 -580
38 40
936 936
-64 -64
2,571 2,366
579 500
Short-term credits b 1,371 1,626 1,500
IMF credits 236 366 366
BIS credits 510
Change in reserves -889 500 170
a National Bank of Hungary statistics.
b Includes net errors and omissions and change in net short-term
trade credits.
The need to produce a current account surplus has
forced Budapest to tighten its adjustment policies.
Beginning in 1979 Budapest shifted economic pri-
orities from promotion of growth to gradual reduc-
tion in the country's current account deficit. The
growth of demand was dampened mainly by sharp
reductions in investment. Although increases in
consumption slowed, the regime tried to maintain
living standards. IMF statistics show that during
1979-1982 investment fell by more than 3 percent
annually while consumption rose by nearly 2 per-
cent annually.
The need to accelerate adjustment in 1983 has
forced Budapest to place a greater burden on the
consumer. Hungary's targets envision a 3- to 4-
percent decline in real domestic demand to be
accomplished by a 1.5- to 2.0-percent reduction in
consumption, a 6.5- to 7.5-percent fall in invest-
ment, and a 3.5- to 5.5-percent reduction in govern-
ment outlays. The Hungarians hope to hold real
GDP at the 1982 level by growth in net exports.F_
Hungarian economists have told the US Embassy
in Budapest that the IMF is likely to press harder
for more structural reforms-probably a more
comprehensive policy linking wages to productivi-
ty-if Hungary requests a second standby program
later this year. While the current program focuses
on demand restraint to address the immediate
balance-of-payments problem, a sustainable im-
provement will require more efforts to strengthen
the efficiency and competitiveness of the Hungar-
ian economy. This year the regime has already
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pushed ahead with additional reforms that link . Hungary: Hard Currency Trade
wage incentives more closely with enterprise profit-
ability, encourage the elimination of excess labor,
and reduce subsidies to inefficient producers.F--]
Prospects for 1983
Current Account. The measures now being imple-
mented will lead to further improvement in the
current account but will not be enough to ensure
Budapest's projected $680 million gain. Hungary
may fall short of its goal of nearly 8-percent growth
in exports despite its commitment to continued
devaluations of the forint. Export growth of 5
percent, for example, would produce a trade sur-
plus of $1 billion and a current account surplus of
only $475 million. In first-quarter 1983, hard cur-
rency exports were up 6.5 percent over the same
period last year, but Hungary may have difficulties
sustaining this growth rate. Exports in early 1982
were exceptionally low but revived late in the year
thanks largely to a record harvest that probably
will not be repeated this year. Although nascent
economic recovery in the OECD should increase
demand for Hungary's industrial exports, Hungar-
ian officials recently complained to the US Embas-
sy that growth in key West European markets is
lagging behind their initial projections. Cash short-
ages in developing countries-particularly Middle
Eastern oil producers that have been a rapidly
growing market for Hungary's food exports-prob-
ably will slow Budapest's export offensive. Hungary
also needs more sales to socialist countries, which
account for nearly one-fourth of hard currency
exports.' This will depend not only on Hungary's
' Although most of Hungary's trade with CEMA countries is
conducted on a clearing account basis, approximately 15 to 20
percent of imports and exports involve hard currency transactions
or exchanges of goods otherwise salable in Western markets (so-
called hard goods). Most of this trade is with the USSR and,
according to Hungarian officials, mainly involves the exchange of
Hungarian grain, meat, and other agricultural products for Soviet
oil outside planned soft currency deliveries
Budapest and the IMF include
these surpluses in Hungary's overall hard currency balance of
I I 1 I I 1
-1 1977 78 79 80 81 82 83a
Confidential
589711 6-83
ability to supply increased quantities of meat and
grain to the USSR, but also upon Moscow's will-
ingness to continue paying hard currency. As softer
oil prices limit Soviet hard currency earnings, the
USSR may become more insistent that Hungary
deliver goods now sold for hard currency in ruble
trade.
So far in 1983 Budapest has cut imports by 5
percent, but the Hungarians have claimed in press
articles, IMF documents, and Embassy reporting
that after reducing imports by 11 percent over the
past two years, they have little scope left for more
cuts without impairing industrial production and
consumer supply. Since Hungary has been success-
ful recently in lining up trade financing, Budapest
probably will bring imports back up to at least last
year's level and trust in continued growth of ex-
ports to ensure a large current account surplus.
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Secret
Borrowing. Hungary is making progress toward
covering its borrowing needs, but success is
uncertain:
? In April, Budapest received a $200 million loan
with three-year maturity from a syndicate of
Western banks, including two Soviet-owned
banks.
? A group of Arab banks also arranged a $100
million credit early this year.
? The Hungarians appear to be in compliance with
the IMF program targets, which will ensure
continued drawdown of standby credits.
? Budapest also hopes that the World Bank soon
will approve $200-250 million in project credits
despite objections that Hungary is not poor
enough to qualify for World Bank financing.
the Hun-
garians have also been lining up short- to medium-
term trade financing from commercial banks, par-
ticularly in the form of bankers' acceptances
efforts to
arrange over million in me lum-term loans
apart from the IMF credits may be too ambitious
in the current lending climate. Indeed, the failure
of attempts to expand the $200 million syndicated
loan indicates many banks remain nervous about
medium-term lending to Hungary. Furthermore,
some bankers are concerned that Hungary is still
losing short-term credit lines.
Reserves. The uncertainties surrounding the size of
Hungary's current account surplus and financing
sources make a $500 million buildup of reserves
appear doubtful. By the end of the year we estimate
reserves will increase by only $170 million to over
Amortization of
medium- and long-
term debt
Gross interest payments 1,014 1,004 731 711 692
Debt service as a share 32.7 33.4 27.5 32.7 30.4
of earnings from
exported goods and
services (percent)
$1.3 billion. In early 1983, when efforts to complete
the $200 million syndication were faring poorly,
senior Hungarian bankers broached the possibility
of renewing the $300 million loan with the BIS to
preclude a renewed drawdown of reserves. Comple-
tion of the syndication made a rollover of the entire
credit less necessary. Nonetheless, according to
press reports, Hungary's low level of reserves in-
duced Western central bankers to grant a two-
month extension on $100 million of the BIS credit.
This loan is to be repaid out of IMF credits
scheduled to be disbursed in June.
Outlook Through 1985. Hungary must address its
fundamental balance-of-payments problems more
effectively because the country needs a growing
hard currency trade surplus to cover rising debt
service payments. According to IMF estimates,
repayments on medium- and long-term debt and
gross interest payments will rise to $2.1 billion in
both 1984 and 1985 compared with $1.7 billion this
year. Hungary will also have to roll over $1.5-2
billion in short-term credits each year. Since banks
probably will remain reluctant to extend new medi-
um-term credits, the Hungarians will continue to
face the problem of bunched maturities for the next
several years. Because of continuing liquidity prob-
lems, Budapest is certain to require a second IMF
standby program in 1984 to obtain additional
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medium-term credits to reinforce its reserves. In-
deed, the Hungarians indicated the possibility of
another $500 million standby credit in documenta-
tion given to banks participating in last year's $260
million loan. 25X1
Structural reforms, while necessary, will not be
sufficient to ensure improved balance-of-payments
performance. Hungary also needs a continued fall
in international interest rates and sustained growth
in its major Western markets. But even projected
current account surpluses will leave Hungary far
short of covering its financing requirements over
the next several years. Thus, the Hungarians will
remain dependent on large borrowings from West-
ern banks and the IMF to meet all their obligations
or face the unpleasant option of reschedulings.F_~ 25X1
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Yugoslavia: Financial Outlook
Since late 1982 Western governments, banks, and
international financial institutions have been trying
to arrange a financial rescue package to restore
Yugoslavia's solvency without a debt rescheduling.
The package aims at refinancing all maturing loans
this year and providing enough new credits to cover
arrearages, an IMF-projected $500 million current
account deficit, and a hoped-for $630 million IMF-
projected increase in reserves.
Progress in completing the package recently stalled
because the Yugoslavs claim the bankers are mak-
ing demands that infringe on their national sover-
eignty. Even if the Yugoslavs and International
Coordinating Committee (ICC) are able to reach
some sort of accommodation, we doubt that the
package will allow for a reserve buildup of more
than $420 million. In addition, the Yugoslavs prob-
ably will not earn enough through exports and
invisibles to hold the current account deficit below
$725 million, even with a $1 billion cut in imports.
Given the difficulties involved in arranging this
year's financial package, we believe private lenders
will not provide enough new loans to cover the
traditional large first-half financing requirement
next year of $2-2.3 billion. In addition, lenders will
be wary because we believe the balance-of-pay-
ments performance this year will fall short of the
IMF projections. By early 1984-or sooner if the
financial package falls apart-some Western credi-
tors will probably try to press Belgrade to begin a
formal rescheduling of its debts. In the meantime,
Yugoslavia has been unable to make sufficient
adjustments to stabilize the balance of payments,
leaving Belgrade little choice but to continue poli-
cies that cut demand and real incomes. The deteri-
orating economic situation will increase strains on
Yugoslavia's fragile political system.
By late 1982 Yugoslavia clearly did not have
sufficient reserves and could not raise enough
credits to cover $4.5 billion in maturing loans and
pay off $600 million in arrearages. Belgrade, how-
ever, steadfastly refused to consider a formal debt
rescheduling. Fears that a rescheduling would
prove politically divisive in Yugoslavia prompted
the US Government and the IMF to initiate a
financial rescue package. The effort grew into a
complicated, interconnected package that includes:
? $1.4 billion in pledges by Western governments
involved in the "Friends of Yugoslavia" effort.
? $3.8-4.0 billion from Western banks, including
$600 million in new loans, $1.8-2.0 billion in
short-term debt rollover, and $1.4 billion in
medium- and long-term debt rollovers.
? $620 million from the IMF as the final tranche
under a three-year standby arrangement.
? $400 million from the World Bank, including a
$275 million structural adjustment loan for raw
material imports.
? A $500 million bridging loan from the Bank for
International Settlements.
Although some parts of the package are being
implemented-the Yugoslavs have already begun
to draw on the BIS, IMF, and government cred-
its-the current impasse between the banks and
Yugoslav negotiators could derail the whole pack-
age. Belgrade objects to the banks' proposed plan
because it calls for the Yugoslav National Bank
and government to assume responsibility for the
debt and in effect recentralize the financial system.
major points of conten-
tion include:
? The right of a Western bank to seize Yugoslav
deposits to pay off arrearages.
? The cross-default clause.
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Yugoslavia: Hard Currency
Financing Requirements
other Yugoslav creditors not participating in the
refinancing. It is important that the Yugoslavs and
the banks resolve their differences because the IMF
funds and at least some of the other credits in the
package are contingent on Western bank participa-
, ,, ,., rt,e -rr-
IMF a
CIA a
Financing requirement
5,585
5,700
5,950
Current account balance -
1,420
-500
-725
Trade balance -
3,779
-2,300
-2,525
Exports
5,858
6,300
6,150
Imports
9,637
8,600
8,675
Net invisibles
2,359
1,800
1,800
Net invisibles, exclud-
ing interest
4,319
3,800
3,750
Net interest -
1,960
-2,000
-1,950
Repayment of short-term credit
2,300
2,000
1,800
Repayment of medium- and
long-term debt
1,690
2,500
2,625
Credits extended (net)
-175
-200
-200
Arrearages b
NA
500
600
Financing sources
4,573
6,328
6,370
Hard currency
6,170
IMF
620
IBRD
400
1,350
Financial credits
300
Export credits
1,050
Banks
3,800
New loans
600
Short-term
rollover
1,800
Medium- and
long-term
rollover
Other
200
Change in reserves
-1,012
628
420
a Projection.
b Arrearages as of 1 January 1983.
? Waiver of sovereign immunity, which would give
banks the right to sue the Yugoslav Government
to enforce terms of the agreement.
the ICC insists
that these clauses are standard for any loan agree-
ment and necessary to protect the banks relative to
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17 June 1983
Additional hurdles remain even if the banks and
Belgrade iron out their differences. Some Western
governments have yet to provide credits pledged as
part of the package.
Yugoslavia must
continue to meet IMF performance criteria, which
will probably be toughened at the midyear review,
to be able to continue drawing on the three-year
Even if all these hurdles are overcome, the credits
will be less than originally envisioned and will be
disbursed later. The bank package will not be
completed until late summer at the earliest and
disbursement of credits will probably lag the imple-
mentation of the package. Furthermore, $350 mil-
lion of the "Friends of Yugoslavia" credits are tied
to purchases of capital goods that Yugoslavia prob-
ably will not buy.
Foreign Exchange Earnings
Boosting exports is a key part of the Yugoslav
effort to ease its financial problems. Yugoslavia,
however, will be unable to redirect enough of its
declining industrial production to the export sector,
and growth in Western markets will not be strong
enough to attain its ambitious goal of increasing
exports 20 percent. Export growth will be no more
than the IMF projection of 7.5 percent, and it could
even fall below 5 percent. Although hard currency
sales. were up 28 percent in January and February,
March and April sales were 1 percent below last
year's level.
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The IMF performance criteria include the follow-
ing provisions:
Monetary Policy
? Money supply and net domestic assets are to
increase by 12 percent.
? Real interest rates are to be raised to positive
levels for nonpriority sectors.
? Yugoslavia is to pass legislation to control inter-
enterprise credits by imposing stiffer penalties for
failure to meet payment obligations. By Septem-
ber 1983 outstanding interenterprise credits are
to be 50 billion dinars below the 169 billion
dinars outstanding in September 1982.
Exchange Rate Policy
? Monthly devaluations of the dinar to offset
inflation and improve the competitiveness of
Yugoslav exports.
Foreign Debt Management
? New loans are limited to $1.5 billion for 1983,
excluding rollovers and new loans to replace
. maturing debt.
Tourist earnings are unlikely to rebound signifi-
cantly from last year's low level. Three-fourths of
tourist revenues are collected during the second
half of the year, and advanced bookings for tour
packages-35 percent of Yugoslavia's foreign visi-
tors-were reportedly down 25 to 30 percent as of
the end of February compared with the same period
last year. Moreover, reports of shortages, especially
of gasoline and food supplies, could again scare
potential tourists. Belgrade has tried to polish its
image by introducing a special dinar check that
gives a 10-percent discount for tourist services,
exempting foreigners from gasoline rationing, and
allocating hard currency to improve supplies in the
Fiscal Policy
? Revenues and expenditures are to increase
13 percent and transfer payments are to increase
18 percent. If revenues rise more than expected,
they will be frozen in a blocked account at the
National Bank until 1985.
Price Policy
? Prices are to be realigned with international
prices and relative price distortions are to be
eliminated. The current price freeze will continue
until the end of June, although adjustment for
dinar depreciation and the mandated price in-
creases will be allowed. Specifically: (1) electric-
ity, coal, railway fares, live animals, and meat
prices have been increased 25 to 35 percent; (2)
petroleum products are up 25 percent; and (3)
rent increases of 30 percent have been recom-
mended.
Incomes Policy
? Real incomes are to fall 7.5 percent in 1983.
Enterprises are to limit payments of personal
income to current net enterprise income rather
than engaging in the past practice of basing
payments on the expected income stream.
We expect remittances from Yugoslav workers
abroad, another important source of foreign ex-
change, to decline in 1983. Limits on withdrawals
from hard currency accounts imposed last year and
fears of new restrictions are deterring workers from
sending money home. The restrictions are limiting
somewhat the outflow of already existing deposits.
We estimate that net inflows will fall by 30 per-
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Yugoslavia: Hard Currency Exports (f.o.b.)
-1982
1983
the National Bank replenishes other foreign ex-
change accounts that cannot be used for general
liquidity. If the bank package falls apart, effective
reserves will be exhausted quickly and arrearages
will increase.
Imports and Industrial Production. The inability
to line up financing has forced the Yugoslavs to cut
imports drastically. From January through mid-
April, imports declined by 18 percent, a sharp drop
after the 15-percent decline from 1980 to 1982.
Even if credits from the Western package are
disbursed, imports will still fall by 10 percent this
year.
The cut in imports has hurt industrial output and
consumer supplies. The growth in industrial output
has slowed markedly since 1979 when Belgrade
first moved to stabilize the balance of payments.
Last year industrial output fell for the first time
since 1952. Production in the first four months of
this year was down 0.9 percent compared with the
same period last year, primarily because of short-
ages of raw materials and intermediate goods. We
Import or Build Reserves
Belgrade will not earn enough foreign exchange or
get sufficient financing to allow both an increase in
reserves and imports at planned levels. We believe
Belgrade will lean toward rebuilding reserves be-
cause it is concerned about its future liquidity and
lender attitudes.
Reserves. The size of the Yugoslav National Bank's
reserve holdings is the key indicator of the coun-
try's liquidity. The lack of a foreign exchange
market and the tendency of the better managed
banks to hoard their reserves force illiquid banks to
depend on the National Bank for hard currency.
Assuming the ICC and Yugoslav negotiators are
able to work out a compromise, by the end of the
year the National Bank's effective reserves-those
reserves that are available to meet liquidity
needs-probably will range between $300 million
and $700 million. Their size will depend on Yugo-
slavia's ability to use the $350 million in Western
government capital goods credits and on how much
Secret
17 June 1983
industrial output will be about 5 percent.
Since the record hard currency current account
deficit of $3.3 billion in 1979, Belgrade has tried to
stabilize the economy with tight monetary policy,
dinar devaluations, and price controls. The aim has
been to slow economic growth and inflation, reduce
demand for imports, and spur exports. Yugoslavia's
efforts have been supported by two IMF programs,
the first of which began in 1980 and was replaced
by the current three-year standby agreement in
1981. This year's IMF program imposes tough
requirements that will cut domestic demand and
living standards. The IMF remains concerned
about continued high inflation and is likely to
require additional interest rate hikes and may
tighten other requirements at the midyear review.
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Yugoslavia: Hard Currency Imports and
Industrial Productiona
Note scale change
Hard Currency Imports(c.i.f.)
Billion US $
Industrial Production
Index: 19791=100
2.2
I I I I I I I I I I I I I I I 1 1
2.0 1979 80 81 82 83
The Yugoslavs have been somewhat successful in
cutting imports, but little progress has been
achieved in stabilizing the domestic economy or in
dealing with longstanding systemic problems.
While monetary policy was tightened as one of the
IMF conditions, the rising use of interenterprise
trade credits has added to inflationary pressures.
Even with price controls, inflation is currently
above 30 percent, similar to last year's rate. F_
First-Half 1984 Balance-of-Payments Outlook
Assuming the bank package is implemented and
Western bankers maintain their short-term expo-
sure, as they pledged, Yugoslavia probably will
have a financing requirement of $2-2.3 billion in
first-half 1984. The IMF projects that Yugoslavia
will repay $1.2 billion in medium- and long-term
loans while extending $100 million in trade credits
during this period. The IMF estimates the current
account deficit will be $700 million; but we believe E
it could run as high as $1 billion. 25X1
Even if the Yugoslav National Bank exhausts its
holdings of uncommitted foreign exchange to meet
the financing requirement during the first half of
the year, external financing of some $1.3 billion to
$2 billion will be required to prevent major arrear-
ages.Othe Yugoslavs should be able to draw 25X1
some commercial and government-backed trade
credits
Bankers
will remain cautious about new lending because of:
? Yugoslavia's likely failure to meet the 1983 IMF
current account target of a $500 million deficit.
? Belgrade's inability to curb inflation and deal.
with other domestic economic problems.
? Uncertainties about a new IMF stabilization
program and lending facilities.
? Widespread belief that the country needs more
debt relief.
We believe some Western creditors may be inclined
to force Belgrade into a formal rescheduling in
1984. Because of the problems in this year's rescue
effort, commercial bankers seem increasingly con-
vinced that rescheduling is the only way to ensure
equitable burdensharing among all creditors. West-
ern governments that reluctantly accepted the pre-
sent packag
riiay insist that Yugoslavia's problems
If the package falls apart, the Yugoslavs will
probably declare a moratorium on debt repay-
ments. This could lead some creditors to press for a
declaration of default to force the Yugoslavs to
request a debt rescheduling. Some elements in
Yugoslavia have raised the specter of debt repudia-
tion, but we believe they are not strong enough to
overrule more pragmatic leaders. The current im-
passe, however, will generate internal debate that
will place further strains on Belgrade's delicate
political structure.
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India: Economic Outlook
Bad weather, electricity shortages, and labor unrest
were the major factors behind India's near-zero
economic growth last year. Widespread drought
not only hurt crops, but it also cut sharply into
hydroelectric power generation. Although more
favorable weather would alleviate many of these
problems, India's longer term outlook is clouded by
looming financial problems. A likely reduction in
concessional aid will coincide with rising debt
repayments, putting growing strains on the balance
of payments in the mid-1980s. Moreover, a gradual
retreat from import liberalization will reduce hoped
for gains in efficiency, and internal unrest could
adversely impact on investment and production. F_
Coping With a Difficult Year
India experienced near-zero overall growth during
the year that ended March 1983. Poor weather
during the summer of 1982 led to a fall of about 6
percent in foodgrain production and reduced gener-
ation of hydroelectric power. Moreover, an upsurge
in strike activity cut into production, particularly in
the textile industry. Nonetheless, industry was still
able to record a small increase in output. A bright
spot was increased production of crude oil from the
offshore Bombay High Field.
Despite weather induced problems in the domestic
economy, India's international financial position
improved modestly last year, largely because of
sharply lower net petroleum imports and stepped up
support from the IMF. IMF lending jumped by
$1.2 billion, enabling India to increase its reserves
by $500 million; reserves fell by $2.4 billion during
the previous year. We estimate that net petroleum
imports probably dropped by almost $800 million
because of increased domestic production and lower
international prices. Gains in manufactured exports
resulted from larger sales to Communist countries
and the Middle East, while growth in the volume of
industrial imports reflected the gradual liberaliza-
tion of licensing controls over the last several years
and purchases for the petroleum industry.
With favorable weather, the trade balance should
improve slightly again this year. We expect another
decline in net petroleum imports that should more
than offset a possible increase in grain purchases
and a decline in exports to the Soviet Union.
Moreover, capital receipts will remain high as a
result of IMF loans, concessional aid, and commer-
cial borrowing already arranged. If the June-Sep-
tember monsoon is poor again this year, however,
New Delhi has little leeway to cope with the
increased import requirements and reduced export
supplies that would result.
Backsliding on Liberalization
Although liberalization of domestic economic con-
trols, apparent since Prime Minister Gandhi re-
turned to office in 1980, ' has been broadened,
policymakers appear to be having second thoughts
about encouraging imports and foreign commercial
borrowing. Gandhi had hoped that liberalization
would increase the efficiency of India's industries
and promote greater competitiveness of exports, but
concerns about future balance-of-payments prob-
lems as well as the percieved need to protect
domestic industry and boost government revenue
has caused some weakening in support for the
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Domestic Indicators
Percent Change
GNP
~ Industry
c Foodgrains
International Reserves
Billion US $
Prices
Index: 1978=100
? Wholesale
Consumer
100
Military Imports
Billion US $
? Agreements
o Deliveries
~ USSR Share
Labor Disputes
Million Mandays Lost
a Estimate.
b Excluding gold.
c Provisional.
d Data on number of agreements with financial participation in 1982 not
available.
Government Approvals of Foreign
Technology and Investment Agreements
Number
~ Equity Involvement
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India's trade relations with the Soviet Union com-
plicate management of overall international pay-
ments problems even though most or all bilateral
payments are made through a rupee account and
do not directly require the use of hard currency.
Most of the growth in India's nonoil exports during
the past three years results from a surge in sales to
the Soviet Union. The bilateral trade surplus has
been more than enough to cover current payments
due for military equipment. Unfortunately, the
resulting payments surplus is of dubious value to
India. It cannot be used to pay for imports from
other countries, and India has not wanted to
increase purchases of inferior Soviet machinery. As
a result, rupee earnings equivalent to about $300-
600 million have accumulated; they are, in effect,
an interest free loan from India to the USSR.
Efforts to restore a balance in bilateral payments
are now hurting Indian exporters.
Current problems may be reversed within three
years. Payments due for purchases of Soviet mili-
tary equipment that has already been ordered will
increase sufficiently to sustain trade at previous
peak levels. If New Delhi signs any large new
agreements with the USSR, it will have to adjust
the nonmilitary trade balance.
program. Even so, incentives have been added to
increase production and exports, and special re-
strictions on very large private companies have
been further relaxed. An increase in the number of
approvals for foreign collaboration agreements
shows continuing strong interest in acquiring ad-
vanced Western technology.
The changing political scene complicates manage-
ment of the economy. Increasingly important state
parties opposed to Gandhi base their appeal, in
part, on the offer of additional consumer subsidies
and resistance to Gandhi's centralized control.
Farmers have become more vociferous in their
demands for higher prices, preferential allocations
of electricity, and a moratorium on repayment of
government loans. Gandhi can ill afford to compete
with opposition parties in populist appeals. She
must also maintain control of resources such as
electricity, water, and grain that must be shared
among the states.
At the same time, India has been hit by a marked
erosion in internal security. Last spring's well-
publicized riots in Assam left 7,000 dead. Poten-
tially more troublesome problems in the prosperous
state of Punjab could disrupt economic activity
there. In a wider vein, conflict seems to be spread-
ing between Hindus and Muslims and among Hin-
du castes. These developments may divert govern-
ment attention from the economy and sour the
investment climate.
India has the potential to move beyond extreme M
poverty and lacklustre growth. Political trends 25X1
among opposition parties and interest groups could
be beneficial if they expedite local development
projects and ensure continuing support for agricul-
ture. The threat of growing instability has not yet
negated the contribution of liberalized economic
controls to the investment climate. Over the next
several years, the balance between improving and
merely coping will be heavily weighted by India's 25X1
ability to avoid severe balance-of-payments con-
Longer Term Financial Prospects
International payments problems will mount sharp-
ly by 1985 or 1986. Disbursements from the Inter-
national Monetary Fund and the International
Development Association will drop, and repay- 25X1
ments of the Extended Fund Facility credit and
recent commercial borrowing are scheduled to be-
gin. Payment for military imports will climb to
$0.8-1.2 billion, double or triple the level of the
early 1980s. The decline in new contracts for
projects in the Middle East that is already under
way will probably reduce worker remittances and
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December 1982 Import licenses for some steel products canceled;
government firms will offer substitutes at internation-
al prices.
February 1983 Central government budget: tax incentivesforproduc-
tion and exports increased; import taxes raised;
business depreciation allowances increased; mini-
mum corporate tax imposed despite other conces-
sions.
April 1983 Import/export policy: manufacturers who export
most or all their production entitled to additional
import licenses and income tax concessions; restric-
tions on imports of components and spare parts
reimposed.
Additional subsidies and concessionalfinance offered
to industries that invest in "backward" areas.
Industrial license no longer required if investment
cost below $5 million and imports less than $400,000
(previous exemption limit $3 million).
Exporters permitted to deduct 1 percent of their
turnover from taxable income.
Offshore oil exploration and services become subject
to income tax. Customs duty proposed for imported
exploration equipment.
May 1983 Barriers to large company expansion in industries
such as fertilizer, pig iron, electronic components,and
chemical machinery eased.
Limits on value of technical designs and machinery
that may be imported without special permission
raised for manufacturers who export a substantial
share of production.
Tightening of import policy to protect domestic
industry.
Primarily a revenue measure, provides additional
protection.
Mixture of measures to raise government revenue,
stimulate economy, and protect domestic industry.
Export promotion efforts extended. Import restric-
tions to ease trade deficit and protect domestic
industry.
Dispersion to area with poor infrastructure raises
business costs and lowers efficiency.
Extends domestic liberalization; no concession on
imports.
Apparently effort to stimulate domestic production
and curb imports in this major investment sector.
Importers of capital goods required to request foreign Effort to curb total commercial borrowing from
currency loans from government financial institutions abroad. Likely to result in higher interest cost for
before seeking foreign suppliers' credits. some industries.
consultancy fees. These foreseeable lower receipts greater recourse to commercial borrowing, an op-
and increased obligations-compared to tion now, may not be possible if financial strains
1982/83-total roughly $3.5 billion. In addition, become obvious.
larger petroleum imports may be needed to meet
rising requirements since domestic production from We believe that India will be hard pressed to cope
known fields will level off after 1985. Substantially with so great a worsening in its external accounts
without curtailing development efforts. Increased
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Secret
-3,435 -7,615
7,948 8,504
30 11
Imports,b c.i.f. c 11,383 16,119
Petroleum 4,046 6,671
Private transfers 1,850 2,700
Current account balance -250 -2,940
Aid disbursements c 1,685 2,100
IDA 547 650
Other medium- and long- 281 288
term borrowing c d
IBRD 149 175
Receipts from IMF 155 1,035
Amortization c d 693 733
Change in reserves 224 -344
a Estimates, based on IBRD, IMF, and Indian Government data.
b Trade (not payment) values.
c Excluding military transactions.
exports and import substitution will help, but only
large new petroleum discoveries, consistently good
weather that permits a resumption of large-scale
grain exports, or an increase in concessional aid
receipts would significantly brighten India's out-
look.
If oil exploration efforts fail and aid prospects
remain bleak, Gandhi would have few options but
to retreat from her liberalized import policy. She
may tighten quantitative controls sooner or more
harshly to appease businessmen hurt by foreign
competition and to respond to a revived interest in
self-reliance. We believe Gandhi is unlikely to
pursue massive foreign investment unless it is ac-
companied by technology transfer.
-6,745 -6,000 -5,700
8,730 .10,000 10,200
220 1,200 900
15,475 16,000 15,900
5,800 6,000 5,000
1,550 1,500 1,500
-3,845 -3,500 -3,400
1,927 2,130 2,035
761 1,084
798 644
408
690
685
-2,398
346
1,885
642
502
Indian policymakers see an anti-Indian bias in a
number of US policy decisions that they believe
harm Indian interests. US military support for
Pakistan underlies much of the continuing friction. 25X1
Both countries are now trying to resolve disputes
about US barriers to the shipment of parts for the
Tarapur Atomic Power Reactor and export controls
that limit advanced technology for Indian industry.
Policies toward multilateral lending institutions are
also a major factor in Indian distrust of the United
States. The United States abstained on India's
1981 request for an Extended Fund Facility and
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Indian officials now fear opposition to full drawing
of the last tranche. They argue that the United
States has reneged on its commitment to provide
funds for the International Development Associa-
tion, seeks to lower India's share of amounts avail-
able, and has actively campaigned against Indian
borrowing from the Asian Development Bank. In
the Indian view, the United States is trying to force
New Delhi to turn to commercial money markets
while the country is still extremely poor, its finan-
cial prospects uncertain, and the perils of interna-
tional debt are especially obvious.
Despite Prime Minister Gandhi's distrust of the
United States, she is still interested in improving
bilateral relations, in our judgment. India seeks
improved access to US markets and technology as
well as greater financial support from multilateral
institutions. Besides, current trade problems with
the Soviet Union make Indian comparisons of
support from the superpowers more favorable to the
United States. Countering government-to-govern-
ment frictions is a strengthening of private links-
many middle class and elite families, for instance,
now have close relatives who have studied in the
United States or work here as professionals. F_
Resentment of US policies combined with the
economic opportunities and constraints India faces
is likely to reinforce Gandhi's widely supported
policy preference for self-reliance. Domestically,
this implies a greater willingness to sacrifice oppor-
tunities for growth and relief of poverty in order to
reduce vulnerability to changes in the policies of
other countries. Internationally, New Delhi's tradi-
tional emphasis on nonalignment will be strength-
ened. If India is able to avoid severe financial
strains, however, the impetus for self-reliance will
again weaken and New Delhi will increasingly seek
to expand commercial relations with Western coun-
tries.
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