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• Collection: General CIA Records
• Document Number (FOIA) /ESDN (CREST): CIA-RDP86T00587R000400510002-8
• Release Decision: RIPPUB
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• Document Creation Date: January 12, 2017
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• Sequence Number: 2
• Publication Date: October 1, 1985
• Content Type: REPORT

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Directorate of seerer-
Intelligence
and South Asia:
A Growing Phenomenon
Countertrade in the Middle East
NESA 85-10207
October 1985
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Directorate of Secret
Intelligence
Countertrade in the Middle East
and South Asia:
A Growing Phenomenon
This paper was prepared byl Office
of Near Eastern and South Asian Analysis. It was
coordinated with the Directorate of Operations.
Comments and queries are welcome and may be
directed to the Chief, South Asia Division, NESA,
Secret
NESA 85-10207
October 1985
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and South Asia:
A Growing Phenomenon
Key Judgments Countertrade-trade that links one transaction to a reciprocal transac-
in ormation available tion-has grown rapidly over the past two years in the Middle East and
as of 16 September 1985 South Asia, enabling countries in the region to discount prices, especially
was used in this report.
of oil; conserve hard currency; enter new markets; and increase existing
market shares for their goods. Middle Eastern and South Asian countries
were involved in countertrade deals worth at least $32 billion in 1984 and,
based on partial reports, at least $24 billion by mid-September 1985.
Countertrade accounted for more-perhaps much more-than 8 percent of
trade in the region during 1984.
US firms were involved in at least $1 billion of this countertrade in 1984,
and they have contracted for at least $2 billion already in 1985. Counter-
trade with Communist countries-about 25 percent of the total we have
documented for the region-accounted for about $7 billion in 1984 and at
least $5.5 billion so far in 1985. Much of this countertrade falls under
clearing accounts-agreements requiring periodic settlement of balances-
with India and Egypt.
Oil is the commodity most frequently involved in countertrade by Middle
Eastern and South Asian countries. this 25X1
countertrade grew from about 1 million barrels per day in 1983 to as much
as 2.5 million barrels per day in 1984. OPEC members use countertrade to
violate the cartel's price guidelines by granting illegal discounts. Middle
Eastern countries have often exported oil-or other primary products-to
US, other Western, and South Asian manufacturers who mainly wanted to
sell their own products in the Middle East and have had to resell the oil or
other items received at additional expense. 25X1
Iran, with its foreign exchange reserves at very low levels and facing tough
competition in oil markets, is the major countertrader in the region-and
probably the world. It accounted for about 25 percent of the value of
regional countertrade we have identified since 1983. Most of the trade is
conducted with large trading houses in Austria and Japan and through a
government-to-government agreement with Turkey.
Middle Eastern nations have turned increasingly to countertrades called
offsets-which require the seller to enter into coproduction, subcontract-
ing, and/or direct investment in the purchasing country. We expect the
iii Secret
NESA 85-10207
October 1985
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countries of the region to increase their demands for offsets that help them
expand and diversify their economies. These deals often involve transfer of
US technology and cost US jobs.
Countertrade by Middle Eastern countries will continue to grow in the
near term, mainly because a soft oil market will present continued hard
currency stringencies for oil exporters and thus incentives to cheat on
OPEC prices. The countries of the region will increasingly require US and
other countertrade partners to subcontract to and coproduce with their
firms in part to gain access to technology.
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Key Judgments
The Regional Setting
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Countertrade in the Middle East
and South Asia:
A Growing Phenomenon
The Regional Setting
Virtually every country in the Middle East and South
Asia engages in countertrade:
? Iran and Iraq, made cash poor by war, countertrade
whenever possible to conserve hard currency. They
cheat on OPEC prices by granting illegal discounts
through countertrade.
? Saudi Arabia has countertraded more than
$1 billion worth of oil for civilian aircraft and will
soon sign a contract for at least $4 billion worth of
military aircraft.
? Israel uses countertrade to acquire modern weapons
technology.
? Libya forces creditors to accept oil instead of cash.
? Jordan countertrades phosphate to increase its mar-
ket share.
? Afghanistan has been forced to take unusable Soviet
goods in return for fruit and hides.
Using an extremely conservative methodology, we
have been able to document that at least 8 percent of
the region's trade in 1984 was countertrade. On the
basis of the large number of deals that we did not
count, we believe that the share may have been as
much as 15 to 20 percent. Our analysis of evidence
from interviews, journals, industry and financial
press, reveals that at
least 65 countertrade contracts worth more than $32
billion were signed in 1984. Partial reports through
mid-September reveal that at least 92 such contracts,
worth more than $24 billion, were signed in 1985.
There were apparently only a few, small deals in
1983.'
Oil is the commodity most frequently countertraded
by Middle Eastern and South Asian countries-F-1
as much as 2-2.5
' The present wave of countertrade is generally regarded to have
started in 1982 when Indonesia instituted a mandatory counterpur-
chase policy for government import contracts.
Countertrade includes at least six distinct forms of
trade. In each the flow of goods in one direction is
linked-or countered-by another flow of goods,
usually in the opposite direction:
? Barter is the direct exchange of goods for goods
without the direct use of money.
? Counterpurchase involves otherwise separable, but
contractually linked sales. For example, India has
proposed to buy Iranian oil, but only after Iran
agrees to buy Indian goods.
? Buybacks (or compensation agreements) require a
company or government to provide equipment or
money for a project and to take payment, usually
over a period of years, in the product of the
enterprise.
? Offsets are common in military and aerospace deals
and require a contractor to license to, coproduce or
subcontract with, or directly invest in domestic
firms.
? Clearing accounts specify that trade will occur for
an agreed period. At the end of the period all
outstanding balances must be settled.
? Switch trading refers to any or all of the above
forms when three or more countries are involved.
million barrels per day are countertraded, most of it
by Arab producers. Only about 1 million barrels per
day were countertraded in 1982-83. With the current
official oil price much higher than the spot market
price, members of OPEC have the incentive to cheat
on price rules, and countertrade is one method used.
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Trading partners of the Middle Eastern and South
Asian nations have been slow to resist the trend to
countertrade because the alternative is often no trade
at all. Costs are considerably higher than those
associated with cash sales, however, and profits are
reduced accordingly.
Case Studies
The following case studies illustrate the magnitude
and variety of motives for which countries of the
Middle East and South Asia turn to countertrade
(see figure 1).
Iran. Tehran probably countertrades more than any
other nation in the world because of its need to
conserve hard currency (see figure 2). It faces a
serious foreign exchange shortage because of its oil
price policy and the loss of trade caused by the war
with Iraq.
we have documented that the value of countertrades
with Iran since 1983 is at least $13 billion, about 25
percent of the countertrades that we have confirmed
in the region. Iran's official foreign exchange assets
dropped from over $20 billion in 1979 to $5 billion at
the end of 1984, and only about $2.5 billion was
readily accessible to Tehran (see figure 3).2 Current
exchange holdings may be even lower because of the
soft world oil prices and Tehran's need to maintain
food and military expenditures. Iran even briefly
attempted to import only through countertrade. It
sees countertrade as conforming with Islamic princi-
ples, which stress bilateral balancing of exchanges.'
After a shortage of foreign exchange led Iran to
briefly prohibit noncountertrade in March 1985, Teh-
ran developed a system of foreign trade that restricts
use of cash to purchases of essential items. All other
goods must be purchased via countertrade, with Iran
mainly supplying oil, or making deferred payments.
Western firms eager to enter the Iranian market
7 About $1.1 billion is held in an escrow account to meet US claims
to be settled by the claims tribunal at The Hague; much of the rest
is tied to loans to less developed countries.
Countertrade is often shrouded in secrecy- "the good
countertrade deal is the one you do not hear about. "
A major business newspaper investigating counter-
trade found that many executives refuse to discuss
the topic. Experienced countertraders say contracts
are often signed without amounts being specified.
They claim that, at the time of signing, they do not
know the value of the goods that will be traded.
Estimates of the value of worldwide countertrade in
1984 vary widely. The IMF estimates that 1 percent
of world trade, or about $19 billion, was counter-
trade; the GATT estimates that 8 percent of world
trade, or about $155 billion, was countertrade. Reli-
able business press reports estimate countertrade at
40 percent, or about $776 billion.
Our method of estimation was to count contracts
signed in 1984 and 1985 and to add their dollar
values. The method is extremely conservative and
probably underestimates the number and value of
contracts signed. Our estimate excludes hundreds of
deals in various phases of negotiation: some were
described as ready to be signed and may have since
been completed. None of these, however, were counted
in our tally. Moreover, many reports of signed con-
tracts list only the kinds of goods involved ("oil for
refrigerated goods" or 'jute for machine parts") and
provide no information about dollar amounts or
physical quantities. Because no dollar figure can be
reliably estimated, we did not include these deals in
our value estimate.
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When oil barter was introduced, it violated the spirit,
if not the letter, of OPEC rules: until this year OPEC
rules made no mention of barter; further, the rules
made no mention of what members could pay for the
goods they received or when they had to take delivery
of the goods. OPEC rules were amended in January
1985 to explicitly prohibit price discounting via bar-
ter, but by then the practice had become widespread.
It had even become official policy in several states.
One widely used method of price discounting occurs
through overvaluing the item to be purchased. Sup-
pose, for ease of illustration, that the official OPEC
price of the oil involved is $30 per barrel and that the
spot market price is $20 per barrel. The OPEC
member wishes to barter for a basket of food worth
$30. The food producer has no incentive to trade for
oil at $30 per barrel, since he can purchase the same
oil on the spot market for $20 per barrel.
The OPEC member simply declares the basket of
food to be worth $45 and agrees to barter 1.5 barrels
of oil for the food.
Oil Oil Food at
at at $45 per
$30 $15 basket
When 1.5 barrels of oil are traded for food worth $30,
the oil has a true value of $20 per barrel.
Oil at Oil Food at
$20 per at $30 per
barrel $10 basket
A second widely used method of discounting involves
interest rates-including the fact that $30 worth of a
commodity to be delivered in the future has a present
value of less than $30.a A middleman may arrange to
accept oil today at the official price of $30 per barrel
and deliver $30 worth of food in the future. The
middleman will then sell the oil at spot prices,
"deposit" an amount less than $30 in a "bank, " and
let interest accrue until the deposit and interest reach
$30 on the date the food is to be delivered. He then
"withdraws" the $30, buys the food, and delivers it.
The discount is the amount by which the "deposit" is
less than $30. That amount will depend upon the
interest rate and the length of time between receipt of
the oil and the delivery of the food.
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"Economists curse countertrade; bankers say they
despise it, " according to a respected business journal.
The reason is that countertrade is inherently ineffi-
cient. The United States, most other OECD coun-
tries, and the GATT oppose countertrade because its
tied trades violate the principle of free trade. The
IMF opposes countertrade because it denies exporters
the unconditional right to their foreign currency
earnings and because countertrade can be used to
avoid paying creditors. .
Because countertraders often do not shop for the best
price and quality as they do in free markets, counter-
trade distorts trade patterns, leads to less than
optimal allocations of resources, and increases cost.
Reliable business press reports that countertrade
deals are 7 to 9 percent more costly than cash sales.
Contracts may be hedged in a variety of ways,
including specification of flexible terms to permit
adjustments in response to price changes, explicit
dealings with assumable risk, and insurance policies,
each of which involves additional costs, as does the
need to hire middlemen or trading houses or to
establish in-house countertrading departments.
Countertraders often must resell purchases at disad-
vantageous prices. Their trading partner may in-
crease the supply of a resource to pay them, leading
to a decrease in price-especially in small markets. A
survey of US businesses in late 1983 found that
72 percent of the goods received by US firms in
countertrade were unwanted and had to be resold-
or countertraded-to someone else. We believe that
these findings are still valid.
US producers who engage in countertrade find that
negotiations are cumbersome and time consuming.
The fact that every countertrade entails at least one
reciprocal transaction makes negotiations more com-
plex and prone to failure than negotiations over
traditional sales.
Figure 1
Countertrade by Middle Eastern
and South Asian Nations, 1985
and/or unwilling to extend credit have scrambled to
put together barter deals. Large foreign trading
houses are often required to organize groups of small
companies to meet the $100 million minimum Tehran
has imposed on barter deals, accordi
financial press reports.
Countertrade has significantly raised the transaction
costs of Iran's foreign trade, resulting in active opposi-
tion by many Iranian technocrats. One major Europe-
an trading house, typical of many, has received
commissions as high as 18 percent to put together
barter deals. Turkish traders, who can send goods to
Iran by land, have taken advantage of their position to
add markups estimated at between 20 and 30 percent
on deals that fall under a $3 billion government-to-
government countertrade accord. Turkey achieves a
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Figure 2
Partners of Middle Eastern and South Asian
Nations in Countertrade, 1985
Figure 3
Iran: Official Foreign Exchange
Assets, 1979-84
substantial portion of its countertrade volume by
acting as a clearinghouse for goods on the way to
Iran,
Tehran has had some success using countertrade to
increase nonoil exports. Yugoslavia, for instance,
signed a $700 million accord in February 1985 to take
nonoil goods worth 15 percent of Yugoslavia's exports
to Iran, according to reliable Western press reports
(see table 1).
Most Western firms dealing with Iran appear content
to accept countertrade as long as the terms of trade
allow a sufficient profit. A few large firms-middle-
size Japanese trading houses, for instance-are proba-
bly even incurring short-term losses to maintain their
position in a potentially lucrative market. Major firms
involved in construction projects that the Iranians
consider essential and that have found countertrade
arrangements unacceptable have been able to improve
terms by using their market power. Other firms have
appealed to, and perhaps paid off, senior Iranian
officials.
Iraq. Facing serious problems meeting its debt pay-
ments this year, Iraq has tried to get most of its
creditors to accept oil instead of cash or to reschedule
payments. Some creditors, France, for example, have
refused to take oil because of the uncertainties over
the oil market. Other creditors, Turkey, for example,
have been forced to take oil at higher than spot
prices-in effect accepting less than full payment
rather than deferrals.
Many large construction projects in Iraq are financed
by oil barter. For instance, French and Italian firms
agreed in August 1984 to take 1.2 million barrels of
Iraqi crude as a downpayment for constructing a
lubricating oil refinery near Baghdad. Before the
French and Italians could find a buyer, the price of
the Iraqi oil fell by slightly more than $2 per barrel,
and the companies lost more than $2.4 million on the
downpayment, according to the oil industry press.
Baghdad is to pay the balance of $35 million over the
next several years in crude oil, refined products, or
cash. The firms risk further losses if oil or refined
products are used.
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Table 1
Selected Iranian Countertrades Since 1983 a
Trading
Commodity
Amount of
Status of
Trading
Commodity
Amount of
Status of
Partner
Imported
the Deal
the Deal
Partner
Imported
the Deal
the Deal
by Iran
(million US $)
by Iran
(million US $)
Miscellaneous
1,000
Contracted
Japan
Tires
200
Delivered
(via large trading
New
Lamb
300
Contracted
house)
Zealand
Lamb (separate
300
Contracted
Miscellaneous,
250
Contracted
deal)
West Germany
Pakistan
Commodities
200
Contracted
in a switch trade)
Spain
Food, steel,
246
Contracted
Belgium
Chemicals,
200
Contracted
industrial goods
fertilizer,
Miscellaneous
200
Contracted
wool
goods
Industrial
70
Contracted
Sweden
Automobiles and
600
Contracted
renovations
other goods
Chemicals
46
Contracted
Switzer-
Rice (from
200
Contracted
Brazil
Manufactured
850
Memoran-
land
Argentina and
goods, materials,
dum of under-
Colombia), tea
services, equip-
standing
(from Sri Lanka
ment
(MOU)
and India), steel
signed
products (from
348
Delivered
, dredg-
Romania),
ing equipment
equipment,
metal, paper,
(from Spain)
agricultural
Syria
Cement
20
Contracted
equipment,
Taiwan
Miscellaneous
300
Contracted
chemicals, food
Turkey
Metals,'machin-
3,000
Contracted
Canada
Miscellaneous
300
Contracted
ery, electrical
China
Unspecified
35
Contracted
goods, chemicals,
East
Miscellaneous
345
Delivered
plastics, miscella-
neous (as a clear-
inghouse)
West
Cars, trucks
300
Contracted
Uruguay
Rice
31
Contracted
Germany
Spare parts
300
Contracted
Yugo-
Assorted
700
Contracted
Trucks,
equipment
200
Contracted
slavia
commodities
Expansion of
auto and truck
factory
200
Contracted
Car and truck
parts and kits
180
MOU signed
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In another major barter deal, Iraq agreed to import
100,000 Brazilian-manufactured Volkswagens during
1985 and 1986. Iraqi oil worth $630 million will be
sent to Petrobras, the oil company of Brazil, which
will sell it and pay Volkswagen of Brazil, according to
the oil industry press. The deal was concluded in
December 1984 after 14 months of negotiations.
Saudi Arabia. The Saudis concluded a $1.34 billion
barter in 1984 of as many as 50 million barrels of
crude oil for 10 Boeing 747s, Rolls-Royce engines,
and spare parts. The US Embassy in Riyadh reports
that in the 1984 deal the Saudis effectively discounted
the price of the oil by up to $2 per barrel by
overvaluing the planes. The Saudis temporarily in-
creased production by as much as 1 million barrels
per day and made full delivery during the summer of
1984, adding greatly to oil price volatility, according
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Yamani opposes all such barter because it undermines
Although
In March 1983 Riyadh turned to offsets-a form of
countertrade requiring the seller to enter into copro-
duction, subcontracting, and/or direct investment in
the purchasing country-to acquire technology, in-
crease domestic employment, and keep foreign
Riyadh was among the last OPEC members to use the
countertrade device and the Saudis denied that the
barter violated OPEC rules, the deal was viewed by
OPEC members as a major change in Saudi oil policy
and justification for others to break OPEC price
guidelines.
Because Riyadh is concerned about its declining share
of the oil market, it is considering other barter deals.4
A $4 billion deal for at least 48 British Tornado
fighters and 30 Hawk jet trainers was approved in
principle in mid-September, with signing scheduled
before the end of the month, according to Western
press reports.' A large unspecified portion of the
payment will be in Saudi crude oil. The United
Kingdom, itself an oil exporter, will have explicit
Saudi permission to resell the oil. OPEC members
usually try to prevent resale of their oil, since resales
occur in the spot market and diminish the cartel's
ability to control prices.
' Each of the cited oil-for-planes barters ended being significantly
larger than preliminary reports indicated as additional special
equipment, more spare parts, and/or maintenance contracts have
exchange at home. Despite rules requiring all govern- 25X1
ment contractors to subcontract at least 30 percent of
the contract value to Saudi-owned firms, offsets have
not increased domestic content significantly because
of shortages of skilled Saudi labor. Foreign firms,
especially those in technologically advanced indus-
tries, report that some Saudi subcontractors are hiring
foreign firms to work under the Saudi firms' names.
Saudi officials recognize these problems and have
been lax in enforcing the rules.
The Saudi air defense system, Project Peace Shield,
will entail offsets from US contractors of at least
$1.2 billion. The entire amount must be spent, accord-
ing to the contract, on nonpetroleum industries in
Saudi Arabia, many of them involving high technol-
ogy. For example, Saudia, the government airline, is
likely to participate in joint ventures with General
Electric to establish an aircraft engine overhaul facili-
ty or with Boeing to establish an airframe mainte-
nance, repair, and support center. Projects to make
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Figure 4
Saudi Arabia: Official Foreign
Exchange Assets, 1979-85
electrical and telecommunications equipment and to
provide computer services have been approved under
the Peace Shield offset program, according to finan-
cial and oil industry press reports. Other projects
remain to be specified.
United Arab Emirates. Like Saudi Arabia, the United
Arab Emirates (UAE) has used barter deals to cheat
on OPEC price rules and to conserve declining foreign
exchange reserves. When the UAE exercised its op-
tion to purchase a second squadron of 18 Mirage
2000s in December 1984, the French agreed to equip
the planes with advanced gear and to accept oil in at
industry press reported that Abu Dhabi discounted
the price of the oil by 13 percent.
Jordan. Jordan countertrades mainly to increase its
share of the world phosphate market, requiring con-
tractors with the Jordanian Government to accept
35- to 50-percent payment in phosphate. The US
Embassy in Amman reports that the Jordanian Air
Force and a US firm concluded a $115 million barter
of phosphate for an automated command and control
defense system in December 1984. The Air Force
soon after proposed a $200 million phosphate-for-
helicopters barter with another US firm, but the deal
has apparently fallen through because the US compa-
ny realizes that it will not be able to sell the phosphate
without a decrease in price.
Israel. Israel promotes offset trades for a variety of
reasons. Offset arrangements provide:
? A source of financing.
? Technology that allows Israeli firms to compete
successfully for US defense contracts.
? A way to incorporate Israeli design into weapon
systems to ensure compatibility with US weapons.
? A boost to the health of the Israeli defense industry
and the Israeli economy as a whole.
? A tool to keep skilled labor from leaving Israel.
? A sign of political support.'
More than $500 million of Israeli export sale's have
been tied to offset agreements, according to the Israeli
business press. Israeli law requires an offset in any
deal in which an Israeli Government agency or state
corporation imports goods and services worth more
than $500,000.
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Libya. Libya uses countertrade to cheat creditors by
paying them less in oil than they would have been
paid in cash. After completion of contracts calling for
cash payments, the Libyans have stated that they
could not pay cash and that the deals would be
converted to barter, according to oil industry and
financial press reports. Creditors from Italy, Greece,
Turkey, India, and South Korea were told that they
could take oil as payment-at official OPEC prices-
or nothing; Turkish contractors were sent about 19
million barrels of Libyan crude in payment for a $700
million debt. The implied price was about $7 per
barrel above the then-current spot market price.
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activity. It plans to import more from countries that
counterpurchase Indian exports. An Indian Ministry
of Commerce committee, established in 1984, has
been considering ways to overcome obstacles to coun-
terpurchases. Among problems cited in the Indian
press are jurisdictional disputes among Indian agen-
cies, with some officials unwilling to accept a loss on
one part of a linked transaction in return for a greater
profit for another agency. 25X1
New Delhi has been
Other Libyan creditors suffered similarly.
Libya has helped Nicaragua through oil barter. A $15
million deal signed in January 1985 provides for
better-than-world prices for the coffee, sesame, cot-
ton, and bananas that Nicaragua will barter for
Libyan crude, according to the US Embassy in
Managua.
India. India has been among those cheated by having
to accept oil in payment of Iraqi debt. Indian firms
were obliged to accept 400,000 tons of Iraqi crude and
100,000 tons of sulfur in September 1983 as partial
payment of $95 million in debt. Although Iraq dis-
counted the price of the oil, the amount offered did
not satisfy the entire debt, and Baghdad insisted upon
refinancing the balance on terms extremely unfavor-
able to the Indians. Indian losses outweighed gains
from discounting.
New Delhi also accepted
Libyan crude in June 1984 for $132 million in debt to
Indian public-sector firms, but, because Libyan crude
is unsuitable for use in Indian refineries, New Delhi
had to find a way to dispose of it. New Delhi
marketed the crude at its own expense initially. Now
it sells the crude through major trading houses at
terms that have not been made public.
trying to negotiate an agreement with Iran since early
1985 to exchange Iranian oil for Indian goods. Indian
tea would be left off the list from which the Iranians
would make their selections because Iran already
willingly buys Indian tea.
New Delhi also engages in countertrade through
buyback arrangements. It is negotiating, for example,
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and take payment in fertilizer.
Egypt. Offset agreements have helped Egypt gain new
Third World customers for its arms industry. Accord-
ing to Western business journals, Egypt has gained
access to so much French arms technology through
offset agreements that Cairo may soon emerge as a
competitor of France, especially in the market for less
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been lobbying for offset clauses in the US military aid
program for FY 1986.
Pakistan. Islamabad has taken steps to increase
greatly the volume of its countertrade because declin-
ing worker remittances and serious trade imbalances
have drastically cut its foreign exchange reserves.
Pakistan's exports under countertrade were at the rate
of $186 million per year for the first eight months of
FY 1985.
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Table 2
Pakistan: Balance of Payments a
Imports (f.o.b.)
5,563
5,769
5,616
6,002
6,130
Net services and transfers
1,774
1,840
2,435
2,306
1,880
Worker remittances
2,095
2,224
2,886
2,737
2,400
Long-term capital (net)
581
746
1,276
882
900
Gross disbursements
956
1,092
1,301
1,234
1,300
Amortization
-516
-492
-386
-542
-550
Other and short-term capital
772
629
390
-34
-30
Financial gap
-362 b
235
-1,1 1,112 b
180
840
Fiscal year ending 30 June of the stated year.
b Surplus for the fiscal year.
cording to the US Embassy in Islamabad, Pakistan's
exports had not been determined at the time the
contract was signed, but it was assumed that they
would be predominantly raw cotton, textiles, and
leather goods.
Algeria. Algeria is not a major countertrader, but it
has proved to be an extremely shrewd and practical
bargainer when it has had to be.
Algeria overvalues the goods received and provides
early delivery of the oil, both methods of granting
hidden discounts.
in April 1985, Algeria agreed to barter
1.4 million barrels of crude oil to a Japanese company
for construction equipment that was assigned an
artificially high value, making the oil seem worth $30
per barrel. The Japanese firm sold the oil in the
spring, but it has until October to deliver the equip-
ment.
The Algerians have eliminated the requirement that
small and middle-size Italian firms accept goods in
return for their services, according to the US Embas-
sy in Rome. The policy probably reflects a realization
that smaller firms are not likely to be diversified
enough to market the goods and may decide not to
trade rather than take oil for goods.
Countertrade With Communist Countries
Middle Eastern and South Asian countries have
engaged in countertrade, mainly in the form of clear-
ing accounts, with Communist states for many years.
Countertrade with Communist countries, however,
has increased for the same reasons that it has in-
creased with the West: hard currency difficulties,
demands that exports be linked to imports, and the
soft oil market. Countertrade with Communist coun-
tries-about one-quarter of the countertrade we have
documented for the region-amounted to at least
$7 billion in 1984 and at least $5.5 billion in the first
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We believe that some debtor nations engage in coun-
tertrade to avoid obtaining cash that would have to
be paid to creditor nations. Cashless trade also
facilitates avoidance of monetary reform measures
that the IMF and World Bank may desire. The IMF
will not make a loan to any country that requires
countertrade.
For example, an Algerian-Brazilian-Polish switch
trade, accepted in principle in February 1985, will
allow all three nations to gain from trade while
avoiding obtaining any money that could be claimed
by creditors who are not involved in the trade:
? Poland has a debt to Brazil.
? Brazil wants oil, and Algeria wants manufactured
goods.
? Algeria agrees to barter its oil for Brazilian manu-
factured goods and to barter additional oil for a
Polish `IOU. "
? Algeria and Brazil will be even since equal values
will be exchanged. Poland's debt to Brazil will be
reduced, since part of it will be transferred to
Algeria.
? Algeria will settle with Poland by accepting Polish
manufactured goods in amounts equal to the debt.
eight months of 1985. Most of that countertrade is
through clearing accounts between Communist coun-
tries and India and Egypt. Communist nations gener-
ally have hard currency problems of their own and
also believe that countertrade is more compatible with
central planning than cash sales, since countertrade is
supposed to avoid the uncertainties of the market:
? India and the USSR, New Delhi's second-largest
trading partner, traded more than $3 billion
through a clearing account in 1984.1 For more than
a decade India has sent agricultural products and
low-quality consumer goods to the USSR in ex-
Figure 5
Algerian- Brazilian- Polish Switch Tradea
a Although switch trades are more costly to arrange than bilateral trades,
switch trades increase the number of options available and lessen problems
of matching desires and offers.
change for oil. We believe that, in the future, New
Delhi will be obliged to increase merchandise ex-
ports to Moscow to balance payments for military
purchases.
? Egypt obtains an array of civilian and military
goods from the USSR through two clearing ac-
counts, one for civilian goods and one for military
goods. Cairo has also bartered miscellaneous goods
to Czechoslovakia for manufactured goods, fertiliz-
er to Hungary for steel goods or cement, and cotton
to China for tea, according to press reports.
? Pakistan will obtain 175,000 metric tons of much-
needed wheat through a switch trade in which
Bulgaria and Czechoslovakia will obtain wheat from
Australia and then trade it to Pakistan
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$164 million of goods in FY 1985, a 100-percent
increase over FY 1984. Other East European coun-
tries are reselling, at a discount, unwanted Paki-
stani goods obtained in barter,
Pakistan will import
electrical equipment and spare parts from the Sovi-
ets and will export cotton, textiles, surgical instru-
ments, and sporting goods under a barter agree-
ment signed in May 1985, according to the US
Embassy in Islamabad and various press reports.
? Afghanistan is forced to barter with the Soviet
Union on terms set by Moscow;
Afghanistan had to accept two large
generators that it cannot use because of lack of
fuel.' Bulgaria has a clearing account with Afghani-
stan that provides very favorable exchange rates to
Bulgaria. Sofia imports goods from third countries
solely for reexport to Afghanistan to earn foreign
exchange from the increased Afghan payments.
? Bangladesh has bartered with the Soviet Union
since 1972, and it also has barter agreements with
Poland, Bulgaria, Czechoslovakia, Hungary, Roma-
nia, China, and North Korea.
Qadhafi will go to Moscow in
the fall and that he will try to obtain Moscow's
agreement to accept oil in payment of Libyan debt.
Moscow had earlier insisted upon payment in hard
currency.
? The USSR has refused Algeria's request that Mos-
cow accept oil as payment for debt. Algeria's offer
to settle its trade deficit with the USSR by sending
refined oil products was refused in 1984, and the
Soviets were not accommodating on other economic
matters, according to the US Embassy in Moscow.
? Sri Lanka had significant barter agreements with
several Communist countries in the 1960s but has
not renewed many of them. A barter agreement
signed with China in 1952 was recently replaced by
a trade agreement providing for payment in con-
vertible currency in all trades. Less than 5 percent
of Sri Lanka's trade is now with Communist
countries, according to the US Embassy in Colom-
bo.
Outlook
Countertrade by Middle Eastern and South Asian
countries will continue to grow, at least until the oil
market strengthens. We do not foresee any fundamen-
tal change in the other conditions that caused those
countries to begin countertrading:
? OPEC members will still have the incentive to cheat
each other and violate OPEC rules.
? Because the liquidity and debt problems of some
countries in the region will not soon be resolved,
cashless trade will continue to retain its appeal.
? Both combatants in the Iran-Iraq war have entered
into long-term barter arrangements that will keep
them countertrading for some time. They will coun-
tertrade for military goods as long as the fighting
continues and then will countertrade for nonmilitary
goods as they rebuild their countries after the war.
We believe there will be an increase in demand for
offset programs. Other countries that have observed
the success of Israel and Saudi Arabia will begin to
make demands of their own. Egypt has already
requested offset agreements from the United States.
We do not agree with business journalists and econo-
mists who view the growth of countertrade as a
response to the recession in the West and expect
countertrade to decrease with the return of prosperity.
We observe that the volume of US countertrade with
Middle Eastern and South Asian countries has in-
creased during the marked economic recovery in the
United States. The volume of countertrade with other
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Western countries has grown as their industrial sec-
tors-those most likely to use the primary goods that
Middle Eastern and South Asian countries export-
have improved. We expect to see more countertrade
between countries in the region. Oil importers with
hard currency shortages, such as Pakistan, will seek
countertrade with countries such as Iran. We believe
that the Saudis will continue to conserve hard Curren-
cy, in part by turning to buyback arrangements in
construction projects, as in the case of the fertilizer
factory construction being negotiated with India.
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Implications for the United States
We share the view of private-sector and US Govern-
ment countertrade specialists that the greatest area of
concern about countertrade for the United States is
offset programs, which-by definition-require tech-
nology transfer. There is also the risk that US tech-
nology will be reexported to third countries, including
the USSR. Offset programs that require US produc-
ers to build and equip modern factories abroad, train
local personnel, and transfer technological knowledge
can only reduce-and in some cases eliminate-the
comparative advantage that is much of the economic
basis for US trade with countries of the region.
Western firms will continue to countertrade, despite
the concern over transfer of US technology and the
increased costs of countertrade. Even though profit-
ability suffers, firms protect market shares, particu-
larly in the oil-producing countries where a foothold
will enable the firms to expand operations when the
oil market begins to recover. Countertrade can also be
used as a financing technique to avoid the strength of
the US dollar. In some cases, Western firms may also
see countertrade as a way to keep production lines
open.
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