INTERNATIONAL ECONOMIC & ENERGY WEEKLY

• Document Type: CREST
• Collection: General CIA Records
• Document Number (FOIA) /ESDN (CREST): CIA-RDP88-00798R000200030006-3
• Release Decision: RIPPUB
• Original Classification: S
• Document Page Count: 42
• Document Creation Date: December 27, 2016
• Document Release Date: April 7, 2011
• Sequence Number: 6
• Publication Date: September 13, 1985
• Content Type: REPORT

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Directorate of
Intelligence
International
Economic & Energy
Weekly
13 September 1985
ecre
D] lEEW 85-037
13 September 1985
ropy 8 4 3
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International
Economic & Energy Weekly
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13 September 1985
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Synopsis
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Perspective-USSR: Oil Export Difficulties Grow 0
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USSR: Implications of Reduced Oil Exports
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South Africa: Financial Difficulties
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World Automakers: Financial Performance and Future Competitiveness0
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United Kingdom: Thatcher Pressured on Unemployment Q
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Bolivia: Courageous Attempt at Economic Reform
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Energy
International Finance
Global and Regional Developments
National Developments
Comments and queries regarding this publication are welcome. They may be
directed to Directorate ojintelligence
i Secret
DI IEEW 85-037
13 September 1985
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International
Economic & Energy Weekly 25X1
Synopsis
1 Perspective-USSR: Oil Export Difficulties Grow
probably will soon be forced to undertake necessary adjustments.
Soviet hard currency earnings from oil sales could decline substantially in
1985-possibly by as much as $3-4 billion. We believe that the USSR is in a
good position financially to handle the sharp decline in oil export earnings for
the balance of 1985. If oil-export earnings remain depressed, however, Moscow
currency earnings.
Declining oil production is apparently preventing Moscow from maintaining
the level of its oil exports to the West. Combined with declining world oil
prices, these export losses could cut Soviet hard currency earnings this year by
as much as $3-4 billion-representing perhaps 10 percent of total hard
3 USSR: Implications of Reduced Oil Exports
Barring a collapse of the rand, Pretoria will probably weather the current
liquidity crunch through reschedulings and some new European bank lend-
ing-albeit at premium rates. Nonetheless, until investor confidence returns
and the political situation stabilizes, the South African economy will remain
iii Secret
DI IEEW 85-037
13 September 1985
continuing pressure on their US and European competitors.
Japan's major producers have amassed financial strengths which will put
13 World Automakers: Financial Performance and Future Competitiveness
issue in the next national election, which must be held by June 1988.
Prime Minister Thatcher's failure to alleviate Britain's severe unemployment
has intensified domestic dissent over her economic policies, despite improve-
ment in most economic indicators. The unemployment rate is likely to remain
in double digits for several years, and the problem is certain to be the major
19 United Kingdom: Thatcher Pressured on Unemployment
23 Bolivia: Courageous Attempt at Economic Reform
Bolivia's new President Paz Estenssoro has announced a no-nonsense austerity
program to put the failing economy back on a firm footing. On the basis of Bo-
livia's lackluster record in sustaining reform, we believe that strict adherence
to the austerity package will be necessary to restore international confidence.
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International
Economic & Energy Weekly
13 September 1985
Perspective USSR: Oil Export Di,~iculties Grow
Declining oil production in the USSR apparently is preventing the Soviets
from sustaining oil exports to the West. Soviet hard currency earnings from oil
sales could decline substantially in 1985-possibly by as much as $3-4 billion,
or over 10 percent of total hard currency export earnings. There are few signs
that deliveries to Eastern Europe will be cut this year. If the Soviets continue
to insulate Eastern Europe from oil disruptions, such a policy would be in stark
contrast with the way the USSR handled a tight hard currency situation in
1981-82, when it eventually diverted oil deliveries from Eastern Europe to the
West.
Moscow has shown little serious concern about its hard currency situation, and
we believe that the USSR is in a good position financially to handle the sharp
decline in oil export earnings for the balance of 1985. If oil export earnings re-
main depressed, however, Moscow probably will soon be forced to take more
active measures, such as substantially increased borrowing, import cutbacks,
and selling more gold.
For the longer term, a continued decline in oil output-and reduced prospects
for oil exports-will pose some difficult choices for the Soviet leadership:
? There is little room for increased diversions of oil from the domestic economy
to boost exports to the West, a maneuver the Soviets have used in recent
years to sustain hard currency earnings. Some slight savings from energy
conservation and substitution programs will probably be realized, but the
prospect for widespread savings is not bright. Thus, any major cutbacks in
domestic oil allocation are likely to result in disruptive bottlenecks that
would threaten Gorbachev's modernization program and perhaps cost him
some political setback.
? Substantial cutbacks to Eastern Europe would result in serious economic
difficulty to these economies. Moscow will have to weigh carefully the
attendant risk of economic instability and increased political tensions in the
region that could stem from such cutbacks.
? The Soviets will need to continue importing sufficient quantities of grain and
feedstuffs for the livestock program, and obtain the necessary industrial
materials to prevent production bottlenecks. Increased imports of Western
machinery also would seem necessary if Gorbachev's industrial renovation
targets are to be met.
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General Secretary Gorbachev recently visited the West Siberian oil and gas
region almost certainly to get ahands-on feel for the problem before finalizing
investment choices for the next five-year plan.
Under these conditions, Moscow probably has little alternative but to accept
some continuing decline in its oil exports to the West, while trying to squeeze
whatever savings it can from the domestic economy and Eastern Europe. In
our judgment, the Soviets will continue to import essential agricultural and
industrial goods, and will have sufficient earnings to purchase Western
machinery and technology that have the highest priority. Reduced hard
currency availability, however, could affect other planned imports of Western
equipment at a time when the Soviet demand for such goods is likely to
increase as a result of Gorbachev's modernization program.
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USSR: Implications of
Reduced Oil Exports
Declining oil production is apparently preventing
Moscow from maintaining the level of its oil ex-
ports to the West. Combined with declining world
oil prices, these export losses could cut Soviet hard
currency earnings this year by as much as $3-4
billion-representing perhaps 10 percent of total
hard currency earnings. So far, Moscow has shown
little concern over the export losses, and we believe
its financial position will allow it to handle the hard
currency losses for the balance of the year. For the
longer term, a continued decline in oil output-and
the resulting impact on oil exports-will pose some
difficult choices for the leadership. Hard currency
imports of agricultural products, needed industrial
materials, and equipment and technology for priori-
ty projects will probably be met, but cuts in other
equipment purchases could set back General Secre-
tary Gorbachev's goals for industrial moderniza-
tion. Diversion of oil exports from Eastern Eu-
rope-not evident thus far-would run the risk of
hurting their fragile economies and fomenting po-
litical unrest in the region.
Soviet domestic oil output fell last year-by about
100,000 barrels per day (b/d)-the first time since
World War II. On the basis of the oil industry's
recent performance, including 14 months of declin-
ing output, we judge that production for 1985 will
fall by over 300,000 b/d, or by about 3 percent
from last year's level.
Moscow is becoming increasingly concerned about
its oil prospects. Major steps taken by the leader-
ship to prevent declines in oil output have been to
no avail. Last year, Moscow increased substantially
investment in oil production, and earlier this year it
overhauled the management of the oil sector. In
early August, the Politburo decided on a 60-percent
increase in construction and assembly work for the
USSR: Oil Production, 1980-85
0 198081828384 1 AS ONDJ FMAMJ
84 85
West Siberian oil and gas complex in the 1986-90
period. While such measures offer some prospect of
slowing the longer term decline in output, they can
do little to improve oil output in the next year or
two.
Reduction in Oil Exports
The West. Soviet oil exports to the West declined
by about 40 percent during the first quarter this
year compared with the same period in 1984. This
was largely due to the harsh winter, which ham-
pered oil production and sharply increased domes-
tic oil consumption. Although few data are avail-
able, oil exports apparently rebounded during the
second quarter-but not enough to offset the earli-
er declines
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Traditionally, the Soviets have substantially accel-
erated oil exports in the latter months of the year to
offset low first-quarter deliveries. According to
Western journals with excellent contacts in the
energy markets, however, oil traders expect the
USSR to cut contract deliveries of oil by between
one-third and one-half for an indefinite period
beginning as early as September. These cuts sug-
gest that Moscow seriously underestimated the
difficulty of turning around the slide in oil produc-
tion that was evident in late 1984. The Soviet State
Planning Committee (GOSPLAN) annually allo-
cates approximate quantities for export to the
West. These allocations, in turn, provide the basis
for the spate of oil-export contract signings at the
beginning of each year. The Soviets have not made
an official announcement, and similar press "war-
nings" sometimes have not been completely borne
out in the past. In addition, the Soviet oil export
agency recently denied that oil deliveries to the
West would decline later this year. Nevertheless, in
our judgment, the recent events are unusual:
? The Soviets generally provide only short notice on
reductions or cancellations in contract deliveries.
This time, they reportedly informed some cus-
tomers several weeks ago, which suggests that the
export difficulties may be substantial.
? When the USSR has claimed force majeure' in
the past, the declarations were usually accompa-
nied by statements that the disruptions in deliver-
ies will be temporary or made up later. Such
qualifications are notably absent this time
around.
Cutbacks are already taking place. Some customers
of Soviet oil reported in the Western press that gas-
oil deliveries to Western Europe were reduced in
August. Finnish oil customers report that Soviet
crude oil deliveries are down by over 20 percent of
contracted amounts so far this year, and expect a
shortfall of about 30 percent by yearend. In addi-
tion, in the spot market-where the USSR makes
roughly half of its sales to the West-prices for
Soviet oil in recent weeks have risen faster than the
market as a whole. Such movements in prices in the
past have preceded a substantial decline in Soviet
oil sales.
To our knowledge, the Soviets have not tried to
boost oil imports from the Middle East for reexport
to the West. During the first few months of the
year, the reexports averaged about 300,000 b/d,
about the same level for all of last year. The Soviets
in recent years have been able to increase oil
deliveries from OPEC-particularly from Libya
and Iraq in payment for arms purchases-as a way
of increasing its overall exports to the West.
Eastern Europe. Less information is available on
Soviet oil exports to Eastern Europe, but there are
only indications of some sporadic and small-scale
cutbacks to Yugoslavia and Bulgaria.
Nevertheless, in our judgment, Moscow is doing its
best to sustain oil deliveries to the region. The
Soviets almost certainly would not make any sub-
stantial cutbacks in midyear, as this would be
extremely disruptive on any centrally planned econ-
omy. Rather, any reduction in such deliveries-as
was the case in 1982-would be made at the
beginning of the following year, in concert with
setting the overall annual economic plan. The
absence of grumbling from the East Europeans
suggest that reductions in deliveries to the region
are only marginal, and that no Soviet announce-
ment has been made of a larger, more general
cutback for next year.
Implications for Hard Currency Earnings
Near Term. The expected decline in the volume of
oil sold to the West, combined with lower world oil
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prices could lead to a reduction in hard currency
earnings of about $3-4 billion for 1985 as a whole.
This would be a drop of 20 to 25 percent in
earnings from oil sales, and could result in a decline
of more than 10 percent in the USSR's total hard
ments. In addition, the Soviets substantially in-
creased short-term borrowing (mainly for grain
purchases) and gold sales.
currency earnings.
Moscow cannot compensate for this drop by ex-
panding other exports. Soviet earnings from natural
gas sales to Western Europe are not expected to
rise substantially this year. On average, Soviet gas
prices have fallen somewhat, and the USSR has
allowed at least one nation to postpone increases in
purchases of Soviet gas. Other exports-including
sales of metals, machinery, and weapons-face
limited developed country or LDC demand and, in
some cases, constrained domestic availability.
The USSR is probably in a fairly good financial
position to cope with this year's oil export decline.
At the end of March Soviet assets in Western
banks stood at a comfortable $8.8 billion. So far,
Moscow has shown few signs of serious concern
about the need to compensate for a major drop in
oil earnings:
? Gold sales appear to to be up only slightly over
the relatively low levels in 1984.
? While Moscow has borrowed close to $1 billion
from the West this year, most of this money
apparently has been used to pay off earlier,
higher-priced loans.
? The Soviets turned down a French offer of ap-
proximately $500 million in credits for Astrak-
han' and Tengiz energy development contracts,
which were signed this spring.
The expected erosion of its oil export earnings
during the balance of 1985, however, could force
Moscow to take necessary adjustment measures in
the near future. Options exercised in the past
include increases in net borrowing, cutbacks in
imports, and larger gold sales. In response to a hard
currency bind that developed in the first half of
1981, Moscow cut back hard currency allocations
to the foreign-trade organizations in late 1981 and
early 1982, causing delays in purchases and pay-
On balance, we believe that the USSR can satisfy
most, if not all, of its import requirements from the
West in 1985. Moscow will be helped this year by a
better domestic grain crop that will substantially
reduce grain import requirements in the latter half
of the year. Moreover, abundant world grain sup-
plies should result in a buyer's market cutting
Soviet import costs. In addition, overall imports of
Western industrial goods during the first quarter
were lower than during the comparable period in
1984. It is not yet clear whether such imports have
remained at reduced levels since then. While Soviet
orders for machinery and equipment are up sharply
during the first half of the year compared with last
year, actual deliveries will not begin to rise until
1986 or beyond, given the usual lags in implement-
ing contracts for large projects. Moreover, many of
the deals are financed by long-term credits.
Longer Term. Beginning in the next year or so, the 25X1
Soviets will likely have to deal with steadily declin-
ing export earnings from oil:
? Domestic oil output probably will continue to
slide despite substantial increases in investment
in the oil industry. Although the oil industry
management has been overhauled, prospects for a
turnaround in output are poor.
? There is little prospect for a reversal in the
decline in world oil prices until the late 1980s.
? Opportunities for boosting arms sales to OPEC
nations-the traditional source for increased oil
imports-are limited by the ability of these na-
tions to absorb more arms.
Moscow will be hard pressed to compensate for the
production decline through reduced domestic con-
sumption. It has been trying to reduce the econo-
my's use of oil for several years, primarily through
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energy conservation and programs for switching to
the use of gas instead of oil in industry. There have
been few signs however, that the USSR has, in
fact, reduced its oil use. The Soviet press has been
mum on successes in this area, suggesting that
progress is dragging despite the leadership's em-
phasis on conservation. In addition, our analysis of
the electric power industry-the main target of the
gas-for-oil substitution programs-indicates that
the oil "saved" at some power plants has been
consumed anyway in offsetting major shortfalls in
the supply of coal to other power plants and in
producing above-plan amounts of electricity.
Prospects for limiting demand during the next
several years also are not bright. Gorbachev's
program for retooling and installing more energy
efficient equipment promises substantial savings,
but only in the long run and after considerable
expense. Over the next several years, the modern-
ization program, vigorously pursued, will itself
consume large quantities of fuel. Indeed, given
Gorbachev's stated objectives, the mix of industrial
output is likely to become more rather than less
energy intensive.
Implications for Eastern Europe
Moscow's allies would have considerable difficulty
coping with a cutback in Soviet oil deliveries. Most
of the countries in the region-plagued by sluggish
export growth, large debt service obligations, and
uncertain borrowing prospects-do not have
enough hard currency to purchase a substantial
portion of their oil requirements on the internation-
al markets. Moreover, securing more oil through
barter arrangements has been made more difficult
because of a reluctance of Third World countries to
increase such deals.
Moscow repeatedly has told its allies that deliveries
will not be cut in 1986-90. It made a similar
promise in 1980, however, for the 1981-85 period,
but cut deliveries anyway in 1982 when it needed to
increase hard currency earnings. In the aggregate,
oil shipments to the region have not increased since
then.
The East Europeans survived the 1982 cutbacks
without much difficulty because the region was
reexporting some Soviet oil for hard currency. Cuts
during 1986-90 would be much more troublesome
as they likely would come out allocations for the
domestic economies-at a time when Moscow will
be putting more pressure on East Europe to in-
crease production and delivery of energy-intensive
goods (i.e. machinery and equipment). Reduced oil
consumption in the region would affect economic
productivity and growth and, in turn, increase the
likelihood of political instability in Eastern Europe
and increased public resentment toward the Soviet
Union.
Implications for Trade With the West
Moscow probably has little alternative but to ac-
cept some continuing decline in its oil exports to the
West, while trying to squeeze whatever savings it
can from the domestic economy and Eastern Eu-
rope. Faced with prospects for substantially re-
duced hard currency earnings, the Soviet leader-
ship may be hard pressed to satisfy the entire range
of import goals in the coming years. We believe,
however, that the Soviets will continue to import
sufficient quantities of grain and feedstuffs to keep
the livestock program on track and obtain the
industrial materials needed to reduce production
bottlenecks.
The reduced availability of hard currency will
probably affect imports of Western machinery and
equipment the most. Barring a series of harvest
failures and/or an unexpectedly rapid decline in oil
production, Moscow should be able to earn enough
hard currency through 1990 to purchase Western
equipment that has the highest priority-equip-
ment needed to develop oil and gas reserves at
Astrakhan' and Tengiz, for example. Any cutback
in imports of other Western machinery and tech-
nology would be occurring at a time when Soviet
demand for such goods is increasing as a result of
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Gorbachev's modernization program. A less conser-
vative borrowing policy, however, could allow Mos-
cow greater leeway in setting the level of these
imports.
Changes in Soviet purchasing strategy may provide
early indication of how the Soviets are assessing
their prospects for oil production and hard currency
exports. Specific indicators might include:
? Scaling back, stalling, and/or canceling project
negotiations now underway.
? Insistence on countertrade arrangements for all
but the highest priority purchases.
? Greater concentration on domestic projects ori-
ented toward supplying the export market when
negotiating purchases from the West.
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Difficulties
Pretoria's recent announcement of a four-month
suspension of repayment of most foreign debt prin-
cipal will undermine investor confidence already
shaken by political uncertainties. The South Afri-
can rand is likely to remain weak at least until the
domestic unrest subsides. Barring a collapse of the
rand, Pretoria will probably weather the current
liquidity crunch through rescheduling and some
new European bank lending-albeit at premium
rates. Nonetheless, until investor confidence re-
turns and the political situation stabilizes, the
South African economy will remain vulnerable.
Developing Debt Cruncb
Pretoria usually has practiced conservative foreign
debt management to assure continued access to
credits despite foreign criticism of its racial poli-
cies. On several occasions the government has
clamped down hard on economic growth to reduce
import demand. In 1983, however, misplaced opti-
mism about crop yields and gold price trends led
Pretoria to allow a rapid economic expansion fund-
ed largely by short-term overseas borrowing. Much
of this is owed to US commercial banks, which now
hold about one-fourth of South Africa's $12 billion
short-term debt, according to US Federal Reserve
data
In August 1984, Pretoria belatedly imposed eco-
nomic austerity measures, which included restric-
tions on consumer borrowing and a 25-percent
prime lending rate. The measures brought the
current account back into surplus but caused the
economy to slump rapidly. Real GDP fell by 2.5
percent between second quarter 1984 and second
quarter 1985.
The current account surplus has not offset a drain
of more than $2 billion in capital over the last 18
months. Much of the early capital outflow went to
reduce foreign indebtedness. More recently, grow-
ing international nervousness over South African
political and economic uncertainties led foreign
banks to trim their credit lines to South Africa.
Capital flight apparently has accelerated as a few
foreign firms sold South African subsidiaries and
some residents sent money abroad for possible
future emigration.
The credit squeeze began gradually with reduced
offerings by US banks but spread to some West
European lenders after the government declared a
state of emergency in July 1985. According to US
Embassy sources and recent IMF data, South
Africa only has about $2.5 billion in foreign ex-
change and gold reserves' and another $1 billion in
anticipated current account surpluses over the next
six months. Against this, the country was facing
some $7 billion in debt obligations through next
March, the bulk of which probably would have
been rolled over in the normal course of events.
As foreign borrowing grew, the rand depreciated.
From an average of $1.30 in the first quarter of
1980, the rand sank to $0.49 in the first quarter of
1985. Reduced direct controls over exchange rates
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allowed the rand to slide downward with the world
price of gold-the source of nearly 50 percent of
South Africa's export earnings.
More recently, the rand has become even more
volatile as South African companies have scram-
bled periodically to obtain foreign currency for
future transactions in the self-fulfilling expectation
of further declines in the rand. In particular,
political events during the past three months, such
as the declaration of a state of emergency and the
arrest late last month of noted antigovernment
activist Alan Boesak, have triggered near-panic
South Africa's commercial bank creditors probably
see little choice but to wait for Pretoria to initiate
negotiations to reschedule the short-term debt.
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some major US and West
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European banks remain confident of South Africa's
willingness and ability to repa
I These banks
likely attribute the debt crunch not to South Afri-
can economic problems, but to concurrent refusals
by many smaller banks to renew expiring credits.
runs on the rand.
In response to a sudden drop in the value of the
rand and an acceleration of withdrawal of foreign
credit lines by some banks, Pretoria suspended
trading on South African foreign currency and
stock markets for four days, followed by an an-
nouncement of a four-month moratorium on most
principal repayments on foreign debts. Interest
payments, however, are to continue.
Although pressures on the rand have been reduced
by the controls on capital, dramatic political events
in South Africa and foreign moves toward new
economic sanctions are still likely to sharply affect
the exchange rate over the near term. Moreover,
the relatively small amount of rand traded-and
local business concern to cover future transac-
tions-will continue to make the currency poten-
tially quite volatile.
The South African central bank has unwittingly
helped to focus foreign investor and creditor atten-
tion on the rand by announcing central bank
intentions to support the currency through market
intervention. The rand is seen by many observers as
an index of investor confidence. If the central bank
cannot stabilize the rand, investors will be con-
vinced that the debt moratorium has failed to
resolve the liquidity crunch. A further sharp de-
cline in the rand would add to creditor uneasiness
and likely complicate negotiations to reschedule the
Bankers may have found some reassurance in
Reserve Bank Governor de Kock's assertions that
South Africa would ask for neither new money nor
renewal of expiring credit lines at rescheduling
negotiations, but only for a slowdown of the pace at
which the country must repay expiring loans. South
Africa's promise to maintain full interest payments
also may have gained patience from bankers, as
banks can avert loan loss provisions as long as
interest payments continue. We estimate South
Africa's interest obligations are about $100 million
per month, which would be covered by the $140
million per month South Africa claims it has
available for debt service. This amount falls far
short of principal repayments currentl bein
,sought by banks, however
Even though trade-related payments are exempt
from the moratorium, we see potential for South
Africa's trade activities to be complicated by the
debt standstill. In response to uncertain prospects
for repayment, banks could refuse to negotiate
South African letters of credit, thus delaying or
possibly preventing shipment of imports. Ina simi-
lar response, South Africa's industrial country
trade partners have begun to curtail export credit
guarantees. According to US Embassy and press
debt.
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reports, Japan and the Netherlands each have
announced restrictions on guarantees since the debt
moratorium was declared.
Options for South Africa
Unless creditor confidence is undermined by a
collapse of the rand, South Africa probably will be
able to reach agreement with foreign banks to solve
its immediate debt problem.
the major international banks
probably would accept a rescheduling of short-term
debt over one year. Moreover, British financial
officials may privately advise UK banks to cooper-
ate with a rescheduling, according to US Embassy
reporting. In addition, early indications are that
some West European banks are prepared to offer
new loans-although possibly at substantial premi-
ums-to fill the financial gaps left by other banks.
Some banks are charging interest rates as high as 4
percentage points above LIBOR for stopgap loans
to South Africa, according to US Embassy report-
ing. In contrast, interest rates for the key Latin
American debtor countries currently are less than 2
percentage points above LIBOR.
Another option for Pretoria would be to sell some of
its gold holdings to help meet debt repayments.
Ofl^icially, South Africa has $2 billion worth of
gold in reserve, but persistent rumors suggest actu-
al reserves are much greater. Because large-scale
gold sales on the open market would cause the gold
price to drop, any sale of reserves almost certainly
would be privately arranged with a few select
buyers. As long as further economic sanctions
against South Africa remain possible, however,
Pretoria probably will be wary of drawing on its
reserve cushion. In a costly, high-risk variation that
would leave reserves intact, South Africa also could
try to mortgage future gold production in return for
immediate cash.
un ess a windfall increase in the gold
price significantly boosted the country's export
earnings, South Africa probably would face years
of stagnation, high interest rates, limited invest-
ment, and double-digit inflation.
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If credit lines evaporated, Pretoria might decide to
renounce its debt altogether, and brace itself for
likely new economic sanctions. The country has 25X1
adequate stockpiles of key resources and spare 25X1
industrial capacity to allow the economy to plod
along for several years. Although this "siege econo-
my" option has been advocated by some rightwing
South Africans, it is unlikely to be adopted except
under extreme duress. Nevertheless, Pretoria prob-
ably will use the threat of indefinitely delaying
repayment of debt obligations to particular banks
or countries if necessary to obtain bank cooperation
in debt restructuring.
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World Automakers: Financial
Performance and Future
Competitiveness
The financial positions of the world's major auto-
makers have changed dramatically over the past
decade. The large Japanese auto firms have gar-
nered great financial strength that will secure their
strong competitive position through 1990. At the
other extreme, Western Europe's volume producers
are in dire financial straits. Five years of losses and
mounting indebtedness have generated deep finan-
cial strains, particularly for the large French auto-
makers-Renault and Peugeot. Although US pro-
ducers have rebounded with record profits, they
remain vulnerable to market downturns and Japa-
nese competition because of relative inefficiency in
small-car production, dependence on sales of larger
cars for profits, and high average labor costs.
YRA and Japanese Profitability
The profitability of Japanese automakers depends
heavily on exports to the US market. Although the
voluntary restraint agreement (VRAJ halted the rap-
idly growing penetration of Japanese autos into the
US market, the yen value of Japanese passenger car
exports to the United States increased nearly 90
percent from 1980 through 1984. The increase was
accounted for by:
? Rising automobile prices in the United States.
? A shift by the Japanese toward exports of larger,
higher priced cars and the addition of high-margin
options.
? The appreciation of the dollar.
A Glaring Contrast
The financial strength of Japan's major automak-
ers has increased steadily. With a high quality, fuel
efficient product line and an aggressive marketing
strategy, Japanese firms have been able to increase
or maintain unit sales during both market down-
turns of the past decade (1974-75 and 1980-81).
These high sales volumes, in conjunction with
strategies to increase labor productivity and reduce
manufacturing costs, have provided steady returns
on sales and assets over the past decade. This, in
turn, has enabled producers such as Toyota to
reduce long-term debt, further reducing costs. The
combination of liquid resources and low debt has
shielded large Japanese automakers from the kind
of financial pressures faced by their US and West
European counterparts.
In contrast, the financial pressure on Western
Europe's automakers has intensified. Costly sales
battles in their home markets and the struggle to
keep abreast of rapidly advancing technological
developments have created a large financial burden
We estimate that the share of total Japanese motor
vehicle profits coming from the US market jumped
from about 20 percent in 1980 to at least SO percent
in 1984. the estimates of
some Japanese economists indicate that the share
may have been as high as 80 percent.
In contrast to exports, sales in the Japanese home
market have yielded meager profits. Because the
VRA limited exports to the United States, the nine
Japanese automakers, particularly the smaller com-
panies with proportionately small quotas, have been
engaged in a domestic price war to maintain the
volume necessary to achieve economies of scale. This
fierce competition has kept domestic profits in Japan
near the break-even point. According to Japanese
auto analysts, Toyota is the only company able to
make a domestic profit because of its more e.~cient
production and dealer network.
Secret
DI IEEW 85-037
13 September 1985
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for nearly every volume producer. Chronic overca-
pacity prevented firms from regaining profitability.
As a result, automakers have cut dividends, re-
duced working capital, liquidated assets, and
turned increasingly to long-term debt to finance
investments in new products and technologies. Al-
though sales for several European firms have begun
to rebound, the losses and high debt burdens have
severely weakened their long-term financial
strength.
West European governments have kept their auto-
makers afloat and maintained employment levels
through substantial financial support in the form of
tax breaks, low-interest loans, and increased equity
participation. Faced with a growing unemployment
problem, governments have thwarted needed labor
cuts in an industry that is typically the largest
employer. Furthermore, companies dependent upon
government support have difficulty planning long-
term strategies because of uncertainty over levels of
future funding.
Domestic Capital Spending
According to recent press reports, Japanese auto-
makers plan to boost domestic capital investment
largely to improve manufacturing efficiencies rath-
er than expand capacity. Major expenditures in-
clude greater application of advanced robotics,
computer-aided design and manufacturing, and
flexible manufacturing systems. Overall, industry
experts estimate the Japanese will increase produc-
tivity 20 percent by the late 1980s by increasing the
use of automation. In addition, we believe substan-
tial funds will be allocated for the development of
larger cars.
West European automakers' investment strategies
are aimed at closing the gap with the Japanese on
production costs. To this end, Renault and Fiat
have each increased their capital spending to about
$1 billion per year, and V W is spending nearly
twice this level.
current spending is
not sufficient for European automakers to regain
competitiveness. QEuropean manufac-
turers need to invest at least $11 billion a year
during the rest of the decade to develop new cars,
update existing ones, and automate their plants.
Because of constrained cash-flow and low profit-
ability, however, the industry's financing shortfall
could reach $20 billion by 1990. Not only are banks
and equity markets unlikely to provide the neces-
sary funding, but European governments-them-
selves strapped for cash-are increasingly reluctant
to sink more money into the industry.
Foreign Investments
ties in both the United States and Canada.
Market access restrictions-both real and poten-
tial-as well as a mature domestic market have
undoubtedly contributed to the Japanese push to
establish foreign production facilities. Heavy reli-
ance on foreign sales-Honda exports nearly 73
percent of total production, Nissan 53 percent, and
Toyota 41 percent-makes the Japanese firms ex-
tremely vulnerable to these restrictions. Even
Toyota, the most reluctant foreign investor, recent-
ly announced plans to build large production facili-
The Japanese have concentrated on building assem-
bly rather than manufacturing plants abroad, thus
retaining domestic production of high-value-added
components, such as engines and drive trains. This
approach keeps domestic auto employment high,
maintains economies of scale in Japan's highly
automated plants, and gives manufacturers greater
control over the price and quality of major compo-
nents.
At the same time, financial problems have forced
European producers, such as Fiat and VW, to pull
out of foreign markets. Their weak financial posi-
tion has not allowed them to maintain expensive
overseas facilities, particularly as these markets
turn down.
R&D Expenditures
Strong finances have enabled Japanese auto firms
to undertake high risk R&D. Although absolute
R&D spending by US automakers is much greater
than that of their Japanese competitors, the ratio of
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World Automakers: Comparative Financial Performance, 1979-84
Japanesea
__ ? French b
Volkswagen
Return on Sales d
Percent
Return. on Assetsr
Percent
_8 1979 80 8] 82 83 84 45 1979
Primary Operating Cash Flowe, h
Billion US $
- Fiat
? United Statesc
Profits e
Billion US $
Debt to Total Capitalizationg
Percent
80 81 82 83 84
Net Sales Per Employee
Thousand US $
-12 1979 80 81 82 83 84 50 1979 80 81 82 83 84
a Weighted average of Toyota and Nissan.
b Weighted average of Renault and Peugeot.
~ Weighted average of GM, Ford, and Chrysler.
d Net profits to net sales.
e Cumulative totals, not weighted averages.
rNet income to total assets.
s Total liabilities to total assets.
h Net income plus depreciation minus capital spending.
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World Automakers: Capital and R&D Expenditures, 1979-84
Percent
Capital Expenditures to Sales
1979 80 81 82 83 84
+~ Weighted average of Renault and Peugeot.
b Weighted average of GM, Ford, and Chrysler.
Weighted average of Toyota and Nissan.
R&D to sales is comparable or greater for the
Japanese.Z Current R&D expenditures center on
further improvements in fuel efficiency through
developments in ceramic ignition parts, electronic
engine and transmission controls, and improved
aerodynamics. Longer term R&D expenditures fo-
cus on ceramic diesel engines and composite mate-
rials. success in
these areas would enhance the Japanese competi-
tive position, giving them a multiyear lead by the
end of the decade in some commercial applications
of fuel efficient and weight-reducing technologies.
0 1979 80 81 82 83 84
Japanese
United States b
Volkswagen
Fiat
capital investment will prevent them from match-
ing US or Japanese levels of R&D. Except for VW,
individual corporate R&D spending for European
automakers is on a much lower level-both in
absolute and percentage bases. Financial problems
have forced Renault to cut R&D by one-third this
year. In the long run, we believe European manu-
facturers will be forced to gain access to new
technologies through joint ventures with US and
Japanese firms.
Japan: Growing Competitive Strength
The increased emphasis on R&D presents competi-
tive problems for European automakers. Small
profits and pressures to devote scarce resources to
' The Japanese figure, however, may be significantly understated
because they do not include substantial R&D expenditures of some
250 component suppliers. According to independent studies, the
R&D expenditures of Toyota and its affiliates may have reached
$1.5 billion last year compared to Toyota's reported $850 million.
Underpinned by its financial strength, the competi-
tiveness of Japan's automakers, in our estimation,
will grow further. Economic recovery in the United
States, coupled with the relaxation of the export
restraint and increasing overseas production,
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should enhance their financial growth and their
ability to carry out aggressive strategies. Moreover,
the shift to larger, higher profit cars will enable the
Japanese automakers to continue amassing large
profits from the US market, making some of them,
Toyota and Nissan in particular, among the most
financially viable companies in the world.
To the extent Japan's automakers are successful in
capturing more of the overseas component and
subassembly markets, their earning power should
grow further. This opportunity is increasingly via-
ble as the Japanese firms build plants in the United
States and Europe and as US firms produce small-
er cars incorporating components (such as engines)
that they cannot economically manufacture. In-
creased component sales, in turn, will allow Japa-
nese suppliers to achieve economies of scale and
further reduce component costs to their parent
companies. At the same time, profits by component
subsidiaries will reinforce their ability to develop
and apply leading-edge product and process tech-
nologies.
Europe: Needed Restructuring
Although the West European auto industry must
take major actions to reduce costs to restore its
financial health, Europe's socioeconomic frame-
work is not conducive to such changes. Structural
difficulties in the European auto industry have
been compounded by government policies aimed at
equalizing the selling prices of cars, reducing ex-
haust pollutants, and cutting the workweek. What-
ever the social benefits of these programs, they add
considerably to the industry's financial problems.
Inevitably, capacity and employment will have to
be rationalized if the industry is to return to
profitability. While national pride and political
realities make it almost inconceivable that any of
the big European producers will be allowed to fail,
most volume producers will be forced to:
? Close their most inefficient plants and layoff
workers to reduce costs, despite strong union
opposition.
? Reduce their broad range of models and look for
market niches that allow a reasonable profit. BL,
Fiat, Peugeot, and Renault have already been
compelled to specialize in low-end segments of
their home markets.
? Outsource major components from lower cost
overseas production facilities. Peugeot, Ford,
GM, Renault, Fiat, and VW already outsource in
a significant way from Spain, and investment in
Latin America and Southeast Asia promises even
greater cost advantages.
? Enter into cooperative licensing agreements or
even mergers. The exchange of technological
knowledge and the reduction in manufacturing
costs through longer production runs have
prompted European competitors to establish joint
production of gearboxes, engines, and transmis-
sions. Because of their inability to fund new
production facilities and long-term R&D, Euro-
pean linkups with the Japanese and US automak-
ers may also increase.
Implications for the United States
As Japanese producers continue to expand manu-
facturing in the United States, the added capacity
could place even greater pressures on market share
and profitability of US automakers. As the low-cost
Japanese producers begin manufacturing and sell-
ing automobiles in the area of US strength, they
may set low prices, increase market share, and
erode the profitability of US firms. As the Japanese
secure a higher share of the upmarket, and as
European niche producers capture more of the
luxury, high-profit end of the US market, the
profitability of US producers may be increasingly
squeezed, lowering their ability to make future
investments.
Furthermore, while US (and European) automakers
were struggling to maintain their domestic mar-
kets, Japanese producers were using their financial
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strength to secure Third World markets. As Japa-
nese firms become established in small but growing
third markets-such as the Pacific Basin, China,
South America, and India-future entry by US
firms may become more difficult. The failure of US
automakers to compete in these markets will give
the Japanese another uncontested profit source,
leaving US firms even more vulnerable at home.
Additional linkups between European and Japanese
companies would increase the competitive problem
for US producers both in Europe and at home.
The current balance of market shares in Europe is
not stable-major changes can be expected unless
further government support is forthcoming to aid
ailing companies. Such aid, however, will further
delay the much needed rationalization of European
production capacity, hurting the profitability of US
producers in the region. Moreover, as the Japanese
circumvent European trade restrictions through
foreign investment, overcapacity and price pres-
sures on European and US automakers will contin-
ue to increase. Current agreements indicate that
the assembly of Japanese cars in Europe will at
least triple to 400,000 units by 1990.
The impact of these trends go far beyond the auto
industry. Because of its sheer size, a healthy auto
industry has the ability to spur development of a
variety of other technologies, often bringing those
technologies to market long before they would
otherwise be commercialized. Japanese efforts in
robotics, advanced materials, and electronics, for
example, have been pulled along by applications in
their auto industry. Because sales to this sector are
so large, technology vendors can gain valuable
production experience and achieve economies of
scale, which in turn facilitate rapid application of
these products in other industries. Automotive ap-
plications of advanced composite materials, for
example, will likely support the development of
special tooling and production experience for apply-
ing similar materials in the next generation of
military and commercial aircraft.
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United Kingdom: Thatcher
Pressured on Unemployment
election, which must be held by June 1988.
Prime Minister Thatcher's failure to alleviate Brit-
ain's severe unemployment has intensified domestic
dissent over her economic policies, despite improve-
ment in most economic indicators. The ruling
Tories are split: moderates advocate that the Prime
Minister tone down her harsh conservatism and
spend more, while rightwingers are wedded to their
original course and want, instead, tax cuts and
fundamental reductions in the welfare state.
Despite strong pressures to show
progress on unemployment, we do not expect the
Prime Minister to make any major policy shifts. As
a result, the unemployment rate is likely to remain
in double digits for several years, and the problem
is certain to be the major issue in the next national
Economic Progress
Prime Minister Thatcher continues to emphasize
the overall improvement the British economy has
shown over the past several years:
? Real GDP growth averaged 2.5 percent in 1982-
84 and probably will register 3.5 percent this
year.
? Inflation dropped from almost 12 percent in 1981
to only 5 percent last year. Despite a recent
acceleration, London will probably be able to
hold the inflation rate for the year to less than 6
percent.
? Industrial production, which had slumped 12
percent during the 1980-81 recession, has gradu-
ally gained momentum since mid-1983 and is
projected to grow about 6 percent this year. In
addition, business profits rose 20 percent in both
1983 and 1984.
? Britain's trade deficit, which had worsened con-
siderably during the coal strike in 1984, has been
declining since May.
Thatcher also can take credit for a number of other
economic successes. She quickly resolved the pound
sterling crisis earlier this year; weathered the year-
long miners' strike that effectively weakened the
unions' power in the heavy industry sector; in-
creased government revenues by more than $8
billion from the sale of state-owned industries; and
started eliminating excessive redtape to spur pro-
ductivity and job creation.
Critics Focus on Unemployment
Nonetheless, election results and opinion polls show
that all of this good economic news is overshadowed
by unemployment. Gallup surveys indicate that 80
percent of the population consider unemployment
to be the most urgent problem currently facing
Britain. The recovery has not created enough new
jobs to compensate for the increasing size of the
labor force. Unemployment-5.7 percent in 1979,
the year Thatcher took office-hit 13.2 percent in
August 1985. The worst hit areas in northern
England and Wales are experiencing levels as high
as 22 percent. Moreover, the time a worker remains
unemployed has lengthened dramatically over the
last few years, and now more than 40 percent of the
unemployed have been out of work for more than
one year.
Secret
DI IEEW 85-037
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United Kingdom: Economic Indicators,
1981-86
Real GDP Growth
Percent
Industrial Production
Index: 1980=100
-2 1981 82 83 84 85~~ g6a 95
Consumer Price Growth
Percent
Public Sector Borrowing
Requirementsb
Billion pounds
0 1981 82 83 84 85 ~~ 86
Unemployment Rate
Percent
Trade Balances
Billion pounds
,~ Forecast.
b Data arc for financial year beginning 1 April of the year stated.
Groups of all philosophical and political persua-
sions-including businessmen, the Trades Union
Congress (TUC), Tory moderates, the SDP/Liberal
Alliance, the Labor Party, and academics-sharply
criticize what they call Thatcher's laissez faire
attitude and offer proposals for reducing unemploy-
ment. Dissident Tory leaders, concerned about
what they describe as "the defeatism over unem-
ployment that has been polluting the political at-
mosphere of this country," founded a private think
tank in May~alled the Employment Institute-to
recommend solutions. Opposition leaders have
scored points by claiming, as one put it, that
"today's Tory Party is a government with a policy
of deliberate unemployment."
In a statement of economic priorities released
jointly with the TUC in August, the Labor Party
promised to make job creation its top priority as
soon as it returns to power. Labor Party leaders put
the budget cost of unemployment (lost taxes as well
as paid benefits) at $25 billion a year. Simulations
of our econometric model support Labor's claim.
The Labor Party proposes greatly increased spend-
ing on infrastructure and job training and wants
the government to play a major role in research and
development and the management of trade.
At the same time, the Prime Minister must respond
to arguments from her rightwing Tory allies, who
remain committed to cutting the role of govern-
ment in the economy in order to promote private-
sector job creation and who say Thatcher must go
even further in her drive for major reforms. Vari-
ous organizations have published figures illustrat-
ing that, despite her rhetoric, Thatcher often does
not adhere to her tight fiscal and monetary targets.
Since 1980, for example, growth in the money stock
sterling M3 has substantially overshot the target
ranges. Similarly, London exceeded the planned
Public Sector Borrowing Requirement (PSBR) by 2
billion pounds in the 1983/84 financial year, and
most forecasters strongly doubt the government's
ability to meet the 1985/86 target. Rightwing
critics point out that total public spending in real
terms in the 1984/85 financial year was more than
9 percent greater than in 1979/80 and that spend-
ing has gone up in all major areas-defense, educa-
tion, health, and social services.
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Thatcher's Response
Thatcher continues to insist that the government
cannot attack unemployment directly. She main-
tains that the government must follow policies
aimed at holding down inflation and reducing
government spending as a share of GDP in order to
provide an economic climate conducive to growth
and job creation. She and Chancellor of the Exche-
quer Lawson dismiss calls for more expansionary
fiscal policy, contending it would result in higher
inflation, not higher output. Lawson also has re-
buffed business demands for an immediate sharp
cut in interest rates.
Nonetheless, Thatcher announced a series of job
creation measures earlier this summer, including:
? Using state funds to encourage economic develop-
ment in depressed areas.
? Removing youth from minimum wage controls.
? Eliminating some of the administrative and tax
burdens faced by small businesses.
? Doubling the amount of money made available to
the National Coal Board for creating jobs in pit
closure areas.
London also is touting its plan to reform Britain's
generous welfare system as an important effort to
reduce unemployment. Thatcher has repeatedly
claimed that present welfare programs discourage
work and hamper economic recovery. The govern-
ment is calling for the phasing out of the State
Earnings-Related Pension Scheme, a heavily subsi-
dized program created by the Labor government in
1978 to supplement the flat-rate universal pension,
and the elimination of payments such as death and
maternity grants, for which all citizens are now
automatically eligible regardless of income. London
wants to encourage the growth of private-sector
pension plans and make pensions more flexible to
facilitate regional and occupational mobility.
Thatcher has promised that savings in public
spending would be translated into tax cuts, which
in turn would stimulate business, consumer spend-
ing, and job creation.
We believe Thatcher will not make any major fiscal
or monetary policy shifts in the coming budget
year. Not only does she firmly believe that her
present economic strategy is the correct one, but
she also does not want to appear to be wavering or
succumbing to criticism. Nonetheless, she is likely
to become somewhat more accommodating to com-
plaints from both the left and right. She probably
will accept some additional spending for job cre-
ation and social and health services to improve her
image, provided enough money is still left over to
permit limited tax cuts.
Under this generally steady policy course, however,
we believe the chances of unemployment falling
significantly in the next few years are slim:
? Demographic trends will continue to place up-
ward pressure on the unemployment rate. The
UK Department of Employment recently doubled
its projections for the rise in the labor force in the
1985-87 period to 200,000 a year.
? Most forecasters expect a slowdown in economic
growth next year, with output growing by about 2
percent a year in 1986 and 1987.
? Government training programs are often poorly
coordinated with industry and reap little benefit.
According to press reports, 60 percent of gradu-
ates from youth training programs fail to either
enter the work force or continue their education.
? Finally, high unit labor costs-which the
Thatcher government has blamed for much of the
unemployment problem-have failed to come
down despite London's attempts to limit the
growth of public-sector wages and reduce the
national insurance contribution employers must
pay for low-paid workers.
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Failure to show progress on the unemployment
front by the middle of 1986 would, in our view,
badly hurt Thatcher in the next election. Her only
hope would be to convince voters that the policies of
the opposition parties would be even less successful
in creating new jobs and would be detrimental to
the overall economy.
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Bolivia: Courageous Attempt at
Economic Reform
In a major attempt to break the inflationary spiral
now reaching the 14,000-percent level, Bolivia's
new President Paz Estenssoro has announced a no-
nonsense austerity program to put the failing econ-
omy back on a firm footing. Faced with his first
major challenge, a nationwide strike in opposition
to the program, the President has stood firm. Paz
Estenssoro has the support of the military high
command in countering public unrest, and opposi-
tion political parties are withholding criticism:
Nonetheless, the government still needs to reform
the monetary system and develop a strategy for
attracting international financial support. On the
basis of Bolivia's lackluster record in sustaining
reform, we believe that strict adherence to the
austerity package will be necessary to restore inter-
national confidence. As austerity cuts living stan-
dards, moreover, we expect additional political
challenges to the reforms.
Tougb Stabilization Measures
Paz Estenssoro wants to stem hyperinflation by
reducing the public deficit, which equaled 23 per-
cent of GDP in 1984. The program announced on
29 August includes:
? A four-month freeze on public-sector wages and a
proposed two-thirds cut in public-sector employ-
ment to 100,000 by the end of the year.
? Import restrictions were lifted and a flat 10-
percent tax was levied on foreign trade transac-
tions to replace complicated and corruption-prone
customs duties.
? A promise to halt subsidies to unprofitable state
enterprises.
? A removal of price controls to revive production
and reattract goods being diverted to the black
market.
? The decontrol of interest rates and reestablish-
ment of dollar-denominated bank accounts to
attract investment capital back to the banking
system.
? A 93-percent devaluation of the peso to encour-
age exports.
? Establishment of a biweekly auction of foreign
currency to maintain a realistic exchange rate.
The US Embassy reports that the IMF has reacted
favorably to the program, which may set the stage
for a formal IMF agreement later this year. Until
then, however, lack of hard currency reserves will
prevent La Paz from lifting the debt moratorium
the Siles government imposed last year. In the
meantime, the government is depending on sales of
gold reserves, exports of an estimated $60 million
worth of stockpiled minerals, and international aid.
According to the US Embassy, Argentina has also
agreed to speed payments for Bolivian natural gas
sales, which are currently $40 million in arrears.
The initial economic impact of the shock treatment
was positive. After a quick spurt in the cost of
staple products, prices retreated, resulting in an
inflation rate only slightly higher than the average
during the two months before the program was
announced. Despite removal of price controls,
black-market exchange rates have fallen 27 percent
to 1.1 million pesos per dollar, roughly equal to the
Central Bank auction rate.
income from import duties is already
up substantially.
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According to a recent academic study, all of'the
following elements have been required to stop hyper-
inflation, defined as price rises in excess oj50 percent
per month:
? The introduction of a new currency and a reform of
the central bank, with absolute limits on the
amount of credit it may grant specified in the
constitution or by international agreement.
? A reduction in state expenditure and an increase in
tax revenue to lower the budget deficit to a level
that can be borne by the capital market. Deficits of
public enterprises should be eliminated by setting
prices to cover costs.
? Long-term rescheduling o.J'external debts with a S-
to 8-year grace period on interest and amortization
payments and an immediate ii~'usion oJ.foreign
credit to cover existing,joreign payments problems
until tax revenues are revived via.fiscal reforms.
? Freeing the exchange rate and lifting any exchange
controls and import and export restrictions. Exces-
sive customs duties and export subsidies should be
gradually rolled back.
? The credibility ojthese measures is typically in-
creased if they are implemented by a new
government.
To date Bolivian price developments parallel a
pattern described in this study that indicates that
prices tend to stabilize quickly once a comprehensive
program is implemented.
The Disparate Domestic Reaction
Competing factions of the powerful Bolivian Work-
ers Central (COB), the largest labor confederation,
closed ranks in rejecting the austerity measures.
Labor denunciations of Paz Estenssoro's program
culminated in a general strike on 3 September.
Bracing for more radical protests, Paz Estenssoro
declared the strike illegal and threatened to fire
striking government workers and to arrest labor
leaders. While the COB has received strong sup-
port among miners and factory workers, govern-
ment workers are wavering and the US Embassy
reports the strike may be winding down.
Anticipating these challenges from labor, the Presi-
dent was reportedly careful to solicit support from
the military high command before the program was
announced. With this key backing, he has placed
the Army on alert to support the National Police in
containing worker unrest. The armed forces-on
direct orders from Paz Estenssoro-have taken
control of airports, petroleum processing facilities,
electricity plants, and telecommunications installa-
tions
Opposition leaders have made little public com- .
ment since the beginning of the general strike,
probably an indication that they. are waiting to see
whether Paz Estenssoro will be able to sustain his
program. Nevertheless, according to US Embassy
sources, the initial private reaction of Bolivia's
political leaders was generally positive, despite
concerns over the impact of the public-sector wage
freeze. Officials of the leading conservative party-
which holds the greatest number of opposition seats
in Congress-give the program high marks. The
leading leftist opposition party says the plan may
promote economic development, but has called for
the Cabinet to submit to Congressional question-
ing.
Paz Estenssoro's program-a major shift from the
statist policies Bolivia has recently pursued-con-
tains essential elements for breaking the inflation-
ary spiral as a first step toward regenerating the
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economy. Several shortcomings are still apparent,
especially the absence of any currency reform or
new legislation to limit the government's ability to
print money or extend credit. In addition, it is
unclear to us whether the new administration has
the technical expertise necessary to carry out the
complex program.
Although the government is now securing interna-
tional approval for its program, it still has been
unable to arrange new foreign aid or trade credits
necessary to bolster its hard currency reserves.
Based on Bolivia's lackluster record in sustaining
reform, we believe that strict adherence to the
austerity package will be necessary to restore inter-
national confidence. Until then, the new adminis-
tration will need to scramble to secure concrete
international support to avert a sharp drop in
imports.
Paz Estenssoro's reform measures are intended to
reinvigorate the private sector, but we doubt that
entrepreneurs, long frustrated by government inter-
vention, will develop confidence quickly enough to
pick up the slack created by massive public-sector
layoffs. Moreover, the revival of the private sector
will be dependent on labor cooperation, and this is
unlikely without a wage compromise. We believe
Paz Estenssoro has room to maneuver on wages,
and, in fact, some concessions will result. The
Planning Minister has announced that the Cabinet
is open to dialogue on the wage issue, the first
indication of its willingness to compromise.
We believe Paz Estenssoro's willingness to use the
military to quell unrest and the likelihood of contin-
ued armed forces backing for the next few months
mean he will not back down on the major elements
of his program, even though its severity is likely to
result in continuing confrontation with radical la-
bor elements. Widespread public sentiment that
drastic economic measures are needed is likely to
discourage effective, large-scale labor protests as
the weakened COB, struggling to save face, moves
toward compromise. The President's success in
walking the narrow line between firm implementa-
tion of austerity and flexibility in gaining domestic
acceptance of the program will provide an impor-
tant indication of whether he has the leadership
skills necessary to overcome his weak political base,
gain international backing, and continue the con-
solidation of democratic rule in Bolivia.
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Iranian Oil Company The National Iranian Oil Company (NIOC) continues to come under attack
Under Pressure from the Iranian Parliament (Majles) because of its inability to increase oil
revenues. In August, managing director Seyed Kheradmand was fired after
defending NIOC oil pricing and sales decisions before the Majles Petroleum
Committee He is the third senior official to
leave NIOC since May. Kheradmand's successor will have similar difficulties
because the Majles expects NIOC to increase oil revenues while supporting
official OPEC prices, an impossible task in the current soft market.
to seek new gas customers beyond its traditional West European buyers.
Algerian-Brazilian The possibility of Brazil importing 1 billion cubic meters per year of liquefied
Gas Deal in Doubt natural gas (LNG) from Algeria is receding as a result of opposition from the
Brazilian state oil company Petrobras. We believe Petrobras fears losing its
monopoly position as well as future outlets for its offshore gas discoveries
should the July 1985 preliminary agreement between the Sao Paulo state gas
company and the Algerian state company, Sonatrach, move forward. To
counter the Algerian proposal, Petrobras has increased the amount of gas on
offer to Sao Paulo from 280,000 cubic meters per day to 600,000 cubic meters
per day beginning in 1987. Despite this setback, we expect Algeria to continue
Turkish-Soviet Turkish negotiators returned from Moscow without signing a contract for the
Gas Deal Stalled purchase of up to 1.5 billion cubic meters (bcm) annually beginning in 1987,
projected to rise to 6 bcm in 2000. Disagreement centered on pricing terms.
The Turks maintained that the agreement in principle of September 1984
permits complete payment in Turkish goods, but the Soviets insisted on partial
payment in hard currency. If the deadlock is broken, Turkey could become
dependent on the Soviets for about 95 percent of its natural gas consumption,
albeit only about 5 percent of its total energy requirements. Moreover, the gas
is initially slated for industry and electrical utilities which could readily switch
to alternative fuels. The two sides are to meet again later this month, and An-
kara may be forced eventually to drop its insistence on a full barter deal.
Ankara has decided to solicit international
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dragging in making aproposal.
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Lebanese Fuel In an effort to force the Lebanese Cabinet to cut petroleum subsidies, the
Crisis Looms Ministry of Finance has stopped paying for imported crude and product. The
move could result in considerable confusion, gasoline shortages, and rapidly
rising fuel prices in the coming weeks. The Director General of the Ministry
told the US Embassy that fuel imports are costing the government over $60
million a month and that about 25 percent of the locally produced and
imported petroleum products are being reexported to other Mediterranean
countries. He commented that the Ministry was prepared to leave petroleum
marketing to the black market, if necessary, to get fuel prices to reasonable
levels. Some fuel shortages developed last week when fighting and kidnapings
in Beirut caused the suspension of petroleum deliveries. Moslem militias have
threatened renewed fighting if the situation, which they accuse the Christians
of creating, does not get better. If the Finance Ministry's plan works, the
Moslem militias may again accuse the Christians of plotting against them and
resort to shelling.
Problems Mounting Manila is seriously considering mothballing the recently completed $2.1 billion
With Philippine nuclear power plant in Bataan Province, west of Manila. Communist Party
Nuclear Power Plant front groups are capitalizing on widespread popular opposition to the plant and
in June sponsored a general strike against the facility. Furthermore, in recent
months Communist insurgents have damaged 28 of the transmission towers
leading from the plant. The plant-long plagued by safety concerns, spiraling
construction costs, and allegations of a $35 million kickback to a business
associate of President Marcos-is unlikely to begin operations in the next
several years. The military admits it cannot defend the transmission towers.
Mothballing the facility will be costly, however. The plant added over $1.9
billion to the country's foreign debt, costs $275,000 a day in interest payments,
and was to be a key element in Manila's strategy to reduce oil imports.
Fourth Taiwan Taiwan has decided to postpone the construction of its fourth nuclear power
Nuclear Power plant. The project launched persistent debate over the extent of Taiwan's
Plant Postponed future electricity needs and about coal as an energy source. The three existing
nuclear plants, one of which was damaged by a fire in July, met 40 percent of
the island's demand for electricity last year. The postponement, coupled with
the closing of unsafe coal mines, will place a greater burden on electricity
production using imported coal, oil, and natural gas. Potential sales of at least
$1 billion in US equipment for the nuclear plant over a multiyear period would
have helped to narrow the trade deficit with Taiwan-expected to be about
$11 billion this year.
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China Power Chinese) negotiated a barter
Generation Equipment arrangement for the purchase of four 500-megawatt coal-fired generators from
Imports the Soviet Union. China will supply wheat, soybeans, and other agricultural
products as payment for the generators to be used in two power plants near the
Pingshuo coal mine, aSino-US joint venture. The sale satisfies one of the
provisions of the Sino-Soviet long-term economic and technical agreements
signed earlier this year, and accounts for one-fifth of China's planned imports
of 10,000 MW of thermal power generation equipment during the Seventh
Five-Year Plan (1986-1990). The Chinese are also negotiating similar
barter/countertrade deals with Czechoslovakian and Romanian suppliers and
have expressed interest in such arrangements with US firms.
New Panamanian World Bank officials told President Barletta last week that Panama will not
Financial Pressures receive an expected $60 million structural adjustment loan this year because of
insufficient progress on required labor and industrial reforms. Completion of
IMF and commercial bank deals, moreover, is tied to World Bank approval.
Demonstrations by organized labor against international lending require-
ments-including one in the Legislative Assembly last week-underscore
Barletta's difficulties in securing economic adjustments. If the financial
program comes apart, Panama will face further cuts in imports, a deepening
recession, and higher unemployment. Public and legislative resistance has
stalled Barletta's austerity package for 1 I months, and the World Bank's
action is likely to fuel nationalist resentment of international financial
institutions. Barletta is certain to press his appeal for emergency US aid. His
failure to secure the necessary funds-either through reforms or aid-will
make him more vulnerable to removal by the military, which looked to him to
bring the economy under control.
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Yugoslav Agreement Yugoslavia has accepted the terms proposed by commercial banks to resched-
on Bank Reschedulings ule payments for debts totaling $3.5 billion that are due in 1985-88. These
creditors are offering to reschedule payments over 12 years with afive-and-a-
half-year grace period, at an interest rate of 1.125 percentage points over
LIBOR. The spread for the reschedulings in 1983 and 1984 is to be reduced by
one-quarter and one-eighth percentage points, respectively. Belgrade undoubt-
edly views the agreement as a victory. After months of protracted negotiations,
the banks made several concessions, including lowering interest rates and
renegotiating the 1983 and 1984 agreements. Belgrade probably believes the
agreement will improve its chances of a multiyear rescheduling from official
creditors early next year.
Global and Regional Developments
EUREKA Joint
Venture
Threatened
Secret
13 September 1985
The first joint venture planned under the French-initiated EUREKA program
on high-technology cooperation may be in jeopardy
giving EUREKA an embarrassing early failure.
project agreed to earlier between France's Matra Group and Norway's Norsk
Data to produce high-performance scientific computers. Recently, however,
officials of the state-controlled French computer firm, Bull, have complained
that the Matra-Norsk Data project is likely to lure French scientists away
from their company. Senior Matra officials are now worried that Paris will
withdraw support. The French Government has tried to persuade Matra and
Norsk Data to include Bull in the project, but Matra-unwilling to lose its
competitive edge to a state-owned rival-is resisting. The inability of West
European countries to agree on the structure or overall financing of EUREKA
has already heightened industry's skepticism of the program, and further
French pressure on Matra and Norsk Data could sour their deal completely,
France announced last June that it would finance under EUREKA a
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Central American Threats by the US Congress to restrict textile imports are causing much
Concern Over US concern among political leaders and potential foreign investors in the Caribbe-
Textile Legislation an and Central America. Specifically, import restrictions could reduce benefits
of the CBI Recovery Act's 807 Program that assesses only value-added duty
on US goods processed overseas and imported back into the United States.
Costa Rica fears losing its
quota-free status and is preventing Asian firms from using Costa Rica to
circumvent US textile quotas. Panama also is worried because Asian countries
have been caught using Panama to circumvent US textile quotas. Caribbean
and Central American officials argue that including their regions in the
proposed legislation would seriously injure the fragile economies of the region.
This could lead to political instability and retaliation against US interests,
including debt-servicing slowdowns.
Developed Countries
Tokyo Restricts Early this month, MITI designated South Africa a "special nation" for export
Export Insurance insurance purposes, a move which will increase the cost of insuring exports to
for South Africa South Africa by about 20 percent. The decision also allows MITI to decide
whether to provide export guarantees on a case-by-case basis. Many Japanese
banks are refusing to provide insurance under the new regulations. Although
the bank's reaction will reduce trade somewhat, we believe the effect will be
limited because exporters can deal on a cash basis or assume the risk
themselves. We believe, however, Tokyo will follow the US lead on trade
sanctions because Japan does not want to be seen as undermining US policy.
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Japanese Domestic In an attempt to dampen US criticism, Tokyo is seeking measures to stimulate
Demand Measures domestic demand in ways that would reduce the trade surplus. In a recent
meeting with US Embassy officers, a senior official suggested he would
welcome US views on such measures. In addition, Prime Minister Nakasone
last week ordered that a special study be produced by the end of the month to
indicate macroeconomic measures that could have an immediate impact on
Japan's bilateral surplus. The timing of these moves reflects widespread
Japanese concern over possible US Congressional action this fall. They also
probably show Nakasone's desire for concrete progress on the trade front
before his planned visit to Washington next month. Disagreement still exists
among Japanese officials on many of the measures under consideration, with
consensus only on tax incentives for housing investment. Even if agreement can
be reached on broader initiatives, however, they are unlikely to have much
short-run impact on trade figures and many Japanese officials continue to view
export restraints as the only viable alternative.
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Secret
Canadian Banks
Oppose
Deregulation
loosen controls on the banking industry.
Ottawa's attempt to partially deregulate financial services is being opposed by
the Canadian banking community, concerned about its exclusion from the
market-freeing proposals. The planned initiatives outlined earlier this summer
propose permitting trust, loan, and insurance companies to set up financial
holding companies that could offer a full range of financial services. The plan,
however, does not include amending the Bank Act, which prohibits banks from
offering trust or investment services. As a result, banks would not be able to
compete on an even footing with the holding companies. Ottawa, however, is
not likely to review the Bank Act any time soon because it fears the six largest
chartered banks-which account for more than one-third of private lending-
would dominate the financial sector if restrictions on their operations were
loosened. In addition, bank deregulation would ease restrictions on foreign-
largely US-banking operations, a step likely to provoke opposition by
economic nationalists in the Tory and opposition parties. Moreover, the recent
collapse of two Canadian banks has further intensified Ottawa's reluctance to
3 3 Secret
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French Budget The 1986 draft budget presented by the government last week will not
Remains Austere significantly change the budget deficit, and we anticipate it will have a neutral
impact on economic growth, which will probably be 2.0 to 2.5 percent in 1986.
Government spending in real terms is scheduled to remain flat, thus the share
of government in GDP will fall. The Ministry of Industry suffered the largest
cutback-a drop in real expenditures of about 20 percent-in response to both
the improved financial health of firms and the Socialists' desire to reduce
subsidies. The Ministry of Interior's budget was increased by about 18 percent
as part of a program to modernize the police. Defense spending will increase
only marginally in real terms. On the revenue side, the tax rate on retained
earnings will be reduced from 50 to 45 percent, and-as announced earlier-
personal income taxes will be cut by 3 percent. Tax brackets were also
corrected for bracket creep, a standard French adjustment.
Australian Unions Prime Minister Hawke's Labor government this month has yielded to trade
Triumph in union demands in semiannual national wage negotiations. Treasurer Keating
Wage Talks agreed last week to give union members pay raises equal to the annual rate of
consumer price inflation. This reversed earlier promises to trim pay increases
to preserve export competitiveness gains since January as the Australian dollar
depreciated about 20 percent. In addition, Keating agreed to increase retire-
ment benefits for union workers in July 1986 and cut income taxes beginning
in September 1986. Hawke's concessions will ensure industrial peace and boost
Labor Party-trade union relations in the near term. Since the plan covers
several years, the move also will reassure foreign investors and foreign
exchange traders about the stability of the Australian economy. Nevertheless,
there will be substantial economic and political costs-increased inflation, a
loss of international competitiveness in manufacturing, and a growing percep-
tion by businessmen that the unions, rather than the Hawke government,
control the economic policy agenda.
Less Developed Countries
LDC Debtor Growth According to current estimates of the major econometric consulting firms, real
Estimates GDP in the key LDC debtors will grow about 2 percent this year and 3 percent
in 1986. Of this group, Brazil and Mexico are expected to perform best,
achieving growth of 3 to 5 percent through 1986. The consulting firms
anticipate negative growth in Argentina and the Philippines for this year with
slight recovery starting in 1986. The other key debtors are expected to grow
just 1 to 3 percent during 1985-86.
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i3 September 1985
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Key LDC Debtors: Projected
Real GDP Growth, 1985-86
Percent
1985
1986
DRI Wharton
Chase
Average
DRI
Wharton
Chase
Average
Key debtors
1.8
2.3
Argentina
-2.7 -5.6
-I.1
-3.1
2.5
1.0
-0.2
1.2
Brazil
3.1 3.5
5.7
4.1
4.0
3.9
3.6
3.8
Chile
1.6 2.2
2.3
2.0
3.6
0.2
3.5
2.4
Mexico
2.9 3.6
3.9
3.4
3.7
3.9
4.9
4.1
Nigeria
- 1.9 2.9
0.5
1.7
0.3
3.0
3.0
2.1
Peru
3.7 NA
2.7
3.2
3.0
NA
0.1
1.5
Guatemalan Five days of rioting in Guatemala City following the announcement of busfare
Economic Adjustments increases is likely to be used by the Mejia government to justify a hold on
Put on Hold economic adjustments prior to presidential elections on 3 November. Chief of
State Mejia, according to US Embassy reporting, believes the risk of social un-
rest outweighs the need for policy reform. The government-in consultation
with the IMF-is preparing an economic package to be introduced after the
election but before the civilian president takes office in January, according to
the Minister of Finance. Although the government and the IMF may reach
agreement on the need for a sharp devaluation, deficit reduction measures will
be more difficult, given strong private-sector opposition to even modest tax
increases. Moreover, Mejia's decision to back down on the busfare hikes and
promise public-sector wage increases will make it all the more difficult for a
newly elected civilian government to make and sustain unpopular adjustments.
Barbados' Severe The Barbadian economy-formerly one of the Caribbean's few strong per-
Economic Problems formers-faces no more than 1-percent growth in real GDP in 1985, following
four years of decline. As a result, real output at yearend is likely to remain
more than 5 percent below the 1980 peak. According to the Central Bank, the
sharp drop in foreign exchange earnings is largely due to continued low world
sugar prices, the country's leading export. Manufacturers also are losing sales
because of intraregional trade disputes and high wages that have deterred
foreign investors. Moreover, the strong US dollar is continuing to hurt tourist
receipts as travelers opt for more affordable European vacation spots. To cover
the island's financial shortfalls and stem the economic decline, the government
has borrowed heavily at home and abroad; external debt increased from
$132 million in 1980 to $360 million in early 1985. Meanwhile, unemployment
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has soared to over 19 percent-a 10-year high-adding to Prime Minister St.
John's political woes. Continuing economic difficulties will boost chances for
an opposition victory in the next national elections, constitutionally due by
March 1986.
Nigeria Seeking President Babangida plans to send a delegation to the United States and other
Western Assistance Western nations to request economic assistance and explain Nigeria's willing-
ness to cooperate with the IM Babangida
told the US Embassy that he plans to hold a national debate on the IMF issue
to gain support for an agreement.
Western receptiveness to Nigerian overtures will influence the regime's
willingness to implement reforms recommended by the IMF. The previous
government's excessive anti-IMF rhetoric probably has inclined Babangida to
calculate that he must gain some tangible economic benefits-such as
immediate access to new long-term credits-if he is to win public acceptance
for a Fund agreement.
More Moroccan Morocco unexpectedly increased prices for most basic foodstuffs by 11 to 40
Austerity percent last week to set the stage for IMF negotiations and Paris Club debt re-
scheduling, according to the US Embassy. This should improve Rabat's
bargaining position with both the IMF and Paris Club creditors during talks
beginning this week. Government officials have put security forces on alert to
limit chances for public unrest like the food price riots of January 1984.
Nevertheless, disturbances are possible if opposition political parties and
various trade unions can formulate coordinated responses. Moreover, Moroc-
co's youth return to school soon, heightening prospects for disturbances.
Kuwait To Cut Kuwait will cut its proposed foreign assistance programs by 40 percent to $900
Foreign Aid million, according to Foreign Minister Sabah al-Ahmed. The Kuwait Fund-
which distributes all except emergency aid-will reduce grants but will
continue to make loans to countries that support the Kuwaiti positions on
international issues. The government decision to cut foreign aid probably was
prompted by falling oil revenues-down by half since 1979. Cuts which would
seriously affect key Arab aid recipients-Jordan, Syria, and the PLO-are
unlikely because of Kuwaiti fear of terrorist reprisals. Kuwait, however, may
reduce oil aid to Iraq once revenues from the Saudi-Iraqi spurline begin to flow
later this fall.
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l3 September /985
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Secret
Soviet Ministerial A Soviet official has told US Embassy sources that General Secretary
Consolidation Gorbachev is planning to combine three entire agricultural ministries and
portions of two others into a single "super ministry." The new organization,
said to be similar to those currently existing in the republics of Georgia and
Estonia, reportedly may be established by year's end. Gorbachev hinted at
such a reorganization in a speech in June and indicated that it would serve as a
model for the other economic sectors. A reorganization of the sort described
would help to overcome some of the bureaucratic infighting and lack of
coordination that have hampered the agricultural and other sectors of the
economy. Like past attempts to streamline the increasingly cumbersome
ministerial structure, however, the reorganization almost certainly would
provoke fierce resistance from the bureaucrats affected. Gorbachev's apparent
determination to proceed reflects confidence that he enjoys sufficient political
momentum to push it through.
Surge in China's China's money supply grew 50 percent in 1984, according to belatedly released
Money Supply official statistics, with 80 percent of the increase in the fourth quarter. The in-
crease has caused China's official inflation rate to more than double so far this
year and lies behind many of Beijing's other recent economic problems,
including excessive industrial growth, runaway capital construction, and
skyrocketing imports. The money supply increase occurred because of reforms
that granted local banks more autonomy to approve loans without proper
guidelines or a mechanism to ensure repayment. The accidental leak of a
government decision to base 1985 credit allocations on 1984 loan totals added
to the fourth-quarter surge. Since March, Beijing has raised interest rates, set
tight credit limits for banks, and increased sales from state-run stores to soak
up excess cash. Credit tightening has not yet slowed China's rapid industrial
growth or dampened consumer spending, but it apparently has created credit
shortages in some rural areas.
The money supply statistics-with their implications of financial mismanage-
ment and bungled reform policies-are politically damaging to Deng Xiao-
ping's reform coalition on the eve of the party conference. Chinese officials are
now pressured by the need to restrain credit to combat inflation, while
ensuring that rural areas have adequate funds to purchase the fall harvest.
Recent press reports, however, suggest~Beijing remains committed to continu-
ing its tight-money policy.
37 Secret
l3 September 1985
Declassified in Part -Sanitized Copy Approved for Release 2011/12/08 :CIA-RDP88-007988000200030006-3
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Declassified in Part -Sanitized Copy Approved for Release 2011/12/08 :CIA-RDP88-007988000200030006-3
Secret
Secret
Declassified in Part -Sanitized Copy Approved for Release 2011/12/08 :CIA-RDP88-007988000200030006-3