INTERNATIONAL ECONOMIC & ENERGY WEEKLY

• Document Type: CREST
• Collection: General CIA Records
• Document Number (FOIA) /ESDN (CREST): CIA-RDP88-00798R000200070005-0
• Release Decision: RIPPUB
• Original Classification: S
• Document Page Count: 42
• Document Creation Date: December 22, 2016
• Document Release Date: July 28, 2011
• Sequence Number: 5
• Publication Date: October 11, 1985
• Content Type: REPORT

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Directorate of
Intelligence
International
Economic & Energy
Weekly
DI IEEW 85-041
11 October 1985
Copy 6 8 3
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International
Economic & Energy Weekly
iii Synopsis
1 Perspective-Mexico: Financial Implications of the Earthquake
3 USSR: Good Grain Crop Cuts Import Needs
15 West Germany: The Gap in Computers and Microelectronic
Components
23
25
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26
Energy
International Finance
Global and Regional Developments
National Developments
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Comments and queries regarding this publication are welcome. They may be
directed to Directorate of Intelligence
Secret
DI IEEW 85-041
11 October 1985
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International
Economic & Energy Weekly
Synopsis
1 Perspective-Mexico: Financial Implications of the Earthquake
Notwithstanding the human tragedy of Mexico's disaster, the effect on the
economy should be minimal. Meanwhile, Mexico City is trying to take
advantage of the disaster by linking their external debt problems to rebuilding
efforts
year to meet its estimated domestic needs.
The recent conclusion of a rescheduling agreement with Western governments
has done little to brighten Poland's financial outlook. Difficulties will increase
next year as more repayments of principal on previously rescheduled debt fall
due.
13 LDC Income Tax Reforms: Promise and Pitfalls
Although the IMF is recommending higher taxes to reduce budget deficits in
some debt-troubled LDCs, several developing countries are considering income
tax rate reductions to bring about greater economic growth and expanded
government revenues through broader tax compliance. Nonetheless, such
efforts could fail to produce the anticipated economic growth unless accompa-
nied by fundamental improvements in the tax administration and collection
process.
3 USSR: Good Grain Crop Cuts Import Needs
With the harvest nearing completion, the USSR appears headed for a grain
crop this year of some 200 million tons, it best since the 1978 record of 237
million tons. The good crop year also means that Moscow would need to
import only about half of the record 53 million tons of grain purchased last
15 West Germany: The Gap in Computers and Microelectronic Components
West Germany-a distant third behind the United States and Japan as an
exporter of computers and microelectronic components-faces major obstacles
in trying to close the gap. While the overall gap will remain large for the fore-
seeable future, West German firms have had good success in applying
microelectronics to the production process and in incorporating microelectron-
ics into finished products.
iii Secret
DI IEEW 85-041
11 October 1985
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The National Unity Government's campaign to curb Israel's triple-digit
inflation has focused on reforming the wage indexation system. Indexation is
not the sole problem, and the government must take stronger measures to cut
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International
Economic & Energy Weekly
Perspective Mexico: Financial Implications of the Earthquake
Notwithstanding the human tragedy of Mexico's disaster, the effect on the
economy should be minimal. Only 2 percent of the city sustained major
damage, and there was no significant effect on the country's industrial base or
oil production facilities. Although cost estimates of the destruction are
sketchy-the US Embassy estimates about $2-3 billion- we expect Mexico
City to receive substantial rebuilding assistance from insurance claims and
international relief funds. In the short term, the reconstruction effort will even
create jobs and will stimulate economic activity.
Public criticism of the government's handling earthquakes relief will dampen
the administration's apparent resolve to reduce the deficit this year
licymakers fear that cuts in key subsidies at a time when
Mexicans are still reeling from the devastation of the earthquake would cause
widespread public resentment. Because President de la Madrid appears to
recognize that a postponement will sharpen the eventual trauma of economic
reform and constrain new lending, however, we believe he is likely to resume
belt tightening as soon as possible.
The de la Madrid administration is using the disaster to strengthen its case for
financial assistance and new lending. The country's immediate hurdle of
meeting a $950 million amortization payment eased as bankers, realizing they
had little choice, reluctantly agreed to Mexico's request for a six-month
deferment. Mexican officials blamed
their inability to pay on the earthquakes, although they acknowledged that the
economy was already in very poor shape. Based on our estimate of Mexico's
foreign exchange reserves, however, we believe they had already planned to
delay payment prior to the disaster. Meanwhile, Mexico City has informed
international banks that, as a result of the earthquakes, its new money
requirement has grown to $5 billion, almost twice the previous estimate.
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International bankers are willing in the near term to pursue a nonconfronta-
tional approach in recognition of the high degree of emotion surrounding the
tragedy and growing charges by Latin debtors that banks are making excessive
demands on their already strained economies. We believe that since bankers
view the earthquake damage as a short-term crisis, however, they soon will
return to pressing for the long-term structural changes that they believe are
necessary to solve Mexico's economic problems. Mexico City realizes that
banks view a new IMF-supported program as a prerequisite for new lending
and has announced its intention to sign another agreement with the fund-de-
spite concern that this would fuel domestic opposition to de la Madrid's
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USSR: Good Grain Crop
Cuts Import Needs
With the harvest nearing completion, the USSR
appears headed for a grain crop this year of some
200 million tons, its best since the 1978 record of
237 million tons. Prospects are also good that the
production of forages-a major livestock feed-will
reach an alltime high, allowing for further in-
creases in livestock products. As a result, total
agricultural output in 1985 probably will exceed
the 1983 record. Production at this level will
improve supplies of quality foods-and enable Gen-
eral Secretary Gorbachev to claim credit for get-
ting the Food Program back on track. The good
crop year also means that Moscow would need to
import only about half of the record 53 million tons
of grain purchased last year to meet its estimated
domestic needs. US grain sales to the USSR during
the marketing year that began on 1 July may
plunge by more than 50 percent from last year's
peak of some 22 million tons
An Improved Harvest
Given normal weather for the rest of the season, the
1985 Soviet grain crop is likely to be about
20 million tons larger than both last year's estimat-
ed output and the estimated average for 1980-84.1
The US Department of Agriculture currently fore-
casts the crop at 190 million tons. Estimates by
other Western grain analysts range from 180 mil-
lion to 200 million tons.
Despite this favorable outlook, several bouts of hot,
dry weather in important growing regions, and the
continuation of the downward trend in the area
sown to grain have cut the potential size of this
' The 200-million-ton figure is our best estimate of the 1985 Soviet
grain crop, but one that is subject to error. On the basis of our
analysis of best and worst case scenarios, there is a 90-percent
probability that the crop will come in between 190 million and
210 million tons, and a 75-percent chance that it will range between
year's grain crop by some 25 million tons' These
losses, however, are much smaller than in the past.
Since 1978, we estimate that the combination of
adverse weather and declining grain hectarage has
cost Moscow an average of roughly 55 million tons
of potential grain output annually.
The outlook for forage crops is excellent. According
to Soviet data, forage procurements as of late
September were running 5 percent ahead of the
record 1983 pace. Given this performance, we
believe that unless the weather deteriorates mark-
edly in the coming weeks, forage production will set
a new record this year. Since harvested forages
comprise slightly more than one half of the nutrient
content of the Soviet livestock ration, the outlook
for feed supplies is quite good.
Remaining Uncertainties
Although available evidence thus far suggests that
the 1985 Soviet grain crop will be the largest since
1978, there remains some uncertainty regarding its
exact size. In the unlikely event that excessive
rainfall occurs during the final few weeks of the
harvest campaign, combining operations could be
seriously hampered, leading to losses in both grain
quantity and quality. Moreover, because the har-
vest is running about one week late, slightly more
grain than normal would be lost if an early snowfall
precluded its completion. The latest Soviet harvest
progress report indicates that a maximum of some
10 million tons of grain are at risk.
' The cutback in grain area appears to be a consequence of
Moscow's policy to greatly expand the amount of arable land put
into fallow. Between 1977 and 1984, the harvested grain area of the
USSR declined steadily from a record high of 130.4 million
hectares to 119.6 million, while fallow increased from 11.7 million
Secret
DI IEEW 85-041
11 October 1985
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1976-80
Average
RSFSR
113.9
78.0
99.5
112.0
94.5
112.0
Ukraine
43.1
38.2
42.0
39.0
44.5
43.0
Kazakhstan
27.5
23.8
19.5
25.0
17.5
21.0
Other
20.5
18.0
19.0
19.0
22.5
23.0
By crop
99.7
81.0
90.0
80.0
77.0
88.0
Coarse grains c
95.1
68.0
80.0
102.0
92.0
99.0
Other d
10.2
9.0
10.0
13.0
10.0
12.0
a Measured in bunker weight, that is, gross output from the
combine, which includes excess moisture, unripe and damaged
kernels, weed seeds, and other trash. For comparison with US or
other countries' grain output, an average discount of 11 percent
should be applied.
b The USSR has not published overall grain production or yield
statistics since 1980. Total grain production in 1981 was unofficial-
ly reported at 158 million tons. Data for Kazakhstan for 1981 and
1982 are official. All other figures represent our estimates.
c Coarse grains comprise rye, barley, oats, corn, and millet.
d Other grains include pulses, buckwheat, and rice.
A number of factors, on the other hand, could boost
this year's grain production above 200 million tons,
perhaps by as much as 10 million tons. We estimate
that the amount of grain growing on land that was
previously fallow increased again this year, con-
tinuing the upward trend begun in the late 1970s.
Although fallowing sacrifices production in the
year in which the land is idled, it usually results in
higher, more stable yields in subsequent years.
In addition, Moscow almost certainly will realize
some benefit from a large-scale program in inten-
sive wheat cultivation that is being undertaken on
some 17 million hectares-nearly 15 percent of the
area sown to grain. According to
Soviet press reports, Moscow has pur-
chased large amounts of Western insecticides, her-
bicides, and fungicides in an attempt to raise
average wheat yields by 1 ton per hectare on the
intensively cultivated areas. Because of the experi-
mental nature of the program, we have been con-
servative in incorporating potential gains into our
200-million-ton figure. We believe that problems
with deliveries of the chemicals to farms and with
field applications will hold this year's results well
below the planned increase of 16-18 million tons.
Nevertheless, we judge that gains of 5 million tons
or more are possible because many of the test areas
experienced favorable growing conditions this year.
Soviet Grain Requirements and Imports
Reduced Grain Needs. This year's crop, coupled
with more efficient livestock feeding practices,
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Estimated Soviet Grain Yields, Late September 1985
Estimated yield a
Average
'VOLGA- '
VVATKA
Soviet Union
aBased on USAF weather dot
Sweden
KAZAKHSTAN
Limit of major grain-growing region
. Lake
Balkhash
Tne Undid Sretee Go.ernmanr nee nor recognized
the incorporerion of Estop s, L.-.. -d L,lh..n,.
-o the SO-1 Union Other boonderefapresentehon
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means that Soviet grain import needs during the
current marketing year (1 July 1985-30 June 1986)
will be down sharply from a year ago. Last year,
the USSR imported roughly 53 million tons of
grain, a new record. Assuming a 200-million-ton
grain harvest this year, Moscow would be only
25-30 million tons short of the quantity of grain we
believe necessary to maintain recent levels of seed,
food, and industrial use, and to sustain growth in
the production of meat and dairy products. This
figure could be somewhat less if livestock feeding
efficiencies continue to improve, as we believe
likely
Slack Grain Buying Activity. Soviet grain pur-
chases thus far in MY 1985/86 are running well
behind last year's record pace. By the end of
September, Moscow had lined up only 12-13 mil-
lion tons of grain for shipment during the current
marketing year compared with about 24 million
tons a year ago. Moreover, the USSR reportedly
has bought only 2.7 million tons of US corn, in
marked contrast to last year at this time when total
purchases from the United States already stood at
over 12 million tons. Moscow has yet to buy US
wheat, despite high-level Soviet assurances given to
Agriculture Secretary Block in late August that it
would buy the remaining 1.1 million tons of wheat
called for under the US-USSR grain agreement
before 1 October.
The USSR's reduced grain-buying activity proba-
bly reflects more than just lower import require-
ments. World grain markets are soft-prices are at
their lowest level in several years and exporters are
anxious to sell off stocks-thus putting Moscow in
a good bargaining position. Moscow's ability to
play the market is somewhat limited, however, by
long-term grain agreements (LTAs) and protocols
with the United States, Canada, Argentina,
France, Brazil, and Eastern Europe that commit
the USSR to buy some 20-23 million tons of grain
in MY 1985/86.?
' Recent actions indicate that Moscow may be readjusting its
thinking on LTAs in light of the growing competitiveness of world
grain markets and its own long-term hard currency outlook. For
example, in negotiations with Argentina-competing for a larger
share of the Soviet market-Moscow has resisted pressure to
Grain Exports to the USSR, 1976/77-1984/85
1976/77- 81/82 82/83 83/84 84/85
1980/81,
The slow buying to date does not necessarily mean
that imports during MY 1985/86 will fall to the
25- to 30-million-ton minimum implied by estimat-
ed domestic needs. Purchases of this magnitude are
already virtually assured because of LTAs and
recent trading patterns that suggest the Soviets
probably will buy another 6 million tons of grain
outside LTA obligations. Given the favorable mar-
ket situation for grain buyers, however, Moscow
could choose to import even larger amounts of
grain and thereby expand the livestock sector be-
yond plan or add more grain to stocks. Even so,
estimates of up to 41 million tons by grain traders,
who generally see a somewhat smaller Soviet grain
crop, currently appear to be high.
Few Import Constraints. The USSR should en-
counter few constraints-either financial or logis-
tic-importing the amounts of grain it needs this
marketing year. Although hard currency earnings
probably will be down about 10 percent-as a
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result of lower oil and gas revenues-Moscow may
be able to offset part of these losses through
increased exports of gold, diamonds, and platinum.
In addition, world grain prices are low, Western
credits and loans are readily available, and grain
imports from India and China-perhaps 2-3 mil-
lion tons-are largely on a barter basis. As for
logistics, the massive grain import program in MY
1984/85 proved that the Soviets have greatly re-
duced the transportation bottlenecks that previous-
ly curtailed grain shipments to the USSR.
Implications
The prospect of a sizable drop in Soviet grain
imports during the current marketing year means
that US sales to the USSR will fall well below the
record 22.3 million tons exported last year. While
some additional purchases of US corn are likely in
the near term, Moscow could remain out of the US
wheat market for several more months given the
large global supplies of exportable wheat. If so, US
wheat prices-already at low levels-could decline
further. Moreover, total US corn exports could be
hurt should Moscow begin substituting low-priced
wheat-from the United States or other export-
ers-for corn
The USSR's potentially best agricultural year ever'
has some favorable implications for Soviet consum-
ers as well as for General Secretary Gorbachev.
The drop in per capita food supplies that occurred
in 1984 should be remedied this year, giving new
momentum to the Food Program. Higher quality
food on Soviet tables almost certainly would boost
worker morale and productivity. Meanwhile, the
possibility of a cutback in grain imports of up to
50 percent from a year ago means that Moscow
could save as much as $2.5-3 billion in hard
currency outlays. Such savings would help offset
the expected downturn in hard currency earnings
this year. For example, Moscow should now be in a
position to make fewer cuts in imports of high-
technology goods than otherwise would have been
necessary.
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Poland: Financial Crisis Continues
The recent conclusion of a rescheduling agreement
with Western governments has done little to bright-
en Poland's financial outlook. Warsaw will be hard
pressed to meet the payments required under this
agreement and others made with banks. Poland
probably will not achieve its planned hard currency
trade surplus for 1985, and creditors remain reluc-
tant to extend enough loans to cover the financial
gap. Difficulties will increase next year as more
repayments of principal on previously rescheduled
debt fall due. The regime probably will try to
bridge the gap by favoring payments to banks over
governments with the hope that the Paris Club-as
in the past-will not declare default. Another
option is a request for further rescheduling of
repayments due on the 1981 and 1982 agreements.
Poland signed an agreement with the Paris Club of
17 Western government creditors in July-after
more than a year of talks-to reschedule the more
than $10 billion in principal and interest due during
the period 1982-84. By eliminating Warsaw's mas-
sive arrearages to Western governments, the agree-
ment was a vital step toward normalizing relations
with creditors. The two sides had initialed terms in
January, but formal signing was delayed when
Warsaw tried to obtain new credits from the
governments and failed to make required payments
on arrears from the 1981 rescheduling agreement.
The Poles claimed that without new credits they
could not meet payments required under the agree-
ment. Warsaw signed the accord only after West-
ern creditors agreed to reconsider the situation if
problems develop.
The Paris Club agreement carries very generous
terms. The overdue debts were rescheduled for 10
years with a five-year grace period ending in 1990.
Half of the interest due this year was rescheduled
Total
Paris Club
Of which:
Arrears
9,717
11,649
Banks
1,185
1,570
2,014
Other
1,963
420
712
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over four years; subsequent interest payments will
be paid in full when due. To implement the agree-
ment, the Poles must pay 50 percent of the 1981-83
interest arrears on the 1981 rescheduling agree-
ment-about $200 million-and conclude bilateral
agreements with the individual governments. War-
saw must also come up with approximately
$1 billion in interest payments due this year under 25X1
two previous rescheduling agreements with the
Paris Club. New credit commitments will be decid-
ed between Poland and Western creditors during
bilateral talks in the coming months
Financing Shortfall
We believe Warsaw lacks adequate resources to
meet these payments plus its obligations due under
bank rescheduling agreements. Excluding the near-
ly $12 billion in debt relief from the Paris Club, we 25X1
estimate that Poland can come up with only $2.4-
2.6 billion this year compared with Warsaw's pro-
jection of $3.6 billion. The Polish estimate for a
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hard currency trade surplus of $1.5 billion appears
overly optimistic-the surplus in the first eight
months of 1985 was $613 million, about $350
million less than the same period last year. War-
saw, so far, has not cut imports as in past years to
meet its goal. Imports during January-July were up
about 11 percent, while exports to the West de-
not consider either of these as reserves, Warsaw
probably could draw upon some of this money if
forced to do so.
1985 Obligations
creased 2.5 percent.
Requests to Western governments for $600-800
million in new credits have produced only minimal
results:
? By the end of August, Austria had signed a
bilateral rescheduling accord with the Poles and
provided $20 million in new commodity credits-
less than 15 percent of Warsaw's original re-
quest-and a $20 million extension of an existing
line of credit for agricultural items.
? France signed a bilateral agreement in late Sep-
tember. While Paris did not announce any new
credits, it previously had hinted that it might
grant about $10 million.
B
Whst Germany may grant $30 million and Swit-
zerland $20 million if bilateral accords are
signed.
The 'Japanese, Danis , an panish Governments
claim they will extend no new credits.
Bilateral accords with several other countries are
held up over which interest rate would apply, and a
few countries are undecided on granting new credit.
Warsaw, in addition, may have some hidden pay-
ment reserves that do not show up in the projections
provided to creditors. Private savings include about
$1.2 billion in hard currency deposits in domestic
state banks, including $340 million put in earlier
this year as a result of increased interest rates and
incentives for travel. Moreover, data from the Bank
for International Settlements (BIS) showed Polish
deposits in Western banks at $1.6 billion in March
1985; Warsaw claims these are "working balances"
for banks and enterprises. Although the Poles do
Even with the rescheduling of 1982-84 debt and
assuming the rescheduling of all 1985 maturities,
Poland this year owed about $3.1 billion, leaving a
financial gap of $500-700 million. In addition to
payments to the Paris Club, Warsaw owed bank
creditors $1:6 billion and other creditors over $400
million. Through the end of the year, payments due
to governments and Western banks totaling $1.4
billion will be particularly difficult to meet.
The Poles already have failed to clear all the
interest arrears on the 1981 government debt. As a
result, the September Paris Club meeting to final-
ize the 1985 rescheduling accord were postponed
concerning the 1982-84 accord as well as bilateral
talks with several governments.
Financial Situation orsens in 1986
We believe the gap between sources of financing
and payments due will widen next year. Warsaw
will owe about $4.8 billion next year assuming
Western governments reschedule almost $1 billion
due in principal and interest on original maturities.
Banks and Paris Club governments are due about
$2 billion each under previous rescheduling agree-
ments, and other creditors are owed $700 million.
The bank payments include $568 million in repay-
ment of principal under the 1981 agreement and
$316 million from the 1982 accord, while repay-
ments to the Paris Club include $550 million in
principal due from the 1981 agreement
We estimate that Poland probably can pay only
$3.6-3.8 billion next year. Nonetheless, the Poles
project covering all payments. We believe Warsaw
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Polish Estimate
CIA Estimate
Polish Estimate
CIA Estimate
Total
3,917
15,264
14,064-14,264
5,202
3,622-3,822
Earned b
2,035
1,900
1,500-1,700
2,050
1,700-1,800
Hard currency trade
1,456
1,500
1,200-1,400
1,650
1,400-1,500
Exports
5,828
6,300
5,700-6,100
6,850
6,000-6,400
4,372
4,800
4,500-4,700
5,200
4,600-4,900
396
500
400
500
.400
183
-100
-100
-100
-100
1,882
13,364
12,564
3,152
1,922-2,022
218
1,000
200
1,830
600-700 c
240
815E
815E
440
440
a Polish financial data.
b Earned payment capacity equals the current account balance
excluding interest.
c Assumes $400-500 million in credits from the IMF.
d Separate agreements during the bank rescheduling accords of
1982, 1983, and 1984 provided that certain percentages of interest
payments be relent in the form of short-term loans.
e Net figure: The Poles received $1.18 billion in revolving credits in
1984 but repaid $940 million.
f Warsaw plans to use $465 million in bank credits in 1985 and
carry over $350 million from last year.
s The bank rescheduling of July 1984 covered payments due
between 1984 and 1987.
h Includes rescheduling of about $10.3 billion due in 1982-84, and
$1.4 billion due in 1985.
forecast by $150-250 million.
is once again being overly optimistic in its projec-
tions of the trade surplus. Warsaw is estimating
that 1986 exports will increase by 9 percent and
imports by 8 percent. Based on 1985 performance,
however, exports are likely to rise only half that
amount, mainly due to a continued lack of raw
materials and quality goods to sell in the West.
Imports probably will be lower than planned be-
cause of the lack of hard currency revenue. Thus,
the trade surplus is likely to fall short of Warsaw's
In addition, Poland is not likely to receive the large
amount of credits projected for 1986. Warsaw is
counting on readmission to the IMF and hopes to
obtain over $1 billion in new credit from that
source next year. Warsaw, however, most likely
will have access to no more than $400-500 million
in IMF loans after entry. To receive more than this
amount, Poland would have to negotiate and ad-
here to a stabilization program. Such negotiations
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Secret
probably would be long and difficult, and would
require the support of workers whose continuing
demands for increased consumption would conflict
with the austerity needed to improve Poland's
capacity for debt repayment. Since lifting martial
law, the regime has backed away from austerity
policies out of concern over provoking worker pro-
test. Poland is not likely to receive much credit
from Western governments next year-Warsaw
has requested over $2 billion-because most gov-
ernments will continue to regard Poland as uncre-
ditworthy.
Warsaw's Options
While the recent Paris Club agreement has created
the impression of progress, Warsaw continues to be
mired in a financial crisis. The lack of funds to
make rescheduling payments will force the regime
to make some choices:
? Pay the banks, not the governments. The Paris
Club allowed Poland to run up arrears of more
than $10 billion in 1982-84 without calling War-
saw in default. As a result, Poland most likely
will delay payments to Paris Club members.
Moreover Warsaw
has implied it would favor banks over govern-
ments, even if payment problems arise. While
arts Club memhPrc mnc+ Uvi, mild they have no real leverage over Warsaw.
? Keep pressing for new credits. Another round of
requests for loans from Western governments-
without more serious attempts by Poland to im-
prove its trade performance-is not likely to have
much success.
? Cut imports. The regime slashed imports in 1983
and 1984 to achieve hard currency surplus targets
when exports did not reach planned levels. War-
saw apparently is holding off on this option,
hoping exports will increase by yearend.
? Further rescheduling of the 1981 and 1982 bank
A rescheduling of the agreements would require the
cooperation of banks and governments in sharing
Poland's payments-which has not occurred to
date. If IMF reentry occurs in 1986, the Fund
could play a role in guiding future negotiations.
The IMF probably would press governments and
banks to provide more debt relief and new credits
before extending its own loans under a standby
program.
sis. Warsaw has not made the policy changes
In any case, these options will provide just another
short-term solution to an immediate financial cri-
necessary to stimulate hard currency exports and
escape the endless cycle of more credit and debt
reschedulings. An adjustment policy formulated by
the IMF in cooperation with the regime may offer
some hope of improvement, but any progress will be
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and 1981 government agreements. Creditors
would not welcome such a request, and,
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Warsaw has given no signals
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that it would ask for such a package.
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LDC Income Tax Reforms:
Promise and Pitfalls
Although the IMF is recommending higher taxes to
reduce budget deficits in some debt-troubled
LDCs, several developing countries are considering
income tax rate reductions to bring about greater
economic growth and expanded government reve-
nues through broader tax compliance. India has
already implemented such a plan, and as many as
seven other LDCs may do likewise in the next year.
Although the personal income tax comprises less
than 10 percent of government revenues in many
LDCs, these actions suggest that LDC govern-
ments are increasing their encouragement of pri-
vate-sector growth. Nonetheless, such efforts could
fail to produce the anticipated economic growth
unless accompanied by fundamental improvements
in the tax administration and collection process.
Without these, tax evasion could continue at a high
level, stifling needed revenue gains even if new
economic growth emerges. This could add to LDC
budget deficit woes while discrediting needed tax
reform in the Third World.
India Steps Ahead
India has recently implemented lower and less
progressive income tax rates in conjunction with
other important economic liberalization measures,
including some deregulation of production controls
and investment licensing. Embassy reporting indi-
cates that marginal income tax rates were lowered
across the board with the intent of encouraging
higher tax compliance and increased investments.
For 1985-86, the highest marginal personal income
tax rate was reduced from approximately 62 per-
cent to 50 percent, down from its 1973-74 high of
nearly 98 percent.
The comprehensiveness of the Indian economic
liberalization program has greatly boosted econom-
ic expectations. The US Embassy reports that the
overall program has created a widespread percep-
tion that the business climate in India will be less
constrained by government redtape and will offer
more and better opportunities for profitable invest-
ments. The US Embassy notes, however, that vol-
untary tax compliance in India has been almost
nonexistent-the roughly 1.4 million noncorporate
taxpayers represent only about 0.6 percent of In-
dia's families. The government has let it be known
that credibility of the tax reform program is at 25X1
stake and that failure to comply with tax laws may
lead to reversal of the recent concessions.
A Flurry of New Proposals Elsewhere
Partly in response to the publicity surrounding
India's program, several other countries plan to
implement, or are considering, similar income tax
rate reductions:
? Pakistan's Finance Minister Mahbubul Haq had
proposed a reduction of the top marginal rate
from 60 to 45 percent in the 1985-86 budget.
According to US Embassy reporting, he has
argued that lower tax rates will decrease tax
evasion while boosting savings, investment, and
economic growth. A national commission is due
to present a detailed review of the entire tax
system at yearend.
? Taiwan's Executive Yuan has agreed to a pack- 25X1
age of individual and business income tax
changes which, if implemented, would reduce the
top individual income tax rate from 60 percent to
between 45 and 50 percent, liberalize several
personal deductions, and reduce the number of
tax brackets from 15 to 12. Press reports indicate
that, if enacted, the entire income tax reform
package could initially reduce government reve-
nues by up to 3 percent.
Secret
DI IEEW 85-041
11 October 1985
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? Jamaica's June 1985 "Green Paper" on tax
reform, prepared with substantial US technical
ssistance, recommends that individual income
tax rates be cut, tax credits drastically simplified,
the number of tax brackets reduced, and the tax
base broadened. Under the plan, which the go-
vernment's Revenue Board seems to prefer, ac-
cording to the US Embassy, the Green Paper
proposes reducing the top rate from nearly 58
percent in 1985 to 40 percent in 1990. The Green
Paper, however, indicates that comprehensive tax
reform will not succeed without a major improve-
ment in the administration of the individual
income tax. Final government tax reform recom-
mendations go to parliament next January.
In his July inaugural address, Peru's President
Garcia announced that he would seek improve-
ment of the tax system, which now collects only
about 25 percent of taxes due, according to the
US Embassy. No more than one-third of the
work force files tax returns, and substantial un-
derreporting of income is commonplace. Garcia
has asked the Congress to increase the penalties
for tax evasion and has stated that his govern-
ment will no longer declare tax amnesties. The
US Embassy estimates that if only half of the
income taxes due were collected Lima could cut
its fiscal deficit roughly in half.
Egypt is considering a five percentage point
reduction in personal income tax rates for all but
the top bracket, which would drop from 80 to 70
percent. By so doing, the US Embassy reports, it
is hoped that a reduction in widespread tax
evasion might increase overall tax receipts. Under
a current USAID agreement, the Finance Minis-
try is now computerizing its tax evasion
monitoring.
Morocco plans to simplify its complicated tax
system as part of tax reforms scheduled for late
1985-86. The US Embassy expects this to include
equalization of tax rates on income from different
sources, a broader tax base, and no increase in
overall tax burden.
? Mauritius will cut personal income tax rates by
50 percent beginning next year, according to the
US Embassy. The government has slashed the
top rate from 70 to 35 percent, reduced the
number of brackets, and increased the level of
personal deductions. The Finance Minister de-
clared during his budget speech in June that an
excessive income tax burden has become a major
disincentive to work effort and risk taking.
We believe that LDC tax reform can spur econom-
ic growth and increase needed government reve-
nues while fostering development through broader
voluntary participation in a country's formal econo-
my, as the example of India suggests. Moreover,
social and economic pressures in numerous develop-
ing countries are likely to strengthen continued
attempts to restructure and simplify personal in-
come taxes in the Third World.
In our view, the most successful income tax reform
efforts are likely to occur in those countries, such as
India and Jamaica, where tax rate reductions are
part of a well-coordinated fiscal package incorpo-
rating improvements in administration and enforce-
ment as well as policy. Without basic upgrading of
tax administration and collection procedures, we
believe rate reductions alone are unlikely to wean
higher income taxpayers from traditional habits o
tax evasion. If so, these tax rate cuts may fail to
generate substantial additional revenues even if
economic growth is forthcoming. Such a demon-
strated fiscal failure could weaken the appeal of tax
reform for other LDCs in which reform might
otherwise fruitfully be implemented.
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West Germany: The Gap in Computers and
Microelectronic Components
West Germany-a distant third behind the United
States and Japan as an exporter of computers and
microelectronic components-faces major obstacles
in trying to close the gap. While Bonn and several
state governments have boosted funding for R&D,
the dearth of new, innovative firms, and continued
dependence on industry giant, Siemens, will proba-
bly limit progress. While the overall gap will
remain large for the foreseeable future, West Ger-
man firms have had good success in applying
microelectronics to the production process and in
incorporating microelectronics into finished prod-
ucts. As a result, West Germany will likely remain
firmly entrenched among the world's top exporters
of products dependent on microelectronics, such as
telecommunications, consumer electronics, office
machines, machine tools, scientific and medical
equipment.
OECD Exports of Microelectronic
Components and Computers
Billion
us $
Percent
Billion
us $
Percent
Total
3.5
100.0
30.3
100.0
United States
1.0
29.7
11.1
36.5
Japan
0.4
11.0
7.4
24.6
West Germany
0.4
12.5
3.1
10.1
United Kingdom
0.3
8.3
2.2
7.2
France
0.4
10.0
1.8
5.8
Italy
0.3
8.8
1.2
3.9
Netherlands
0.3
7.3
1.1
3.5
Sweden
0.1
3.3
0.6
1.9
Canada
0.2
5.4
NEGL
NEGL
Other
0.1
3.8
1.8
6.0
Why West Germany Failed to Keep Pace
In the mid-1970s Japan surpassed West Germany
as the second-largest exporter of computers and
microelectronics, and the Japanese lead has been
growing ever since. West Germany today holds less
than 1 percent of the world computer market and
remains dependent to a large extent on imports of
semiconductors from the United States and Japan.
West Germany's failure to keep pace with the
United States and Japan can be explained by five
factors:
? The continued dominance of large, slow-moving
corporations.
? The absence of either a German equivalent to
Japan's MITI, which has promoted and coordi-
nated the Japanese microelectronics industry, or
a large defense and space program, which has
stimulated the US industry.
? The lack of a true West European common
market, preventing the economies of scale needed
to absorb high R&D costs.
that inhibit high-tech firms in general.
Among the structural factors that have been partic-
ularly troublesome is a management style that
tends to slow the conversion of R&D into market-
able products. German management is generally
very conservative and risk-averse, puts relatively
little emphasis on marketing, and tends to ignore
mass production strategies. Such delays are partic-
ularly serious in electronics, where technological
change is occurring very rapidly. Moreover, after
long success With existing product lines, West
German managers developed an overconfident,
? A shortage of skilled manpower-rated by West
German manufacturers as their biggest obstacle
to using more microelectronics.
Secret
DI IEEW 85-041
11 October 1985
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Secret
even arrogant attitude toward foreign competition.
Chipping Away at the Gap
In addition to increasing financial and technical
assistance to promote R&D overall, Bonn last year
singled out electronics for a special five-year, $1.2
billion promotion program. A similar effort in the
mid-1970s had flopped because most of the funds
went to just the large companies, such as Siemens
and AEG, and the projects chosen were not aimed
at new markets. To avoid the same pitfalls, Bonn
assembled a group of industry organizations, re-
search specialists, and private companies to partici-
pate in the planning. Projects involving applied
research in integrated circuits, data processing,
telecommunications, and industrial automation will
be eligible for subsidies of up to 50 percent. More
recently, Research and Technology Minister
Riesenhuber announced another five-year program
worth about $130 million to promote R&D in
microperipheral technologies, which includes sen-
sors and power transistors.
State governments-which provide 40 percent of
government support-also are targeting electronics
with direct R&D subsidies, training and informa-
tion programs and technology parks. These
government-financed parks provide working space
and a variety of business services to lower barriers
for new firms. In the forefront of the promotional
efforts are Baden-Wuerttemberg and Bavaria,
which already host the vast majority of West
Germany's electronics firms.
Siemens and Nixdorf are taking their own steps to
close the gap. To expand its share of the semicon-
ductor market, more than 90 percent dominated by
the United States and Japan, Siemens opened a
major addition to a plant in Austria last November
that began producing 256K chips early this year.
Siemens claims the facility is the largest and most
modern microchip production plant in Europe and
will help narrow West Europe's microchip technol-
ogy gap, which it estimates at two years behind
Japan and six months behind the United States.
Last year Siemens also launched an ambitious
project with Philips of the Netherlands to develop
one- and four-megabit chips. Siemens's hopes that
this project would catapult it into the lead were
dashed when Toshiba recently came out with sam-
ples of a one-megabit chip. Siemens decided this
summer to purchase the Toshiba design and coop-
erate with Toshiba in chip development. With
Toshiba's help, Siemens now plans to begin selling
a one-megabit chip by 1986 instead of 1987 as
originally planned, and its 1989 target date for
four-megabit chips apparently still stands.
Siemens recognizes it must keep abreast of chip-
making skills that can be applied to the more
sophisticated microprocessors and other devices
needed to compete in telecommunications and of-
fice automation. Acquisition of US and Asian firms
figures prominently in its strategy. It has only a
bare toehold in the US-chip market now but re-
cently decided to build a new plant in the United
States devoted to gallium arsenide integrated cir-
cuit production. Siemens also is working with two
French firms-Thomson CSF and Matra-Harris-
on applications-specific integrated circuits, which
constitute a growing share of the world semicon-
ductor market.
Nixdorf's goals for the next four to five years, after
having already achieved 20-percent growth per
year over the past decade, are to double output, add
10,000 employees (a 50-percent increase), and de-
velop its telecommunications business to capitalize
on the growing integration between computers and
communications. Although receiving little in gov-
ernment support, Nixdorf is one of West Ger-
many's most successful companies, and
is today IBM's only serious
competitor in o ce computers in West Germany.
Despite a poor track record against the United
States and Japan, West Germany leads the rest of
the world as a supplier and user of computers and
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components. Siemens is the largest computer com-
pany outside the United States and Japan, and
Wacker-Chemie supplies the bulk of the world's
chip-making silicon. Siemens is the only supplier
outside the United States, Japan, and South Korea
of the 256K DRAM, the most advanced computer
memory chip in full commercial production. In
some areas, West German microelectronics tech-
nology is second to none, for example, in X-ray
lithography-a technology likely to permit the
microchip density needed in the 1990s.
West Germany is also a leader in factory automa-
tion-a field dominated by computer-assisted-
design, computer-assisted-manufacturing, and oth-
er microelectronic applications. According to a
recent study of West German, French, and British
factories, the West Germans use microelectronics
proportionately more in the production process.
The survey found 51 percent of West German
factories using microchips in the production pro-
cess, compared to 47 percent of British and 38
percent of French factories.
West Germany also is making progress in incorpo-
rating microelectronics into its finished products to
keep them competitive. In product areas increas-
ingly dependent on microelectronics, such as ma-
chine tools, office machines, scientific and medical
instruments, telecommunications equipment, con-
sumer electronics, and even automobiles, West
Germany remains solidly among the world's top
three exporters despite market share losses over the
past decade. West German exports are booming,
for example, in machine tools, where the fastest
growing portion of the market requires microelec-
tronic control units.
West Germany will not be able to close the gap in
computers and microelectronics as long as industry
advances are occurring so rapidly. The problems
that have led to the gap can be corrected only very
slowly if at all. While federal and state government
support for electronics is helping to encourage a
more dynamic and competitive West German com-
puter and component industry, Bonn realizes the
main impetus must come from the private sector.
Although formidable, Siemens and Nixdorf alone
cannot compensate for the dearth of new innovative
firms, which represents the biggest obstacle to
closing the gap. A more conducive climate for
company startups is taking shape in West Germany
but at too slow a pace to make a difference in the
medium term.
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Israel:
Inflation and Indexation
The National Unity government's campaign to
curb Israel's triple-digit inflation has focused on
reforming the wage indexation system. Because
indexation has taken much of the sting out of
inflation, successive Israeli governments have been
able to get by with stopgap measures that have not
realistically addressed other pressing issues. Index-
ation is not the sole problem, and the government
must take stronger measures to cut inflation, in-
cluding reductions in real government expendi-
The Inflationary Spiral
Israeli inflation-growing from the two-digit levels
in the early 1970s to 445 percent in 1984 and
currently running at about 275 percent (at an
annual rate)-has been caused by a series of exter-
nal shocks and government policies:
? Inflation during the 1970s was largely due to
increases in oil prices. The first oil price shock
alone increased Israel's oil import costs by an
amount exceeding 3 percent of its gross national
product. The second oil price hike in 1979 proved
even more damaging because of the loss of do-
mestic oil resources with the return to Egypt of
the Sinai oilfields.
? Excessive demand, fueled by government spend-
ing, has also been a major factor. Starting in
1977, Likud-led governments resorted to an ex-
pansionary fiscal policy to curry favor with Israeli
consumers, while pursuing such costly projects as
the expansion of settlements on the West Bank
and the invasion of Lebanon. Large annual bud-
get deficits were financed by either borrowing in
the private sector or by printing money. Further-
more, exchange rate policies designed to boost
exports also increased import prices.
? The lifting of capital controls at the end of 1977
added further impetus to inflation by allowing
Israelis to hold both foreign currency and foreign
bank accounts. In particular, Patam accounts-
dollar-linked shekel accounts-further increased
the money supply as the shekel fell against the
dollar.
Indexation of wages to the consumer price index
(CPI) has been an important-but not predomi-
nant-factor in the inflationary process. Indexation
was originally promoted as a mechanism to help
ensure social justice, but more recently, it has
become a political necessity to protect Israelis from
the ravages of triple-digit inflation. In the process,
indexation has expanded into virtually every aspect
of the Israeli economy:
? The current wage agreement-temporarily sus-
pended by wage-price accords-indexes wages at
80 to 90 percent of the previous month's increase
in the consumer price index.
? Pensions and welfare payments are fully linked to
the CPI.
? Most financial assets-such as long-term savings
accounts or government bonds-are partially or
fully linked to the CPI or some foreign currency.
? Taxes are fully linked to the CPI and adjusted on
a quarterly basis
Wage indexation does not by itself completely
protect Israeli workers from inflation. With indexa-
tion at less than 100 percent and applied with a
one-month lag, real wages theoretically would fall
and thus dampen demand. Normal promotions and
Secret
DI IEEW 85-041
11 October 1985
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Secret
the high level of success enjoyed by most labor
unions in securing additional wage boosts, however,
have combined with indexation to raise real wages
an average of 5.3 percent annually during 1977-83
Percent and was close to 1 percent last year, despite a sharp
400
Oil price
shock-return
of Sinai oil
300
fields Lebanon
Financial
invasion
liberalization
200
Oil price expansionary
shock fiscal policy
100
Package
Package deal I Austerity program
J F M A M J J A S 0
j4- 1984
Package
deal I1
Hn
D J
F M A M J J A
- 1985 -~
I I I I I I I I I 1 1
-30 A S 0 N D J F M A M J
1984 -h 1985
Such wage growth has discouraged the serious
social disruption typical of countries with triple-
digit inflation. Work actions are common but usu-
ally are mounted to press the government to adopt
tougher anti-inflationary policies, not for higher
wages. Because indexation has taken much of the
sting out of inflation, successive Israeli govern-
ments have been able to get by with stopgap
measures that have not realistically addressed other
pressing issues, such as reforms in monetary policy
and curbs on government spending.
An additional problem is that high wage growth
has not been matched by increases in labor produc-
tivity, ensuring that aggregate demand continues to
outstrip supply. Labor productivity grew by just 1.6
percent per year during 1977-81 and has steadily
dropped the past three years. Some of the main
factors contributing to this decline include:
? The hesitancy of employers to lay off workers for
fear of labor unrest or being caught short when
demand strengthens.
? High marginal tax rates that have reduced wor-
kers' incentives.
? The use of substantial blocks of work time to
juggle personnel assets and make purchases to
hedge against inflation.
Indexation also has contributed to resource misallo-
cations with investment a major casualty. With
most financial assets indexed, Israelis have been
unwilling to risk investing money in capital goods
with uncertain real rates of return. Real investment
fell more than 9 percent last year and is projected
to drop 10 to 15 percent this year, contributing to
poor productivity performance.
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Israel: Labor Productivity and Real
Wage Growth, 1977-84
15
12
9
Real wage
growth
F_
F1
3
0
Labor
productivity
Recent Indexation Adjustments
Since the first wage-price package deal in 1984, the
government has reached several agreements with
the Histadrut labor federation to revise the cost-of-
living-adjustment (COLA) formula. For a brief
period the indexation formula was reduced by one-
third, but more recently the COLAs have been
suspended outright. The government's agreement
to grant supplemental lump-sum wage payments,
however, has helped offset these losses. Nonethe-
less, real wage growth during the first nine months
of the coalition government was less than it would
have been without the revisions, and, since the
imposition of July's austerity program, real wages
have fallen to the level of about four years ago.
Moreover, the government recently gained Hista-
drut's agreement in principle to forgo further spe-
cial wage adjustments until 1 April 1986, when the
current public-sector wage agreement expires.
The government's recent adjustments to the wage
indexation formula are steps in the right direction,
but record July inflation of 27.5 percent and the
struggle to keep monthly inflation under the cur-
rent 4-percent target suggest that stronger mea-
sures are needed. Moreover, broad popular support
for current polices-as reflected in public opinion
polls-could wane in the coming weeks if workers
perceive that they are once again bearing the brunt
of austerity. To deal effectively with triple-digit
inflation, the government must enforce the entire
package of restrictive policies outlined in its July
program plus implement additional measures,
including:
? Freeing the Bank of Israel from monetizing
budget deficits. The Bank of Israel would then be
better able to coordinate monetary policy with
the government's inflation targets. Legislation
has been introduced to accomplish this.
? Additional reductions in real government expen- 25X1
ditures and going ahead with the planned dis-
missal of thousands of public-sector employees.
? Further indexation reform, especially of financial
assets to spur investment. Next April's expiration
of the current wage accord would be an oppor-
tune time for such an adjustment.
? New tax reforms designed to cut tax rates and
boost worker incentives.
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Energy
OPEC Meeting Ends OPEC ministers adjourned their two-day session last Friday after failing to
in Discord reach any new agreements. Six of the group's 13 members requested higher
production quotas, but, with Saudi Arabia unwilling, a compromise could not
be forged. Ecuador boycotted the last day of the session, vowing to reconsider
its membership. Failure to compromise on output quotas sets the stage for
members to increase production unilaterally. Prices might not weaken in the
near term, however, because of higher winter demand, and current uncertainty
about Iranian and Soviet oil exports. Although unlikely, if no further damage
is sustained at Khark Island, Iranian exports could begin to increase as early
as next month, renewing intense downward pressure on prices.
Iraq Lines Up Iraq has lined up customers for the 330,000 b/d of Basrah light crude to be ex-
Customers at ported over the last three months of this year via the recently completed Iraqi-
Iran's Expense Saudi pipeline. Iraq has won term contracts by pegging prices 40 to 60 cents
per barrel below spot prices on comparable crudes,
Japanese firms are buying most of the oil-up to 200,000 b/d. Iran
will be particularly irritated by Iraqi sales to Japan-Iran's most important
market-and may be compelled to match Iraqi discounts. Moreover, Baghdad
will probably try to convince Japanese firms and other Iranian customers that
it is a more reliable supplier considering Tehran's recent difficulties in
exporting oil from Khark Island.
25X1
2oA]
Restoration Continues Despite continued Iraqi attacks Iran is proceeding with restoration efforts on
at Khark Island the T-jetty on Khark Island. tankers at two T-jetty
berths with oil-loading arms in place and no new damage to any oil facilities.
25X1
the Ganaveh complex on the mainland shows new
pipelines being laid to the shoreline. that two pipes will run 25X1
to loading buoys in water deep enough for most tankers. The presence of the
tankers at these berths indicates that the southern portion of the T-jetty is now 25X1
at least partially operational, which doubles the previous capacity of Khark.
Exhorts of oil are now probably about 1 million barrels per day from Khark.
Ganaveh confirms that Tehran has begun to install an 25X1
alternate export facility that could add another 2 million b/d of capacity when
completed by mid-to-late December. 25X1
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DI IEEW 85-041
11 October 1985
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Secret
Norwegian Gas
Sales Negotiations
Soviet Gas to
West Berlin
not developed.
Negotiations for the sale of 15 billion cubic meters of gas per year from
Norway's giant Troll field to a consortium of West European buyers are
progressing, according to press reporting. Although agreement in principle has
been reached on volumes and on a 1995 startup date, price discussions have yet
to begin. West German industry officials believe a commercially acceptable
price, estimated by industry at $3.70 to $3.80 per million Btu, may not be suf-
ficient to cover the high development costs of the field. If so, Oslo may face
pressure to alter its production tax on Troll. Both Statoil, the Norwegian state
oil company, and the continental buyers, led by West Germany's Ruhrgas, are
optimistic, but past sales negotiations suggest talks could drag on much longer
than expected. If agreement is reached, continental West European depen-
dence on Soviet gas in the year 2000 could be reduced to about 30 percent of
consumption compared with a projected level of nearly 40 percent if Troll is
West Berlin's gas supply.
Siberian gas began flowing to West Berlin last week, as scheduled, under the
terms of a 1981 contract that calls for the annual delivery of up to 650 million
cubic meters. The contract runs to the year 2008 with optional five-year
extensions. The gas reaches the city via a new pipeline spur through East
Germany. An Allied precondition for the contract-which has been met-was
that West Berlin provide storage for one year's supply to guard against the
possibility of interruption. Although Soviet gas is expected to cover only about
8 percent of West Berlin's total energy consumption, it will account for all of
North Korea Faces The sinking of a North Korean oil tanker during an Iraqi attack on Khark Is-
Oil Problems land on 19 September will exacerbate longstanding energy shortages caused by
inadequate oil imports and a poorly developed electric power system. This loss
comes at an especially bad time, with fuel needed for the fall planting now un-
der way. The 225,000-ton tanker, was roughly twice the size of North Korea's
only other tanker and was used primarily to carry Iranian oil. The Iranian con-
nection has been very important because it has enabled P'yongyang to barter
arms for oil. Iran has supplied about one-third of North Korean crude, with
the remainder coming from the USSR and China.
Soviet oil production problems, Moscow may be unwilling to help out at this
time. China could easily assist, but its oil is heavier than Iran's and thus less
suitable for making the lighter products. For the longer run, P'yongyang
probably will want to buy another tanker, although its extremely poor credit
rating may make it difficult to do so.
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11 October 1985
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Guyana's Financial Guyana's severe foreign exchange bind threatens to further depress the
economy-1984 output was only 76 percent of the peak 1976 level-and
increase pressure on President Hoyte to find viable solutions as he gears up for 25X1
elections required by next March. In September, Trinidad and Tobago
suspended its oil credit facility because of Guyana's inability to pay arrears of
$217 million; future purchases apparently will be made in cash. 25X1
Meanwhile, worsening rice and petroleum shortages are like Ty to
undercut Hoyt's recent efforts to consolidate business and labor support, as
well as increase the chances of social unrest and increased repression.
EC Commission
Proposes To Cut
Steel Subsidies
Global and Regional Developments
The EC Commission took its first step toward a new steel policy by prohibiting
subsidies to the struggling industry except in specified cases. If the proposal is
approved by the Council of Ministers, as expected, subsidies after 1 January
1986 would be permitted only to help cover research and development, meet
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11 October 1985
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Secret
environmental regulations, or to assist plant closures. Under the current EC
steel program, companies have received about $4 billion annually as aid for re-
structuring. By sharply cutting back subsidies, the Commission hopes to
reduce excess production capacity, estimated by the EC at 20-25 million
metric tons, roughly 12 to 15 percent of the total. Tighter curbs on subsidies
will be only one element of the Commission's next steel program. Between now
Ind the end of the year, discussions covering price, production, and import
India's Increased
Economic Ties to Japan
controls will be held between the Commission and EC member states.
been increasing its economic aid to India.
India and Japan are moving to increase bilateral economic cooperation. In
mid-September Prime Minister Gandhi's economic adviser, L. K. Jha, went to
Japan to pave the way for the Prime Minister's visit in late November. In talks
with Japanese officials and businessmen, Jha stressed Indian hopes for
stronger economic ties, including increased Japanese investment and coopera-
tion in high technology. New Delhi believes Japanese technology could avoid
the potential political burdens of a similar relationship with the United States.
Japanese businessmen are keenly interested in New Delhi's hints that it will
liberalize trade and joint venture regulations, and reportedly have targeted
computers and telecommunications-which would put them in direct competi-
tion with US business interests. The Japanese Government, for its part, has
25X1
Possi le Japanese The fall session of the Diet, which begins next week, will consider measures to
Economic Stimulus ease trade friction by expanding domestic demand. The commitment to budget
austerity by Prime Minister Nakasone and the powerful Finance Ministry,
however, probably rules out sharp increases in government spending or major
tax cuts over the next year. The government instead is likely to reduce
regulations governing private business and introduce measures to encourage
private-sector financing of public works. Tokyo may also open some previously
Secret
11 October 1985
eveloped Countries
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ruling party leaders to bring on October trips to the United States.
restricted land to intensive real estate development, sweeten an existing tax
break on housing, and implement a small cut in personal income tax rates. We
believe the ruling party's recent announcement of a 17-point agenda for
expanding domestic demand-including government-financed public works,
major tax cuts, and an easier monetary policy-has little chance of passage
this fall and was intended largely as a public relations gift for Nakasone and
Revamping Japan's
Spring Wage Offensive
sized firms. Recent shuntos have granted these workers much smaller pay
ncreases than male permanent employees of large corporations who fare
Several Japanese unions are attempting to restructure the shunto-the annual
spring wage offensive-in an effort to increase wages in small and medium-
competitiveness.
Japan May Buy Tokyo is again debating the purchase of US grain for use as food aid for
US Grain LDCs. According to the US Embassy, Prime Minister Nakasone wants Japan
for Foreign Aid to buy 10 million metric tons of grain from the United States over seven years.
10 times Japan's food aid budget for 1984.
take the lead because they are in a better position to bargain than present ne-
gotiators, such as the steelworkers. A substantial change in the shunto is likely
to be difficult, however, because of opposition from unions at large companies
who realize increased wages for the smaller firms-principal suppliers for the
larger enterprises-will affect their own company's prices, sales, and export
membership is dropping. Although the details of the restructuring are still
being formulated, its proponents believe unions in high-tech industries should
ompanies from participating in union activity at a time when overall union
)etter because of seniority and sex differentials built into their wage system.
ome unions fear this wage discrepancy will discourage workers in smaller
Last March, Washington called on Japan to purchase up to 10 million tons of
wheat over four years-Tokyo bought 77,000 tons of US wheat for food aid
programs in 1984. Funding, however, continues to be the sticking point. A 10- 25X1
million-ton program would cost about $1.5 billion at current prices, more than
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11 October 1985
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project
Tokyo will likely gauge
Washington's reaction to overtures made during the high-level ruling Liberal
Democratic Party delegation's early October visit before deciding on the
West German Firms A number of West German firms are turning to European suppliers in an
Shunning US Suppliers effort to avoid problems with strict US export controls. Officials of MBB, one
of Western Europe's largest defense contractors, expressed strong concern to a
US official recently about a new US licensing procedure that, under certain
circumstances, could result in a US audit of a foreign firm's internal control
procedures. The officials cited two recent examples of large contracts MBB
awarded to French over US firms to avoid involvement with US export
controls. Also, they said the Airbus consortium-MBB is a major partici-
pant-gradually is reducing US content, now down to just 20 percent by value
for the new A-320 from 30-35 percent in the original A-300.
French Inflation
Continues Downward
Secret
11 October 1985
half because of weak demand and the traditional bunching of wage increases
in the first half. The prime rate has also fallen by over 1 percentage point since
the beginning of the year. If the dollar remains near its present level, the 12-
month inflation rate by yearend will be only slightly above the official 5-
percent target and well below the 6.7 percent recorded at the end of last year.
The 12-month inflation rate in August fell to its lowest level in over a decade,
5.6 percent, continuing an almost unbroken trend since late 1983. The
slowdown reflects falling prices of imported raw materials, down by over 16
percent in the first eight months, in part due to the depreciating dollar.
Moreover, the Socialist austerity program has helped hold wage increases to
3.2 percent for the first six months of 1985, as compared with 3.6 percent for
the same period last year. We expect wages to moderate further in the second
4
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Less Developed Countries
of critically needed bank funds.
Chilean Economic Recent steps to revive Chile's stagnant economy and defuse mounting popular
Stimulus discontent may endanger its IMF-supported austerity program. Public-sector
retrenchment-including sharply cut subsidies for refinancing mortgages and
for small business loans-had stalled growth in the second and third quarters
of this year. This, coupled with an annual inflation rate of over 35 percent, has
left much of the middle class near bankruptcy and threatens major social
unrest, according to Embassy reporting. In response, the economic team
recently boosted the money supply, delayed a devaluation, and invoked
protectionist measures to stimulate domestic growth by the end of this year.
Although these moves will provide short-term relief, they will likely worsen the
country's problems in 1986 by fueling inflationary expectations, provoking
capital flight, depressing domestic savings, and stimulating import demand.
Moreover, we believe Santiago will be forced to seek IMF waivers on its deficit
spending and foreign exchange reserve targets by early next year. This could
worsen already strained relations with its creditors and disrupt disbursements
likely early next year, after the debt deal is signed.
Labor Pressures President Lusinchi may soon have to take steps to address labor's intensifying
Venezuela's Lusinchi criticism of his economic stabilization program. Labor Federation head
Delpino, at the Federation's May Congress, complained about sliding real
wages, growing unemployment, and labor's unfair share of the austerity
burden. In August, he and other labor leaders attacked the proposed debt
rescheduling, saying that it would absorb needed domestic financing, and
demanded a renegotiation with creditor banks to obtain better terms. In
September, labor leaders called for increased outlays on public works,
government subsidies for 30 staples, and a shakeup of the economic cabinet.
Later in the month, labor leadership raised the specter of street demonstra-
tions. Last week Delpino issued a call for across-the-board wage increases.
Although we believe demonstrations are not imminent, the threat nevertheless
signals a tougher stance by labor. Lusinchi will likely attempt to appease
labor-a critical constituency-through such measures as an ambitious public
investment program, the continuation of price controls, and a promise of an
unemployment insurance program. While we do not believe that he will accede
to labor's wage and subsidy demands, changes in the economic cabinet are
investors to open factories in any product area and to invest in public-sector en-
terprises. The plan would also remove restrictions on private-sector imports,
allow unrestricted importation of hard currency, and encourage, partially
through Central Bank guarantees, investment by Arab states and Syrians
Syrian economy. the plan would allow private I 25X1
Syrian Economic The government has circulated a four-year economic reform plan that, if
Reform Plan implemented, would substantially expand the role of the private sector in the
29 Secret
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investment.
riving abroad. Despite initial approval by President Assad and the Cabinet,
these reforms will face stiff resistance from Bath Party socialists and public
enterprise managers. While the program would be a big step, the proposals
revealed so far do not address the major problem of exchange restrictions
which burden the whole system and discourage legitimate trade and foreign
Problems Over Saudi Defense Minister Sultan has exempted the military from a government
Saudi Budget Cuts order to cut the nonsalary allowances-overtime, per diem, and housing-of
all public employee The cuts, amounting to
about 20 percent of the total pay package, were ordered last spring in reaction
to a steep decline in oil revenues. Although Riyadh recently increased its oil
production and government spending is running below the $55 billion budget-
ed, Saudi Arabia will still have a large deficit this year. Sultan is trying to
avoid angering the military and to prevent the loss of skilled manpower to the
private sector. By exempting military personnel and pursuing an ambitious
military procurement program the government will have to look elsewhere for
spending cuts. Development projects are likely targets, because Riyadh will
proceed cautiously, if at all, in paring general subsidies.
Zambia Implementing President Kaunda announced on 4 October that the exchange rate of Zambia's
Major Economic Moves currency and the allocation of foreign exchange to importers will henceforth be
determined by a weekly foreign exchange auction.
These moves are the latest in a series of reforms begun in 1983 to re-
verse foreign payments deficits and the growth of foreign debt by reducing
import demand. Zambia's foreign exchange problems stem from a decline of
almost one-half since 1980 in copper exports, which account for 90 percent of
total Zambian exports. The auction may lead to a devaluation of as much as
75 percent against the dollar, according to press reporting.
Bangladesh
Foodgrain Prospects
Secret
11 October 1985
population growth rate.
Good weather and increased use of high-yielding strains have provided
Bangladesh with record foodgrain crops, according to the US Embassy.
Production of rice and wheat for FY1984-85 (July-June) is estimated to be a
record 16 million metric tons, despite the severe cyclone last May, and
projected to be 16.5 million tons this fiscal year. The Embassy predicts that
the bumper crops will reduce this year's commercial food imports by more
than 70 percent. Large government stockpiles, however, have depressed rice
prices for farmers. Over the longer term, Bangladesh will have to continue
major production gains to keep pace with its high 2.8-percent annual
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US-Thai Trade Dispute The US countervailing duty petition filed last month against rapidly increasing
Over Rice imports of Thai rice will heighten bilateral trade tensions. Following recent
Congressional proposals to cut imports of Thai textiles and other manufac-
tures, the petition undoubtedly will exacerbate Thai fears of reduced access to
its leading export market. Bangkok has been coping with a soft world market
for rice, the leading Thai export, by moving aggressively to increase export
volumes. As a result of attractive prices and improved quality, Thai rice is cut-
ting into traditional US markets such as Western Europe, Africa, and the
Middle East
Nepalese Economic
Problems
Rapidly growing imports are likely to precipitate a serious foreign-payments
problem this year. Foreign exchange reserves at the end of the fiscal year in
mid-July fell to $60 million, about one-half the previous year's level and
equivalent to less than six weeks of imports. A team from the IMF recently
found that a standby agreement is warranted. Targets for the standby are
likely to include a 10-percent reduction in the regular and development
budgets, an adjustment in the exchange rate, and other measures to increase
exports and reduce imports. India has agreed to provide immediately about one
fourth of a promised $40 million grant for road construction to help cover
imports until IMF funding is available. Nepalese government officials are
reluctant to implement austerity measures during the October-November
holiday season-particularly restrictions on purchases of consumer goods.
Moscow Searching for Concrete examples of General Secretary Gorbachev's strategy for accelerating
Hidden Economic short-term growth may be emerging.
Resources
Gorbachev's most promising sources for sustained short-term growth are more
intensive use of existing resources. Ordering cost reductions is another attempt
to find investment reserves for more efficient use elsewhere. Across-the-board
cuts in construction costs are probably in the cards for other ministries.
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Soviet Economic
Experiment Sharply
Criticized
An article in the prestigious literary journal, Novy Mir, has sharply criticized
the economic experiment introduced in 1984 for failing to attack the root
cause of Soviet economic ills-the USSR's system of central planning. The
article notes that a key element of the experiment-making fulfillment of
contractual sales obligations the principal yardstick for evaluating and reward-
ing enterprise performance-does little to ease the enormous waste of
resources characteristic of the Soviet economy, for example, the huge accumu-
lation of uninstalled equipment. The author also argues that the experiment,
while giving enterprises somewhat more autonomy over wage and investment
expenditures, will not promote technological innovation, to which Gorbachev
has given priority. This is one of several articles in the Soviet press in recent
months that are harshly critical of basic features of the Soviet economic
system. These critiques suggest that the regime welcomes debate even on
sensitive economic issues, as it struggles to formulate an economic reform
game plan.
Eastern Europe's Eastern Europe's surplus in its hard currency trade fell in the first half of the
Hard Currency Trade year to less than half that of the same period last year, reversing the trend of
steadily improving trade balances over the last several years. Even with the
economic recovery in Western Europe, East European exports fell by 4
percent. Imports rose by 6 percent as Eastern Europe increased purchases of
energy and raw materials. Eastern Europe's deteriorating trade performance, a
result of harsh winter weather and declining commodity prices, has forced
Bulgaria, Hungary, and Romania recently to seek loans. At the same time
several East European countries have increased their exports to the USSR,
possibly at the expense of hard currency sales. Declining export performance
will complicate Poland's struggle to make debt payments due later this year
and Yugoslavia's attempt to meet IMF foreign reserve targets.
Secret 32
11 October 1985
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Eastern Europe: Hard Currency Trade
January-June 1984 and 1985 a
Million US $
1984
1985b
Percent
Change
1984
1985
Percent
Change
1984
19856
Total
15,231
16,110
5.8
18,085
17,356
-4.0
2,854
1,246
Bulgaria c
1,153
1,274
10.5
1,483
1,335
-10.0
330
61
Czechoslovakia c
1,560
1,468
-5.9
2,160
2,004
-7.2
600
536
East Germany d
2,484
2,618
5.4
2,619
2,645
1.0
135
27
Hungary
1,994
2,313
16.0
2,450
2,213
-9.7
456
-100
Poland
2,152
2,246
4.4
2,957
2,835
-4.1
805
589
a Includes intra-CEMA hard currency trade.
b Preliminary.
c Estimates for trade with nonsocialist countries.
d Trade with OECD countries only. In recent years, East Germany
has run large surpluses with developing countries.
Beijing Devalues
Currency
China's State Administration for Exchange Control on 3 October announced a
modest devaluation to a record low of 3 yuan to the dollar. The yuan's value
against the dollar has declined by 46 percent since 1982, and is now 13 percent 25X1
lower than one year ago. China's currency is inconvertible, but the government
reportedly sets the exchange rate daily against an undisclosed basket of foreign
currencies. The devaluation is yet another indication of the reform-minded
leadership's growing commitment to using economic levers to regulate the
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economy. Faced with a large trade deficit this year, Beijing apparently
decided, with the advice of the World Bank and IMF, to devalue in order to
boost exports and cut imports. This move follows the recent party approval of
the outline of the next Five-Year Plan (1986-90), which calls for a 50-percent
increase in exports, but only a 40-percent rise in imports during the plan
period.
Secret
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