INTERNATIONAL ECONOMIC & ENERGY WEEKLY

• Document Type: CREST
• Collection: General CIA Records
• Document Number (FOIA) /ESDN (CREST): CIA-RDP88-00798R000400070004-9
• Release Decision: RIPPUB
• Original Classification: S
• Document Page Count: 42
• Document Creation Date: December 22, 2016
• Document Release Date: June 27, 2011
• Sequence Number: 4
• Publication Date: July 11, 1986
• Content Type: REPORT

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Directorate of
Secret
International
Economic & Energy
Weekly
11 July 1986
Secret
DI IEEW 86-028
11 July 1986
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Secret
International
Economic & Energy Weekly
11 July 1986
iii Synopsis
1 Perspective-Foreign Reaction to the New US Farm Program
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3 Thai Rice Exports: Concern Over the US Farm Bill 25X1
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7 Thailand: Easing of Austerity After Election Likely 25X1
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11 France: Modernizing the Financial Markets 25X1
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15 China: Seeking Foreign Technology for Telecommunication 25X1
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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 of Intelligence
Secret
DI IEEW 86-028
11 July 1986
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International
Economic & Energy Weekly
Synopsis
1 Perspective-Foreign Reaction to the New US Farm Program
Widespread foreign criticism of the 1985 US Farm Bill has centered on the $1
billion, three-year export enhancement program (EEP), and several countries
are considering retaliation. The Farm Bill is thus likely to increase tensions in
relations with our allies and key LDC grain exporters, but also will provide the
United States negotiating leverage during upcoming GATT talks.
3 Thai Rice Exports: Concern Over the US Farm Bill
Thai concerns about the negative effects of recent US farm legislation on Thai
rice export earnings are causing tensions with the United States that could
complicate US initiatives in a number of areas, including narcotics control and
the new GATT round.
7 Thailand: Easing of Austerity After Election Likely
Despite the lack of debate over economic issues preceding the election on 27
July, we believe the next government-whatever its composition-will move to
ease the unpopular two-year austerity program. This, however, may threaten
Thailand's recent progress toward financial stability and intensify the concerns
of its international creditors.
11 France: Modernizing the Financial Markets
The French Government over the past two years has engineered a near
revolution of French financial markets. These reforms should also better equip
France to compete in the face of worldwide capital market integration and
bring the French financial system more closely in tune with that of the United
States.
15 China: Seeking Foreign Technology for Telecommunications
Acquisition of foreign equipment and technology is a key element of China's
plans to modernize its inadequate telecommunications network. Imported
equipment will boost telecommunications services, particularly for the major
cities and the energy sector, although we believe continuing problems in
procuring and assimilating equipment and technology will slow the moderniza-
tion.
iii Secret
DI IEEW 86-028
11 July 1986
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International
Economic & Energy Weekly
11 July 1986
Perspective Foreign Reaction to the New US Farm Program
Widespread foreign criticism of the 1985 US Farm Bill has centered on the
$1 billion, three-year export enhancement program (EEP), and several coun-
tries are considering retaliation:
? The strongest reaction has come from the European Community, with
Brussels particularly condemning targeted export subsidies under the EEP.
France and the United Kingdom especially fear loss of traditional markets
and escalation of a costly subsidy war among the major grain exporters.
? Thailand has protested that it will lose up to 40 percent of its rice export
market this year, although the US Embassy has recently estimated a more
moderate 10-percent loss.
? Buenos Aires believes aggressive US exports through lower prices and the
EEP will seriously damage Argentina's grain exports this year.
? Uruguayan rice growers claim below-market US prices will cause irrepara-
ble damage to their rice industry by taking away markets in Peru and Brazil.
Some US competitors have launched efforts to counteract the bill's effects.
The EC will continue its aggressive marketing policies designed to match or
undercut US export prices, and
Canada and Australia have increased subsidies on their recent wheat exports
to India and the Middle East
Although the US legislation is only one factor influencing the world market,
sharply lower US export prices for rice, wheat, and coarse grains and broader
use of export subsidies to stimulate grain sales will almost certainly weaken
world grain prices this year. According to industry analysts, changes in US ag-
ricultural policy could drive prices down 20 to 25 percent below last year's de-
pressed levels and keep them low for at least the next two years.
Large grain buyers such as Japan and the USSR will benefit from reduced im-
port costs. Moscow has stated that exclusion from the EEP is an obstacle to
their purchasing more US wheat. The USSR is obligated to purchase an
additional 3 million metric tons of US wheat to fulfill the terms of the US-
Soviet Long-Term Grain Agreement. As a result of favorable domestic
production forecasts, the Soviets will undoubtedly fall short of this target.
Nonetheless, we estimate that, because of lower US prices and the higher
quality grain available only in the United States, they may buy an additional
200,000 tons in the next three months. Despite the recent fall in US prices, ag-
gressive sales tactics by other major wheat exporters will continue to undercut
US export competitiveness.
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The Farm Bill is thus likely to increase tensions in relations with our allies and
key LDC grain exporters but also will provide the United States negotiating
leverage during upcoming GATT talks. Major grain exporters-including the
EC, Canada, Australia, and Argentina-may see a severe drop in export
revenues since global import demand is not expected to rebound substantially
in response to the lower prices. Those without massive income and export
subsidy programs to benefit farmers-notably Australia, Canada, and Argen-
tina-will be hardest hit. Farmer unrest in these countries could escalate,
magnifying this year's pattern of farm strikes and demonstrations. With other
competitors such as Thailand, disputes over grain markets could complicate
US initiatives in different areas, such as narcotics control.
Increases in EC budget costs because of the US Farm Bill may push the EC
toward addressing agriculture more broadly in a new GATT round of trade
negotiations. Lower world prices could add at least $1 billion to EC export
subsidy costs this year, according to State Department analysis. The looming
budget crisis will make it increasingly difficult for the EC to match US export
subsidies and will probably induce the Community to consider reforms.
Although the EC is unlikely to allow a GATT round to substantially alter its
protective Common Agricultural Policy, some changes, such as reductions in
export subsidies, might become more likely, but only if domestic price supports
in other countries are also discussed.
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Thai Rice Exports:
Concern Over the
US Farm Bill
Thai concerns about the negative effects of recent
US farm legislation on Thai rice export earnings
are causing tensions with the United States that
could complicate US initiatives in a number of
areas, including narcotics control and the new
GATT round. Bangkok is accusing Washington of
unfairly subsidizing US rice exports under the 1985
US Farm Act, depriving Thailand of at least $60
million a year in foreign exchange earnings. In fact,
much of the recent decline in Thai rice earnings
stems from weak demand and exportable surplus of
lower quality rice-where the United States is not
a major competitor. Thailand, the world's largest
rice exporter, has not launched a major export
subsidy program in response, but it has undertaken
other efforts such as reducing export taxes to
counter the Farm Bill's impact. Although the new
US rice export policy is only one factor influencing
the world market, Bangkok will probably continue
pressing the US rice issue in international trade
meetings and in bilateral forums.
While world rice production has risen by 24 percent
in the last five years, the amount traded interna-
tionally has fallen by about 1 million tons. Stock-
piles amount to a record 24 million metric tons-
about 8 percent of annual world consumption,
according to USDA estimates. Total world rice
export earnings fell by one-half during 1982-84,
largely as a result of declining prices and reduced
export volume, according to World Bank estimates,
as big importers such as South Korea and Indone-
sia became self-sufficient and world recession re-
duced demand. By the end of June this year, the
benchmark Bangkok price had fallen to $226 per
ton from a high of $633 per ton in 1981.
Declining rice export earnings in recent years have
thus spurred Thailand - along with other export-
ing countries-to explore innovative tactics for
selling surplus stocks. Bangkok has boosted sales in
traditional US markets with improved quality, low
prices, government-to-government and barter ar-
rangements, and aggressive marketing campaigns.
The Thai effort has recently been complicated,
however, by the US "marketing loan" program
launched in April. Mandated by the 1985 Farm
Bill, the new program allows farmers to repay
government crop loans at prevailing world prices.
Largely as a result of the program, US rice prices
have fallen by more than one-third since the pro-
gram was launched, according to the USDA, nar-
rowing the gap with Thai prices to about $65 per
ton. Prices have stabilized in recent weeks and the
USDA expects them to remain level for the rest of
the year.
Thai Response and Options
The decline in the rice market has considerable
political and economic implications for Thailand.
Although diversification had reduced the share of
rice exports in total Thai agricultural exports, rice
still provides jobs for more than one-half the Thai
population. In addition, vested interests in the Thai
rice trade continue to play a powerful political role
in the country
Faced with strong domestic protests from the politi-
cally powerful rice trade interests, Thai officials
have reacted to stiffer US competition in interna-
tional rice markets by:
? Launching a lobbying campaign against the mar-
keting loan program, both within the United
States and among other grain exporters such as
Australia, Uruguay, and Canada.
? Making plans to buy 200,000 tons of milled rice
to boost domestic prices.
Removing most export controls on rice, such as
stockholding requirements and export taxes.
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World Rice: Production,
Consumption, and Trade, 1975-86
1981
398.9
272.3
3.1
3.0
7.0
13.1
1982
412.7
281.5
3.6
2.5
5.7
11.8
1983
419.5
289.6
3.7
2.3
5.9
11.9
1984
452.7
308.1
4.5
2.1
6.0
12.6
1985
468.0
314.0
4.0
1.9
5.6
11.5
? Offering to arrange government-to-government
barter deals, for example, Brazilian tractors for
Thai rice.
Bangkok's room for maneuver, however, is con-
strained at least in the near term. While farm
supports are an attractive option at a time when
Thailand is beginning to profit from the declining
cost of oil imports, according to Embassy reports,
the expense of such an operation would strain Thai
resources.
Furthermore, declining rice revenues
argue against encouraging increased production,
because farm prices for rice barely cleared produc-
tion costs in 1985, according to Embassy reporting.
of significant increases in purchases from Brazil
and Iran. However, continued price declines for
lower quality rice and the probable loss of market
share in high-quality markets in Western Europe
are likely to result in rice earnings lower than the
$825 million achieved last year.
Over the longer term, most experts agree that a
world rice glut is building, with no relief in sight for
at least five years. Former importers such as Indo-
nesia, India, South Korea, and the Philippines are
now self-sufficient and may develop their own
surpluses. Although Brazil plans to double pur-
chases this year to nearly 1 million tons, policy
shifts are already under way aimed at boosting rice
production and regaining self-sufficiency. Falling
oil prices will intensify cutbacks in rice imports by
the Middle East and other oil-exporting countries,
such as Nigeria.
Outlook and Implications
Prospects for an upturn in the world rice market
are not good. World rice trade is expected to
amount to only about 12 million tons this year,
according to USDA estimates, only 4 percent above
the very low level of 1985. The volume of Thai rice
exports will be up this year by 300,000 to 400,000
tons, according to recent Embassy reports, because
Although the new US export policy is only one
factor influencing the world market, Bangkok will
probably continue pressing the US rice subsidy
issue in international trade meetings and with
Washington. Bangkok has gained support from
some grain exporters, such as Australia, though its
complaints so far have failed to evoke a significant
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Thailand and the United States: Monthly Average Rice Prices, 1980-86
United Statesa
Thailand b
I I, I I I I I I I I I I I I , , I I I I I I ~ I I I I 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 Li
a Number 2, Milled, 4-percent c.i.f. Rotterdam.
6100-percent grade B c.i.f. Rotterdam.
c January through June.
response from other US competitors, such as Paki-
stan, China, and Burma. The Thais will host a
conference of "nonsubsidizing agricultural export-
ing nations" in Pattaya on 22-24 July, where the
rice issue will be a featured agenda item. Invita-
tions to the meeting have been sent to Australia,
Hungary, Argentina, Uruguay, Brazil, Colombia,
Chile, Canada, Indonesia, Malaysia, New Zealand,
and the Philippines.
More generally, if the US-Thai rice issue remains
heated, it may begin to erode Thai cooperation with
the United States on issues such as Cambodian
refugees and narcotics. Within Thailand, the US
Farm Bill-coupled with proposed US legislation
potentially damaging to Thai trade interests, such
as limits on textile imports-remains a politically
contentious issue. If Bangkok does not mount a
costly effort to subsidize exports any time soon,
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Thailand: A Model of Agricultural Diversification
Despite its concern for rice export earnings, Thai-
land has the most diversified agricultural sector in
Southeast Asia. Its total agricultural exports are
worth about $4 billion annually, about 60 percent
of total exports. Both agricultural and total export
earnings have expanded significantly in recent
years, fostered in part by a dramatic change in the
composition of Thailand's major exports. As re-
cently as the mid-1960s, rice accounted for about
one-third of total exports and over 50 percent of
agricultural exports. In 1985 rice accounted for
less than 12 percent of total exports, but earned
more than $800 million, more than three times the
level of the mid-1970s. Over the last decade,
however, nontraditional exports such as tapioca
products, corn, sugar, fruits, and seafood-along
with manufactures-have fostered significant
earnings growth and have laid the foundation for a
broader, more stable Thai export base.
The government and the private sectors have
played complementary roles in this expansion. The
government has contributed by constructing roads
and irrigation systems and developing high-yield-
ing crop varieties. In the private sector,
farmers and traders have
responded quickly to favorable world market
opposition forces may try to exploit resulting farm-
er discontent. There are also indications that the
USSR, which has increased purchases of Thai rice
in recent months, may attempt to exploit US-Thai
trade friction. According to press reports, Moscow
has offered to barter technology for rice and has
attempted to depict the United States as responsi-
ble for Thai rural poverty.
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Thailand: Easing of Austerity
After Election Likely
Despite the lack of debate over economic issues
preceding the election on 27 July, we believe the
next government-whatever its composition-will
move to ease the unpopular two-year austerity
program. A consensus has developed among Thai-
land's major parties that the recent fall in world oil
prices provides an opportunity to compensate for
the effects of depressed commodity prices and
austerity that have widened economic disparities
among important domestic interest groups. As a
result, we believe the new government probably will
begin to stimulate the economy while making little
headway on economic reform. This, however, may
threaten Thailand's recent progress toward finan-
cial stability and intensify the concerns of its
international creditors.
Economic Pressures Building
Political observers expect the biggest winners in the
balloting-and the key parties in the new coali-
tion-will be the Democrat Party (DP) and the
Thai Nation Party (TNP). Most likely, Prime
Minister Prem, who has been in office since 1980,
will head the new coalition government. The DP
favors increased development spending and govern-
ment stimulation of the economy, while the TNP
advocates a freer hand for the private sector and
relies on business interests for much of its political
strength. Whatever the outcome of the election,
major financial problems await the new
government:
? A government budget deficit, that has been stuck
at almost 5 percent of GDP since 1984.
? With over $18 billion in foreign debt, debt-service
costs are now nearly 25 percent of the budget and
likely to rise
? Trade-related problems probably will rein in
Thailand's current account receipts for the rest of
the decade. We expect prices to remain depressed
for the country's major commodity exports, espe-
cially rice. Rising protectionism in the developed
countries threatens diversification into manufac-
tured exports.
As a result, Thailand faces another year of modest
growth by its own standards. Government econo-
mists recently revised their forecasts slightly up-
ward, largely on the strength of the decline in the
price of oil, which comprises nearly one-fourth of
Thai imports, and we expect that real growth will
remain in the 4- to 5-percent range through 1987.
This would be a far cry from the 8- to 10-percent
annual rates of the late 1970s.
We believe that any new government will ease
austerity, despite the large budget deficit, and
begin stimulating the economy in response to the
spending demands of businessmen, farmers, and
military leaders who are,
all increasingly frustrated by conserva-
lenders.
tive economic policies. As a result of the decline in
oil prices, demands for more government spending
are probably too politically attractive to be ignored,
according to the US Embassy. The biggest hitch in
this likely scenario is whether Finance Minister
Sommai-the architect of the austerity program
who has hinted he may retire-will remain in the
government. With Sommai, whose toughness is
well respected among international bankers, the
government probably could successfully manage
higher spending while retaining the confidence of
its major international creditors. Without Sommai,
however, we believe the government is less likely to
keep the budget deficit to a level acceptable to its
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There are several likely areas for increased
spending:
? Introduction of commodity price supports. Such
a program probably would benefit only middle-
men and fail to encourage needed diversification
out of rice production.
? Subsidized interest rates to the housing sector.
While boosting the depressed housing, sector, this
would divert funds from other more productive
sectors.
? Revival of the eastern seaboard industrial devel-
opment program. Critics argue that the $4-5
billion program has too low an economic return
and could add substantially to the worrisome debt
problem.
Important economic reforms, that in our judgment
would greatly improve Thailand's growth potential
over the near term, are likely to make little head-
way under the new government. For example,
reform of deficit-plagued public enterprises-the
most inefficient sector of the Thai economy-will
suffer because of the political power of military
board members, public enterprise bureaucracies,
and public-sector unions. Moreover, an outmoded
tax structure that limits Thailand's ability to com-
pete in world markets might also elude further
reform under the next government. In the financial
sector, however, the new government will be under
pressure to implement effective banking regulation
in the wake of last year's highly publicized bank
failures.
The Danger Ahead
We believe any move by the new government to
stimulate the economy will raise concerns among
international creditors about the competency of
economic management and about Thailand's abili-
ty to handle its outstanding debt.
Longer Term Economic Concerns
Low savings and investment rates. Inadequate do-
mestic savings, from which the government fi-
nances most of its budget deficit, are straining the
economy through high interest rates and a growing
debt service burden. The US Embassy reports that
Thailand invested roughly 21 percent of its GDP
last year, down from 28 percent in the late 1970s,
and the savings rate is similarly down,
Inadequate and inefficient tax structure. Heavy
indirect taxes, which provided over three-fourths
of all government revenue in 1984, encourage
inefficient import substitution and discourage
manufacturingfor export. Tax evasion is wide-
spread, with almost half of all corporations declar-
ing losses for tax purposes,
Depressed farm incomes. The agricultural sector
contributes one-fourth of Thailand's GDP. The
third year of buoyant crop production in Thailand
pushed wholesale agricultural prices down almost
9 percent in 1985. Rapid expansion of land under
cultivation has forced new farmers onto increasing-
ly marginal land, while lack of modern farm
technology has resulted in soil depletion, growing
environmental and irrigation problems, and agri-
cultural yields among the lowest in Asia, accord-
ing to the US Embassy.
Growing unemployment. Total, unemployment, in-
cluding underemployment, is currently about 7
percent, and some foreign observers believe it may
reach double digits by 1990. We believe that
economic growth would have to be accompanied by
reform of Thailand's education system to alleviate
the long-term unemployment problem.
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international commercial banks now
consider medium- and long-term lending to Thai-
land to be a high risk. Most banks, moreover, have
reduced their medium-term exposure in Thailand
in the last two years, troubled by apparent instabil-
ity, falling commodity export prices, and a growing
view that the Thai Government is fiscally irrespon-
sible,
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France: Modernizing the
Financial Markets
The French Government over the past two years
has engineered a near revolution of French finan-
cial markets. The final 18 months of the Socialist
government-ending in March-saw an unprece-
dented freeing and rationalization of the markets
that should improve their efficiency and the alloca-
tion of capital. These reforms will allow Paris to
control the money supply through open market
operations rather than quantitative credit controls.
They should also better equip France to compete in
worldwide capital market integration and bring the
French financial system more closely in tune with
that of the United States.
The Previous System
The French financial system traditionally has been
heavily regulated and rigidly compartmentalized.
Three distinct submarkets-a money market, a
mortgage market, and a securities market-operat-
ed under different rules and the rates charged
different borrowers varied greatly. In addition,
credit controls, fixed fees, and regulated interest
rates destroyed competition among banks and bro-
kers, raising the cost of financial operations and
reducing options for investors.
The absence of a unified financial system respon-
sive to market forces also made monetary policy
less effective. Because, at most, one-half of all
credit was sensitive to market interest rates, large
rate increases were required to stem the demand
for credit-increases that threatened the solvency
of many small and medium-sized firms. Conse-
quently, monetary policy after 1972 relied mainly
on quantitative credit controls imposed on a month-
ly, bank-by-bank basis with substantial penalties
for banks exceeding the limit. The controls were
inefficient, however, because some financial institu-
tions were practically exempt, some forms of credit
were only partially controlled, and the Bank of
France was obliged to supply funds to refinance
export credits at fixed rates, guaranteeing banks
easy access to liquidity.
After decades of study and inaction by the right, it
was ironic that a Socialist government began liber-
alizing the financial system. Under the direction of
Finance Minister Beregovoy, the government in
late 1984 began a series of financial reforms that
together constitute an almost revolutionary change.
Most of the impetus for reform came from econom-
ic factors, although the desire to curb the monopoly
powers and privileged position of banks also played
a role. In addition to seeking greater capital market
efficiency, the government recognized that without
modernization France would be left far behind in
the competition for international financial business.
Moreover, the Socialists realized that streamlining
French financial markets would aid in the fight
against inflation and might also lower the govern-
ment's own substantial financing costs.
New Financial Instruments. One of the focal points
of the Beregovoy reforms was the creation of new
financial instruments, particularly in the short-
term market, to better suit the needs of both
investors and borrowers. This also tended to unify
the market by allowing capital to flow more freely
and efficiently. The chief reforms include:
? Opening a market in negotiable short-term gov-
ernment bills-initially with maturities of 2 to 6
years-and the creation of certificates of deposit
for 6-month to 2-year terms, with negotiable
interest rates for amounts greater than $750,000.
Both measures will provide firms, mutual funds,
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and individuals with an important alternative to
bank deposits, and the competition should help
lower the cost of financing.
? Authorizing firms to issue commercial paper for
10- to 180-day terms, thus giving them direct
access to capital markets and reducing their costs.
A private credit rating agency, set up to evaluate
the risks in this market, should help provide the
public with more information about traditionally
tightlipped French firms.
? Creating long-term, government-guaranteed,
mortgage-backed bonds similar to Ginnie Maes.
This should make more mortgage money available
and increase the liquidity of financial institutions
by allowing them to sell their real-estate-backed
assets. It will probably also give a boost to the
beleagured French construction industry.
Deregulating Financial Markets. A second goal
has been to relieve financial institutions of burden-
some regulations, allowing them to operate more
efficiently and respond more easily to competition.
Among the major reforms in this area are:
? Easing foreign exchange controls to permit more
French foreign investment, to give French firms
more flexibility in their international operations,
and to allow them more leeway to hedge against
foreign exchange risks.
? The creation of a financial futures market that
will enable companies to protect themselves
against changes in interest rates.
? The introduction of negotiable bank fees and
brokerage commissions to increase competition
and reduce charges to customers.
? The opening of a limited morning trading session
on the Paris stock exchange, as a step toward a
system of continuous trading. Related stock ex-
change reforms include authorizing brokers to
become market makers by trading on their own
accounts and holding inventories and the creation
of an unlisted securities market.
? Treating interest, dividends, and capital gains
equally for tax purposes.
? Reducing the volume of government-subsidized
loans-from $40 billion in 1984 to just over
$30 billion in 1986.
? Allowing bond issues of less than $150 million
without prior authorization to improve bond mar-
ket access for small and medium-sized firms.
Improving Monetary Control. Beregovoy loosened
the so-called Encadrement du Credit, or system of
credit ceilings, and moved toward replacing it with
a regulatory mechanism based on depositing re-
serves with the Bank of France. The object was to
allow a greater leeway in lending and to permit
more effective central bank control of the credit
base. In addition, the government imposed the
same reserve schedule on all banks. Eventually, the
Bank of France hopes to be able to transmit
interest rate signals through its open market opera-
tions to control credit growth more quickly and
effectively, although this may come at the cost of
more short-term interest rate volatility.
The conservative Chirac government has taken
some steps to continue the reforms begun under
Beregovoy, notably the further easing of exchange
controls. It has also abolished the much maligned
devise titre system under which investors wishing to
purchase foreign securities had to pay a premium
for the necessary foreign exchange. Meanwhile, the
Finance Ministry has announced that, barring an
unexpected increase in inflation, it will abandon all
quantitative credit controls by 1 January 1987. It
has also expanded the maturities permitted for
some bonds, commercial paper, and certificates of
deposit, and has permitted banks to set their own
hours.
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Prereform Barriers to a
Dynamic Financial Market
? About one-half of all French credits were subsi-
dized through numerous channels at greatly vary-
ing rates. Housing and exporters, rather than
industry, were the main beneficiaries.
? The medium- and long-term bond markets were
regulated to keep interest rates low, and credit
was rationed by a system favoring official or
quasi-official borrowers. Since small- and medi-
um-sized borrowers had little direct access to
long-term credit, they were heavily dependent on
bank loans.
? Monetary policy relied primarily on credit con-
trols rather than reserve requirements and inter-
est rates. Controls generally heavily penalized
any bank growing faster than its allowed norm,
preventing more efficient banks from growing
relative to their competitors.
? The system created special deposit-taking institu-
tions-the Post and National Savings Banks-
that collected deposits and were required to lend
them to special borrowers or to retail banks. This
limited the access of some retail banks to low-
interest funds and made them vulnerable to
small interest rate changes.
? Most interest rates on deposits as well as banking
and brokerage fees were regulated.
? Firms and individuals did not have direct access
to the money market, but rather had to go
through banks.
? Short-term government liabilities could be held
only by banks. Financial markets were not inno-
vative, and savings instruments for small savers
were particularly limited.
? The Paris stock exchange was anachronistic, with
prices being fixed once a day in a brief afternoon
session, during which brokers matched buy and
sell orders. In addition, brokers did not buy for
themselves or keep inventories to make markets
but only engaged in pure brokerage, which meant
the market was thin and clumsy.
Despite these initial steps and the free market
rhetoric of the Chirac government, the continuation
of the reform process is not assured, in our view.
The controlled financial system in France was,
after all, largely the ad hoc creation of previous
conservative governments. Although we believe the
conservatives will try to press ahead with financial
deregulation, they may backtrack in the event of
resurgent inflation or an otherwise deteriorating
economic situation. A key indicator of the govern-
ment's commitment to reform will be the speed
with which it pushes denationalization and the
extent to which it encourages the denationalized
banks to take full advantage of the less restrictive
operating environment. In addition, by further re-
ducing subsidized credits and by announcing con-
tinued increases in reserve requirements, the Bank
of France can signal its intentions to move toward a
full dismantling of credit controls.
Ultimately, the new monetary control system will
require greater day-to-day involvement by the
Bank of France in managing the price of money
through open market operations. The conservatives
have already proposed a new charter for the Bank
of France to grant it greater autonomy, and the
issue is likely to be taken up by the National
Assembly this fall.
Central bank officials believe, however, that the
new government will move cautiously toward an
interest-rate-based policy out of fear of exacerbat-
ing the turmoil that bank denationalization is
already likely to cause. Diplomatic reporting indi-
cates that the French banking community is also
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Secret
skeptical that the right will entirely abandon all
vestiges of quantitative controls, and fears that the
government may fall back on controls as a safety
net if the liberalization thus far appears inflation-
ary.
Finally, for the modernization to continue and for
Paris to compete internationally, the most pressing
need now is for the locus of innovation to move
from the government to the private sector. The
financial sector has been so tightly controlled in the
past that most bankers and brokers no longer think
in terms of innovation, assuming the government
will not allow it. The recent reforms and the
election of a government committed to the free
market may have brought a suitable environment
for private initiative. If the new government reaf-
firms its commitment to reform and does not
discourage innovation by excessive regulation, it
will be a healthy sign for continued modernization
and the emergence of Paris as a world-class finan-
cial center.
Overall, the financial reforms are likely to have a
positive impact on the French economy. Although
the French financial market is likely to experience
growing pains as it adjusts to a more open regula-
tory environment, the reforms should lead to more
efficient investment decisions and facilitate a more
effective monetary policy. They will also make the
French financial system more closely resemble that
of the United States, and should help further
capital market integration in the European Com-
munity. Over the long run, the reforms should help
open the French economy to foreign investment and
boost Paris's standing as an international financial
center.
Secret 14
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China: Seeking Foreign Technology
for Telecommunications
Acquisition of foreign equipment and technology is
a key element of China's plans to modernize its
inadequate telecommunications network. Over the
last several years, China has sharply increased
imports of telephone switching, fiber optics, and
other equipment and production know-how. Japan
has been China's major equipment supplier, but
other countries are competing fiercely to expand
their share of China's telecommunications mar-
ket-often using low-cost financing to capture Bei-
jing's business. Imported equipment will boost tele-
communications services, particularly for the major
cities and the energy sector, although we believe
continuing problems in procuring and assimilating
equipment and technology will slow the modern-
ization.
Improving the Telephone System
The waiting list for a telephone exceeds 200,000
nationwide, according to Chinese statements, and
presumably would be even longer if applicants
thought they could reasonably hope for installa-
tion. China intends to increase the number of
telephones from about 5 million in 1985 (about one
phone per 200 people) to 13 million in 1990 and 33
million in the year 2000, a significant investment
of money, resources, and personnel. The addition
of 28 million phones over 15 years would require,
on average, almost 1.9 million installations per
year-more phones than were installed over the
past five years combined. We believe China exag-
gerated the improvements in its telecommunica-
tions network during 1981-85 and that plans for
China's outmoded and overworked telecommunica-
tions network is unable to meet rapidly growing
government and commercial telecommunications
needs. Beijing's goals for modernizing during the
next five years are ambitious, especially compared
to its recent achievements. China plans to expand
and improve the telephone system, especially in key
cities and coastal areas; upgrade and extend the
entire network; and develop a domestic communi-
cations satellite network.
Acquiring foreign telecommunications equipment
and technology is crucial to this modernization
strategy. For example, China intends to use digital
communications to meet its needs for high-speed
data transmission and secure communications, but
it produces mostly analog equipment. Although
China's telecommunications research has pro-
gressed, China's ability to move from prototypes to
volume production is poor because of equipment
shortages, an unskilled work force, poor manage-
ment, and lack of familiarity with sophisticated
production processes. The sheer size of demand also
dictates acquiring equipment and production ca-
1986-90 are beyond China's capabilities.
Technology Priorities and Acquisitions
China's strategy calls for advanced technology for
priority needs and older systems for other require-
ments. Beijing is most interested in buying manu-
facturing machinery and know-how to improve its
ability to produce its own equipment. Although
some Chinese buyers are willing to purchase equip-
ment for selected priority uses, Beijing underscored
its emphasis on technology transfers in mid-1985
when it formally tied future purchases to technical
cooperation. Priorities include advanced telephone
switching, fiber optics, and satellite communica-
tions; China also wants pulse-code modulation,
advanced microwave, and multiplexing technology.
Telephone Switching. Although China claims it
has begun producing an indigenous microprocessor-
controlled switch, domestic production is largely
pacity from abroad.
Secret
DI IEEW 86-028
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Secret
limited to crossbar systems without stored-program
controls. Two major agreements signed in the last
several years with foreign suppliers-one, a joint
venture with a Belgian subsidiary of ITT for the
production of 300,000 lines of advanced switching
systems annually-will greatly boost China's pro-
duction capabilities. Press reports suggest China is
interested in perhaps one other major purchase of
switching technology. Canada, France, Italy, the
Netherlands, Sweden, Switzerland, the United
States, and West Germany have supplied telephone
switching and related equipment and know-how. F_
Fiber Optics. China has produced several dozen
short, low-capacity fiber optic systems that are in
operation in major cities, but we believe they are
experiencing technical problems with higher capac-
ity, single-mode optical fibers, transmission devices,
and large-scale production.
In the past two or three years,
L China has signed agreements with several
foreign suppliers for high-speed 140-megabits-per-
second fiber optics systems for both intracity and
long-distance transmission systems; they have also
acquired technology, equipment, and training to
produce fiber optic cable and components. We
estimate these purchases will allow China to begin
deploying a fiber optics network by 1991, five years
or so earlier than if China had relied solely on
indigenous capabilities. China is continuing to seek
fiber optics production technology; suppliers in-
clude Italy, Japan, the Netherlands, the United
Kingdom, and the United States.
Satellites. China has launched two communica-
tions satellites, a significant accomplishment, but
evidence indicates they are experiencing operation-
al difficulties. Progress also has been slow in devel-
oping a direct broadcast communications system.
Beijing postponed the purchase of a foreign broad-
cast satellite and production technology after ex-
tensive negotiations with a US firm and a West
German consortium, in part, because of disagree-
ments within the Chinese bureaucracy on the type
of system preferred, which foreign supplier to use,
or even the need for foreign procurement. Although
Beijing plans to continue to launch indigenous
communications satellites, current problems with
this program may cause China to reopen negotia-
tions for the purchase of satellites or production
technology. To help meet its immediate needs,
China recently purchased two Intelsat transponders
to augment several already under lease. Although
China produces its own ground stations, it has also
purchased ground station equipment from Canada,
the United States, and Japan.
Foreign Competition
Chinese imports of telecommunications equipment
have risen rapidly over the past several years.
Japan is China's leading direct supplier of telecom-
munications equipment; its dominance is particu-
larly strong in microwave technology. According to
Nippon Electric Company, it has installed a total of
4,700 kilometers of microwave systems-equiva-
lent to about 25 percent of China's microwave
network-and won 80 percent of Chinese micro-
wave orders in the last several years. According to
trading partner data, the value of Japanese tele-
communications equipment sales to China in 1985
was five times greater than that of the United
States, the second-largest single supplier. The value
of West European exports to China exceeds US
sales, however, and individual suppliers-particu-
larly the United Kingdom, France, and West Ger-
many-are narrowing the gap with the United
States.
Foreign suppliers foresee $3-5 billion in sales to
China over the next five years and are scrambling
to secure their market positions amid indications
that Chinese purchases will eventually be limited.
Foreign estimates of the Chinese market may be
high; Chinese officials have publicly stated they
plan to spend $3-4 billion on telecommunications
modernization by 1990, a figure that includes
domestic expenditures as well as imports. Central
government concern about the compatibility of
foreign equipment has led some officials to try to
limit the number of suppliers; others have indicat-
ed, however, that China is looking for additional
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Chinese Imports of Telecommunications
Equipment, 1978-85
Sources of Chinese Telecommunications
Equipment Imports
sources of technology-including Eastern Eu-
rope-to avoid dependence on any one supplier.
Beijing is also attempting to reduce costly duplica-
tion in technology imports. Furthermore, acquisi-
tions of foreign production technology will in time
reduce China's import needs.
China is skillfully playing competitors off against
one another to get more technology and better
financial terms. Chinese officials have assured for-
eign visitors that telecommunications remains a
priority despite the current policy of conserving
foreign exchange, but they stress that proposals
that would reduce China's foreign exchange costs
will be considered the most favorably. The procure-
ment process can be frustrating to both foreigners
and the Chinese; the numerous Chinese entities
involved in producing, buying, and using telecom-
munications equipment often result in confusion
over the requirements, funding, and authority for
purchases. Although COCOM approvals for trans-
fers of advanced technology to China are increas-
ing, the COCOM process delays the acquisition of
aHong Kong data are largely reexports, of which approximately 54 percent are from
Japan, 4 percent are from the United States.
b Estimated.
systems and know-how. We expect that Beijing-as
well as US allies in COCOM-will continue to
press Washington to further loosen COCOM con-
trols for transfers to China.
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Principal Players in Chinese Telecommunications
Ministry of Posts and Telecommunications. Owns
and operates national communications facilities; a
major purchaser of foreign equipment and
technology.
Ministry of Electronics Industry. Develops, manu-
factures, and procures telecommunications equip-
ment for the common carrier network, industrial
users, and the military.
The Military. Uses its own communications sys-
tems as well as the common carrier network;
involved in research, planning, and deployment,
including the fiber optics and communications
satellite programs.
Ministry of Petroleum Industry. Purchases foreign
equipment to support offshore and onshore oilfield
communications operations and pipeline
maintenance.
Ministry of Water Resources and Electric Power.
Plans to expand communications supporting power
grid maintenance; seeks foreign equipment.
Ministry of Railways. Procures foreign equipment
and services for upgrading its independent telecom-
munications network.
Ministry of Coal. Seeking foreign equipment to
support communications with remote mining
operations.
US firms have sold China a variety of telephone
switching, radio, fiber optics, cable, satellite ground
station and multiplexing equipment and technol-
ogy. US firms are at a marketing disadvantage
compared to their foreign competitors, however, for
several reasons:
? Many foreign firms are offering government-
subsidized financing for telecommunications pro-
jects. France, Italy, Japan, and the United King-
dom have all offered credits or low-cost loans.
The Belgian Government granted two soft loans
valued at $12 million and assumed 10-percent
ownership in the switching equipment joint ven-
ture to help its firm close the deal. According to
press reports, Sweden is prepared to offer similar
support to assist a Swedish firm in becoming
China's third major switching technology
supplier.
? US firms entered the market relatively late-
Japan has been selling telecommunications equip-
ment to China since at least the early 1970s.
Statements by Chinese officials
suggest that West European suppliers such as
France have also benefited from longstanding
political ties to Beijing.
? US equipment based on North American stan-
dards is less attractive to Beijing, which wants to
adopt the standards used by most other countries.
Chinese officials frequently express a preference
for US technology, however, and US firms appear
more willing to transfer technology than some other
suppliers; Chinese officials are particularly critical
of Japanese firms for their reluctance to transfer
technology. In addition, US firms generally offer
training and support services, both sought by
Beijing.
Prospects for Chinese Telecommunications
Foreign purchases, in addition to indigenous ef-
forts, will speed improvements in key projects such
as communications support for energy development
and telephone and data links between major cities.
We believe that military communications-already
far superior to civilian systems-will also benefit
from the increased speed, capability, and flexibility
offered by fiber optics and advanced switching
systems. Nonetheless, China's civil communica-
tions services are likely to continue to be inade-
quate to support the growing demands of economic
modernization, in our view. Improvements in
China's production capabilities will take time.
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China also faces continuing difficulties in integrat-
ing foreign equipment into the existing network and
in assimilating foreign technology. Inadequate
communications services are likely to remain, hin-
dering business transactions, cooperation between
central and provincial organizations, and develop-
ment of outlying regions.
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Energy
OPEC OPEC crude oil production averaged 18.9 million b/d in June, an increase of
Production Update 800,000 b/d from May levels. This increase came primarily from Saudi
Arabia, which used netback discounting and aggressive marketing to push its
output up by 1 million b/d. Libya's output rose as well-by 200,000 b/d-as
US oil companies raced to make the most of their equity rights before they
were required to stop liftings on 30 June. These increases more than offset the
fall in Iran's output as a result of Iraqi attacks on crude oil production
facilities, reductions in the shuttle fleet due to desertions and tanker damage,
and movement of the shuttle operation from Sirri to Larak.
OPEC Oil Production, 1986
First Second May
Quarter Quarter
Qatar 0.3 0.3 0.3 0.3
Saudi Arabia a 4.4 (4.3) 4.8 (4.7) 4.5 (4.3) 5.4 (5.3)
UAE 1.2 1.4 1.5 1.5
a Amount in parentheses excludes production from the Neutral
Zone, whose output is divided between Saudi Arabia and Kuwait
and included in their country quotas; the Neutral Zone has no
production quota of its own.
Secret
DI 1EEW 86-028
11 July 1986
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Secret
Spot Oil Spot oil prices have fallen below $10 per barrel in the wake of the inconclusive
Market Trends OPEC meeting last week. Prices for North Sea and US crudes are near their
early April lows, now trading at $9.70 and $11.20 per barrel, respectively.
High OPEC production continues-a large volume of crude is still in transit
and is expected to put further downward pressure on prices when it arrives in
the market this month. Early indicators show that consumption during the first
half of the year may have been less than anticipated, with substantial volumes
of crude and products being stocked. This early stockbuild is likely to reduce
demand for new oil in the later part of the year, thus erasing OPEC hopes for
stronger demand. In the absence of production restraint, prices are likely to
continue to be weak through at least the end of the summer.
Kuwait Repairing The apparently Iranian-backed attacks on Kuwait's Al Ahmadi oil facilities on
Oil Facility Damage 17 June caused moderate damage but failed to disrupt significantly production
or exports. According to the US Embassy, the critical central mixing manifold
was almost completely destroyed and will take about three months to replace.
This manifold blends crude from Kuwaiti oilfields and feeds the intake
manifolds at both north and south tank farms. The south tank farm intake
manifold and the north tank farm discharge manifold were less seriously
damaged. The attacks initially cut Kuwait's productive capacity of about
2 million b/d by about half. Prompt repairs to the north tank farm discharge
manifold and new connections installed to bypass damage, however, have
restored capacity to about 1.6 million b/d-more than enough to maintain
current exports of approximately 1.1 million b/d. The flexibility of the
Kuwaiti oil system to cope with further attacks will be reduced until all of the
damaged facilities are fully restored.
Secret
11 July 1986
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Secret
Soviet Hard Currency
Bind Affecting
Pipeline Projects
no new major pipeline
projects will be undertaken in the next two years. postpone-
ment of the gas pipeline to Eastern Europe as a result of budget cuts for the
gas industry and the fall in hard currency gas revenues in the wake of the oil-
price decline. The Soviets have scheduled six major pipelines from the
Yamburg gasfield in the current five-year plan. One is already in operation
and another is almost half finished. Construction of a third, the "Progress"
pipeline to Eastern Europe, began in late May, but it is too early to gauge the
pace of construction. Because all of the planned pipelines will require high-
pressure pipe from Western Europe or Japan, hard currency considerations
may impede the program as long as world energy prices and Soviet hard
currency revenues from oil and gas sales remain depressed.
Chinese Oil China produced 2.53 million b/d during the first half of 1986, only 2 percent
Production Growth more than during the same period last year. Production at Daqing, China's
Slows largest field, declined 4 percent because an accident in January shut down one
of the field's major power stations for several months.
Jthe lower growth rate will have little effect on domestic oil
supplies, which will benefit slightly from a drop in exports-down 11 percent
in the first quarter. Nevertheless, Beijing will continue to ration domestic oil
supplies tightly so it can expand exports if international prices rise. Significant
new finds at Shengli probably will keep China's oil production growing
through the rest of the decade.
China's Coal China produced 403 million metric tons of coal during the first half of 1986,
Production Drops nearly 2 percent less than during the same period last year. According to
Slightly statistics published in China Daily, most of the decrease was due to a 10-per-
cent decline in production at small mines, while production at the large state-
owned mines grew slightly. The small mines, operated by individuals and
collectives, produced about one-fourth of China's coal last year. Small-scale
coal production had grown rapidly during the past few years because Beijing
allowed all of this coal to be sold at market prices, often four or more times the
state's price. The proliferation of small mines, however, has depressed the
market price of coal, which may have prompted some peasants to switch out of
coal mining to other industries. A recent tightening of rural loans also may
have contributed to the decline. Coal Ministry officials recently told US
officials that some small mines in South China would soon be exhausted.
Premier Zhao Ziyang recently encouraged more small-scale coal production,
indicating Beijing is planning to continue relying on small mines for a
significant portion of its coal.
23 Secret
II July 1986
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Secret
South Africa South Africa's top financial officials last week sought to moderate-but did
Hints at not refute-a statement by Pretoria's Ambassador to the United Kingdom
Nonpayment of Debt that South Africa would consider not repaying its foreign debt if economic
sanctions were imposed. According to the US Embassy, Reserve Bank
Governor de Kock and Finance Minister du Plessis gave assurances that South
Africa intends to repay its debts, but each noted that sanctions against the
country's exports would hurt foreign exchange earnings needed to meet its
obligations'. Du Plessis publicly described the Ambassador's remarks as a
statement of fact rather than a threat. Pretoria probably views repudiation of
its debt only as a last resort because the probable resulting exclusion of South
Africa from international financial markets would complicate already serious
domestic economic troubles. Moreover, this episode follows a pattern of similar
veiled threats-restricting strategic mineral exports or expelling the foreign
mine laborers-intended to discourage international pressure. As pressure for
sanctions continues, however, some international banks might join South
Africa in emphasizing the spillover effects on foreign creditors of sanctions
against the country's exports.
Mexico Preserving The Mexican Finance Ministry announced last week that the government's
Its Options on Debt $600 million monthly debt service payments were current and expressed
optimism about prospects for a new financial package by the end of July. The
announcement, however, does not end speculation that the government may
suspend foreign debt payments. Press statements indicate government officials
are examining ways to protect the country's dwindling foreign exchange
reserves, including a scheme to make interest payments temporarily through
peso escrow accounts in Mexico. Mexico is in the final stages of formulating a
new economic agreement with the IMF and probably sees no advantage in
suspending debt payments now. Peso escrow accounts would limit foreign
exchange outflows to foreign banks; this in turn would keep reserves from
falling further. Mexico City might still halt debt payments if it reaches an im-
passe with the IMF or if reserves fall precipitately, as they did in 1982.
Secret
II July 1986
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France Agrees
To Reschedule
Iraqi Debts
Iraq's recent agreement with French banks on debt rescheduling increases the
chances for accommodation with other commercial lenders in Western Europe
commercial sources.
The French
banks say they may also advance new credits to Baghdad. Iraq's failure to
make payments on its commercial debt this year has caused many Western
banks and export credit agencies to reduce credit lines to Baghdad. Paris had
discontinued credit guarantees to Iraq in April when Baghdad missed a
$120 million debt payment but recently rescheduled Iraqi official debts. Iraq
may find it somewhat easier to reach agreements with commercial lenders in
Japan, Baghdad's largest source of imports last year, who had said they would
reschedule only if Iraq reached agreements with other lenders. Even so,
Baghdad is unlikely to obtain substantial amounts of additional credit from
and Japan.
Egyptian Reform IMF officials have stated that Egypt's recently released reform plan represents
Package progress but does not yet constitute a basis for an IMF standby agreement.
Falls Short of Specifically, Fund representatives cited weaknesses in addressing the budget
IMF Endorsement deficit, credit expansion, and exchange rate reform. In addition, the Egyptians
remain totally opposed to a multilateral debt rescheduling under IMF
auspices. Cairo still appears convinced that the United States and other major
creditors will provide debt relief on a bilateral basis, thereby avoiding a strict
IMF-supported adjustment program. The country's growing inability to meet
debt obligations and import requirements appears to make some form of debt
rescheduling inevitable by the end of this year.
Foreign Exchange Recent projections by the IMF indicate that Zambia is facing a financing gap
Shortages Threaten of $165 million during the remainder of 1986. Lusaka already has accumulat-
Zambian Currency ed arrears totaling $58 million to the IMF and about $50 million to Western
Auction commercial banks since it signed IMF standby and Paris Club agreements in
March. Although the arrearages and looming foreign payments gap are in part
the result of a decline in exports, they stem mainly from Lusaka's imprudent
diversion of foreign exchange from debt service and mining imports to the
foreign exchange auction in order to prop up the exchange rate. Growing
pressures to reimburse these accounts could cut foreign exchange allocations to
the auction later this year and lead to a devaluation of 50 to 55 percent,
according to US Embassy estimates. We believe that a devaluation on this
scale would induce Lusaka to tamper further with the auction and that, in a vi-
cious circle, this would undermine IMF and foreign donor support needed to
keep the exchange rate from declining even .further. The growth of arrearages
may jeopardize negotiations on disbursement of a $62 million IMF loan this
fall, according to Embassy reporting.
25 Secret
11 July 1986
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Global and Regional Developments
Soviet-Japanese
Joint Ventures
Stall
Japanese businessmen are increasingly pessimistic about the prospects for joint
ventures proposed by Moscow at the mid-April meeting of the Japan-Soviet
Union Joint Economic Committee. The Japanese initially regarded the joint
venture proposal as some willingness on Moscow's part to accept foreign
capital. The continued vagueness of Soviet proposals has subsequently tem-
ered Ja anese attitudes
original lukewarm Japanese response.
The
Soviet decision to postpone some of the projects and to assume full manage-
ment and engineering responsibility for the remainder has weakened the
West European West European foreign and research ministers meeting in London last week
Agreement on agreed to establish a secretariat for the European Research Coordination
EUREKA Agency and selected 62 projects worth at least $2 billion for R&D over 10
years under the EUREKA banner. Firms involved in EUREKA projects will
provide their own financing, and the Governments of France, West Germany,
the United Kingdom, and several other countries will offer subsidies, tax
breaks, and special loan programs. The ministers agreed to locate the
EUREKA secretariat in Brussels, to study ways of obtaining venture capital
for projects, and to reject a membership bid by Yugoslavia. Direct government
funding commitments for EUREKA remain relatively small, and the program
has yet to attract the participation of large, technically advanced firms.
Secret 26
11 July 1986
likely to seek involvement.
US Embassy reports indicate that major firms in Sweden are also
skeptical of EUREKA. In addition, skepticism in official quarters, including
Prime Minister Chirac's government, may make high-technology firms less
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Impasse on Soviet Negotiations for the construction of a 600,000-metric-ton-per-year alumina
Alumina Plant plant in Greece by the USSR seem to have reached an impasse. The viability
in Greece of the $500 million project depends on the USSR and Bulgaria absorbing all of
the plant's output. In 1985, after six years of negotiations, the three countries
reportedly signed an agreement that called for the USSR to purchase 400,000
tons each year at favorable prices to compensate for the construction of the
plant. Bulgaria agreed to purchase the remaining 200,000 tons, one-half to be
paid for in hard currency, the balance in compensating trade. In mid-June,
however, Sofia apparently reneged on the agreement, probably having second
thoughts on the terms. Athens has now turned to Moscow to absorb the entire
output of the plant, but the USSR probably does not need the extra amount.
Moscow's primary motive for concluding this agreement was to provide a long-
term source of alumina for expansion of its aluminum production, at a low
hard currency cost. If the deal falls through, the USSR-which produces 25X1
about 65 percent of the raw materials it needs to make aluminum-would
probably turn to other countries, such as Jamaica, for its supply.
Afghan-Soviet The Kabul regime signed a protocol with the USSR on 3 July for housing con-
Protocolfor struction in Afghanistan. Under the terms of the agreement, the Soviets will
Housing Construction deliver material and equipment valued at 2.04 million rubles-approximately
$2.9 million-to Afghanistan in 22 months. The regime plans to construct
more than 1,500 residential apartments annually with this material. The
expansion of housing construction-which was announced as a priority in the
government's Socioeconomic Development Plan for 1986-91-has probably
been necessitated by the large flow of refugees from the Afghan countryside
into Kabul. Since 1979, the population of Kabul has expanded from 913,000 to
over 2 million, according to census data and estimates obtained by the US Em-
bassy in Kabul.
27 Secret
II July 1986
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National Developments
Developed Countries
Canadian Ottawa has again delayed introduction of a controversial bill-long desired by
Pharmaceutical US companies-that would lengthen the period pharmaceutical innovations
Legislation Stalled are covered by patents. Supporters of the bill claim. it would generate $1.4 bil-
lion in investments and 3,000 new jobs, while opponents argue that its main
impact would be to boost drug prices for Canadian consumers. Anticipation of
widespread opposition to the planned changes, as well as ongoing trade
disputes with the United States, led Ottawa to postpone announcement of the
proposed patent legislation several times in recent months. The government
will now use the summer parliamentary recess to gauge public reaction. We
believe it will again stall on introducing a bill when Parliament resumes in the
fall, particularly if the United States has imposed tariffs on softwood lumber
in the interim
Japanese Proposal Echoing the sentiments of Japan's labor leaders, the Labor Ministry's annual
To Shorten Workweek white paper advocates, for the first time, reducing work hours as a means of in-
creasing productivity and consumer demand. The report urges employers and
unions to make the five-day workweek a priority and notes that Tokyo is
studying the feasibility of amending the Labor Standards Law to shorten the
legal workday. The guidelines will certainly be cited as part of government
efforts to reform Japan's export-oriented economy at the late July US-
Japanese meetings on macroeconomic adjustments. Changes in the present
system, however, will be incremental at best. In the past, influential Japanese
employers' organizations have strongly opposed government recommendations
to reduce work hours, arguing that an increase in leisure time and leisure-
related expenditures will only generate inflation and reduce Japan's interna-
tional competitiveness. According to the US Embassy, labor leaders are
reluctant to challenge management's hardline position, in part, because of
rank-and-file apathy on the issue. Moreover, a shorter workweek would do
little to stimulate domestic demand unless the more difficult problem of wage
increases were also addressed.
Secret 28
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Parliamentary Opposition to important aspects of the Thatcher government's social security
Opposition to reform legislation has surfaced in the form of two amendments passed by the
Social Security House of Lords. The first change would reverse the government's plan to force
Reform all households, including those of the unemployed, to pay at least 20 percent of
their local property taxes. (Currently, about 3.5 million households receive a
full rebate on property taxes, and another 3.8 million households receive a
partial rebate.) The other amendment would create a new community care
allowance for the severely disabled to replace other benefits that the govern-
ment's bill eliminates. Prime Minister Thatcher and Social Services Secretary
Fowler oppose both changes, which together would add at least $700 million a
year to public spending. Tory leaders claim that party discipline will be strictly
enforced to overturn the amendments when they come before the House of
Commons. Despite this rhetoric, London may be forced to accept changes in
the bill because 13.3-percent unemployment and mounting controversy over
inadequacies in the educational system and national health service have made
social security an extremely sensitive issue.
Postponement of London's decision to postpone the sale of 10 regional water authorities
British Water represents only a temporary setback to Thatcher's privatization program, but
Authority Sale is politically embarrassing. The government announced last week that legisla-
tion authorizing the sale-expected to raise $7.7-$10.8 billion-will be
delayed from this autumn's parliamentary session until after the next election,
which could be held as late as June 1988. Environment Secretary Ridley
explained that more time was needed-two difficult issues are whether to sell
all 10 authorities at once and how to provide for the pensions of the 50,000 em-
ployees. Ridley also reportedly wants further studies on the impact of turning a
basic public monopoly into a private monopoly. The Labor Party, pointing to
recent privatization setbacks-British Airways and Royal Ordnance, the state
arms and munitions company-accused the government of abandoning one of
its central economic objectives. These delays, however, probably will not
interfere drastically with the Tories' goal of raising about $7 billion in each of
the next three years from the sale of state assets. Planning continues for sales,
in a possible third Thatcher term, of assets such as the state-owned electricity
network and parts of the National Coal Board and British Steel Corporation.
Government Collapse With the fall of the government on 27 June further discussion of the 1987 bud-
Delays Italian get is likely to be delayed until the fall. Although the government traditionally
Budget Planning does not begin its budget preparations until September, Parliament last month
called on the Cabinet to set a 1987 budget deficit target before the August re-
cess, rather than waiting for the spending program to be approved. Parliament
had hoped this would speed passage of the budget and also encourage the
Cabinet to make the difficult decisions about spending cuts. The Cabinet
reportedly had agreed to a deficit target of $67 billion for 1987-as compared
with $73 billion this year-but the government collapsed before it could
present the proposal to Parliament. Party leaders and prospective cabinet
members agree that the budget process must be improved and the budget
deficit sharply reduced, but a new government is unlikely to tackle the touchy
budget issue until after the summer holiday.
29 Secret
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Madrid Privatizes Madrid took an important step last month in its effort to privatize unprofitable
Car Manufacturer public enterprises. With the sale of Seat, the state-owned car company, to
Volkswagen, Madrid rid itself of one of its top money losers. Seat had not
made a profit since 1977, and last year accounted for one-fifth of the red ink at
INI, the state industrial holding group, whose total losses amounted to about 1
percent of GDP. The sale should advance Madrid's goal of rejuvenating
Spain's traditional industries because VW plans to invest $3.5 billion in new
plant and equipment. Its technological and managerial expertise should also
enhance Spain's ability to compete in the West European market. To secure
the deal, INI had to pay $1.3 billion to liquidate Seat's past debts. In addition,
VW plans to trim Seat's swollen work force by about one-fifth, or 4,500 jobs.
This will stimulate some criticism in unemployment-plagued Spain, but the
only serious opposition is likely to come from the Communist labor union, and
we expect VW to have little trouble with its plans.
Less Developed Countries
Brazil's External Brazil's strong trade performance so far this year will probably strengthen the
Accounts Healthy government's resolve to stick with its independent stance on debt. The US
Embassy reports that Brazil's trade surplus for January-May totaled
$5.0 billion, up nearly 20 percent from the same period last year. The decline
in the US dollar-to which the cruzado is tied-helped fuel a 10-percent
increase in exports, to $10.3 billion, paced by sales of manufactured goods,
coffee, soybean meal, and iron ore. Brazil's imports rose slightly to $5.3 billion,
and their composition changed as well. Brasilia applied the 40-percent decline
in its oil bill to increase food imports-offsetting shortages caused by increased
domestic demand and the drought-while raw materials and capital goods
imports climbed in the wake of booming industrial output. On the basis of a
projected trade surplus of about $13 billion and lower interest payments, we
estimate that the current account will balance this year, compared with a
deficit of over $600 million in 1985. The improvement in the external accounts
will ease the burden of interest payments, but it is also likely to make Brasilia
even more adamant in its refusal to negotiate with the IMF as a prerequisite
for future debt reschedulings.
Ethiopian Economic According to recent US Embassy reporting, Ethiopia's economic pressures
Pressures Eased have eased significantly this year. In Addis Ababa, retail prices are lower and
food availability greater than expected earlier. Commercial imports of wheat
are up because of increased foreign exchange availability from high coffee
export prices and low oil import prices. Also, farmers are believed to be selling
local grain stocks to purchase inputs for the bumper crops expected later this
year in the wake of excellent rains. We do not believe the improved economic
picture has firm underpinnings, however, given the economy's structural
problems and softening coffee prices.
Secret 30
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Pakistan Anticipates Pakistan is expecting a record wheat harvest of at least 13.5 million metric
Record Wheat Harvest tons for the fiscal year ending 30 June 1986-almost a 20-percent increase
over last year's crop, which suffered from water shortages-according to US
Embassy and press reporting. Increased production will allow Pakistan to
eliminate wheat imports-1.8 million tons last year-for a savings of at least
$200 million during the current fiscal year. Moreover, the Minister of State
for Food and Agriculture said the government has given initial approval to the
export of 500,000 tons of wheat this year, adding at least $55 million to export
earnings, according to press reports.
Soviets Cut Civilian The Soviet State Planning Committee reportedly is planning a "big cut" in the
Titanium Allocation amount of titanium allocated to the Ministry of Nonferrous Metallurgy. This
may be indicative of more widespread allocation reductions in the economy.
Shortages could slow modernization and expansion programs under way in the
nonferrous metals and chemical industries, which account for a large share of
civilian titanium consumption. Products made with stainless steel could
probably be substituted, but this metal is also in short supply. The cut could
signal increased military demand. The defense industries, which traditionally
have had the highest priority for allocations and are the largest consumers of
the metal, use titanium products in the production of submarines, aircraft, and
missiles. Slow production during 1981-85 has probably resulted in tight
supplies-we estimate that production grew at an average annual rate of only
about 1 percent during the period. In 1985, we estimate that the USSR
produced approximately 71,000 metric tons of titanium, roughly two-thirds of
global output.
Hungary Moves The Hungarian Government has ordered state enterprises to tie future wage
To Limit Wages increases to productivity. Compared with the first quarter of 1985, industrial
and construction wages in first quarter 1986 rose 8 and 16 percent, respective-
ly, outstripping plan targets as well as increases in productivity and inflation.
Despite the 6-percent decline in real earnings over the previous five years, the
1986 plan called for average wage increases of only 5 to 5.5 percent-equal to
projected consumer price inflation-to help restrain domestic consumption so
more resources could be devoted to exports. Recent reforms giving enterprises
greater control over revenues and increasing worker influence, however, led to
larger pay raises. Strict enforcement of the new wage limits probably will
bring wage increases within the planned range by yearend. Hungary's senior
economic official, Ferenc Havasi, has indicated that even a minimal increase
in real wages may not be possible until 1988. Any further decline in real wages
in state industry is likely to aggravate social tensions over widening income dis-
parities, especially among those who lack opportunities to moonlight in the
private sector.
31 Secret
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East European Plant Within the past two years, fires have heavily damaged three major East
Fires Slow Microelec- European integrated circuit (IC) plants. The latest fire, in May 1986, caused
tronics Development $30-45 million in damages to the Hungarian Microelectronics Enterprise
(MEV), cutting Hungary's IC production capacity-estimated at 23 million
ICs per year-by about 50 percent. A fire in August 1985 destroyed one of
Czechoslovakia's leading microelectronics R&D centers and damaged its most
advanced production line, causing about $2.5 million damage. Finally, in May
1984, a fire gutted a new Romanian IC plant outfitted with Western
equipment just a few days before it was slated to begin production.
Although Hungary, Czechoslovakia, and Romania have probably moved
quickly to offset the effects of the fires, development of IC industries will be
considerably delayed. Within days, the Hungarians began contacting the
USSR, East Germany, and Czechoslovakia, as well as West European firms,
to negotiate joint ventures and equipment leasing schemes to replace equip-
ment destroyed in the fire. Nevertheless, we estimate that it will take the
Hungarians a minimum of two years to regain previous production levels.
Czechoslovak R&D capabilities will be hampered until equipment and facili-
ties can be replaced, but Romania has probably regained limited production
capabilities and is geared up to full-scale production. Rebuilding these
facilities will put considerable strain on the three economies, requiring
diversion of investment funds and expenditure of limited hard currency to
replace specialized Western equipment. Most of this equipment is COCOM
controlled and has to be acquired illegally, slowing efforts to outfit the plants.
The gap probably cannot be filled by other CEMA suppliers, and we expect in-
creased efforts to import ICs from the West, many of which may be COCOM
controlled. The USSR and Eastern Europe already legally and illegally import
up to 100 million ICs annually from the West.
China's China devalued its currency by 13.5 percent against the dollar on 5 July in re-
Devaluation sponse to continuing concerns about its trade balance. We estimate that China
ran a trade deficit of about $8 billion in 1985. Preliminary Chinese data
indicate that the trade deficit in the first quarter of 1986 was about the same
as in the same period last year. This devaluation follows a 7-percent
devaluation in October, reflecting Beijing's determination to improve its trade
performance by greater reliance on economic incentives. Premier Zhao Ziyang
complained in March that, because of China's irrational price structure, the
profits from domestic sales of many products are greater than profits from
exports. Announced during an annual visit to China by an IMF delegation, the
devaluation highlights Beijing's efforts to align its trading system with
Western practices, and may be viewed by Chinese leaders as a step to smooth
China's entry into GATT. In addition, Beijing undoubtedly hopes the devalua-
tion will help reduce black-market trading of Chinese currency, but the yuan is
still overvalued and may be devalued again before the end of the year.
Secret 32
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