INTERNATIONAL ECONOMIC & ENERGY WEEKLY

• Document Type: CREST
• Collection: General CIA Records
• Document Number (FOIA) /ESDN (CREST): CIA-RDP88-00798R000400170003-9
• Release Decision: RIPPUB
• Original Classification: S
• Document Page Count: 48
• Document Creation Date: December 22, 2016
• Document Release Date: July 12, 2011
• Sequence Number: 3
• Publication Date: September 19, 1986
• Content Type: REPORT

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Directoratg of -Seem4
Intelligence
Weekly
International
Economic & Energy
DI IEEW 86-038
19 September 1986
675
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International
Economic & Energy Weekly 25X1
iii Synopsis
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1 Perspective-The IMF/IBRD Annual Meetings: Still Wrestling With LDC Debt
3 LDC External Debt: Significant Trends and Risks
7 Mexican-IMF Agreement: The Risk of Spillover
13 International Financial Situation: Outlook for Key East Asian Debtors
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23 Western Europe's Automobile Industry: Stiff Challenges To Restructuring
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Energy
International Finance
International Trade
Global and Regional Developments
National Developments
Comments and queries regarding this publication are welcome. They may be
directed to Directorate of Intelligenc
Secret
DI IEEW 86-038
19 September 1986
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International
Economic & Energy Weekly
Synopsis
1 Perspective-The IMF/IBRD Annual Meetings: Still Wrestling With LDC Debt
The joint annual meetings of the IMF and the World Bank are again bringing
creditors and debtors together under a cloud of LDC debt problems. The more im-
portant discussions will occur in the informal sessions focusing on the current debt
problems and the strategy for dealing with them
3 LDC External Debt: Significant Trends and Risks
LDC debt probably will reach about $855 billion by yearend 1986-up some $21
billion from yearend 1985. We expect a major resurgence in LDC demands for ex-
ternal financing and debt relief and increased deterioration in LDC economic
performance.
7 Mexican-IMF Agreement: The Risk of Spillover
We believe the Mexican-IMF agreement announced on 22 July breaks new ground
on debt negotiations, and it is likely to become a model for other debtors. The prec-
edents established in the agreement could create new risks for debtor-creditor
cooperation.
13 International Financial Situation: Outlook for Key East Asian Debtors
Commercial bankers, battered by their troubles in Latin America, are becoming
more apprehensive as the East Asian LDC's ability to repay their foreign debts de-
teriorates. While none of these countries is in a crisis, all with the exception of
South Korea may require debt relief within the next two years.
Crude oil sales picked up in the second quarter and Moscow can keep oil exports
high for the rest of the year because of continuing high domestic oil production
and increased reexports of Middle Eastern oil. Nonetheless, a rise in domestic
demand could dash any plans for increased exports and further depress earnings.
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23 Western Europe's Automobile Industry: Stiff Challenge To Restructuring
The performance of the West Eurpoean automobile industry has improved
recently because of generally better economic conditions, but continued excess
capacity and political constraints on reducing the labor force cast a shadow over
longer term prospects. Although Western Europe's major producers are, to varying
degrees, turning to robots and automated design and production processes to
improve efficiency, these efforts will not be enough to beat back the Japanese, who
have increased exports and are expanding assembly operations in Western Europe.
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International
Economic & Energy Weekly
19 September 1986
Perspective The IMF/IBRD Annual Meetings: Still Wrestling With LDC Debt
The joint annual meetings of the IMF and the World Bank are again bringing
creditors and debtors together under a cloud of LDC debt problems. The mood is
not one of apprehension over the stability of the international financial system as it
was in Toronto in 1982 following the shock of the Mexican and the Brazilian
financial crises, nor is there the sense of anticipation felt last year in Seoul when
the United States unveiled the initiative now known as the Baker Plan. The feeling
instead seems to involve a deepening frustration by debtors and other financial
players with the slow progress made in reducing the debt burden on LDCs.
This series of meetings, which begin on 28 September with the IMF Interim
Committee meeting, have a variety of topics scheduled for discussion, including
aid coordination in Sub-Saharan Africa, World Bank investment programs, and a
World Bank capital increase. The more important discussions, however, will occur
in informal sessions. These bilateral meetings, involving commercial bankers and 25X1
government financial officials from creditor and debtor countries, undoubtedly will
focus on the current debt problems and the strategy for dealing with them.
In this arena, the chief issue will be the contention of the LDCs and even some
creditor banks that a revised approach extending beyond the general guidelines of
the Baker Plan is needed. For their part, the common theme of the LDCs has been
a return to economic growth instead of additional austerity. In practical terms, this
translates into additional funds from creditors with reduced or minimal condition-
ality. A number of debtors believe the IMF has outlived its usefulness, and the
World Bank-or a new agency-should administer the adjustment process in
individual countries over a longer time period. From the debtors' standpoint, this
involves a much greater role for the developed country governments to ensure a
steady flow of funds into the LDCs.
Bankers also would welcome a greater creditor government role in the debt
strategy to protect their position. Most bankers-particularly in the United States
- want to reduce their foreign exposure and are extremely reluctant to continue
involuntary lending to a core of debt-troubled LDCs. On the other hand, bankers
realize that, without continued new lending, the risk of a payment interruption by
one or more major debtors increases dramatically. In particular, there is a nagging
fear that a major creditor such as Mexico will take some unilateral action-
limiting payments to a share of export earnings, for example-that would take
repayment decisions out of the bankers' control. Bankers, therefore, look to
creditor governments to assuage the threat of any total or partial payments
moratorium.
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We believe these trends may put the ball largely in the court of the developed
countries, with the US Government being viewed as the leader; some players in the
debt crisis may even use the meetings as a forum to increase such pressure. If de-
veloped country governments are forced to take on this role, they will face a
difficult challenge. The most immediate task will be to keep the Mexican deal, al-
ready showing signs of bogging down, on track. Although the developed countries
will reaffirm the need to adhere to the current debt strategy with some
modifications to promote economic growth, a final resolution to the Mexican-and
thus other-negotiations almost certainly will require the involvement of high-
ranking Western government and banking officials.
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LDC External Debt: Significant
Trends and Risks
LDC debt probably will reach about $855 billion by
yearend 1986-up by some $21 billion from yearend
1985. We project that LDC debt service payments
will be about $115-120 billion in 1986, about the
same as last year. Given the stagnation of LDC
exports, the aggregate LDC debt service ratio will
remain high-above 20 percent-and constrain im-
provements in their debt situations. We expect a
major resurgence in LDC demands for external
financing and debt relief and increased deterioration
in LDC economic performance.
The Debtor's Perspective:
Increased Relief Needed
Because of reduced bank lending, dubious prospects
for other sources of financing-such as foreign aid or
direct investment-and falling prices for many of
their key exports, the major debt-troubled countries
face an economic development crisis. Moreover, many
LDC government officials believe that the approach
to balance-of-payments adjustments taken by some
since 1982-seeking to improve export performance
and cut imports with monetary and fiscal measures
and more realistic interest and exchange rate poli-
cies-has not worked. Finally, the debtor countries
appear no closer to regaining access to voluntary,
substantial medium-term loans from commercial
banks.
Aggregate LDC External Debt, 1979-85
Medium/
long-term
official
Medium/
long-term
private
creditworthiness in the international financial mar-
kets. The net outflow of resources from these coun-
tries to commercial banks and creditor countries
totaled some $22 billion in 1985 and is continuing at a
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As a result of these trends, LDC living standards have similar pace this year.
fallen, unemployment has risen, inflation remains a
worry, a rising share of domestic savings goes into
interest payments, and domestic investment has Country Situations
slowed dramatically. In effect, economic development
for many LDCs has been deferred to preserve limited
Mexico-facing dwindling reserves, negative growth,
and rising inflation-secured an IMF letter of intent
in August. Current debt negotiations may lead to a 25X1
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$12 billion international rescue package that may
include $6 billion in new commercial bank loans for
1986 and 1987 and a contingency fund to cover
earnings losses from a further oil price decline. If
bankers refuse to renew substantial lending or provide
significant concessions this fall, we believe Mexico
will again raise the specter of a payments suspension,
possibly by opening a special account in the central
bank where interest owed to foreign banks would be
deposited in pesos rather than in dollars.
After a good start, Argentina's Austral Plan is falter-
ing and Buenos Aires is likely to ask for as much as
$1.5 billion a year in new money for 1986 and 1987,
coupled with a program to reschedule about $14
billion of debt due during those years. In addition, it
might seek interest rate concessions. Argentina could,
on its own, take some action to cap interest payments
if domestic labor unrest grows worse and banks rebuff
Buenos Aires's efforts to obtain the $3 billion. Presi-
dent Alfonsin has reiterated the need for interest
concessions to Argentina because of the depressing
effect of US-subsidized sales to the Soviet Union on
world wheat prices.
According to Embassy reporting, Venezuela may re-
quest $600 million in new money, ask for postpone-
ment of $3.4 billion in principal repayments due
during 1987-89, and seek further unspecified conces-
sions on interest rates. Venezuela recently attempted
a scheme to pay off private-sector debts totaling
almost $5 billion with low-interest, long-term bonds.
The scheme was scrapped in the face of strong
bankers' resistance. Caracas is now likely to seek a
less objectionable rescheduling arrangement with
bankers.
Peru has serious problems with its relations with
creditors, and there is a danger that it may be the first
debtor in recent years to be formally declared in
default. Already, the IMF has declared Peru ineligi-
ble to draw on Fund resources. Lima continues to
limit debt payments to 10 percent of export earnings
and would welcome similar actions from other debtors
in support of its position.
Bank creditors expect that Egypt will need a debt
rescheduling soon-its first-to help offset sharply
lower oil export revenues and worker remittances. In
addition, Nigeria will need as much as $1 billion in
new loans annually over the next few years, according
to World Bank estimates, even with maximum debt
rescheduling. Lagos still must formalize an IMF
standby arrangement to obtain commercial bank new
money and a Paris Club rescheduling.
In Asia, the greatest problem is the Philippines,
which, despite some recent limited economic gains,
remains burdened by its $26 billion external debt. The
most immediate challenge for President Aquino is to
get foreign financial assistance flowing into the coun-
try again. Hopes are that an IMF-supported program
will be in place in time for Manila to draw its final
commercial bank new money disbursement before the
end of the year. Executing a new economic plan
without considerable new external financing will be
difficult because of the discord among Aquino's Cabi-
net members.
Creditors' Financial Positions and Perspectives
While debtor positions are growing more strained,
some international banks-especially smaller US
regional banks and West European banks-are in a
better position now to deal with LDC payment diffi-
culties than they have been since the debt crisis began
in mid-1982. Most banks have increased their capital
base while lending little additional money to debt-
troubled LDCs, and they have built up reserves
against some bad loans. As a result, these banks now
feel they can refuse to participate in new lending if
they find the arrangements unacceptable.
In part because of their strong financial positions,
commercial banks will remain unwilling to extend
new medium-term loans to most LDCs unless pres-
sured to do so in financial packages in conjunction
with the IMF De-
spite being more a e to extend such loans, the banks
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Commercial Bank Exposure to 15
Troubled Debtors, 1985a
Other
28.8
West Germany
8.1
Japan b
13.9
United States
32.3
United Kingdom
16.9
u Data are for December 1985. The 15 countries are Argentina, Bolivia,
Brazil, Chile, Colombia, Ecuador, Ivory Coast, Mexico,. Morocco, Nigeria,
Peru, Philippines, Uruguay, Venezuela, and Yugoslavia.
b Estimated.
prefer to further reduce their exposure and improve
the integrity of their loan portfolios. Private credi-
tors-primarily commercial banks-probably will
boost their lending by only 3 to 5 percent during 1987.
Moreover, most of the increase in bank lending will
come in conjunction with debt restructuring packages
for a handful of major debtor countries.
We believe raising new money for heavily indebted
countries will even be difficult when the country has
IMF support and, at the same time, IMF support
need not preclude a debtor from seeking concessions
from creditors. US regional banks and other foreign
banks with small exposure, for example, would prefer
to write off their Mexican debt and take a loss than to
contribute to a new loan they believe would not be
paid back. Thus, the forced bank lending to LDCs
over the medium-term probably will be concentrated
even more among the largest commercial banks in the
world-increasing both the burden and the risk of
new LDC exposure for these banks.
New lending to LDCs is also discouraged by a
secondary market that trades LDC debt at a deep
discount and the rapid evolution of financial markets
that is changing bank lending strategies away from
sovereign country lending.
banks complain about what they
and often this charge is not tax deductible.
perceive as conflicting signals from their regulators
that penalize them for lending new money, even
within the context of the Baker initiative. For exam-
ple, in Japan and several European countries, supervi-
sory authorities require sizable reserves against both
old and new loans. As a result, these banks must take
a charge against earnings when they make new loans,
Outlook: Compromise Likely, But Risks Remain
In our view, debtor-commercial bank negotiations
during the next 18 months probably will result in
some middle ground between large forced lending or
partial debt forgiveness by commercial banks and
unilateral debtor action-the costs to both parties of a
complete breakdown in debtor-creditor relations are
extremely high. From the creditor point of view, the
Baker initiative provides a broad framework within
which bilateral negotiations will be carried out.'
On the debtor side, while they will
continue to press for concessions, they, too, probably
will accept compromise-agreeing to actions such as
changing the basis for interest rates from US Prime to
LIBOR, for example. Nevertheless, a break from the
current debt strategy-by either a major debtor or
creditor-cannot be ruled out.
In this environment of increased debtor demands for
relief and commercial bank reluctance to lend, we
believe there may be a number of situations where the
US Government may be called on to intercede be-
tween the two groups:
? Almost certainly, Washington will have to stay
involved in the Mexican financial negotiations. The
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short-term risks are that foreign creditors will re-
main unconvinced of the extent of economic reform
and be unwilling to supply new money in the
amount requested. In addition, disagreement over
Mexican proposals could drag out negotiations, in
which case there would almost certainly be difficul-
ty in meeting interest payments on the external
debt.
? If a major debtor country chooses to unilaterally
curtail interest payments, the United States will be
called upon by international banks to use its lever-
age to bring the debtor around or to provide new
regulatory changes to help cushion the resulting
Washington's need to intervene in resolving LDC debt
difficulties also will be affected by global economic
policies and conditions. If the industrial West, partic-
ularly the United States, were to go into a recession, if
dollar interest rates were to rise, or if trade protection
continues to grow, LDC debt service problems would
increase and debtors almost certainly would demand
countering actions from Washington.
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Mexican-IMF Agreement:
The Risk of Spillover
We believe the Mexican-IMF agreement announced
on 22 July breaks new ground on debt negotiations. It
is likely to become a model for other debtors who are
facing similar financial difficulties. They will proba-
bly put strong pressure on creditors for comparable
debt relief, citing a bleak financial outlook, prior
economic reform efforts, or a special relationship with
creditors. The precedents established in the agree-
ment could create new risks for debtor-creditor coop-
eration. For example, if key debtors fail to receive
what they consider to be equal treatment, it is possible
that they may adopt unilateral measures to limit their
debt service payments.
Major concessions of the IMF-Mexico letter of intent
include:
? The amount of new financing. The agreement as-
sumes over $12 billion in new money between now
and the end of 1987, with half coming from com-
mercial banks, according to financial press report-
ing. Multilateral banks, led by the World Bank and
IMF, will supply nearly $4 billion. The remaining
$2 billion are international export and US farm
credits.
We believe several Latin American countries are
candidates for spillover. These debtors will base argu-
ments for debt relief on current financial hardships,
the need for renewed economic growth, and prior
structural adjustment achievements. These countries
have closely followed the Mexican talks and are
positioning themselves to demand similar concessions.
Argentine officials will be quick to point out the
progress of the year-old austerity program, the Aus-
tral Plan, which has sharply lowered the inflation
rate, reduced the government budget deficit as a share
of GDP, and set the stage for short-term industrial
improvement. Nonetheless, agricultural exports have
been depressed by falling prices, and Buenos Aires
also will cite the US decision to subsidize agricultural
sales to the Soviet Union as wreaking further havoc
with their foreign payments position.
= Buenos Aires already is drawing out its negotia-
tions to see the outcome of the Mexican agreement.
Brazil-with a foreign debt of more than $100 bil-
lion, massive debt service payments, and a high debt
service ratio-is also likely to seek Mexican-type
? Tying additional loans to commodity prices. A
contingency fund has been created under the letter
of intent to insulate Mexico from the further effects
of declining oil prices. New money would be made
available automatically if oil prices fall below $9 a
barrel for more than 90 days during the first nine
months of the accord, less if prices rise above $14
per barrel.
? An orientation toward growth. The Fund agreed to
let Mexico tailor an economic recovery program
that allows real GDP growth of at least 3 percent
starting in 1987. In addition, a $500 million reserve
was established and will be disbursed to bolster
domestic investment if the economy fails to recover
by the first quarter of 1987.
? The longer term creditor commitment. Mexico can
seek medium-term lending commitments from cred-
itor banks beyond the 18 months covered by the
IMF-supported program. In addition, the letter of
intent reportedly allows Mexico to automatically
renew the IMF package for another year at the end
of the program.
Although most of the official funding has been ap-
proved for the package, Mexico's commercial credi-
tors have yet to agree to provide the $6 billion laid
out in the accord.
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Key LDC Debtors: The Road to Financial Problems, 1975-86
Low Commodity Prices... Plunging Oil Prices ... And Slowing OECD Real GNP ... Have Sharply Cut Export Earnings
Index: 1980=100 Index: 1980=100 Percent Billion US S
I I I I I I I I I I I 1
0 1984 85 86a 0 1984 85 86 0 1984 85 86a 120 1984 85 86a
Raising the Debt and Debt Service Burden ...
Debt Payments Debt Service Ratio
Billion US $ Percent
And Reducing Average Annual
Real GNP Growth
Percent
a Data for 1986 is for the first half.
b Estimated.
concessions, despite its strong current account position flationary spiral, reduced interest rates, and set in
and substantial foreign exchange reserves. The Sar- motion some market-oriented reforms that could
ney administration has repeatedly argued that foreign strengthen the economy
creditors should give Brazil the easiest financing
conditions in Latin America because of that country's Venezuela may argue for debt relief on grounds of a
economic adjustment achievements. Brasilia can cite poor financial situation, the need to revive a stalled
the elimination of a current account deficit that was economy, and bank reluctance to provide new funds.
$16 billion in 1982, tax reform, and budget consolida- Low oil prices will cost Venezuela $5-6 billion in
tion. More recently, the Cruzado Plan-Brazil's six-
month-old austerity program-has weakened the in-
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export revenue this year, and we forecast a 2-percent
decline in real GDP. As a result, Caracas may request
a postponement of $3.4 billion in principal payments
due during 1987-89. In our opinion, a rescheduling of
public- and private-sector debt, coupled with the use
of foreign exchange reserves, should be sufficient to
cover the loss of export revenue in the near-term.
Despite a strong record of economic management,
Ecuador, beset by the sharp drop in oil prices that will
slash export revenues by $500-600 million this year
and increase the current account deficit to $750
million, has had to negotiate increased financial assis-
tance and institute additional economic reforms. Giv-
en Ecuador's poor financial outlook, we believe that
Quito is a strong candidate for requesting concessions.
The Central American Core Four countries-Costa
Rica, El Salvador, Guatemala, and Honduras-may
be candidates for spillover. We expect total debt
service will remain near 40 percent of goods and
services exports-more than double the 1980 level.
We forecast a slight increase in real GDP this year
that will do little to offset the 5-percent decline from
1980 to 1985. Despite an expected improvement in the
trade picture this year due to higher coffee prices and
lower petroleum imports, we expect most of these
debtors to seek payment concessions and new financ-
ing citing the need to compensate for five years of
eroding export earnings, the continued fall in per
capita income, and the need to combat insurgent
threats.
Peru's financial outlook is clouded by a number of
adverse factors, including persistently low commodity
prices. Because of President Garcia's attempt to
secure de facto debt relief by linking debt repayments
to export revenues, and a near-complete lack of
investor confidence, Peru almost certainly will not
obtain major debt concessions from commercial banks
or the IMF unless it substantially alters its hardline
position on debt repayment
In general, the potential for spillover is not as great in
Asia as in Latin America. Most of these countries
have considerably stronger financial positions. More-
over, Asian debtors are less belligerent toward credi-
tors and are more amenable to implementing mea-
sures to permit full servicing of debt obligations.
Indonesia and Malaysia have suffered economic and
financial reverses during the past two years. Lower oil
prices and, for Malaysia, a drastic decline in commod-
ity prices have sharply reduced export earnings for the
two countries, and the decline of the US dollar has
boosted debt servicing costs on the portion of foreign
debt that is nondollar denominated. While short-term
measures such as use of foreign exchange reserves and
modest increases in foreign borrowing will be suffi-
cient to cover the financial gaps during the next 18
months, over the 1988-90 period both countries will
need substantial amounts of new funding to maintain
high GDP growth and absorb labor force increases
unless oil and commodity prices rebound. If these
funds are not forthcoming, Mexican-like debt conces-
sions could be requested.
The Philippines is an exception to this more optimis-
tic Asian picture. Since 1984, Philippine export earn-
ings have been depressed by a 40-percent drop in
commodity prices, imports have been slashed, and real
GDP has fallen more than 2 percent. Moves by
President Aquino, however, have put economic adjust-
ment measures into effect-tax measures have been
passed, trade liberalization is under way, and reform
of financial institutions has begun. With renewed
economic growth a top government priority, Manila is
seeking the support of its foreign donors for a growth-
oriented economic strategy that includes a multiyear
debt rescheduling and tolerates a high government
budget deficit.
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Among the major Middle Eastern and African debt-
ors, Egypt's export revenues have been devastated by
lower oil prices and a sharp drop off in worker
remittances, and even with modest import cutbacks
we believe Cairo will require substantial new funding
to meet financial needs. Egypt will probably also point
to a new economic reform package as justification for
debt relief, although Cairo has proven more adept at
proposing reforms than at implementing them. Final-
ly, Egypt will continue to cite its special relationship
with the United States as an argument for debt
concessions.
Nigeria could make the argument that its financial
condition is worse than Mexico's and that major debt
relief is a necessity. The oil price drop will slash
Nigerian export earnings by as much as $5 billion this
year, and political considerations will make meaning-
ful austerity measures difficult. Nevertheless, Nigeria
does not seem willing to press the issue of debt relief.
Lagos is aware that past actions-such as accumula-
tion of large debt arrearages and refusal to make
needed reforms-have made creditors reluctant to
undertake further lending.
We believe the precedents established in the Mexican
agreement may create new financial risks for both
major debtors and international creditors:
? The conduct of current debt negotiations may dete-
riorate. The Mexican package makes it politically
more difficult for other debtors to continue paying
without extracting concessions from creditors and
harder to operate under the old strategy where
continued financing was contingent on a strict IMF-
supported program. If a debtor fails to receive what
it considers adequate financing or payment terms,
or cannot find other ways to reduce debt payments,
there is a greater possibility that it will use its
leverage and unilaterally act to curtail payments.
? Financial relations will become more complicated.
Key debtors with narrow export bases-such as
Argentina, Indonesia, and Venezuela-could de-
mand terms linking commodity export prices to
repayments. Similarly, LDCs may follow Brazil's
lead and try to link debt payments to GDP.
Alternative Payment Schemes
While we believe debtor demands for relief will be
modeled after the Mexican financial package, alter-
native schemes have been proposed-and some imple-
mented. These include tying payments to export
revenues (Peru and Mexico), issuing bonds to service
debt (Venezuela), and domestic currency deposit
schemes (Mexico). Some of these proposals could
surface again as debtor countries search for ways to
ease their financial problems. Creditors have general-
ly responded harshly to unilateral attempts at reduc-
ing debt payments, viewing such payment schemes as
setting dangerous precedents and as obstacles to
financial negotiations. When unilateral actions are
taken, banks often retaliate against the LDC by
cutting back short-term trade financing. They may,
however, also take more drastic steps: banks threat-
ened legal action against Venezuelan firms when the
bond system was first announced.
? The question of spillover will grow in importance as
future LDC debt negotiations progress. Debtors
may step up bilateral contacts and keeping each
other informed of current negotiating strategies.
Troubled debtors may use this network to time
announcements of alternative payment schemes to
maximize their effect.
? Commercial creditors will become more opposed to
negotiating with debtors if the Mexican accord
becomes the standard. They will also remain hesi-
tant to extend new longer term loans to most LDCs
unless pressured to do so in conjunction with an
IMF-supported program. Involuntary bank lending
over the next few years will fall more heavily on the
world's larger banks, increasing their risks and
exposure.
Offsetting these risks is the perception that Fund
flexibility with Mexico-allowing larger budget defi-
cits and tying further assistance to growth-may
encourage other recalcitrant debtors to stay within the
case-by-case strategy and not go it alone, as Peru has
done. However, should key debtors fail to receive
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Secret
what they consider to be equal treatment, it is possible
that they may adopt unilateral measures to limit their
debt service payments.
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International Financial Situation:
Outlook for Key East Asian Debtors
Commercial bankers, battered by their troubles in
Latin America, are becoming more apprehensive as
the East Asian LDCs' ability to repay their foreign
debts deteriorates.' With their exports hit hard by
depressed prices for oil and other commodities and by
protectionism in the industrialized countries, the
economies of the East Asian countries are beginning
to show serious signs of strain. While none of these
countries is in a crisis, all with the exception of South
Korea may require debt relief within the next two
years.
Changing Financial Positions
Assessing a Country's Debt Burden
There is no precise way to measure how much debt a
country can safely carry. Ultimately, the breaking
point comes when creditors as a group perceive that
the load is too heavy and begin to pull back their
credit lines. Creditors' perceptions are not based
exclusively on arithmetic ratios political and psy-
chological considerations also play a role-but credi-
tors do look at the numbers:
? Total debt in relation to gross national product. A
ratio above 40 percent is worrisome; 50 percent and
above sounds alarms.
Indonesia's financial position has suffered the great-
est deterioration. With petroleum accounting for more
than 70 percent of its foreign exchange earnings, the
sharp drop in world oil prices has cut Jakarta's export
earnings by $6 billion this year. Because Jakarta
earns dollars for its oil and much of its debt is in yen,
depreciation of the dollar will probably raise Jakarta's
total debt obligations by $800 million. We believe
Indonesia's external financing gap will jump to almost
$5 billion a year for the next three years-compared
with $2 billion in both 1984 and 1985. While Jakar-
ta's foreign exchange reserves and undrawn credit
lines provide some cushion, Indonesia will be forced to
increase its external borrowings this year. In the past,
Indonesia has enjoyed excellent access to capital
markets. Some bankers, however, are concerned by its
growing debt servicing obligations-almost $6 billion
in 1986-and are reluctant to lend more. At the same
time, officials in Jakarta are concerned over the
potential for rising social unrest, political instability,
and unemployment-already estimated at 35 per-
cent-if the prices of oil and natural gas languish at
present levels or fall further.
' We have analyzed four East Asian countries with significant debts
to commercial banks-Indonesia, Malaysia, South Korea, and
Thailand. The Philippines was not addressed in depth because its
? Total debt in relation to exports of goods and
services. Any figure above 200 percent raises
eyebrows.
? Short-term debt as a share of total debt. Anything
over 25 percent is undesirable; a growing share is
also a danger sign.
? Total debt service principal and interest-in rela-
tion to exports of goods and services. The most
widely used benchmark. A country in the 25-
percent range is in the danger zone, higher than 30
percent raises red fags.
? Foreign exchange reserves as a share of total debt.
A low level of reserves is a danger signal. Reserves
that are more than 20 percent of total debt are
reassuring.
? Total interest in relation to exports of goods and
services. This ratio is considered critical at levels
above 20 percent.
Secret
DI JEEW 86-038
19 September 1986
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Secret
Key East Asian Debtors: Indicators of Debt Servicing Ability, 1980-86
Total debt as a share
of GNP
G
Q
0
?
0
o
O
?
?
?
?
?
o
0
Total debt as a share
of exports
?
?
?
?
O
O
?
?
?
?
?
?
o
Short-term debt as a
share of total debt
?
o
0
Q
?
?
o
O
o
O
o
o
?
Total debt service as a
share of exports
?
o
0
0
o
O
?
?
o
a
O
a
Foreign reserves as a
share of total debt
O
?
?
ED
?
?
o
o
O
o
O
O
O
o
Total interest as a
share of exports
?
,
?
T
?
-
?
?
?
,
O
T
Note: Six categories of indicators were used to determine the threshold beyond
which a country's ability to repay its debts would be in jeopardy.
O Indicates that the threshold was exceeded.
o Indicates a ratio came within 10 percent of exceeding the threshold.
O Indicates a ratio in the safe range.
Thailand's worsening ability to service its debts stems
from falling commodity prices, the appreciation of the
yen against the baht, and a spiraling government
budget deficit. Indeed, the budget deficit-expected
to top $2.3 billion this year-endangers Bangkok's
compliance with its IMF-supported adjustment pro-
gram. Structural weaknesses in Thailand's financial
sector also could hurt its previously good credit rating.
Nonetheless, the newly elected government faces
strong political pressures to increase spending. With-
out a modest improvement in the economy, the gov-
ernment can expect increasingly vocal opposition
across the political spectrum. Two important issues
that could prove to be the most difficult politically, in
our opinion, are the establishment of a system to
better regulate financial institutions and a more effi-
Malaysia's financial situation is also becoming pre-
carious. Falling prices for oil, tin, and other commod-
ity exports, in conjunction with weaker demand for
Malaysian electronic exports, have worsened Malay-
sia's debt outlook. The rapid rise in Malaysia's total
debt in relation to its GDP-the ratio nearly doubled
from 1981 to 1985-is clearly cause for concern.
In contrast, South Korea's debt servicing ability has
improved this year due to the combined impact of low
oil prices, low interest rates, and increased export
competitiveness as the yen appreciates against the
cient system of tax collection.
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Key East Asian Debtors (continued)
Total debt as a share
O
O
O
O
o
O
O
O
O
O I
O
O
O
of GNP
Total debt as a share
0
o
O
o
0
0
0
o
O
o
o
O
o
O
of exports
Short-term debt as a
0
0
0
0
0
0
0
0
0
0
0
0
0
0
share of total debt
Total debt service as a
O
O
O
O
O
O
O
p
0
0
0
O
0
0
share of exports
Foreign reserves as a
0
0
0
0
0
0
?
0
0
0
0
0
0
0
share of total debt
Total interest as a
O
O
O
O
O
O
O
D
O
O
0
0
0
0
share of exports
difficulties.
won. Seoul's large debt and heavy reliance on short-
term credit lines, however, leaves it vulnerable to
shifts in bankers' confidence. Specifically, with short-
term debts of $17 billion against foreign exchange
reserves of $8 billion, Seoul is highly exposed to
almost any disruption in its access to the financial
markets. While not overly concerned with the current
level of political unrest, bankers' skittishness could
increase if the political situation worsens. If they were
to respond by cutting trade credit lines, South Korea
would find itself faced with immediate financial
Indonesia, Malaysia, and possibly Thailand, because
of their reliance on commodity exports, may, over the
next two years, require debt relief. These countries,
however, will try to protect their access to private
capital markets, and therefore are unlikely to take
radical debt actions. Indonesia-the prime candidate
for relief-may take a nontraditional approach by
trying to reschedule bilaterally with individual credi-
tors such as Japan. Moreover, encouraged by the
terms Mexico received in its recent debt negotiations,
Indonesia could conceivably push to have its debt
repayments tied to the price of oil as well. Indeed, if
debt relief is needed, each of these East Asian coun-
tries is likely to argue that it is entitled to substantial
concessions given its past performance in fulfilling its
debt obligations.
As South Korea's debt servicing capability improves,
Seoul is likely to take advantage of favorable econom-
ic trends to reduce its reliance on foreign borrowing.
Without debt relief, the other East Asian countries
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Secret
East Asian LDCs: Key Economic
Indicators, 1982-85
-5.3
27.9
3.0
0.1
Billion US $
(unless otherwise indicated)
will have to undertake significant domestic adjust-
ments that will slow economic growth even more.
Given the extent to which they have already cut
imports and slashed development spending, these
countries will be forced to make economic choices
that will be politically painful. One option is to open
up their economies to more foreign investment. Thai-
land and Indonesia have each announced a new
program of incentives in an attempt to lure such
capital inflows. Such investment, however, will be
slow to materialize and the measures needed to
encourage the necessary levels of investment would
force the governments to relinquish a significant
portion of their economic control.
The ability of these countries to repay their debts and
stimulate their economies is determined largely by
factors beyond their control. In the short run, we
believe the degree of adjustment required could
threaten the status quo:
? Tensions between various ethnic groups are likely to
increase if economic conditions continue to deterio-
rate. In Indonesia, resentment is focused on the
economically powerful Chinese business class.
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Secret
? Conflict is likely to increase as religious leaders take
on a larger political role. The full implications of the
emergence of clerics as critics of political and
economic policies remain to be seen. The reemer-
gence of Islamic fundamentalism has the potential
to cause problems for the political leadership in
Indonesia and Malaysia.
? Cuts in military expenditures as part of economic
adjustment could lead to a breakdown in the tradi-
tional military-government partnership.
Implications for the United States
Washington can expect the East Asian countries to
become increasingly vociferous in demanding prefer-
ential treatment on a number of issues. In the debt
area, the East Asian LDCs can be expected to push
for concessions that equal, if not exceed, any granted
to the troubled Latin debtors. The East Asian coun-
tries can also be expected to intensify their lobbying
efforts on trade issues with emphasis on US legisla-
tion aimed at protecting agricultural products and
textiles. Moreover, these countries could prove to be
more resolute and less cooperative during the new
round of GATT negotiations. In a broader context, in
an attempt to play major creditors against one anoth-
er, key East Asian countries may actively court
Japanese financing and hint at preferential treatment
for creditors that are the most forthcoming in an
attempt to win additional concessions from US inter-
ests.
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Soviet Oil Trade in a Weak Market
The USSR's crude oil sales lagged badly in the first
part of the year as domestic needs cut into supplies
and Moscow's rigid pricing policy made its oil uncom-
petitive on the slack world market. Only higher sales
of refined products kept total oil earnings from drop-
ping even further. Crude oil sales picked up in the
second quarter and Moscow has the potential to keep
oil exports high for the rest of the year because of
continuing high domestic oil production and increased
reexports of Middle Eastern oil. Moscow has a strong
incentive to boost oil exports over the remainder of the
year-petroleum is the largest Soviet hard currency
earner. Nonetheless, a rise in domestic demand could
dash any plans for increased exports and further
depress earnings. How the Soviets resolve some cur-
rent pricing disputes with West European buyers and
Middle Eastern suppliers over the next month should
give a clearer indication of the direction in which sales
are heading. If Moscow resolves pricing problems to
the satisfaction of both West European buyers and
Middle Eastern suppliers, then higher exports are
likely.
Soviet hard currency crude oil sales in 1986 got off to
a slow start for the second consecutive year. First-
quarter export volume was only 250,000 b/d com-
pared with an average of 500,000 b/d for the same
period in 1980-84. High seasonal domestic demand
and oil production problems hindered early sales as
they did in 1985, but Moscow's unwillingness to
competitively price its crude oil was also to blame.
Moscow's stubborness most likely reflected an inabil-
ity to properly assess the extent or duration of the
weakening market and make corresponding price
adjustments quickly. The Soviets clung to their offi-
cial contract price of $28 per barrel in early January
while world spot prices were falling, and even when
the Soviets began to offer discounts by midmonth
their price remained above world levels. The Western
press reported that buyers had suspended spot market
purchases and most hard currency contract deliveries
In contrast to the falloff in crude sales in the first
quarter, exports of refined products increased about
25 percent compared with average first-quarter prod-
uct sales over the last five years. These sales helped
keep oil revenues from plunging further as the aver-
age price of Moscow's products was about one-third
higher than that of its crude oil.
By late winter a pressing need for hard currency,
increased oil availability due to rising domestic pro-
duction, and the probable recognition that prices were
likely to remain depressed for an extended period
prompted Moscow to reconsider its pricing policies.
Soviet price competitiveness improved with the adop-
tion in March of netback pricing-an arrangement
that sets crude oil prices on the basis of prices received
for products refined from that crude. Buyers respond-
ed by boosting second-quarter volume purchases 20
percent over the same period in recent years to
roughly 1 million b/d.
Problems with hard currency sales apparently had
little impact on Soviet deliveries to Communist cli-
ents. The lack of complaints from East European
capitals and the absence of unusually high spot
purchases by East European buyers suggest that
Moscow maintained deliveries close to the 1985 level
of 1.4 million b/d. Similarly, the Soviets continued to
keep up oil supplies to Nicaragua and Cuba.
Moscow is likely to see improved oil supplies in the
second half of the year:
? Domestic oil production through July is up by
300,000 b/d over the same period last year and may
continue at about this rate for the rest of 1986.
? Moscow also will have additional supplies of Middle
Eastern oil to reexport, as some countries step up oil
shipments to pay for arms.
by late January.
Secret
DI IEEW 86-038
19 September 1986
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Secret
USSR: Hard Currency Oil Trade Recent Middle Eastern Oil Deals
Indicators, 1985-86
Million b/d
2.0
I II III IV I IIa
1985 1986
Billion US $
5
I II III IV I II
1985 1986
us S
35
I
1985
a Estimated.
b Weighted average.
IV I II
1986
The Soviets signed an agreement with Libya in April
to boost imports of oil by 70,000 b/d over the last
eight months of the year. Algerian oil shipments-
which averaged less than 20,000 b/d for the first six
months of 1986-climbed to over 150,000 b/d in
July-August, and a similar amount is scheduled for
this month. Iraqi deliveries for the year are running
about 30 percent ahead of last year's pace of 65,000
b/d. Although most Middle Eastern oil was reexport-
ed to soft currency partners in Eastern Europe and
India early in the first half of the year, recent reports
indicate that Moscow has increased reexports to the
West.
to upward pressures on consumption.
How much of the additional oil will be available for
export is problematical:
? Pressures to increase domestic consumption will be
up as winter approaches and the Soviets try to
compensate for Chernobyl' by increasing oil use at
thermal power stations.
? Gorbachev's modernization program is likely to add
At present, there is no indication that the USSR has
dramatically increased oil sales. On the contrary,
Soviet pricing policies are
still hurting sales. In mid-August, the Soviets cited a
firming oil market as an excuse to impose somewhat
stiffer netback pricing terms, resulting in a shar drop
in contract sales, according to the trade press.
Moscow has even run into some pricing disputes with
its Middle Eastern suppliers
How Moscow resolves these problems over the next
Crude month should be an indicator of its export plans.
Should Moscow choose to play hardball with its
pricing policies, then it may be that the Soviets have
calculated that domestic consumption is likely to rise
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Secret
more than usual, taking priority over exports. If,
however, Moscow resolves these pricing problems to
the satisfaction of both its West European customers
and Middle Eastern suppliers, then higher exports are
likely for the last quarter.
On balance, we expect hard currency oil exports to
total 1.2-1.3 million b/d for the year. Even assuming
that the Soviets can increase second-half export vol-
ume by 20 percent above first-half levels, earnings for
the year are likely to be in the $7-8 billion range. By
comparison, Moscow's oil earnings peaked in 1983 at
$16 billion and were down to $11.4 billion last year.
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Western Europe's Automobile Industry:
Stiff Challenges To Restructuring
The performance of the West European automobile
industry has improved recently because of generally
better economic conditions, but continued excess ca-
pacity and political constraints on reducing the labor
force cast a shadow over longer term prospects. In the
near term, West European 'governments are reducing
subsidies to automakers and instead are relying on
trade restrictions and local content legislation to help
the industry. Although Western Europe's major pro-
ducers are, to varying degrees, turning to robots and
automated design and production processes to im-
prove efficiency, these efforts will not be enough to
beat back the Japanese, who have increased exports
and are expanding assembly operations in Western
Europe.
Automobiles, Western Europe's single largest indus-
trial sector, is beginning to show some signs of
recovery after five years of losses during 1980-84
totaling $3 billion. Generally sluggish economic
growth in Western Europe throughout the early 1980s
and high unemployment yielded flat sales and output.
Although the industry as a whole still lost money in
1985, the market began to improve and sales reached
10.6 million units, the highest since 1979.
Prospects for continued improvement are good this
year and next for automakers if, as we expect, West
European economies continue their upturn:
? Consumer demand should remain firm as real per-
sonal income continues to rise. Declining inflation,
aided by the declining dollar, has also worked to
drive down interest rates, helping sales of consumer
durables and autos in particular.
? Generally weak raw material prices are continuing
to help producers hold down costs while low oil
prices are benefiting both producers and consumers.
? Income tax cuts in some countries-such as West
Germany and Belgium-will help boost consumer
confidence and spending.
? The appreciation of the Japanese yen has raised the
price of Japanese cars in Western Europe, although
not to the extent it has in the United States
For many firms, restructuring efforts to reduce cost
and improve efficiency have helped restore profit-
ability. Some automakers, particularly the small,
specialty producers-Mercedes, Jaguar, and Volvo,
for example-took advantage of the US economic
recovery and the strong dollar and concentrated on
increasing exports to the' United States. Four of the
six West European volume automakers-Fiat, Peu-
geot, Volkswagen, and Ford of Europe-were able to
turn a profit last year, primarily because of their
extensive restructuring programs-Renault and GM
of Europe sustained heavy losses. Fiat and Volks-
wagen in particular have trimmed labor forces and
automated to the extent that break-even points are
now at substantially lower output levels than in
previous years.
The major West European firms face a wide range of
challenging problems that may be masked during
upswings in the business cycle. Industry experts be-
lieve West European production capacity must be cut
10 percent, by 1 million units, in the next two years to
bring supply in line with demand to guarantee profit-
ability for the six volume producers. According to
Data Resources Incorporated, however, without com-
pensatory capacity shedding, the West European
automobile industry will increase its capacity by
about 1 million units to 14 million by 1990. In
addition to expanded Japanese production in Europe,
all the major producers except Renault plan to boost
capacity.
Secret
DI 1EEW 86-038
19 September 1986
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Secret
The six volume producers in Western Europe-
Volkswagen, Fiat, Renault, Peugeot, and the West
European subsidiaries of Ford and General Motors-
control more than 70 percent of the West European
market. Among the volume producers, Fiat and
Volkswagen have had the greatest success restructur-
ing their operations and lowering costs.
Fiat enjoys a highly protected home market that has
helped profit margins. The Japanese can sell only
about 2,500 vehicles per year in Italy because of an
agreement dating back to 1953. Fiat's success is also
the result of sharp reductions in production costs.
Employment is down about 30 percent since 1979,
and absenteeism-endemic in Italy-dropped from
20 percent in 1980 to just 4 percent by 1983. The Fiat
example is important because the firm's automobile
division is earning profits-almost $280 million in
1985-despite having withdrawn from the US mar-
ket.
Surging exports enabled Volkswagen to overtake
Ford last year and become the market leader in
Western Europe. VW s worldwide profit last year was
estimated at more than $200 million, up from $83
million in 1984. The company's success stems pri-
marily from exports of high-priced Audis to the US
market, windfall gains from the dollar during 1983-
85, and the rising sales of its Golf model, the best
selling car in Western Europe in 1985.
million profit in 1985 after five years of losses.
Company officials point out that their firm's recovery
was achieved with comparatively little government
support. Most of Peugeot's improved performance
results from extensive restructuring and the populari-
ty of its 205 model, one of Western Europe's best
selling cars. Renault continues to perform poorly,
and, with domestic sales down 23 percent in 1984 and
another 7 percent in 1985, it piled up $2.6 billion in
losses. The company is implementing many of the
structural reforms already under way in most coun-
tries, but at a much slower pace.
GM, which owns Opel in West Germany and Vaux-
hall in Britain, has been pursuing a strategy of
boosting its market share through aggressive price
discounting. GM sold a record 1.2 million units in
1985 but lost $372 million, in addition to the $291
million lost the previous year. Its share of the West
European market, however, rose from 8.2 percent in
1981 to 11.4 percent last year. GM is in the process of
reorganizing its West European operations to in-
crease production efficiency. Ford has consistently
turned a profit throughout the decade. It already has
a modern relatively low-cost production facility in
Spain and is seeking to merge with another West
European firm to reduce development costs; talks
with Fiat and Alfa Romeo have thus far proved
unsuccessful.
Peugeot returned to profitability last year and is
concerned about Paris's plans to bail out its state-
owned domestic rival, Renault. Peugeot earned a $60
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Secret
Western Europe: Selected Economic Statistics, 1980-85
Have Contributed to Flat Automobile
Sales in an ...
4
-3 1980 85 0 1980 85
And, Together With Rising Automobile Industry
Real Wages ...
Index: Big Four 1980 wages= 100
And Relatively Poor Motor Vehicle
Industry Productivity ...
Index: Japanese 1980 productivity= 100
0 1980 85 0 1980 85
Have Helped Produce a Chain of
Automobile Industry Losses
Billion US S
West European automakers suffer from a less flexible is viewed by some automakers as an ideal base for
labor force than that in the United States. Temporary exports. Nevertheless, by preventing companies from
layoffs are not allowed and overtime is viewed by laying off excess workers, unions have limited the use
most labor unions as a management ploy to keep of labor-saving equipment.
employment down. Recalcitrant labor unions also
make it difficult to reduce wage costs. Although still In the past, government intervention created problems
lower than in the United States, wage rates in West- by enabling firms, which may have been forced to
ern Europe are generally higher than in Japan, Euro- upgrade product lines and streamline operations or
pe's major competitor in the low-end market. Spanish
wage costs are an exception, and, consequently, Spain
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Secret
Selected Countries: Real Hourly Earnings
in the Automobile Industry, 1980-85 a
United States
15.88
15.41
15.54
15.21
15.34
15.62
Japan
6.93
7.15
7.54
7.74
7.83
8.15
West Germany
15.53
15.90
16.25
16.79
16.73
17.31
France
10.36
10.69
11.24
12.91
11.79
11.70
a Deflated hourly earnings converted at 1980 exchange rates.
b Estimated.
leave the market, to maintain operations despite
heavy losses. Faced with rising unemployment rates,
governments often thwarted the need for restructur-
ing by trying to protect or create jobs in the industry.
Although West European government attitudes are
changing, too many jobs are at stake for them to
completely abandon protection of the industry; rough-
ly 5 million workers are either directly or indirectly
employed by the West European automobile industry.
Instead of direct subsidies, governments are now
relying more on trade restrictions and local content
legislation as a means of aiding the industry.
Rising Japanese Penetration
For the past five years, Japan's auto producers
have held approximately 10 percent of Europe's
9-11 million car market. Japanese auto manufactur-
ers, however, increased their shipments of passenger
cars to the European Community by 40 percent
during the first seven months of 1986 compared with
the same period last year. Mounting trade friction
between the EC and Japan resulted in MITI's deci-
sion to voluntarily restrain exports of vehicles to the
EC to approximately 1.1 million cars this year-still a
10-percent increase over the 1985 level. Japan's share
is greatest in countries where there are no domestic
vehicle industries to protect. For example, Japanese
automakers have secured 34 to 38 percent of the
passenger car markets in Norway, Finland, and Den-
mark. West Germany and the United Kingdom re-
main Japan's largest markets with sales of over
515,000 vehicles in 1985.
Japanese automakers are responding to growing im-
port restraints by establishing production facilities in
Western Europe. Plans are already in the works for
local European production of 350,000 Japanese cars
by 1990. This figure includes only models for distribu-
tion in Europe with Japanese nameplates. Other
ventures by Toyota, Daihatsu, and Subaru could
result in an additional 220,000 units, thus raising
potential Japanese car production in Western Europe
to nearly 600,000 by the late 1990s. This increased
local production, combined with imports, could boost
Japan's share of the market to roughly 15 percent by
1990.
Despite some recent improvements, West European
automakers will continue to face stiff competition, low
profitability, and excess capacity. Price will remain of
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Secret
secondary importance at the upper end of the market,
but it will still play an essential role at the lower end,
keeping the pressure on profit margins. As a result,
reducing costs will become even more important over
the medium term. Nonetheless, national pride and
political realities make it very unlikely that any of the
mass market producers would be allowed to fold.
The continuing drive to restructure the West Europe-
an automobile industry could be slowed because of the
potential political impact. As firms strive to increase
productivity and competitiveness over the next two
years, more layoffs will be required at a time when the
socialists in West Germany, France, and Great Brit-
ain will be vying for a comeback in national elections.
Union disturbances are most likely to occur during
these election periods when the jobs issue can receive
maximum public attention.
Japanese exports and assembly operations in Western
Europe are likely to exacerbate EC-Japanese trade
relations. The Japanese are using their West Europe-
an plants to concentrate on producing low-priced
automobiles while boosting exports of more upmarket,
high-profit models. If indeed the Japanese continue to
increase their share of the West European automobile
market as we expect-even if accomplished by direct
investment-it is likely to fuel protectionist senti-
ments not only against Japanese automobiles but also
other Japanese imports as well-consumer electron-
ics, semiconductors, and machine tools are likely
targets.
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Briefs
Iraq Seriously Iraq's 16 September attack on Khark Island inflicted
Damages Khark Island severe damage. Khark's T-jetty that had been the principal outlet for Iranian
crude has been indefinitely knocked out. Tehran can maintain exports, however, by
using Khark's Sea Island loading terminal and/or floating terminals northeast of
the island. The Sea Island terminal has been experiencing electrical problems and
is highly vulnerable to attack while tankers are loading. This latest attack will
magnify Iran's recent export problems by making it extremely difficult to lure
customers to load at Khark and relieve pressure on its overextended oil shuttle sys-
tem. The attack reflects Baghdad's increasing pressure on Iran's economy and, if
followed up, is likely to reduce Iranian export capacity. Iran apparently responded
to the attack on Khark by using a small ship to attack a Kuwaiti tanker located in
waters off the Saudi-Kuwaiti Neutral Zone. Sales of Neutral Zone oil production
on Iraqi's behalf have been used by Kuwait and Saudi Arabia to support the Iraqi
war effort.
Iranian Pipeline Two Iranian oil pipeline projects have been shelved because of cost considerations,
Projects Suspended Iraqi attacks against the oil
loading facility at Khark Island prompted Iran to do feasibility studies on pipelines
to carry oil south to Taheri where ships could load with reduced risk. While cost
was definitely a consideration-at least $2 billion to complete both pipelines-we
believe Iran also was dissuaded by a recent Iraqi attack against Sirri Island. By
demonstrating its ability and willingness to attack facilities well beyond Taheri,
Iraq underscored the potential vulnerability of the pipelines.
Impact of Sanctions on If consuming countries imposed sanctions on South African coal for five years,
South African Coal Pretoria would lose about $750 million per year
The effects of mine deterioration, reduction of marketing and logistics infrastruc-
ture, and loss of markets to other exporters would cost South Africa an additional
$1 billion per year over a five-year period after the sanctions were LF __J
Pretoria is presently
earning about $1.1 billion annually from coal exports, accounting for 14 percent of
total export earnings. In response to sanctions, coal prices could rise in Western
Europe and Japan by as much as $12 to $15 per metric ton over current levels of
about $40 to $45 per ton.
29 Secret
DI IEEW 86-038
19 September 1986
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Lower Retail Oil production prices have fallen sharply in all major consuming countries in
Product Prices response to lower crude oil costs. The rate of decline among individual products
varied. Heavy fuel oil prices have registered the sharpest drop, probably reflecting
strong competition from other fuels, while retail gasoline prices have registered the
smallest decline because of a high tax component. Consumers in Japan have
benefited the least because the government protects its refining industry. Italy, the
United Kingdom, and France have raised taxes mainly on motor gasoline to raise
revenue-and to hold down demand-while most other countries have passed
lower crude costs through to the consumer.
Regular Heating Heavy
Gasoline Oil Fuel Oil
China Speeds Concerns about growing domestic oil consumption appear to be accelerating
Oil Exploration China's timetable for exploring and developing its northwestern basins.
in Northwest Beijing indicated a willingness-not evident six
months ago-to begin exploratory drilling even before completing a multiyear
survey program. The Chinese said they expect domestic oil consumption, which
only last year regained 1979 levels, to grow 5 percent annually through the end of
the century. To reach its modernization goals for the year 2000, China needs oil to
rapidly develop its commercial and transport sectors, but cannot count on its
existing mature fields beyond the early 1990s. Despite Chinese efforts to attract
foreign cooperation, Western firms will be reluctant to participate in the northwest
on a large scale any time soon because of low world oil prices, reduced exploration
budgets, and China's inadequate infrastructure for these remote basins.
Secret 30
19 September 1986
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LDC Summit In the closing declaration of the recent summit meeting of the Nonaligned
Declaration Movement (NAM), the NAM suggests that LDC debtors should be able to limit
on Debt debt service payments to a share of export revenues. This proposal, as in the past,
is unlikely to be embraced by most major debtors. We believe Peru's appeal at the
summit for a united, hardline approach to the debt problem will be undercut by
the diverse financial situation of LDCs, the modest successes of Latin debtors'
innovative adjustment programs, and the wait-and-see attitude of debtors toward
Mexico's debt negotiations. The chief debt-related impact likely to emerge from
the summit will be a strengthened LDC resolve to loosen the strings attached to of-
ficial and multilateral development assistance. Specifically, debtors probably will
call for more funds with less conditionality from international creditors when the
IMF and the World Bank meet in Washington next week.
Brazil's New The Sarney administration is eager to begin negotiating a new type of multiyear
Multiyear rescheduling of 1987-91 debt During his
Debt Strategy visit to Washington on 11 September, President Sarney stressed to the National
Press Club and the Congress that Brazil must negotiate lower debt service
payments to permit increased imports, greater investment, and continued high
economic growth. Brasilia will be a tough negotiator in
talks with creditors this fall and will push for a reduction of net debt servicing pay-
ments as a percent of GDP from this year's 4.0-percent level to about 2.5 percent
next year. In the judgment of the US Embassy, however, the Brazilians will
continue to avoid unilateral actions and probably believe they can attain the 2.5-
percent goal by negotiating a switch in the base rate for interest rate payments
from US prime to LIBOR, a reduction of the spread on 1987-91 maturities, and
new commercial loan cofinancing with the World Bank.
Iraqi Debt Iraq continues to have difficulty making debt payments to international banks.
Problems Continue
JBaghdad is now seeking
a two-year deferment of payments on a $500 million loan obtained in 1983.
Previously, Baghdad had hoped to continue payments on this loan-including a
$65 million payment due 30 September-to bolster its sagging credit reputation
among Western banks that already hold overdue Iraqi short-term debt.
Secret
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Secret
Tunisian IMF Tunis is moving quickly to secure $250 million in badly needed financing from the
Negotiations IMF. The US Embassy in Tunis says that a signed letter of intent for the 18-
Progressing month standby loan is likely by the end of September with IMF approval possible
by late October. To smooth negotiations, the government has cut an additional $50
million from the development budget at the risk of slowing efforts to reduce
troubling unemployment. A primary goal of the new IMF package, however, is to
boost Tunisia's foreign exchange reserves, which now cover only several days of
imports. Nevertheless, any relief will be temporary as Tunisia's current account
probably will remain in deficit next year. The government will have to secure
additional funds to cover the projected $350 million financing gap. While debt
service is not yet a major problem, the government may have to consider some
form of debt relief over the next several years if new sources of funds are not forth-
coming.
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19 September 1986
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Secret
Circumventing According to the US Embassy in Kuala Lumpur, shipments of textiles-towels-
US Import Quotas from Pakistan are being transshipped through Malaysia to circumvent US quotas.
Some shipments depart Pakistan with correct declaration, then are believed to go
to Hong Kong where the goods are relabeled. The goods are then sent through
third countries such as Malaysia, Sri Lanka, or the Philippines for re-export to the
United States.
Taiwan To Restrict A series of recent public announcements confirm that Taiwan will restrict steel
Steel Exports to exports to the United States. In a unilateral move to counter a possible voluntary
the United States restraint agreement (VRA) the Taiwan Steel and Iron Industries Association plans
to limit 1986 September to December steel exports to the United States to 20,000
metric tons per month. Allocation among Taiwan's steel manufacturers and
traders will be based on their share in January to July shipments. To ensure
compliance with the export restraint program, Taiwan's customs authorities are
starting a shipment-checking procedure. Also, in order to control an export surge,
Taiwan's Board of Foreign Trade (BOFT) will limit firms' exports during
September and October to not more than one-half of their total allotment. BOFT
is hopeful that Washington will accept these measures and that imposition of a
VRA will not be necessary.
EC Imposes EC foreign ministers meeting in Brussels decided on 15 September to impose
Limited South limited economic sanctions on South Africa. The new measures include a ban on
African Sanctions imports of iron, steel, and gold coins, as well as on new EC investments in South
Africa. Coal, which was on the list of items tentatively agreed to in June, was not
included because of Portuguese and, especially, West German objections. The iron
and steel ban will take effect on 27 September, but the other sanctions will be de-
layed until means of enforcement are worked out. EC coal imports from South Af-
rica are worth more than $780 million, almost twice the combined value of
imported South African iron, steel, and gold coins. The exclusion of coal ensures
that the EC sanctions will have little effect on the South African economy. Strong
advocates of sanctions, such as the Netherlands and Denmark, were forced to
compromise in order to gain a consensus. While the question of sanctions is
probably settled temporarily, the problem of South Africa is likely to remain high
on the EC agenda.
Secret
19 September 1986
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New Soviet The USSR provided Managua with a $25 million hard currency loan late last
Hard Currency Loan. month, but at a nonconcessionary rate of interest.
to Nicaragua
The most recent Soviet loan apparently fulfills Managua's
request in June for a total of $100 million. This is double Managua's hard
currency earnings this year and presumably will allow the Sandinistas to buy badly
needed spare parts and repay some of their more pressing debts. Moscow has its
own hard currency problems, but the amount it offered in this transaction is
comparatively small.
Continued Progress Latin American efforts toward regional economic integration continue to move
on Latin American forward. In August Uruguay formally joined the Argentine-Brazilian economic
Regional Integration integration agreement.
Secret
19 September 1986
end of the year.
Mexico City is focusing on diversification of trade (away from the United States),
increased exports to Latin America, and reassertion of Mexican preeminence in
Latin American political affairs. Argentina is actively encouraging Mexican
participation to offset Brazil's dominance in trade and other regional economic
matters. Mexico hopes to begin negotiations with Argentina and Brazil before the
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Developed Countries
Canadian A grain handler's strike is adding to the troubles of the Canadian grain sector.
Grain Troubles With prospects of a record 52-million-metric-ton harvest, Canadian exports
already face falling world grain prices and increased competition from the United
States and the EC. The walkout began 3 September and closed the port of
Thunder Bay, which normally handles one-half of grain exports from the
Canadian prairies. Current export orders can be filled from stockpiles, but if the
strike lasts into October the Canadian Wheat Board may be forced to renege on
several contracts. Rail shipments to other ports can handle only one-fourth the
normal export volume, and increase transportation costs by about $5 per ton. A
long strike is likely to result in growing pressure on the federal government to pass
back-to-work legislation. Such a move would displease labor, but the Mulroney
government needs to be seen as active in defending Canada's grain market share,
as well as sensitive to the demands of western Canada, a traditional Tory bastion.
Growing Role of Despite the Sarney administration's stated commitment to increased private-sector
Government in participation in Brazil's economic development, the government's economic role
Brazilian Economy continues to grow. The government increasingly has centralized decisionmaking
and has expanded control over the economy this year, according to the US
Embassy. The comprehensive price freeze enforced by the government in March as
part of the anti-inflation Cruzado Plan-and which probably will not be eased in
the foreseeable future has
discouraged much-needed private-sector investment. By contrast, accor ing to the
US Embassy, public-sector investment is rising considerably and the public-sector
deficit this year will be at least as large as that of 1985, despite the Cruzado Plan.
government efforts to streamline its large network of
35 Secret
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state corporations will be essentially cosmetic, at least until after November's
national elections. Also, recent adjustments to the Cruzado Plan-particularly a
forced savings scheme-has been heavily criticized in the business community as a
means of financing a large public deficit disguised as an effort to cool off demand.
the business community does not maintain
a genuine dialogue with, or have significant influence on, the government.
Uruguay-Brazil Montevideo and Brasilia signed a series of trade expansion accords last month,
Trade Pact which, according to Finance Minister Zerbino, could double Uruguay's exports to
Brazil-currently about 10 percent of its total foreign sales-over the next two
years. According to press reports, Brazil has agreed to buy a substantial portion of
Uruguay's agricultural exports, including 60 percent of rice production and one-
half of meat production. In exchange, the Embassy reports that Montevideo has
agreed to abolish duties on many industrial imports from Brazil, starting with 800
buses to be imported over the next five years. We concur with Montevideo's
judgment that the sales will reinforce Uruguay's recent surge in exports, which
during the first half of 1986 increased 20 percent over the same period last year.
Moreover, despite Uruguay's inefficient production techniques and tendency to
take only limited advantage of export opportunities, we feel the accords will
significantly boost President Sanguinetti's export promotion plans and help
generate economic growth of about 3 percent during 1987.
Tunisian Tunis has moved to consolidate its control over the country's two primary labor
Unions Reunited movements-the UGTT and the UNTT-by reorganizing them into a single
union. Although membership is being enforced by the government, some labor
rank and file are shunning the new organization because of concern over
government control, internal disputes over leadership, and the continued incarcera-
tion of labor leaders. the government has
promised union leaders independence if the new union neither sponsors nor
encourages strikes, refrains from any political activity, and requests no salary
increases-conditions labor militants are unlikely to accept. The UGTT, in
particular, has gained labor support because of its aggressive stand on wages and
willingness to confront the government on labor issues. Coupled with intraunion
rivalries and the UNTT's more progovernment stand, the new union may actually
prove to be an obstacle to labor harmony. Moreover, if the new union survives, it
could become an even greater force to reckon with if government control cannot be
maintained.
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19 September 1986
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Kabul Businessmen
Apprehensive
Minister of Commerce Jalalar, who has held his post since 1979, was criticized at
a Politburo session in late July and in subsequent regime statements for failing to
meet first-quarter trade goals and threatened with removal if foreign and domestic
trade performance do not improve. The minister is generally regarded as a patron
of private industry, according to the US Embassy, and businessmen in Kabul fear
his removal could signal a crackdown on this sector. Businessmen are particularly
concerned that Kabul may reverse a policy-promoted by Jalalar-of exempting
them from military service. As a result, Kabul businessmen are shifting funds to
foreign banks and limiting investment in joint ventures with the regime, according
to the US Embassy. The threat against Jalalar-who has close ties to the
Soviets-probably represents an attempt by General Secretary Najibullah to
consolidate his power rather than a shift in attitude toward the private sector.
Bangladesh Announces Bangladesh's current government budget-1 July to 30 June-addresses many of
Annual Budget the policy issues raised by foreign aid donors, but Dhaka may find it difficult to
implement needed reforms-removal of subsidies and expansion of private-sector
participation. Even with projected foreign aid of roughly $1.3 billion, Dhaka is still
facing a $100 million budget deficit. According to the US Embassy, emphasis will
be placed on economic development-expenditures are budgeted to rise 6 percent
in real terms-while nominal spending on other items is projected to increase only
enough to keep pace with inflation. Many of the government's key priorities imply
backsliding on important reforms. For example, Dhaka plans to increase subsidies
on fertilizer and diesel oil to encourage expansion of irrigated acreage, and efforts
to increase loans to the private sector by reducing interest rates threaten the
already shaky banking system. Officials in Bangladesh are concerned that
cutbacks in foreign assistance, particularly by the United States and the Interna-
tional Development Association, will force them to scale back their development
effort.
37 Secret
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Tanzanian Progress A recently approved $75 million, 18-month standby arrangement with the IMF
Toward Reform and a government anticorruption campaign are likely to sharpen the conflict
between Tanzanian President Mwinyi and party Chairman Nyerere. The govern-
ment already has implemented preliminary reforms by increasing consumer and
producer prices, freezing wages, devaluing the currency, and cutting the budget,
The US Embassy reports that at least two episodes of
unprecedented civil unrest occurred in August as a result of the cuts in government
spending, causing some officials to worry that further cuts will bring more
violence. Mwinyi's campaign against corrupt officials has earned him widespread
popularit
Nyerere publicly supports the campaign,
~A longtime
opponent of economic reform, Nyerere may try to reassert his political power by
derailing the IMF accord. Mwinyi's newfound grassroots support may help
cushion discontent over the austerity measures and allow him to consolidate his po-
sition by removing Nyerere appointees from the government or by reorganizing the
Cabinet. Failure to act against corrupt members of Nyerere's clique, however,
probably would cost him the essential support of important moderates in the
government.
Indonesian Indonesia's unexpected 31-percent devaluation of the rupiah on 8 September is
Currency Devaluation aimed at shrinking the trade deficit that widened by nearly two-thirds during the
last year. According to US Embassy reporting, Jakarta's dramatic move-perhaps
the first in a series of tough economic policy decisions-follows a nearly 40-percent
decline in oil export earnings and a sharp increase in imports. According to the US
Embassy, the devaluation will make it more difficult for Jakarta to service foreign
debt, however, as well as possibly trigger widespread price increases. The
devaluation is unlikely to correct the serious structural problems in Jakarta's high-
cost economy, which make Indonesian manufacturers uncompetitive in the world
market. Economic indicators-had suggested the rupiah-which has been free of
foreign exchange controls and had gradually depreciated in recent years-was not
overvalued. The US Embassy reports that the growing imbalance in its external
accounts suggests to bankers that Indonesia may have to reschedule its $37 billion
foreign debt by late next year.
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New Yugoslav Yugoslav trade union and regional officials are protesting government-sponsored
Wage Law Protested restrictions on wage increases and trying to amend the controversial law. The law
in some cases requires workers to return what are now defined as wage
overpayments made in recent months. Yugoslav officials and media report the new
law is contributing to a growing number of strikes. The new government of
Premier Mikulic is in a no-win situation. Strict enforcement of the law would raise
labor discontent and provoke more strikes. Backing off would weaken Mikulic's
credibility, reduce prospects for the adoption of future government proposals, and
add to inflationary pressures. The intent of the new legislation-to tie wages more
closely to productivity-is sound, but the government has been pushing implemen-
tation without having built a political consensus among Yugoslavia's regions and
key interest groups. Enforcement will become even more difficult in the months
ahead.
China Sweetens Beijing is taking steps to encourage new foreign investment, which officials claim
the Deal for has dropped 20 percent in the first half of 1986. Regulations may be issued in
Foreign Investors October to restructure joint-venture labor costs, to reduce fees and taxes charged
joint ventures, and to give joint ventures greater authority to hire and fire workers.
China has already extended tax holidays on foreign leasing and interest earnings,
and has announced that the Bank of China will offer preferential loans to joint
ventures. Premier Zhao Ziyang recently stressed the need for China to maintain
competitive labor costs, tacitly admitting that joint-venture labor subsidy charges,
combined with low productivity, erode China's comparative advantage. Joint-
venture problems will probably persist, however. One reported plan for adjusting
labor costs would reduce subsidies but raise wages, resulting in only a slight drop
in joint-venture labor bills. In addition, although Zhao Ziyang has cited joint
ventures problems in obtaining foreign exchange, local officials have indicated that
in the future joint ventures will be required to negotiate individually for hard
currency allotments, which may prove troublesome. Finally, some localities may
resist central efforts to cut redtape and reduce joint-venture fees.
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China Expects More worker remittances are fast becoming a major
Earnings from source of foreign exchange. To improve relations Beijing has often provided Third
Labor Exports World countries with free labor and construction projects, but the Beijing
Economic Daily says China since 1979 has charged for $2.7 billion worth of
completed construction and labor contracts in 81 countries and has already signed
for another $2.9 billion. Projects include school buildings, bridges, office buildings,
and railroads-a 210-megawatt, $53 million power plant built for Pakistan is the
largest contract to date. More than 50,000 Chinese workers are presently overseas.
They are paid only room and board while abroad, but upon their return to China
they receive the yuan equivalent of about 10 percent of the foreign exchange paid
Secret 40
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