INTERNATIONAL ECONOMIC & ENERGY WEEKLY

• Document Type: CREST
• Collection: General CIA Records
• Document Number (FOIA) /ESDN (CREST): CIA-RDP89-00995R000100020003-8
• Release Decision: RIPPUB
• Original Classification: S
• Document Page Count: 38
• Document Creation Date: December 27, 2016
• Document Release Date: August 24, 2012
• Sequence Number: 3
• Publication Date: January 8, 1988
• Content Type: REPORT

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Intelligence
Weekly
International
Economic & Energy
8 January 1988
DI IEEW 88-001
8 January 1988
Copy 8 4 9
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noecrei
Internatio
nal
Economic
& Energy We
ekly I
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7 Argentina:
Heading for a Sh
owdown on Debt
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Key LDC
Debtors: Continue
d Export Growth Tied to OECD Demand
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21 USSR-Eastern Europe: Inching Toward Currency Convertibility in Intra-CEMA
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Energy
International Finance
International Trade
Global and Regional Developments
National Developments
directed to Directorate of Intelligence,
i Secret
DI 1EEW 88-001
8 January 1988
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International
Economic & Energy Weekly
Synopsis
By all accounts, Prime Minister Takeshita-who assumed office in November-is
a skilled politician, representing the return of a more traditional, consensus-
oriented Japanese prime minister whose strong suit and focus will be domestic
politics rather than foreign policy. There is considerable disagreement among
political analysts, however, on whether this approach will represent a plus or minus
for US-Japanese relations.
3 West European Trade Outlook: Implications of Japan's Export Offensive
West European officials will press Tokyo harder in 1988 to slow the diversion of
exports from the United States to the EC and to open Japanese markets to their
goods. EC pressure for greater access to Japanese markets could complicate the ef-
forts of US exporters to strengthen their foothold in Japan.
7 Argentina: Heading for a Showdown on Debtl
Argentina's foreign payments position has turned desperate. We believe the
external payments situation, coupled with internal political pressures, is likely to
compel Argentina to halt interest payments on foreign commercial debt this year
unless the international financial community provides new money or an innovative
way of reducing interest payments-with few strings attached.
Key-debtor LDC export earnings rebounded strongly last year-following sharp
declines the previous two years-mainly on the strength of higher oil prices and in-
creased prices for major commodities such as copper, rubber, and sugar. We
believe that slower OECD economic growth will sharply reduce export gains for
key debtors this year.
Although the number of LDC arrangements with the International Monetary I
Fund (IMF) increased in 1987, repayments exceeded new drawings from the Fund
in the first 10 months of last year. Nonetheless, the IMF will remain a key player
in international efforts to resolve the LDC debt problem and will become
somewhat more flexible in its treatment of the debt problem, in our judgment.
iii Secret
DI IEEW 88-001
8 January 1988
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OVUM
21 USSR-Eastern Europe: Inching Toward Currency Convertibility in Intra-CEMA
Trade
The CEMA premiers-at their October meeting-agreed on the first tentative
steps toward currency convertibility in intra-CEMA trade, but these measures will
have little immediate impact. Widespread convertibility is, at best, many years
away and depends upon sweeping reforms in the domestic economies. Nonetheless,
if Moscow and its supporters can push through their ambitious plans, CEMA
trade and economic performance should improve substantially in the 1990s.
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Secret
International
Economic & Energy Weekly
whether this approach will represent a plus or minus for US-Japanese relations.
By all accounts, Prime Minister Takeshita-who assumed office in November-is
a skilled politician, representing the return of a more traditional, consensus-
oriented Japanese prime minister whose strong suit and focus will be domestic
politics rather than foreign policy. Takeshita arrives in Washington next week
without an extensive track record in dealing with the United States, and his
performance so far has done little to suggest his approach to bilateral relations.
There is considerable disagreement among political analysts, however, over
Japan: Differing Views on Prime Minister Takeshita
anxious
prove his ability to manage the all-important US relationship, Takeshita will be
Those who argue that the Takeshita administration will be good for the United
States tend to focus on his ability to deliver-that is, his skill and leverage in bro-
kering the often difficult domestic agreements needed to make policy concessions
that will satisfy Washington. This school of thought points to Takeshita's
perceived inexperience in foreign affairs as a potential plus for the United States.
Proponents of this view contend that, because any Japanese prime minister must
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they see him as ready to make concessions to Washington, banking 25X6
on his strength at home to pacify domestic groups whose interest might be
sacrificed in deals that are struck. 25X1
keep relations with Washington on solid ground.
of his backers.
Others see Takeshita's trait (consensus-building
style, and impressive political connections-as having little net benefit for
Washington. Indeed, in the current contentious environment, some argue that the
new Prime Minister's background could present an impediment to smooth bilateral
relations. These analysts suggest that, because of his focus on domestic issues,
Takeshita will not strive to strengthen the US relationship but, rather, will merely
attempt to stave off pressure from Washington. His political strength and high
popularity ratings make it unnecessary for him to prove himself in foreign policy.
In addition, to maintain his all-important ties to interest groups, such as the
construction lobby, the Prime Minister is seen always keeping an eye on the needs
commodations to "foreign interests."
Those who regard the advent of Takeshita as favorable for bilateral relations note
that, because of his penchant for careful political spadework before reaching
agreements, he will be able to follow through on promises in a way that Nakesone
sometimes found difficult. Takeshita's political strength-grounded in his position
as head of the ruling party's largest faction, his carefully maintained networks in
political circles, government, and his business, and high popularity ratings-also
will equip him to weather the domestic criticism that inevitably will follow any ac-
Secret
DI IEEW 88-001
8 January 1988
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tions," addressing domestic political rather than,US concerns.
Proponents of this more downbeat view argue that Takeshita, lacking a feel for the
United States, may fail to recognize when an issue is critically important to
Washington. Unlike Nakasone, who made extensive use of US advisers, Takeshita
has had only limited contacts with foreigners. Even when he sees the importance of
an issue, Takeshita is likely to delegate the matter to the bureaucracy and the rul-
ing party, where difficult issues, such as trade concessions, may get lost in time-
consuming battles among ministries and interest groups. When decisions do
emerge, they will also represent incremental change,.rather than broader "solu-
evident
It is obviously still too early to assess how the Prime Minister will approach
bilateral issues, but notwithstanding his. stated desire to give US relations top
priority, we believe his initial lack of action on pressing issues raises some
concerns. Takeshita has left difficult decisions, such as
removing agricultural quotas declared illegal by GATT and increasing foreign
access to Japan's construction market, to the bureaucracy. Although a clearer
picture of Takeshita may emerge by the Toronto summit this summer, we doubt he
will break new policy ground. Rather, with the US presidential and Congressional
elections this fall, Tokyo may temporize in dealing with emerging issues, biding its
time until the interests of a new administration and Congress become more
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Secret
West European Trade Outlook:
Implications of Japan's Export
Offensive
hold in Japan.
the efforts of US exporters to strengthen their foot- 10
hampered by the long-run decline in Western Euro-
pe's industrial competitiveness and by self-defeating
EC trade policies, which have stimulated Japanese
expansion into new market sectors. EC pressure for
an officials believe that without additional constraints
Japan, whose exports are now much more price
competitive in the EC than in the United States, will
rapidly increase sales of motor vehicles and parts and
of several high-technology products. In addition, the
West European officials will press Tokyo harder in European Community: Trade With
1988 to reduce the EC's rapidly growing trade deficit Japan, 1983-87
with Japan. They want Tokyo to slow the diversion of
exports from the United States to the EC and to open
Japanese markets to their goods. Most West Europe- Billion US $
pan's exports to the United States. F___] ing and fabrics, and food.
and almost eight times as fast in 1987. In yen terms, deficit from increasing and have generally been con-
Japan's exports to the EC in 1986-87 grew even more centrated in relatively lower technology areas-auto-
impressively in relation to the actual decline of Ja- mobiles, organic chemicals, medical products, cloth-
the EC, expressed in dollar terms, grew more than
twice as fast as exports to the United States in 1986,
I I I I
0 1983 84 85 86 87a
The rapid growth of EC imports from Japan in 1986-
87 has produced a trade deficit that has grown by
more than 60 percent since 1985.1 Japan's exports to 3'5447'-88 25X1
Japan's exports to the EC have been highly concen-
trated in motor vehicles and parts and in several high- Incentives for Export Offensive
value, high-technology commodities. The Big Four
EC countries and the Netherlands have borne the Japan's 1986-87 export offensive has been facilitated
brunt of the increases in Japanese exports. EC exports by the modest 9.2-percent appreciation of the yen
to Japan have not grown fast enough to keep the against the European currency unit (ECU), compared
with the 100 percent appreciation against the US
Secret
DI IEEW 88-001
8 Januart 1988
EC imports,
f.o.b.
EC exports,
f.o.b.
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EC and the United States: Imports From
Japan, 1985-87
European Community b
(billion US $)
Growth from the previous year in
dollar terms (percent)
Growth from the previous year
in yen terms (percent)
United States (billion US $)
Growth from the previous year
in dollar terms (percent)
Growth from the previous year
in yen terms (percent)
a Data through October annualized.
b EC- 12 for all years.
20.9
30.9
37.2
4.3
47.8
20.4
4.1
4.4
5.0
66.6
81.8
83.9
10.0
22.8
2.6
9.7
-13.0
-10.6
dollar. This gap has left Japanese products much
more price competitive in the EC market than in the
United States. West European officials fear Japan
will continue to exploit this gap by increasing sales to
Western Europe more rapidly than to the United
States.
The failure of the EC and most of its members to
remain industrially competitive in high-technology
products, relative to Japan and the United States, is
an additional factor behind Japan's export success.
Much of EC's failure may be attributed to inadequate
long-term investment, weak productivity, high real
wages, and rigid labor markets. In addition, self-
defeating EC trade policies often have had the per-
verse effect of stimulating Japanese industrial com-
petitiveness while limiting that of the EC. EC
countries have compelled Japan to place more and
increasingly sophisticated products under voluntary
export restraints (VERs). Each new layer of VERs has
provided Japanese producers with added incentives to
seek out new, higher priced, and usually higher
technology areas not yet subject to restraint. As VERs
began reducing television recorder sales, for example,
Japanese electronics firms generated new growth in
such products as data processing and telephone line
equipment.
have offered.
The EC almost certainly will consider toughening
trade policies affecting Japan during 1988. Commis-
sion officials acknowledge Japanese steps to reduce
the bilateral trade imbalance but regard the pace as
far too slow. EC officials worry that Japan is giving
priority to the United States when making decisions
affecting trade and investment, and that this will lead
to the United States and Japan "dividing up the
world," according to US Embassy reporting. They
will place the highest priority on compelling Tokyo to
give more consideration to the EC in formulating its
policies. Specifically, the EC is seeking Japanese
concessions on:
? EC participation in the Kansai airport construction
project.
? Improvement of the Japanese import inspection
system for pharmaceuticals.
? Expansion of the 24-percent share allocated to the
EC in Japan's $1 billion emergency government
procurement program.
In addition, the EC wants new trade consultations in
selected sectors, such as dairy products and illegal
imitations of West European brand name goods. It
also is pressing the Japanese to comply in 1988 with a
GATT ruling to reduce duties and taxes on imported
wine and spirits, rather than in 1989 as the Japanese
In other areas, the EC will continue to press for
greater European access to Japan's financial markets
and for Japanese assistance for EC exporters in the
form of low-cost loans. The EC wants a bigger role in
financing exports to Japan and full EC participation
in Japan's new commercial paper market and in a
transformed "modern interbank system"-like those
in many European banking centers.
The appreciation of West European currencies rela-
tive to the dollar during 1986-87 will continue to lead
to lower growth in the EC and probably will encour-
age heightened protectionism by the Community.
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European Community: Top 15 Imports From Japan, 1985-87 a
Million
US $
Data processing parts and accessories 302
a Commodities were ranked by annualized 1987 values that were
based on data through October 1987. All data are in f.o.b. (free on
board) terms.
Whether initiated jointly or independently by EC
members, protectionist reactions to the worsening
deficit with Japan probably would contribute to re-
duced confidence in global financial markets in 1988
and place additional downward pressure on world
economic growth
The likelihood for increased EC discrimination
against Japanese exports, contradicting GATT's mul-
tilateral philosophy, could limit negotiations in the
Uruguay Round. The EC has invoked anti-Japanese
protectionist measures, despite its overall trade sur-
plus with the rest of the world, putting it in open
conflict with the GATT's multilateral principle that a
country's overall trade balance, not a specific bilateral
Growth Million Growth Million Growth
From the US $ From the US $ From the
Previous Previous Previous
Year Year Year
(percent) (percent) (percent)
trade imbalance, should guide its trade policies. In
addition, many of the EC's 1987 trade policies were
precedent-setting because they were targeted primari-
ly against Japan in spite of a lack of evidence of injury
to a particular European industry. These policies
included: new surveillance procedures and contingen-
cy tariffs on high-technology goods targeted by US
tariffs, new antidumping actions-which included im-
ports of components as well as finished goods, and
imposition of new, higher domestic content require-
ments targeted at all Japanese assembly plants locat-
ed in Western Europe. Intensification of these protec-
tionist trends in 1988 would increase the likelihood of
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an EC-Japan trade war while complicating and slow- From the US perspective, the limited but measurable
ing the Uruguay Round's negotiations. success of the EC's aggressive requests for greater
Because of the Community's concerns about expand-
ing US-Japanese trade relations, the EC probably
would welcome greater involvement in US-Japanese
We believe this ad hoc approach to resolving
trade disputes would provide a productive venue for
moderating the EC's bilateral protectionist tenden-
cies
Japanese market access have begun and will continue
to reduce selected US exports. For example, in spite of
current EC complaints about the inadequacy of its 24-
percent share of Japan's $1 billion emergency govern-
ment procurement program, the United States was
originally set to get nearly all of that business.
Therefore, EC gains in the Kansai airport project and
in other Japanese markets probably will come at the
expense of US firmsF___-]
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Argentina: Heading for a
Showdown on Debt
Argentina's foreign payments position has turned
desperate. Buenos Aires ended 1987 with a $4 billion
current account deficit and perhaps only $500 million
in reserves, and we expect a similar-sized deficit this
year. We believe the external payments situation,
coupled with internal political pressures, is likely to
compel Argentina to halt interest payments on foreign
commercial debt this year unless the international
financial community provides new money or an inno-
vative way of reducing interest payments-with few
strings attached. Meanwhile, international and do-
mestic confidence in President Alfonsin's ability to
manage the economy is rapidly eroding.
The last bloom of President Alfonsin's 1985 economic
stabilization plan has faded. Inflation reached 177
percent during 1987, according to press reports,
against a government goal of 42 percent. The public-
sector deficit is running at about 7 percent of GDP,
compared with 4.5 percent in 1986. In addition,
Argentine GDP growth-which reached 5.3 percent
in 1986-is slowing to a standstill as a result of
declining real wages and a dearth of investment
capital. F_~
The economic team attempted to stabilize the situa-
tion in October by announcing a wage and price
freeze, the deregulation of interest rates, a major
devaluation of the austral, and a new tax package
designed to halve the fiscal deficit, but the results
have been disappointing. The gap between the official
and parallel exchange rate quickly widened again to
the 30- to 40-percent range because of lack of follow-
through devaluations, and "deregulated" interest
rates have failed to keep up with those on the parallel
financial market. In addition, the wage and price
freezes-which were lifted at the end of December-
proved less effective than the previous two times
Alfonsin imposed them.
Stymied by political infighting, the emergency tax
package had still not passed Congress.by the end of
the year, and, although the US Embassy reports that
it may be passed early this month, the diversion of
part of the tax revenues to provincial governments will
probably dilute the measures' overall effectiveness.
Buenos Aires has made even less progress on the
expenditure side. Treasury Secretary Brodersohn ad-
mits that political pressures render him unable to
reduce government spending
External Trends Portend Debt Difficulties
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2bAl
Argentina's policy-related domestic economic difficul-
ties are mirrored in its external accounts. An uncom-
petitive exchange rate and the high cost of credit-
combined with low international commodity prices
and poor growing conditions-have hurt agricultural
exports, while an industrial export promotion program
proved less successful than the government forecast.
As a result, Buenos Aires' debt service ratio bur-
geoned to 71 percent-one of the highest in Latin
America. Meanwhile, imports increased about 15 25X1
percent last year after Buenos Aires loosened import
restrictions in accordance with a World Bank trade-
related structural adjustment program
Current account difficulties are placing increasing
pressure on Argentina's fragile international reserves
position. The US Embassy reports that Argentina's
liquid reserves may have equaled $500 million at the
end of December-enough to cover only one month of
imports. Any new money comes and goes quickly.
December disbursements by the IMF and the World
Secret
DI IEEW 88-001
8 January 1988
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On 14 June 1985 President Alfonsin announced the
Austral plan, which-with its price and wage freeze,
introduction of a new currency, and promised end to
printing-press financing of the fiscal deficit-broke
the back of inflation and caused the President's
popularity to skyrocket. The President, however,
used the ensuing honeymoon to advance pet political
initiatives, such as moving the capital to Viedma and
reforming the Constitution, instead of to implement
significant structural reforms of the Argentine
economy.
On this score, Alfonsin's rhetoric has far outpaced his
actions. In 1985 he announced plans to increase
,private-sector participation in the oil sector but has
only recently begun to offer major concessions to
international oil companies. In early 1986 he prom-
ised to privatize some of Argentina's burdensome
state-owned enterprises, but has only sold one signifi-
cant company-a moderate-sized airline. Alfonsin
has emphasized increasing government revenues in-
stead of decreasing expenditures, shying away in
particular from the layoffs that would be necessary to
limit the massive bureaucracy's draw on publicfi-
nances. In addition, the President's economic team
resorted to only partially successful promotion pro-
grams-rather than consistently competitive ex-
change rates-in an effort to boost exports. It was
only a matter of time before inflation reappeared and
the economy slowed down.
We believe that it may be too late for Alfonsin to
regain the public's confidence in his ability to handle
the economy. Many Argentines believe the current
economic morass proves that the perceived sacrifices
they made during the Austral plan were in vain, and
they are ill disposed toward further austerity. More-
over, Alfonsin 's Radical party must now compete
with the newly invigorated Peronists, who will prom-
ise anything but austerity as the 1989 presidential
election approaches.
Bank, for example, went to repay a $500 million
bridge loan from the United States and several other
governments.
International banks have become ill disposed to in-
crease lending to Argentina, and many have conclud-
ed that a debt moratorium is inevitable,
addition, the IF is becoming increasingly -disillu-
sioned with Buenos Aires' continued inability to meet
performance targets on the fiscal deficit, inflation,
and profit repatriation. It is unclear whether a belated
passage of the tax package would be sufficient to
satisfy the Fund and induce it to grant an additional
performance waiver.
The ruling party's loss to the Peronists during Sep-
tember's off-year elections has reduced Alfonsin's
ability to withstand pressures for a moratorium. Or-
ganized labor and some members of Alfonsin's own
Radical Party have stepped up demands for halting
interest payments. The US Embassy reports that even
a leading conservative Radical has publicly stated
that there may be no other alternative. Moreover,
Peronist leader Antonio Cafiero-who initially dis-
tanced himself from his party's traditional promora-
torium stance following the September elections-has
recently called for a suspension of debt payments,
according to press reporting.
Alfonsin, himself, may be warming toward the idea of
a cessation of interest payments. In early November
discussions with the US Ambassador in Buenos Aires,
he privately threatened a debt moratorium unless the
IMF granted Argentina a waiver on missed perfor-
mance targets without further concessions, according
to the US Embassy. Alfonsin subsequently publicly
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Argentina: Selected Economic Indicators, 1984-87
Note scale change
Real GDP Growth Rate
Percent
Inflation
Percent
Real Industrial Wage Growth
Percent
87a -18 1984
endorsed limits on debt service and rejected strict
IMF conditionality at the Group of Eight summit.
This position was a sharp shift from the moderating
influence that Argentina had exercised at previous
Inter-American regional debtor conferences.
Severe foreign payments difficulties will continue this
year. We expect increased interest rates and stepped-
up capital flight to at least partially offset moderate
increases in agricultural export prices and in the pace
of industrial exports. Businessmen will continue to
underreport exports and overinvoice imports in an
effort to compensate for the overvaluation of the
official exchange rate and facilitate the transfer of
funds abroad. We project that Argentina will run a
current account deficit of $3.9 billion this year and
require an additional $2.2 billion from international
creditors in order to finance it.
Although we do not believe Buenos Aires will aban-
don its mildly free market oriented economic program
during the coming year, it will probably become more
concerned with selling its policies to the public than
with heeding the views of international creditors-
thus increasing the chances for a confrontation over
the debt. This would be especially true if Alfonsin
decided-in light of a resurgence of inflation above
the 20-percent monthly level, for example, which
could occur by March-to replace Economy Minister
Sourrouille with a politician such as Foreign Minister
Caputo or former Interior Minister Troccoli.
We believe the odds are better than even that Argen-
tina will at least temporarily halt interest payments on
commercial debt this year-perhaps as early as the
first quarter. The first flashpoint would be a decision
by the IMF not to grant Argentina another waiver at
its review of October performance targets scheduled
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~ecrei
Argentina: Balance of Payments, Million US $
1985-88
Services and transfers
-5,535
-4,972
-4,860
-5,535
Interest
-5,132
-4,416
-4,400
-5,130
Capital account
2,824
2,258
2,868
3,179
Net direct
investment
919
574
450
600
Net commercial
bank lending
2,047
1,252
1,250
700
Other net lending
1,902
1,606
2,499
1,879
Change in arrears
-2,044
-1,174
-1,331
0
Change in reserves
1,871
-565
-1,200
1,500
Financing gap
2,193
a Estimated.
b Projected.
to take place this month. Buenos Aires could opt for a
moratorium to counterbalance the political embar-
rassment of being "scolded" by the IMF. Such an
IMF decision would prohibit international banks from
disbursing a third $550 million tranche of their
$2 billion loan during the first quarter. Therefore,
even if Buenos Aires did not suspend interest pay-
ments immediately after an unfavorable IMF deci-
sion, it might have no other choice by 9 March, when
a lump sum quarterly payment to banks is due.
Other flashpoints during 1988 are on 9 June, 9
September, and 9 December, when additional interest
payments to banks are due. As the year progresses,
Argentina's foreign-payments situation will change
from difficult to unsustainable unless it receives new
money from the international financial community.
We believe a nonconfrontational solution, however, is
possible as President Alfonsin would still prefer the
additional inflow of foreign funds to a debt moratori-
um. Since Argentina has been one of the few Latin
American countries receiving new money, it has more
to lose from radical action than many other debtors.
Alfonsin would almost certainly be receptive to novel
debt initiatives proposed by creditors. He may inter-
pret the recently announced Mexican scheme as a
signal that banks are willing to consider new proposals
to reduce debtors' interest burden. A scheme analo-
gous to plans that Alfonsin has already suggested in
public-such as the capitalization of debt to fix
interestpayments at 3 to 4 percent-would be attrac-
tive, particularly since it would bolster the President's
domestic political standing. Any initiative, however,
might still need to be accompanied by sufficient new
money to avert the immediate crisis and ensure a
healthy reserves position. It would also need to come
with few strings attached regarding economic perfor-
mance
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Key LDC Debtors: Continued Export
Growth Tied to OECD Demand
Key-debtor LDC export earnings rebounded strongly
last. year-following sharp.declines the previous two
years-mainly on the strength of higher oil prices and
increased prices for major commodities such as cop-
per, rubber, and sugar. We believe that for the group
of key debtors that we examined, slower OECD
economic growth will sharply reduce export gains this
year.' Should the developed countries fall into reces-
sion, we forecast a sizable decline in key debtor
exports. In our opinion, lower LDC export growth will
tighten debtor financial pressures, increase the LDCs'
need for debt relief, heighten political pressures with-
in debtor countries, and further strain debtor-creditor
relations
Higher oil prices, continued moderate economic
growth in the developed countries, favorable LDC
exchange rate policies, lower LDC domestic demand,
and a strong rebound in commodity prices led to
higher export earnings for the key LDC debtors in
1987. For the 11 countries we examined, exports
jumped more than 14 percent last year, the best
performance 'since 1980.2 Many individual countries
recorded strong export gains:
? Brazilian exports increased 15 percent last year,
following declines in 1985 and 1986. Greater target-
ing of export markets because of lower domestic
demand-as well as real exchange rate deprecia-
tion-boosted exports. Sales of soybeans, transport
equipment, and manufactured goods were higher,
more than offsetting lower sales of coffee and iron
ore.
Nigeria, Peru, Philippines, and Venezuela.
] Data as of 18 December l987.F___-]
? Malaysian exports increased nearly 16 percent last
year because of higher oil prices and sharply in-
creased sales of textiles and electronics parts.
According to US Embassy reporting, much of the
growth in manufactured goods exports went to new
markets in Japan and the Pacific Basin.
? Mexican export earnings soared 34 percent last year
on the strength of a 46-percent jump in oil sales and
strong growth of manufactured goods exports.
Among major export sectors only agriculture re-
corded a decline, primarily because of weaker
prices.
? Strong recovery in prices for coconut products
boosted Philippine exports by 8 percent. Electronics
and textiles exports also recorded solid growth.
Chile, Indonesia, Nigeria, Peru, and Venezuela re-
corded export gains ranging from 5 to 20 percent.
? Argentine export earnings fell nearly 9 percent last
year, sinking to their lowest level this decade.
Continued weakness in prices for agricultural prod-
ucts and the adverse impact of widespread flooding
in agricultural production zones accounted for most
of the export decline:
? Colombian export earnings fell about $250 million,
or ,6 percent, in 1987, following a strong $1.7 billion
gain in 1986. Coffee exports fell sharply as prices
plunged, but the decrease in export earnings was
partially offset by higher exports of coal, oil, and
nontraditional produc
Secret
D/ /EEW 88-001
8 January 1988
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Key Debtor LDCs: Export Earnings, 1986-88
Export growth since 1987 NA NA
(percent)
a Case I is the moderate growth scenario.
b Case I I is the slow growth scenario.
Case III is the recession scenario.
Billion US $
(unless otherwise indicated)
We believe that key-debtor export growth this year is
unlikely to match last year's performance. Even if
modest OECD economic growth continues, private
forecasts indicate that oil prices are likely to be more
stable than in 1987, and that key commodity price
gains probably will not match the increases achieved
last year,. To determine the impact of changes in
OECD real GNP growth on key debtor export earn-
ings; we utilized three different OECD real growth
scenarios for 1988:
? Under the slow-growth scenario-which we believe
to be most likely-key LDC exports would grow
about $4 billion, or an average of 3 percent, but this
would still mark the first time since 1979-80 that
key LDC export earnings had risen two years in a
row. Given the assumption that oil prices remain
unchanged, nonoil exporters would realize the larg-
est percentage increases.
? Under the moderate growth scenario, key debtor
LDC export earnings would rise about 7 percent.
Nonoil exporters would record the strongest export
growth. Oil exporters such as Indonesia and Malay-
sia-whose nonoil exports are sensitive to changes in
demand-also would benefit. Debtors with small .
nonoil export sectors, such as Nigeria.and Venezue-
la, probably would realize smaller export .gains..
? Under the recession scenario, key LDC export
earnings would fall $8 billion, or nearly 7 percent,
putting individual country exports at or near de-
cade-low levels. Major oil exporters would be partic-
ularly hard hit by the combination of falling oil
prices and lower prices for exports of commodities
and manufactured goods
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Key Debtor Export Earnings: Selected Commodity Price Changes
and Their. Impact, 1987 a
Price Change Since 1986
(percent)
Effect on 1987 Export Earnings Due to Price Change
(million US $)
Debtor
Impact
Indonesia
62
Venezuela
138
Copper
13.6
Chile
244
Mexico
87
Peru
59
Philippines
U
50
50
Lead
41.4
Chile
161
Mexico
65
Peru
68
Nickel
11.8
Indonesia
50
iippines
16.
261
-
2
8
Tin
7.0
Bolivia
7
Indonesia
62
a aysia
17
Thailand
9
Mexico
8
Peru
8
-16
Malaysia
-6
Nigeria
Coffee
-37.0
Brazil
-899
oom ia- -
.-1,328
Zaire
-132
Fishmeal
13.5
Ecuador
35
Peru
2
Philippines
35
Sugar
8.1
Brazil
6
Philippines
7
Thailand
22
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To determine the extent to which factors such as
OECD real GNP growth, LDC nonoil export prices,
exchange rates, and the price of oil exert major
influences on LDC export earnings this year, we
utilized three alternative scenarios:
? A moderate growth scenario, which assumes 3
percent average real GNP growth in the OECD
.countries in 1988. Nonoil export prices increase 5
percent as demand for LDC commodity and manu-
factured exports continues to grow. Oil prices re-
main unchanged as increased oil demand roughly
matches OPEC's continued overproduction.
? A slow growth scenario, which assumes 1.5 percent
real GNP growth in the OECD countries in 1988.
LDC nonoil export prices are assumed to increase
only 2 percent as industrial country import demand
slows. Oil prices remain unchanged.
? A recession scenario, which assumes no real GNP
growth in the OECD countries in 1988. LDC nonoil
export prices decrease 5 percent as OECD import
demand declines. Oil prices fall $2 per barrel
because offalling demand and continued
overproduction.
In each of these scenarios, it is assumed that LDC
real (inflation-adjusted) exchange rates remain un-
changed. To the extent that real exchange rates
depreciate, LDC export earnings should increase.
Implications for LDC Imports and Debt Servicing
The implications of our three alternative export sce-
narios for LDC imports and debt servicing vary. The
solid export growth under the moderate OECD
growth scenario would provide a much-needed,
though modest, measure of financial relief and allow
for higher imports of essential industrial inputs and
spare parts. On the other hand, financial pressures
likely would remain high under the slow growth
scenario, with little funding available to boost imports
unless debt service relief-either through unilateral
action by the LDCs or negotiation with bilateral and
multilateral lenders-was forthcoming. Under the
recession scenario the loss of export revenue would
make financial pressures much more acute, signifi-
cantly increasing the need for substantial debt relief.
Slow or negative export growth also could heighten
political and social tensions within debtor countries,
and increase strains between debtors and their credi-
tors. F___1
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xci ca
LDCs: Mixed Outlook for
IMF Arrangements
Although the number of LDC arrangements with the
International Monetary Fund (IMF) increased in
1987, repayments exceeded new drawings from the
Fund in the first 10 months of last year. Nonetheless,
the IMF will remain a key player in international
efforts to resolve the LDC debt problem and will
become somewhat more flexible in its treatment of the
debt situation, in our judgment. The Fund, for exam-
ple, will probably expand its medium-term assistance
to LDCs, especially the poorer ones, as a result of the
its decision to create an $8.4 billion enhanced struc-
tural adjustment facility (ESAF) to complement its
existing $3 billion Structural Adjustment Facility
(SAF). We believe, however, that LDC arrears and
failure to meet economic performance criteria under
IMF-supported programs will continue to be a prob-
lem in LDC-IMF relations. In addition, LDC leaders
are likely to become more vocal this year-given
mounting domestic dissatisfaction with economic aus-
terity-in their demands for reform programs with
less'stringent austerity requirements and an unlinking
of bank lending from IMF-supported programs.=
Arrangements Increase in 1987.. .
The number of LDC arrangements with the IMF was
47 as of the end of October 1987-up from 40 at
yearend 1986. There has been a shift, however, in the
composition of the LDCs' arrangements with the
Fund toward those that provide medium-term bal-
ance-of-payments assistance, such as the SAF intro-
duced in 1986, and away from arrangements that
emphasize shorter-term assistance-standby arrange-
ments. The number of standby arrangements fell from
30 in 1986 to 25 through October 1987, while the
number of SAF arrangements more than doubled
from nine to 21. Chile continued to be the only
member country with an arrangement under the
extended fund facility-another medium-term assis-
tance facility.
The decline in the number of standby arrangements is
a result of a failure to renew agreements, the suspen-
sion in arrangements because of failure to make
timely repayments to the Fund, such as Zambia, or in
the case of South Korea, success in overcoming
balance-of-payments problems. Sub-Saharan African
countries expanded their. share of the total number of
LDC standby arrangements last year-from 55 per-
cent to 60 percent-while the number of standby
arrangements for Latin American and Asian member
countries declined slightly. LDCs who dropped their
standby arrangements last year included Ecuador,
Mali, Nepal, Panama, South Korea, Uruguay, and
Zambia, while new standbys were approved for Ar-
gentina, Egypt, Jamaica, Nigeria, and Somalia. I 125X1
The rapid.rise in the number of SAF arrangements-
133 percent higher than yearend 1986-reflects the
facility's recent introduction and the expanding need
for medium-term assistance. Most of the structural
adjustment arrangements begun last year, as in 1986,
were approved for African countries, including the
Central African Republic, Chad, Guinea, Guinea
Bissau, Madagascar, Mozambique, Somalia, Tanza-
nia, Uganda, and Zaire, as well as Bangladesh and
Nepal.
Despite the increase in the number of arrangements
last year, net financial flows to the LDCs were a
negative $3.6 billion as of October 1987-compared
with a negative $2.2 billion in 1986. Moreover, net
financial flows could be as low as negative $4.3-
4 billion by yearend 1987. Net negative financial
flows were mostly a result of members' repayments of
large Fund borrowings that were incurred during the
earlier years of the debt crisis as well as reduced new
borrowings in 1987.
Secret
DI IEEW 88-001
8 January 1988
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The IMF has several facilities to assist member
countries who are experiencing short-term as well as
medium-term balance-of-payments difficulties. LDC
arrangements under these facilities allow members to
borrow from the Fund's resources by using domestic
currency to `purchase" either special drawing rights
(SDRs)-the Fund's unit of account-or other mem-
ber countries' currency up to a certain share of the
borrower's quota-a member's subscription in the
Fund. Repayments are made by using SDRs or other
currencies specified by the Fund to "repurchase" or
buy back the borrower's domestic currency. Borrow-
ers must also pay a charge that reflects the Fund's
borrowing costs plus a margin. Loan disbursements
are usually made in installments and are generally
contingent upon the borrower's ability to meet the
economic criteria under a performance plan that it
has developed with the Fund's assistance. A member
risks a suspension in Fund disbursements if it fails to
comply with performance criteria or repay its obliga-
tions to the Fund from a previous arrangement that
has come due. Overdue obligations to the IMF can
also prompt it to suspend the borrower's arrangement
with the Fund. A variety of assistance facilities are
available to member countries:
? The upper credit tranchefacility is intended to
assist members in overcoming balance-of-payments
difficulties, allowing them to draw up to 75 percent
of their Fund quota. Borrowings are usually provid-
ed in the form of standby arrangements that include
performance criteria and installment drawings.
Standby arrangements usually last one to two
years, and repayments are required within five
years. The first credit tranche facility allows a
member to borrow up to 25 percent of its quota.
This facility does not require performance criteria
or drawings in disbursements and is used.when the
member's balance-of-payments deficit is relatively
small.
? The extended fund facility is designed to assist
members over a three-year period in overcoming
structural maladjustment, cost price distortions, or
poor export performance that result in balance-of-
payments problems. Extended arrangements allow
members to borrow up to 140 percent of their
individual quota, although the borrower must have
an annual program of policies to correct these
problems as well as meet performance criteria to be
eligible for disbursement installments. These ar-
rangements require repayments within four and a
half to 10 years.
? The enlarged access facility is used to provide
additional longer term funding under standby ar-
rangments and extended arrangements for members
who face substantial payment imbalances that ex-
ceed resources available to them under the upper
credit tranche and extended fund facilities. Repay-
ments must be made within three and one half to
seven years and conditionality also applies to dis-
bursements from this facility.
? The structural adjustment facility (SAF) was intro-
duced in 1986 to provide loans to low-income
member countries who are experiencing prolonged
balance-of-payments problems and have imple-
mented medium-term macroeconomic and structur-
al adjustment programs. In order to be eligible,
these low-income countries cannot be international-
ly creditworthy and must have a per capita GNP of
less than $750. Under their structural adjustment
arrangements, member countries are allowed to
borrow up to 63.5 percent of their quota over a
three-year period with installment drawings contin-
gent upon performance criteria. Repayments must
be made within 10 years with a five-and-a-half-year
grace period. Under the new enhanced structural
adjustment facility (ESAF)-which was announced
in late December-eligible member countries will
be able to borrow up to 250 percent of their quota.
Repayments must be repaid over 10 years with a
five-year grace period.
? Other IMF lending resources include the compensa-
tory financing facility (CFF) and the buffer stock
financing facility. The CFF is designed to help
members who are experiencing a temporary excess
in the cost of cereal imports or;temporary export
shortfalls caused by external factors. The buffer
stock financing facility is set up to help finance
member countries' contributions to international
commodity buffer stock schemes, subject to bal-
ance-of-payments needs. Borrowings from these fa-
cilities must be repaid within 39 months to five
years.
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LDCs: Status of IMF Arrangements,
as of 31 October 1987
Type of
Arrangement
Date of
Expiration
Agreed
Amount
Undrawn
Balance
Argentina .
Standby
30 Sep 88
1,470.4
1,093.2
Central African Republic Standby 31 May 88 10.6 9.2
Madagascar Standby 16 Feb 88 39.6 13.2
Nigeria Standby
Senegal Standby 25 Oct 88 28.1 22.7
Somalia Standby
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LDCs: Status of IMF Arrangements,
as of 31 October 1987 (continued)
Type of
Arrangement
Date of Agreed Undrawn
Expiration Amount Balance
the IMF.
Total borrowings in 1987, as in 1986, continued to be
drawn mostly from the IMF's credit tranche facility,
which includes standby arrangements. One-half of the
members' borrowings from the Fund last year-$2
billion-were under the credit tranche facility, down
from an 80-percent share in 1986. Drawings under
the compensatory financing facility (CFF)-a facility
for temporary export shortfalls-accounted for 38
percent of total disbursements. Borrowings under the
extended fund facility and the SAF accounted for
only a small share of total drawings. Regional access
to funds was heavily in favor of Latin America last
year, although Sub-Saharan Africa accounted for the
majority of the number of LDC arrangements with
percent of LDC repurchases.
LDC repayments-also known as repurchases-to the
Fund amounted to $7.7 billion last year, as of 31
October, of which nearly half were made to the credit
tranche facility. Repayments to the CFF accounted
for 31 percent of total LDC repayments. Latin Amer-
ica accounted for more than one-third of repurchases,
while Asia was the second-largest repayer, totaling 24
The problem of arrears-overdue obligations to the
IMF-and noncompliance, which is a failure to meet
performance criteria under IMF economic adjustment
programs, continue to be a thorn in the IMF's
relations with the LDCs. IMF programs have been
suspended in six countries because of overdue obliga-
tions to the Fund-which totaled $1.5 billion as of 30
April 1987.' Overdue obligations were only $0.6
billion on 30 April 1986. These arrears are approxi-
mately equal to the Fund's reserves, although they are
relatively small, compared with outstanding Fund
credit. To strengthen the IMF's financial position, the
Executive Board raised the target for the Fund's
annual net income from 5 percent of reserves to 7.5
percent for 1986-88
' The six countries and suspension dates are Peru, August 1986;
Guyana, May 1985; Liberia, January 1986; Sudan, February 1986;
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IMF: Comparison of Total Drawings
and Repayments, 1980-87a
I I I I I I I
0 1980 81 82 83 84 85 86 87b
a Excludes purchases in the reserve tranche and
trust fund loan disbursements.
b As of 3 I October.
Failure to meet economic criteria under IMF-support-
ed programs-risking a suspension in fund disburse-
ments-is also a major problem. Somalia and Zaire,
for example, are out of compliance with their IMF-
supported programs, while Bolivia and Egypt are on
the verge of failing to meet their economic criteria.
Zaire exceeded its 30 September standby target on
net credit to the government by $50 million and
probably also missed its 31 December target. Accord-
ing to Embassy reporting the IMF recently requested
Cairo to devalue its official exchange rate, increase
interest rates, raise agricultural and energy prices,
and reduce its fiscal budget deficit. Argentina and the
Philippines recently received waivers from the Fund's
Executive Board after Buenos Aires failed to meet its
targets for reducing inflation and the fiscal deficit and
Manila was unable to meet its net international
reserve level target.
We believe the LDCs will urge the IMF to accept
reform programs with less stringent austerity require-
ments and will call on commercial banks to untie loan
disbursements from Fund program compliance. LDC
leaders are calling for economic growth at the expense
of reform as austerity programs become increasingly
unpopular domestically. Some LDCs probably will
push commercial banks-as Brazil has done-to
agree to delink their loan disbursements from IMF
loan disbursements. We expect some LDCs, such as
the Philippines and Argentina, will continue to experi-
ence difficulty in achieving program compliance this
year-possibly risking a suspension of IMF as well as
commercial bank loan disbursements. The issue of
arrears is also likely to remain this year, posing a
problem for the debtors by prompting a suspension of
their IMF program as well as for the IMF by
restricting the Fund's ability to lend.
Despite these problems in LDC-IMF relations, we
believe the LDCs will continue, for the most part, to
rely upon the IMF as a source of funds and a provider
of technical assistance in designing and monitoring
economic restructuring programs. Moreover, IMF
involvement will continue to be important for debtors
who are seeking funds from commercial banks be-
cause the banks usually require an IMF arrangement
for new funding or multiyear rescheduling packages.
Finally, Japan is expected to require LDCs to have an
active IMF-supported program to benefit from To-
kyo's capital recycling program, providing a carrot for
some LDCs, especially in Latin America, to maintain
or return to an arrangement with the Fund.
Despite net negative disbursements and sometimes
contentious LDC-IMF relations because of tough
conditionality, the Fund will continue to play a cen-
tral role this year in continuing international efforts to
resolve the LDC debt situation. Moreover, the IMF
will probably take a slightly more flexible and more
growth-oriented approach to the debtors' situation,
although it will probably continue to require the
LDCs to achieve performance criteria to be eligible to
receive disbursements from the Fund. The IMF, for
example, recently created an $8.4 billion ESAF-
proposed last year by the IMF's Managing Director,
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Michel Camdessus-which will complement its exist-
ing $3 billion SAF. Use of the ESAF will probably be
boosted by the IMF's decision to allow LDCs with
existing SAF arrangements, which allow them to
borrow only up to 63.5 percent of quota, to switch to
ESAF arrangements that have a maximum of 250
percent of quota.
The IMF is also considering a US proposal to change
performance criteria and disbursements from quarter-
ly to semiannual for extended arrangements or stand-
by arrangements that are longer than 18 months as
well as include structural reform measures in pro-
grams through performance criteria. The IMF is
considering another US proposal to create a new
facility-external contingency facility (ECF)-to re-
place the CFF. Like the CFF, the ECF would provide
medium-term assistance to members facing export
earning shortfalls and higher-than-expected increases
in import prices. The ECF, however, would also
provide assistance to countries in the event of unantic-
ipated higher interest rates.F_~
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USSR-Eastern Europe: Inching
Toward Currency Convertibility in
Intra-CEMA Trade
At the October meeting of CEMA ' premiers, the
USSR acknowledged for the first time that an over-
haul of Bloc financial relations is needed to spur
closer economic integration and better quality exports
from Eastern Europe. The premiers agreed on the
first tentative steps toward currency convertibility in
intra-CEMA trade, but these measures will have little
immediate impact on trade. Widespread convertibility
is, at best, many years away and depends upon
sweeping reforms in the domestic economies. None-
theless, prospects for movement toward convertibility
are better now than ever, and, if Moscow and its
supporters can push through their ambitious plans,
CEMA trade and economic performance should im-
prove substantially in the 1990s.
Currency inconvertibility is rooted in the basic mech-
anism of the centrally planned economies: planners
rather than market forces determine what goods are
produced and for what purpose. Money has no power
over economic activity because, in theory, no amount
of rubles can attract resources away from a use
specified in the plan. Although reforms have weak-
ened the planners' authority in many CEMA coun-
tries and given more scope to profits in economic
decision making, currencies remain limited in their
influence over resource allocation.
The CEMA countries have debated for more than 20
years the need for a convertible currency and the
elimination of bilateral settlement of intra-Bloc trade.
Spurred in part by complaints from East Europeans,
the 1971 "complex program" for CEMA integration
called for convertibility. No steps were taken to
achieve this goal because of a slowdown in the CEMA
economies, the uneven levels of development of the
' Members of the Council for Mutual Economic Assistance
(CEMA) include Bulgaria, Cuba, Czechoslovakia, East Germany,
Hungary, Mongolia, Poland, Romania, USSR, and Vietnam.F_
individual countries, and the inadequate quality of
goods. Moreover, the proposals stood no chance as
long as the USSR showed no interest in convertibility.
The failure of CEMA's past efforts to introduce
convertibility deterred the expansion of intra-Bloc
trade and the resulting gains in efficiency and quality.
Countries have little incentive to boost exports to
CEMA partners because they cannot use transferable
rubles earned through trade surpluses to increase
imports from the bilateral partner or a third partner.
The surpluses cannot be converted into goods because
scarcities in these economies limit the availability and
quality of goods for trade. In addition, exchange rates
are set artificially, and differences in prices between
economies play little role in attracting resources to
their most efficient used
The October CEMA Council session-the annual
meeting of the premiers of the member countries-
devoted considerable attention to convertibility as one
of the major reforms needed to improve trade. After
discussing several sweeping proposals for convertibil-
ity, the premiers finally agreed that national curren-
cies should be "mutually exchangeable" between en-
terprises with direct ties-those that have approval to
bypass their own ministerial hierarchy to deal directly
with counterparts in another country. In principle, for
example, a Soviet enterprise could pay rubles to a
Czechoslovak firm with which it has direct ties in
order to buy machinery, parts, components, licenses,
or services.
Yet how much scope a CEMA enterprise, such as the
Czechoslovak firm, would have in spending the cur-
rency from its exports is unclear. If a firm could
Secret
DI IEEW 88-001
8 January 1988
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Compared with market trade systems, CEMA's
clearing trade arrangement is inflexible and offers
weak or perverse incentives, resulting in inefficiency
and lack of quality:
? Annual trade protocols are negotiated the year
before transactions occur, and five-year trade plans
limit medium-term options.
? The need to balance trade bilaterally means that
each purchase must be matched by a sale to the
same partner.
? The heavy involvement of planners and foreign
trade and industrial ministries leaves enterprises
far removed from customers and suppliers.
? Holders of transferable rubles earned through a
trade surplus have limited opportunities to spend
them.
? Trade is set by plan targets rather than spurred by
the profit motive.
? Inconvertibility encourages imports and deficits in-
stead of exports and surpluses.
? Quantity is generally more important than quality.
? Prices do not give effective signals for directing
economic activity and allocating resources.
exchange the currency for another CEMA currency
to purchase goods from another firm with which it has
direct links, the new arrangement would be a limited,
but still important step toward a more efficient multi-
lateral payments system. Otherwise, the new convert-
ibility has little meaning. Settlement would remain
essentially a barter between the two partners, with
only a limited selection of goods that could be pur-
chased by the rubles earned from the sale to the
USSR.
Citing the CEMA decision, some East European
countries have already announced some steps toward
implementing limited convertibility. In late October,
Hungary and Poland agreed that profits from joint
ventures will be distributed in the currency of the
country in which the operations are located. At the
same time, Czechoslovakia announced a streamlined
ning of 1989.
Odd Members Out. The CEMA premiers deferred
proposals for wider convertibility for further study
amid apparently sharp disagreements. In a press
conference following the CEMA,session, CEMA Sec-
retary Sychev indicated-that the decision to pursue,
limited convertibility was not supported by Romania
and East Germany.' Both countries, which adamantly
oppose Gorbachev's agenda of. decentralizing reforms
and joint ventures between CEMA enterprises, re- -
portedly objected that convertibility would undermine
their governments' control over economic policy. Ro=
manian Premier Dascalescu, citing the requirement
for unanimity on major CEMA decisions, even threat-
ened implicitly Bucharest's withdrawal; from CEMA
if the principal of unaminity were abandoned. The
other East Europeans sharply criticized Romania's
and East Germany's refusals to go along
The premiers' decision on convertibility will have a
negligible impact on CEMAeconomic relations, for
the next few years. Because the agreement covers a
very small volume of transactions and .leaves open
many questions about how it will work, nearly all of
the supporters of convertibility emphasized that im-
plementation must be gradual. A Soviet economist
told the press in early November that, even under
favorable conditions, five or six years will. be required
to achieve convertibility
This small step toward convertibility, nonetheless,
testifies to the determination of the USSR and several
of the East European CEMA countries to consider
major changes in the way they do business. The
prospects for genuine convertibility have improved
now that the USSR is taking the lead in pushing for
reform of CEMA's monetary system, and support
2 Vietnam also did not approve convertibility
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among the East Europeans has broadened from long-
time advocates, Poland and Hungary, to recent con-
verts, Czechoslovakia and Bulgaria.
The chances of eventual convertibility are also en-
hanced by the improved climate for economic reform.
Partly inspired by Gorbachev's agenda in the USSR
and partly for their own reasons, most of the East
European countries have announced new economic
reform packages this year. Indeed, progress on con-
vertibility will depend heavily on the implementation
of economic reforms in the USSR and Eastern Eu-
rope. More rational internal pricing and more effec-
tive domestic financial mechanisms are essential to
establishing currency convertibility among the
CEMA economies.
While the CEMA premiers' decision to study further
financial reforms delays major changes, the continued
drafting of proposals will keep convertibility a live
issue. The experiment to exchange national currencies
between enterprises with direct ties will be important
in determining what further steps toward convertibil-
ity can be taken. Answers to several key questions are
likely to emerge as enterprises feel their way toward
limited convertibility.
and export orientation, some of the major hurdles to
convertibility with Western currencies would be
cleared. It would still require a substantial leap for the
CEMA economies to be strong enough to face world
competition. In any case, Gorachev and his East
European counterparts do not plan to carry the
reforms this far, and this would undermine Bloc
economic unity.
Economic Reform. Domestic reforms may be driven
to some extent by changes in CEMA. Moscow has not
yet pushed the East Europeans hard to undertake
specific reforms, but progress on convertibility may
require the East Europeans to reform their foreign
trade and revise their exhange rate systems.' Indeed,
pressure for convertibility could be a lever against the
more recalcitrant members. Alternatively, continued
adherence to central planning by Bucharest and East
Berlin could frustrate efforts toward convertibility
and test Moscow's hands-off policy toward reform in
Eastern Europe
Foreign Trade. The uncertainty about convertibility
will complicate negotiations set to begin next year on
1991-95 trade plans. While the new procedures will
have little impact on the remainder of the 1986-90
trade plans, the coming five-year plan may well see a
significant impact from changes in monetary rela-
tions. Heightened importance of money in driving
CEMA economic relations would make trade more
flexible and thus reduce the authority of-if not the
Progress toward convertibility touches-at least tan-
gentially-on a large number of issues in Soviet-East
European economic relations. In most cases, the link-
ages run in both directions: greater convertibility and
developments in other key areas are mutually rein-
forcing and inseparable.
CEMA Integration. Achieving the longstanding vi-
sion of a single CEMA market will require full
convertibility of the national currencies. Linking the
economies through a network of meaningful exhange
rates and effective currencies would sharply increase
the economic interdependency of the CEMA coun-
tries and make their economies more open to each
other
Convertibility Between Western and CEMA Curren-
cies. Because intra-CEMA convertibility would ratio-
nalize foreign and domestic prices and foster quality
need for-detailed trade plans.
Quality. The achievement of widespread convertibil-
ity would promote Gorbachev's goal of improving the
quality of goods traded in CEMA. Trade surpluses
and transferable ruble balances are now undesirable
because only shoddy surplus goods are available for
purchase. If countries holding currency surpluses were
able to convert them into goods, competition should
spur trade partners to offer more desirable goods.
' Moscow is sending mixed signals: the Soviet delegation at the
CEMA session was clearly frustrated by the resistance of East
Germany and Romania, but Gorbachev's published remarks to the
premiers after the meeting appear to leave decisions about reform
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Pricing. Both within the CEMA economies and in
intra-CEMA trade, price-setting mechanisms will
have to be substantially revised to become more
flexible. CEMA foreign trade prices, which are pres-
ently based on the average of world market prices
over the previous five years, will have to be closer to
current Western prices, or the CEMA countries will
have to develop their own market price system. This,
in turn, will require a closer relationship between
domestic and external prices and some convergence of
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Norway Concerned Norway is facing difficult policy decisions about the-development of major projects
About Fast Pace of Oil that are crucial to the level of North Sea oil and gas output in the mid-1990s and
and Gas Development beyond. A rash of oil and gas company applications is expected soon for large new
projects. If it approves all the projects, Oslo believes a huge, inflationary bulge in
offshore investment would occur, followed by a gap in investment in the mid-
1990s, with depressing effects on the country's offshore industry in the future. Oil
companies argue that enforced delays would place intolerable strain on field
economics in view of the money already spent, thus souring interest in further
exploration and development of Norwegian fields. Ironically, it was Oslo's easing
of tax terms a year ago because of plunging oil prices that has led to the surge of
interest in development projects.
Panama's Financing Panama's prospects for securing external funding to help finance a projected
Problems budget gap of more than $300 million this year are poor. The US Embassy reports
that government officials are counting on at least $260 million in new loans from
commercial banks, and from the IMF, the World Bank, and the Inter-American
Development Bank; they plan to siphon profits from government-owned companies
to cover the remaining shortfall. Panama
also is depending on foreign commercial banks to honor a suspension of debt
payments until March, even though the regime has not obtained a promised IMF
letter of intent. Foreign private banks probably will maintain the debt moratorium,
realizing that Panama does not have the money to pay servicing obligations and
that declaring Panama in default might cause renewed capital flight. The banks
will be reluctant to offer new money without an IMF accord, however, and the re-
gime does not want to risk unrest by making other far-reaching reforms.
Meanwhile, growing financial difficulties might increase Panama's interest in
funding from the Soviet Bloc and Libya
Rosy Rhetoric, Recent positive rhetoric from high-level West German and Soviet officials about
Practical Problems their bilateral trading relationship disguises many practical obstacles that are
for West German-Soviet hindering expanded trade. Foreign Minister Genscher and Christian Social Union
Trade leader Strauss are publicly urging the West to take Gorbachev's reforms seriously,
and to take steps to assist the Soviet leader's domestic restructuring program.
Genscher and Strauss both stress the special importance of Bonn's trade link to
Moscow, and Genscher recently argued for relaxing COCOM restrictions, which
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the Soviets claim have cost the West German firm Siemens substantial business.
Despite such encouraging statements, a number of factors are hindering the
economic relationship. West German exports have actually dropped almost
continously in real terms for the past four years when measured on a quarterly ba-
sis-largely reflecting a drop in Soviet oil revenues-with investment goods and
machine tools down sharply in the past year. Joint ventures are being hampered by
the lack of a bilateral investment guarantee. Moscow, nearly a year after
indicating its willingness to negotiate such an agreement, is now reportedly ready
to do so, although West German officials are skeptical the Soviets will sign the ba-
sic West German guarantee, which ensures an unrestricted transfer of profits in
hard currency. Quotas and tariffs on goods such as textiles also hinder trade,
although Bonn has pledged to seek a more accommodating position on this within
the EC.
Thai-Soviet-Japanese The Asian-Pacific Company (ASPAC), a first-ever marketing arrangement be-
Trade Venture tween Thai, Soviet, and Japanese firms, is scheduled to begin operation in early
January. ASPAC's partners recently met in Moscow to discuss trade proposals
worth more than $1 billion. The largest deal probably will be a $660 million oil
swap that would channel Soviet-origin or Soviet-traded petroleum through
ASPAC, possibly to Vietnam, Laos, Cambodia,.or China. Although the venture
probably will boost Thai-Soviet two-way trade significantly from the $94 million
recorded in 1986, a disagreement between the Japanese and Soviet partners over,
marketing rights for other Soviet products could slow the pace of sales elsewhere in
the region.
Italy Signs Economic Italy and Argentina signed a five-year $4.5 billion aid and investment accord last
Pact With Argentina month, but disbursement problems and investor caution will probably leave the
program short of its goal. Rome has committed $1.5 billion in soft loans over the
1988-92 period for public works and smaller "productive" nonpublic works
projects, namely industrial projects. The projects are expected to involve about
$1.5 billion in Italian private investment and an equal amount of repatriated
Argentine capital. Rome already has allocated about $240 million in soft loans to a
gas processing plant project at Neuquen and a telephone digitalization project in
Buenos Aires. Argentina must exempt Italian investments from capital and profit
repatriation restrictions to attract wary investors and establish a financial
administrative entity before the program can get off the ground. More important,
Argentina must streamline administrative procedures to implement the small,
nonpublic works projects that are expected to-account for a large portion of the
program. According to Embassy reporting, a $270 million Italian soft loan
program initiated in 1985 to encourage investment by small and medium-sized
Italian firms has been little used because of Argentine bureaucratic inefficiencies.
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Algerian-French The failure of year-long talks to yield a liquefied natural gas contract is souring
Economic Relations Algerian-French relations. Algeria is holding out for a 20-year, fixed-price, fixed-
Deteriorate quantity contract while the French want market price fluctuations taken into
account. Algerian frustration over the deadlock has led Algiers to abrogate
existing maritime and aviation accords with France. Moreover, according to the
US Embassy in Algiers, the government is threatening to freeze $100 million in
transfers due Air France and is drawing up proposals to cut back French imports
drastically. Although the Algerians may delay payment to French firms for
services rendered, they are unlikely to pursue policies-such as declaring a
moratorium on debt owed the French-that would jeopardize their international
credit rating. The decline in Algerian-French relations could create opportunities
for more US commercial activity with Algeria
Turkey Disappoints Iran failed to achieve its major objectives at the latest meeting of the Economic
Iran's Hopes for Cooperation Organization (ECO)-a group founded four years ago and consisting
Economic Cooperation of Iran, Turkey, and Pakistan t the
November meeting, Tehran sought the immediate elimination of certain tariffs,
broad movement toward a free trade area, and unlimited truck transit rights
within ECO. Ankara apparently resisted these proposals because they either
decrease Turkish revenues or detract from Ankara's drive to join the EC; Tehran
has frequently touted ECO as the forerunner of an alternative, Islamic, common
market. In addition, the same issues are to be discussed at the Turkish-Iranian
joint economic meeting scheduled for early 1988, and Turkish officials may not
have been prepared to negotiate these points during the ECO meeting. Pakistan
was reportedly more favorably disposed to the Iranian proposals, but it may have
coordinated its positions in ECO with Turkey to prevent Iran from dominating the
organization. ECO will probably continue to face difficulties in finding agreement
among its parties, in part because Ankara accords it a much lower importance
than Tehran.
Renewed Strains Public splits within the Kohl government over economic policy have begun to
Over West German reemerge. Economics Minister Bangemann recently suggested that additional
Economic Policy steps to stimulate the economy might be needed, but Chancellor Kohl ruled them
out. The public differences were quickly papered over by a senior Economics
Ministry official, who stressed that both Bangemann and Kohl agree nothing
needed to be done now, and that Bangemann had simply reiterated his view on pol-
icy action if the economy stagnates. Bangemann, however, was almost certainly
reflecting the view of his Free Democratic Party that Bonn needs to do more to
stimulate growth. Most party members rejected the government's recent invest-
ment program as grossly insufficient. Moreover, former Economics Minister
Lambsdorff continues to urge enactment of the Stability and Growth Law, which
would involve substantial tax cuts. Chancellery officials, although supportive of
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the goal of additional stimulus, were critical of Bangemann's remarks; they
claimed airing a dispute with the Chancellor could create uncertainty about the
government's policies and undercut investment. Kohl and Christian Democratic
Ministers remain more concerned about Bonn's growing budget deficit, which
almost certainly will be one-third higher than currently projected.
Canada Increases Ninety percent of Canada's farmers will. benefit from farm subsidy programs in
Agricultural. Subsidies 1988, with most help going to western grain producers. Ottawa plans to give
farmers $825 million in direct cash payments under a special program established
last year to help protect farmers from the international grain subsidies war. In ad-
dition to the direct payments, Ottawa will write off more than $750 million in
farm-related debts, including half of the $1.1 billion accumulated debt of a
government-sponsored crop insurance program. Ottawa also has offered $225
million over the next three years to the Farm Credit Corporation-the lender of
last resort for farmers-to cover future loans. In total, Ottawa and the provincial
governments probably will give farmers nearly $3 billion in direct and indirect aid
in 1988. Although revenue from crop sales fell by about 6 percent in 1987,
government grants raised net farm income to a record high, and we expect 60 per-
cent of net farm income in 1988 will again come from Ottawa and the provincial
governments. The planned 1988 disbursements exceed those called for in last
spring's budget estimates, and since offsetting cutbacks elsewhere are unlikely so
soon before an election, Ottawa is likely to miss its budget deficit target this year.
Israeli Cabinet Approves According to press reports, Finance Minister Nissim gained Cabinet approval on
1988 Budget Sunday for the 1988/89 government. budget-which begins on 1 April-following
intense behind-the-scenes negotiating. The budget is for 48.6 billion shekels-
about $30 billion at the current exchange rate-and provides for about $470
million.in spending reductions. Subsidy reductions of about $180 million and
across-the-board cuts by government ministries of about $200 million comprise the
bulk of.the proposed cuts. The Cabinet-approved budget now goes to the Knesset
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for final approval. While it is not likely that major budget changes will take place
in the Knesset, further chipping away-especially from the proposed across-the-
board ministerial cuts-is probable before the budget ultimately is passed.
Thai Economy Shows A second year of high export growth-coupled with strong foreign investment
Dynamic Performance inflows and a recovery in domestic demand-pushed Thailand's real GDP growth
in 1987 to more than 6 percent last year, while inflation was held to 3 percent. On the basis
of preliminary figures from the Central Bank, we estimate that exports increased
by 25 percent compared with 1986 levels, to $11.3 billion. Sales of processed raw
materials and manufactured products almost doubled, and exports to the United
States were up more than 20 percent, to almost $2 billion. A 37-percent surge in
imports pushed the trade deficit to $1.5 billion, however, and the current account
moved from a small surplus in 1986 to a deficit of $580 million, or slightly more
than 1 percent of GDP. With capital inflows of more than $900 million in 1987-
much of it Japanese investment-and the likelihood that exports and investment
will remain strong, we estimate that the real GDP will grow at about 6 percent
again in 1988.
India's Private-Sector Declining private-sector profits may have an adverse impact on New Delhi's
Profits Decline economic liberalization program. According to US Embassy reporting, the after-
tax profitability for the private sector is expected to decline from 14 percent in the
fiscal year that ended March 1987 to 7 percent in this fiscal year. New Delhi had
hoped that liberalization measures, which include reducing restrictions on imports
and industrial production and reforming the tax system, would help modernize the
industrial sector and boost output significantly. The government has looked to a
more efficient and profitable private sector as an increasingly important source of
funds to finance industrial expansion. Some industrialists complain that liberaliza-
tion, especially higher imports, are hurting the country's private industrial sector.
We believe, however, that the severe drought over the last year-which has
reduced income and demand for many industrial and consumer items-as well as
the inability of Indian firms to quickly adapt imported technology, continue to be
the major factors hampering Indian competitiveness and output. Moreover,
longstanding structural deficiencies such as high cost inputs and inadequate power
supplies are also major constraints. Opponents of liberalization nevertheless will
continue to blame the program for the country's slower industrial performance and
press New Delhi to back away from its commitment to implement further
liberalization measures.
Afghan Currency Afghanistan's currency has declined sharply against the US dollar and other
Depreciating foreign currencies on the Kabul free market during the last month, after
remaining fairly stable since early August. The afghani currently stands at an
unprecedentedly weak 189 afghanis to the dollar, a drop of 8.6 percent since late
November. According to the US Embassy, the decline was triggered, in part, by
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the increased demand for hard currency in late November when the regime offered
a large quantity of sugar for sale to local businessmen and required payment in
hard currency. The depreciation probably is also the result of the uncertain
political situation and a decline in Afghanistan's hard currency exports-in
particular raisins and karakul pelts-this fall. The afghani's decline will make
Western imports-such as machinery and medicines-more expensive and may
contribute to rising prices for some food items in the bazaar.
Nigerian Finance Finance Minister Chu S.P. Okongwu not only survived a cabinet reshuffle in
Minister Hangs On December-despite rumors of his impending replacement-but gained the Eco-
nomic Development portfolio. His expanded authority should simplify the budget-
ary process, according to US Embassy officials, and eliminate existing tension
between the two ministries. These same officials, however, report that Okongwu is
not an effective spokesman for the regime's austerity measures. His abrasiveness,
unpredictability, and lack of knowledge of economic details have earned him poor
marks from his own ministry, the Armed Forces Ruling Council, and the domestic
and international business communities, according to Western diplomats. Okong-
wu's frequent charges that the international community has not provided enough
new financing for Nigeria and his propensity to nitpick at nearly completed
agreements have caused delays in debt rescheduling. Okongwu is reportedly close
to President Babangida, a relationship that probably accounts for his continuation
in high positions.
Haiti's Forts To Cope Haiti is trying to ease the impact of recent aid cuts. but probably will face a finan-
With Foreign Aid Cuts cial crisis shortly after the election period ends early next month. To cope with the
suspension of $69 million in US and multilateral balance-of-payments support,
Port-au-Prince has raised gasoline taxes, delayed paying civil servants, and
announced a 20-percent cut in the salaries.of military officers, according to the US
Embassy. The ruling council almost certainly wants to avoid imposing austerity
measures before the scheduled inauguration of a civilian president on 7 February.
The military salary cuts merely rescind a portion of the 90-percent increase in base
pay granted to all military personnel in October. To retain the military's loyalty,
the government probably will shift the burden of most budget cuts to the civilian
sector. Such a move, however, risks a new round of popular unrest as the full im-
pact of the measures begins to take hold by March
China's Trade Balance China reduced its trade deficit to $3.5 billion in 1987 from $12 billion in 1986.
Improves Chinese customs statistics indicate that a 23-percent surge in exports accounted
for much of the improvement, but the imposition in early 1987 of stricter controls
on the use of foreign exchange resulted in a 3-percent decline in imports. China's
merchandise trade balance, net of insurance and shipping charges, was probably in
surplus for the last two quarters, after 11 consecutive quarters in the red. In
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addition, income from services was probably up significantly-earnings from
tourism were up 30 percent through October, for example-suggesting China will
post its first current account surplus since 1984. Accordingly, China's foreign
exchange holdings almost certainly have grown since Beijing reported its Septem-
ber reserves had reached $14 billion, a $4 billion jump from January's level.
China's external accounts will probably continue to improve despite growing
protectionism in many developed-country markets. For example, in the last half of
1987, the value of China's textile exports-the nation's largest foreign exchange
earner-increased 25 percent despite the filling of many Western quotas on
Chinese goods. As a result, Beijing will probably ease import restrictions in 1988.
Beijing's success in promoting exports is largely responsible for its widening trade
surplus with the United States. US statistics project a $3.8 billion gap for 1987,
double the level of 1986.
Hanoi Facing la critical shortage of foreign exchange is forcing 25X1
Critical Shortage Vietnam to cut export prices. A recent Vietnamese delegation to Bangkok was
of Foreign Exchange instructed to negotiate a coal sale at any price in order to obtain currency to repay
overdue debts, Hanoi is also trying to support 25X1
construction projects without spending hard currency by bartering scrap metal for
fabricated steel. Vietnam's foreign exchange woes-the IMF estimates that
reserves are less than $10 million, or about three days worth of imports-will
probably continue over the next year. Prospects for increasing foreign exchange
revenues are poor because of Hanoi's almost total dependence on exports of
agricultural products and handicrafts. In addition, Vietnam's occupation of
Cambodia and its poor credit rating have isolated Hanoi from Western financial
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Vietnam's Economic Hanoi has introduced economic reforms designed to force state-run enterprises to
Reforms operate more profitably and to lure badly needed foreign investment; results are
likely to be mixed. The new measures allow state-run firms more autonomy in
hiring, investing, pricing, and disposing of unwanted assets. In return, enterprises
will be held accountable for their profits and losses; those perennially in the red
will lose their subsidies and be forced into bankruptcy. Hanoi has also given final
approval to a long-awaited foreign investment code allowing as much as 99-percent
foreign equity in joint ventures, repatriation of profits, and full investor control
over work forces; the only areas closed to foreign investment are defense and
public utilities. The new measures lack clear guidelines on how far enterprises may
go in exercising their decisionmaking authority; the ambiguity risks more confu-
sion than benefits. Enterprises are likely to test the limits of their authority, for ex-
ample, by sharply increasing investment and imports, thereby aggravating infla-
tion and foreign exchange problems. Despite the new foreign investment code,
most Western firms are not likely to risk investing in Vietnam because of the
country's weak banking system, poor infrastructure, and massive, inefficient
bureaucracy.
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