INTERNATIONAL ECONOMIC & ENERGY WEEKLY

• Document Type: CREST
• Collection: General CIA Records
• Document Number (FOIA) /ESDN (CREST): CIA-RDP97-00770R000100610001-5
• Release Decision: RIPPUB
• Original Classification: S
• Document Page Count: 34
• Document Creation Date: December 22, 2016
• Document Release Date: May 19, 2011
• Sequence Number: 1
• Publication Date: October 24, 1986
• Content Type: REPORT

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International
Economic & Energy
Weekly
24 October 1986
Secret
DI IEEW 86-043
24 October 1986
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International
Economic & Energy Weekly
24 October 1986
iii Synopsis
1 Perspective?London's "Big Bang": Implications for International
Financial Markets
OGI
3 United Kingdom: Bracing for the "Big Bang"
EURA
7 IMF and World Bank: Changing Roles
OGI
11
15 South Korean Textiles: Industry in Transition
0EA
19 Briefs Energy
International Finance
International Trade
Global and Regional Developments
National Developments
Indicators
Comments and queries regarding this publication are welcome. They may be
directed to . Directorate of Intelligence,
i Secret
DI IEEW 86-043
24 October 1986
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International
Economic & Energy Weekly
Synopsis
1 Perspective?London's "Big Bang": Implications for International
Financial Markets
The financial deregulation in the United Kingdom scheduled for 27 October?
referred to as the Big Bang?is only the latest step in the unprecedented
restructuring of the world's financial markets. Although the Big Bang will
internationalize the United Kingdom's previously insulated domestic financial
markets, the deregulation will be more sweeping than similar US actions taken in
the mid-1970s and its impact will extend well beyond London.
3 United Kingdom: Bracing for the "Big Bang"
The British financial sector is facing sweeping liberalization aimed at increasing
its efficiency and keeping it competitive with the New York and Tokyo capital
markets. We think the move to deregulation will strengthen British financial
markets, but US and Japanese companies will probably dominate these markets.
7 IMF and World Bank: Changing Roles
The unexpected resignation of Jacques de Larosiere raises new speculation about
the Fund's future role in the management of the LDC debt crisis. Even with the
World Bank assuming a greater role, however, Bank-Fund coordination and
greater Bank emphasis on debtor policy-based lending is likely to result in
continued focus on structural reform?albeit medium term?in return for en-
hanced funding to debtor countries.
11
15 South Korean Textiles: Industry in Transition
We expect textiles to remain South Korea's major export over the next few years,
but the industry faces tough challenges from new agreements limiting textile
exports to the United States and Westen Europe, and from low-cost producers
such as China.
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Perspective
International
Economic & Energy Weekly
24 October 1986
London's "Big Bang": Implications for International Financial Markets
The financial deregulation in the United Kingdom scheduled for 27 October?
referred to as the Big Bang?is only the latest step in the unprecedented
restructuring of the world's financial markets that is lowering barriers to the
international flow of capital. Although the Big Bang will internationalize the
United Kingdom's previously insulated domestic financial markets, the deregula-
tion will be more sweeping than similar US actions taken in the mid-1970s and its
impact will extend well beyond London. Experts agree that no major financial
center has ever been shaken to the extent of the Big Bang and, because of the re-
sulting boost in London's global financial stature, international financial firms are
competing fiercely to establish a foothold.
A competitive shakeout of financial firms in London following deregulation
appears inevitable. Financial experts expect US firms?with their experience and
reputation for flexibility and innovation?to emerge as world leaders. Big Bang
deregulation will provide US and Japanese financial firms with many new
opportunities. The elimination of barriers between the banking and securities
industries will allow US and Japanese commercial banks in London to trade
securities, which they are prohibited from doing in their own countries. Some
experts believe this will serve as a trial for possible similar deregulation by the
United States. Japanese firms, backed by their massive capital bases, will be able
to underprice many competitors. While they will maintain a presence on the world
scene, European firms?primarily British and West German?will be overshad-
owed by the US and Japanese financial giants.
Following deregulation, London?already the world's top foreign exchange and
Eurobond trading center?will also be in a position to capture global trading in
other nontraditional financial instruments. The overhaul of London's market
information system, coupled with its location at the center of the world's time
zones, make it a natural hub for the emerging 24-hour global financial market.
This gives London an edge over the world's two other principal money centers,
eroding New York's position and keeping Tokyo a distant third. Europe's second-
tier money centers are also likely to be adversely affected by London's strength-
ened position. According to US Embassy reporting, European brokers for the most
part expect their home exchanges to lose business to London; we believe Frankfurt,
Paris, and Zurich will fare reasonably well, while Milan and Madrid appear most
vulnerable. At a minimum, these smaller exchanges will be forced to reassess their
own regulatory framework to remain competitive.
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On the basis of the US experience with more limited financial deregulation, the
Big Bang will probably thin the ranks of international financial firms in the
London market over time. The survivors will substantially boost their global
competitiveness, and thus the world's financial transactions are likely to be
increasingly concentrated in a handful of large international firms that will
dominate financial markets into the next century. Countries that seek to buck this
trend toward globalization by maintaining or tightening regulation will risk
hurting the global competitiveness of their domestic financial institutions. Such
concentration, however, will create new vulnerabilities for the international
financial system?financial troubles for one of these large firms could destabilize
the entire system?increasing the need for supranational financial regulation.
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United Kingdom: Bracing
for the "Big Bang"
The British financial sector is facing sweeping liberal-
ization aimed at increasing its efficiency and keeping
it competitive with the New York and Tokyo capital
markets. The changes in the way the City of London'
does business will culminate in the so-called Big Bang
on 27 October, with attention centering on the end of
fixed commissions on stock transactions. We think the
move to deregulation will strengthen British financial
markets, but US and Japanese companies will proba-
bly dominate these markets.
The Move Toward Liberalization
The catalyst for the Big Bang comes from a 1978
legal action that the British Government brought
against the London Stock Exchange for allegedly
monopolistic behavior. Realizing legal proceedings
would be protracted and costly?and, in the end, a
losing cause?the exchange eventually reached an
out-of-court settlement with the Thatcher government
in 1983. The government agreed to drop its antimono-
poly suit in return for the City's agreement for far-
reaching deregulation of its practices by 1986.
Even without this court action, we believe several
interrelated factors made liberalization inevitable if
London was to remain competitive with other finan-
cial centers:
? Wall Street's abolition of fixed commissions in 1975
enabled US securities firms to undercut their Brit-
ish counterparts on large transactions.
? The abolition of foreign exchange controls by the
Tories in 1979?although it helped London become
the center of the Eurobond market?enabled many
large institutions to purchase British securities in
the United States.
' Britain's equivalent of Wall Street, the "City" is the financial
district of London.
3
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British Financial Sector
Although it has lost some ground in recent years, the
City of London still ranks in the top three of world
financial centers along with New York and Tokyo.
The City has been the center of the Eurocurrency
market since the 1960s with deposits totaling $775
billion in 1985. A recent survey by the Bank of
England showed the City dominates foreign exchange
trading, handling an average of $90 billion a day?
$40 billion more than New York. London also is the
world leader in insurance and reinsurance, shipping
contracts, and trading in many commodities. A finan-
cial futures exchange is presently undergoing rapid
growth and could challenge for world leadership.
The City makes a significant contribution to the
British economy and has experienced rapid growth
since the abolition of exchange controls in 1979. Its
foreign exchange earnings have risen nearly fourfold
since 1979 and totaled more than $10 billion last
year. Overall, the financial sector accounts for about
7 percent of British GNP and is the main reason for
the rapidly increasing role of services in the British
economy. The sector accounts for about 10 percent of
total employment-2 million jobs?up from 6 per-
cent in 1975.
? New technology has internationalized the world's
capital markets by linking the major trading centers
and allowing 24-hour trading.
? US and Japanese competitors are better capitalized
and offer more financial services than do London's
traditional old securities firms. According to some
estimates, until last year the combined capital of all
London Exchange firms was less than that of Mer-
rill Lynch.
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United Kingdom: Overseas Earnings of
Financial Institutions, 1975-85
Billion US $
12
/Brokerage and
investment
9
6
3
0 1975
80
85
Commodity
trading
Banking
Insurance
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Changes in British Markets
The Big Bang on 27 October will usher in the most
sweeping liberalization of a financial market this
century. The changes?most of which were initiated
by the City itself?will dwarf those made by Wall
Street in the 1970s and will substantially alter the
way the City conducts business.
Negotiated Commissions. The most important aspect
of the Big Bang is the abolition of fixed commissions
on the trading of stocks. The lack of negotiated
commissions has not only impeded competition among
British financial firms, but also has made them
increasingly uncompetitive internationally. For exam-
ple, the lowest commission currently available is 0.3
percent?for large transactions?while on Wall
Street commissions for institutional traders run as low
as 0.15 percent. Many money managers expect UK
commissions to fall by about 30 percent after the Big
Bang.
Secret
Dual Capacity. Another important change is that
securities firms will now be able to perform both
brokerage and jobbing activities. Under the current
single-capacity system?unique to London?some
firms employ jobbers?individuals who actually buy
and sell securities, making a profit on the spread
between the purchase and sale prices; other firms
employ brokers?who buy and sell securities for their
clients from jobbers and make a profit on commis-
sions. To encourage competition, brokers will be
allowed to conduct transactions with their firm's
jobbers only if the jobbers' sale price at least matches
the lowest price on the market. Moreover, jobbers
must now list their prices on the Exchange's electronic
listing.
Gilt Market Trading. A third key change is that the
Bank of England will end the restricted trading on the
gilts market, where British government securities are
traded. At present, one company, Mullins, acts as the
government's broker while two jobbing firms domi-
nate the market. The Bank of England is setting up its
own issuing group and 27 firms plan to deal in gilts?
market analysts expect mergers and some outright
failures to reduce this number because of the relative-
ly small size of the market. The Bank of England is
also contemplating selling gilts by the auction-style
approach used by the US Treasury.
Additional Changes. In preparation for the Big Bang,
the London Stock Exchange has made several
changes in its rules to encourage financial groups
outside of the City to become members. As of 1
March 1986, the Exchange began allowing foreign
firms to become members. In addition, firms outside
the City can now own up to 100 percent of member
firms, whereas the previous limit was 29.9 percent. On
29 April, the government announced the creation of a
sterling-denominated commercial paper market that
will allow firms to raise funds directly from lenders,
as an alternative to going through commercial banks.
To protect investors, the government restricts this
activity to large companies listed on the London Stock
Exchange and having net assets of a least $75 million.
British financial analysts believe this new market will
attract firms that now go abroad?especially to the
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Regulating the City
The post?Big Bang regulatory environment is not yet
set, but apparently will continue to stress self-regula-
tion while formalizing the role of government as a
watchdog. Under the present system, the financial
markets police themselves with only informal govern-
ment supervision. The new framework contained in
the Financial Services Bill now being hotly debated in
Parliament will vest day-to-day regulatory power in
the Securities and Investments Board (SIB)?com-
posed of market participants appointed by the govern-
ment and ultimately responsible to the Department of
Trade and Industry. The bill is partly modeled after
US regulations although the SIB will not have the
enforcement powers of the Securities and Exchange
Commission, in particular the SEC's prosecuting
authority. Other self-regulatory organizations, such
as the London Stock Exchange, will be overseen by
the SIB, and their regulations must be at least as
stringent as those of the SIB. In order to conduct
business in British financial markets, participants
will be required to obtain permission from either the
SIB or one of these organizations. The new legisla-
tion will not affect the Lloyds Insurance Market,
which is covered by other legislation, or the banking
markets, which the Bank of England will continue to
supervise.
Thatcher's approach to policing the City as set forth
in the Financial Services Bill appears to satisfy few
people in the City or Parliament. Both Conservative
and Labor MP's agree that increased supervision is
necessary to maintain the City's integrity, especially
in the wake of the Lloyds insurance scandal in the
late 1970s and the questions about the collapse of
Johnson Matthey Bankers last year. The Conserva-
tives, however, want minimum regulation of the
markets so as not to hamper the City's ability to
attract business; they have rewritten many of the
bill's provisions to accommodate the concerns of
large financial firms. The Labor Party, on the other
hand, is inherently distrustful of the City, and wants
even tougher regulations. Though Laborites succeed-
ed in increasing the powers of the SIB, they argue
that self-regulation will not work even with greater
disclosure rules and increased requirements to coop-
erate with the SIB. While the major changes brought
about will remain in place, in all likelihood, there
will be additional regulations in the future, especially
if another scandal hits the City, or a Labor govern-
ment takes office after the next election due by June
1988.
United States?for short-term funds. They expect
that 15-to-20 percent of British commercial borrow-
ing will take place in this market within two years.
Implications
Overall, the Big Bang is likely to have a positive
impact on the British financial sector and on the
economy. London will strengthen its position as the
center of Eurobond trading, and we expect the City to
attract new capital and to recapture much of the
business it has lost overseas in recent years. In the
end, the changes should boost London's international
financial stature and cement its place as one of the
three most important financial centers along with
New York and Tokyo.
5
While the longer term outlook is bright for the City of
London as a whole, individual firms will face a severe
shakeout as they adjust to a more open and competi-
tive environment, and the likelihood of a scandal will
increase as institutions scramble for business. US and
Japanese financial giants have acquired stakes in
British firms and opened their own City offices in
anticipation of the Big Bang. Only eight of the top 20
brokerage firms operating in the City remain in
British hands, and the merger and acquisition mania
that has swept the City probably will continue for
some time. US firms, experienced in operating in a
competitive and highly innovative market, are likely
to dominate the City when the dust settles, and
Japanese firms will have a strong presence as well. As
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World Stock Exchange Trading Volumes,
1984
Percent
Total = US SI.8 trillion
Other - 7.6
Other Europe - 20.5
New York - 42.3
London - 5.3
NASDAQ - 8.5
Tokyo - 15.8
310733 10.86
the Westland Helicopter and British Leyland affairs
demonstrated, there is a danger of backlash if foreign-
ers are seen as dominating what had been a uniquely
British market. This could force even a Tory govern-
ment to take some action to ensure that the City of
London retains a distinctly British flavor.
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IMF and World Bank:
Changing Roles
The unexpected resignation of Jacques de Larosiere,
the managing director of the International Monetary
Fund for the past eight years, raises new speculation
about the Fund's future role in the management of the
LDC debt crisis. The World Bank, also under new
leadership, could move to center stage depending on
the resolution of such key issues as voting power and
the amount of the next capital increase. Even with the
World Bank assuming a greater role, however, Bank-
Fund coordination and greater Bank emphasis on
debtor policy-based lending is likely to result in
continued focus on structural reform?albeit medium
term?in return for enhanced funding to debtor
countries.
IMF: Backing Away On Debt
The IMF's traditional role in managing the LDC debt
crisis is diminishing. Debtors, and now some creditors,
believe LDC financial difficulties are more deep-
seated and protracted than the temporary balance-of-
payments problems that the Fund's austerity pro-
grams are designed to correct. While, in the past,
commercial and official creditors have been reluctant
to reschedule debt or provide new funds if a country
has not reached an agreement with the IMF, now?of
the big debtors?only Mexico has a current IMF
agreement:
? Brazil recently rescheduled long-term debts of $15.5
billion. Brasilia has insisted it will not accept IMF
participation in the renegotiation of the remainder
of its $105 billion debt.
? Colombia secured a $1 billion loan from creditors
without a formal IMF agreement, and recently
announced that it will not renew its informal moni-
toring agreement with the Fund, which expires 31
October.
? Peru refuses to negotiate with the IMF. Lima owes
the Fund over $160 million, and has been declared
ineligible to receive additional IMF resources.
On the creditor side, the recently exhibited flexibility
by the Fund in negotiations with Mexico probably will
reduce the value of the IMF stamp of approval. The
Mexican agreement linked $600 million of additional
Fund assistance to the price of oil and allowed
considerable leeway in setting a target for Mexico's
budget deficit. Without the tough policies traditional-
ly prescribed as part of IMF-supported programs,
bankers are likely to be even more reluctant to
participate in financial packages for debtor countries
and may increasingly ask for guarantees from creditor
governments or the World Bank as an incentive to
lend.
Mounting Arrears
In addition to losing some of its influence in managing
debt problems, the Fund's ability to make financial
resources available for use by member countries also
is being eroded by the problem of mounting payment
arrears. Overdue obligations to the Fund have bal-
looned from about $95 million in June 1984 to about
$975 million in June 1986, with $490 million now
overdue by six months or more. This sharp upward
trend probably will continue?countries currently in
arrears have additional payments totaling about $1.2
billion falling due in 1987, which they probably will
be unable to meet.
While there is little immediate threat to IMF re-
sources?uncommitted, usable resources currently
amount to about $30 billion?we foresee increasingly
negative long-term effects on the Fund's financial
position. Fund officials are worried that arrears will
begin to impact on their ability to borrow from official
creditors on similar terms and conditions as in the
past. They are especially concerned because they need
borrowed resources to finance the Fund's Enlarged
Access Policy for debtors who have reached their
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Overdue Financial Obligations to the IMF,
1982-86 a
Million US S
1,000
800
600
400
200
More than
6 months
0-6 months
1982 83 84 85
a Data through June.
86a
310727 1086
borrowing limits under the Fund's regular programs.
Because many LDCs have reached their quota limits,
almost one-third of the Fund's loans to LDCs current-
ly fall under this program.
World Bank: Filling the Gap?
As the IMF's role in managing the debt crisis dimin-
ishes, we believe the World Bank will be increasingly
called on to fill the gap while continuing to meet the
needs of its traditional constituents?the poorer
LDCs.I
Concessional Aid. As part of its traditional role, the
Bank's members have agreed to a $1.5 billion increase
for the Bank's "soft loan" window, the International
Development Association (IDA). As a result, the IDA,
which channels low-interest, long-term loans to the
poorest LDCs will be able to lend $12 billion in the
1987-90 period. About 45 percent of the new funds
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will be reserved for Sub-Saharan Africa; India and
China together will be allocated 30 percent, leaving
25 percent for all other IDA clients.
Cofinancing and Guarantees. As it becomes a more
active participant in the debt strategy, the World
Bank is increasingly participating in commercial loans
and offering guarantees to commercial creditors. In
Chile, for example, the Bank guaranteed one-half of a
$300 million commercial cofinancing project in order
to help Santiago put together an overall package of
almost $6 billion in reschedulings and more than
$1 billion in new money. In the Mexican rescue
package, creditors won a Bank guarantee of $500
million. In addition, the Bank's private-sector financ-
ing arm, the International Finance Corporation, has
launched two programs in the past year that provide
guarantees for equity investments. The Multilateral
Investment Guarantee Agency (MIGA) will insure
investors against noncommercial risks such as war,
political unrest, currency nonconvertibility, and ex-
propriation. A second progam, called Guaranteed
Recovery of Investment Principal (GRIP) will remove
all risk of capital loss, a primary concern among US,
Japanese, and European investors.
Changing Loan Policies
Since their introduction in 1980, structural adjust-
ment loans (SALs) and sector adjustment loans?
loans conditioned on policy or institutional reform?
have become important vehicles for promoting sus-
tainable economic growth in LDCs. In fiscal 1986,'
policy-based loans amounted to $3 billion or 19
percent of the Bank's total lending, up from 12
percent in FY 1985. In Mexico, for example, most of
the Bank's $1.9 billion contribution will be disbursed
as sector loans to support trade liberalization, export
development, and agricultural reform. At present, the
Bank projects its policy-based lending will remain
between 15 and 20 percent of total lending. We
believe this is an attainable goal if, as the IMF
continues to show flexibility in its dealings with
'The World Bank's fiscal year is 1 July to 30 June.
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World Bank Commitments by Lending
Instrument, 1980 and 1986 a
1980
Total = US $11.5 billion
Other assistance b Project lending
36 61
Structural and
sectoral adjustment lending
3
1986
Total = US $16.3 billion
Other assistance b Project lending
36 45
Structural and
sectoral adjustment lending
19
a Fiscal period ends 30 June of the stated year.
b Includes technical assistance, emergency reconstruction, and
sector investment and maintenance.
310726 10.86
debtors, pressure for more fast-disbursing nonproject
loans from the World Bank eases. If the IMF resumes
its role as a tough negotiator, however, debtors may
increasingly turn to the World Bank for help. Brazil
and Colombia, for example, have obtained large
sector loans from the World Bank but have refused to
sign formal agreements with the Fund.
9
Difficulties In Boosting Bank Capital
Even though the Bank has become more visible in the
overall debt strategy, budgetary constraints in mem-
ber countries and political squabbles over voting
power could hamper increased participation. For ex-
ample, the IDA replenishment negotiations were con-
cluded only after months of political maneuvering on
the part of the industrialized countries. Japan offered
its $2.5 billion contribution in exchange for a 1.6-
percent increase in its Bank voting shares. Italy and
the Netherlands also walked away with additional
shares, but the exact size of the increase has not been
worked out. To make these voting shares available,
the United States agreed to release some of its 20
percent?which would have eliminated the US veto
power in the World Bank?in return for Bank agree-
ment to lower the veto threshold to 15 percent. This
amendment, however, must be approved by the US
Congress and the legislatures of other countries. Bank
critics may push for other changes in Bank policy,
while debtor governments, critical of continued US
veto powers, may attempt to block the amendment
altogether.
The political quarrels probably will erupt again when
negotiations for a Bank General Capital Increase
(GCI) get under way. An IBRD study suggests that if
the Bank is to boost its nonconcessional lending to
$16-21.5 billion by 1990, as it projects, the member
countries will have to approve the increase as early as
1987. The existing capital stock can support contin-
ued lending only at about $14 billion per year.
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The size of the GCI will be based on determinations
of the desired future volume of lending, the share of
fast-disbursing loans, repayment terms on future
loans, and exchange rates. For example, an IBRD
study suggests a GCI of $37.5 billion will be needed to
sustain annual lending at $20 billion with 20 percent 25X1
in policy-based loans. Other issues to be resolved
include the amount of money that will actually be
paid in, as opposed to simply committed by member
governments, and the allocation of new voting shares.
With voting shares based on the amount of the
member's capital contribution, LDC voting power
would be diluted; debtors are likely to push hard to
preserve their voting strength.
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Role of the Regional Development Banks
Although the bulk of regional bank lending continues
to be geared to project assistance, these banks may
follow the World Bank's lead and institute policy-
based lending:
The Asian Development Bank (AsDB)
? Loan commitments in FY 1985 totaled $1.9 billion.
? The AsDB has concluded negotiations for a $3.6
billion replenishment.
? The AsDB charter does not allow for policy-based
lending. The Bank, however, will produce an eco-
nomic strategy study for each of the 27 borrowing
countries to try to influence, where necessary, their
economic policies.
? The AsDB 's recently established Private Sector
Division signifies increased Bank emphasis on sup-
porting private-sector development.
The African Development Bank (ADB)
? Loan commitments totaled $1.2 billion in 1985.
? The ADB gives priority to projects that contribute
to regional development and integration.
? The Bank recently initiated policy-based lending
through cofinancing with the World Bank.
? Negotiations for a capital increase are likely to
begin soon.
The Inter-American Development Bank (IDB)
? Loan commitments in FY 1985 totaled $2.1 billion.
? All loans are currently project loans entailing poli-
cy conditions only at the project level.
? The IDB has discussed implementing quick-dis-
bursing sectoral loans, but no decision has been
reached: of the 15 major debtors, 10 are members
of the IDB.
? Negotiations for a $250 billion capital increase are
continuing. The most contentious issue is voting
procedures for loan approvals?the United States is
seeking a 65-percent majority requirement.
Secret
IMF/World Bank Collaboration
The debt crisis has blurred the distinct roles of IMF
and World Bank operations. The Fund is now focus-
ing more and more on medium-term structural adjust-
ment, while the Bank, through its policy-based lend-
ing, is paying increasing attention to macroeconomic
policy issues. To avoid the possibility of imposing
conflicting policy conditions on a country, the Bank
and Fund staffs assist each other in economic analysis
and in the formulation of policy recommendations.
We believe cooperation between the two will continue
to increase as evidenced in the Mexican package. A
major step in coordination was also taken in March,
when the Bank and the Fund agreed to jointly
administer a $3.1 billion structural adjustment facili-
ty to support growth-oriented programs in Sub-
Saharan Africa.
Outlook
Debtor and creditor governments and commercial
banks are increasingly looking to the World Bank as
the new power broker in the debt strategy. We
believe, however, that with more flexibility in its
conditions, longer terms on its loans, resolution of the
arrears problem, and more leadership in developing
innovative fixes for problems, the Fund can continue
to play an important role. It is unclear, however, what
the ultimate role of the Bank in the debt problem will
be. The Bank's ability to participate will depend on
member support for a generous capital increase,
passage of the veto amendment to ensure continued
US support, and strong leadership from new President
Barber Conable. We believe the Bank may also have
to plan for larger increases in structural and sector
adjustment lending if it hopes to convince commercial
banks that it truly intends to act as an agent of
economic reform in LDCs.
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South Korean Textiles:
Industry in Transition
We expect textiles to remain South Korea's major
export over the next few years, but the industry faces
tough challenges from new agreements limiting textile
exports to the United States and Western Europe, and
from low-cost producers such as China. Moreover, the
industry's costs are likely to continue to rise faster
than its productivity because of limited investment in
the new technologies. The inevitable transition of the
textile industry from economic growth leader to de-
clining industry status could cause political problems
for Seoul when this major employer of unskilled labor
cannot continue to absorb large numbers of workers
from Korea's growing population.
Textiles Still Dominate Exports . . .
The textile industry retains its first-place standing
among all South Korean export industries, but its
share of total South Korean exports has fallen-21
percent in 1985 compared with 40 percent in 1971.
The slide began in the 1970s, when South Korea
began to diversify its exports by emphasizing capital-
intensive chemical and heavy industries, and has
continued more recently as Seoul has turned to
knowledge- and technology-intensive manufacturing.
The composition of textile exports has also shifted as
low- to mid-priced apparel and knitted goods?nearly
60 percent of exports in 1985?have displaced fibers
and fabric, textile export mainstays during the early
1960s.
The United States is South Korea's biggest customer,
taking 35 percent of its textile exports last year.
Korean textiles have been particularly attractive to
US consumers because of their low prices. Seoul's
currency policy?the won is loosely tied to the dol-
lar?helps keep Korean producers competitive in the
US market vis-a-vis other major producers in Hong
Kong, China, Taiwan, and Japan. Moreover, the won-
dollar linkage and protectionist barriers in Japan and
Europe have limited expansion of Korean textiles to
non-US markets.
15
Secret
. . . But Are Slipping in Importance
Despite policies designed to diversify the economy
away from light, labor-intensive business lines, and
their decreasing share of exports, textiles remain
South Korea's largest industrial sector. Textile's slice
of overall manufacturing has declined, but at a slower
rate than its share of exports because rapidly rising
incomes have boosted domestic demand. Fibers, fab-
rics, and apparel accounted for about 15 percent of
the value added in manufacturing in 1985, a loss of 3
percentage points since 1976.
Textile production continues to lose its luster as a
source for new jobs?a trend that hits hardest the
young unskilled job seeker. In the past, this labor-
intensive industry has drawn off much of the "youth
bulge" in South Korea's rapidly growing labor force.
As a result, Seoul must rely on rapid growth in newer,
capital- and knowledge-intensive industries, as well as
services activities, to take up the slack. According to
IMF estimates, in the 1970s, when the textile industry
was dominant, 60,000 jobs in manufacturing were
created for every 1-percent increase in manufacturing
output. The same output growth rate now yields just
40,000 new positions, suggesting South Korea must
average 10-percent annual real growth in the manu-
facturing sector to accommodate the 400,000 new
entrants to the job market each year.
Seoul's efforts to encourage the textile industry to
update technology for the improvement of quality and
productivity have had little effect, and economic
technocrats in Seoul are worried about the industry:
? Textile profits are being squeezed by labor costs
that are outpacing improvement in worker produc-
tivity. While not yet at a critical point, the pattern is
similar to the disasterous one in the late 1970s,
before the severe "correction" in wages brought on
by the 1980 economic slowdown and the Chun
government's efforts to wring inflation out of the
economy.
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South Korea: Textile Trade, 1978-85 South Korea: Textile Industry,
1970-85
Percent
Note scale change
Share of Total Exports Share of Value Added to Manufacturing Industry
Percent
40
30
20
10
0 1978 810
20
15
10
5
0 19170 715 810 81 812
85
Composition of Exports, 1985
Total= US $6.3 billion
Other - 5
Carpets and felt 4
Cotton and wool - 7
Synthetic fibers
and fabric - 25
Apparel - 36
Knitted goods - 23
Export Markets, 1985
Other - 35
West Germany - 4
Saudi Arabia - 5
Hong Kong - 6
Employment Trends
Index: 1980 =100
83
814 85
120
Total manufacturing
90 1978 719 80
85
Employee Cost and Productivity
Percent
40
Cost per employee
30
20
United States - 35
10
Gross value
added
Japan - 15 0 1978
310728 10.86
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79
80
84
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? The profit squeeze has dissuaded textile firms from
investing in new technology. Overall, the growth of
the value of textile plant and equipment, adjusted
for inflation, has been trending down, indicating
that leading investors are shying away from textiles.
Although South Korean textile workers have made
solid wage gains and won improved on-the-job safety
standards, they are falling behind their counterparts
in other manufacturing sectors. Textile wages have
risen nearly 8 percent in real terms since 1980
compared with the 9-percent real increase on the
average for manufacturing as a whole:
? A profile of textile workers explains part of the gap.
Many textile workers are women-66 percent com-
pared with 33 percent for nontextile industries?
who often quickly leave the textile work force for
marriage or better jobs. As a result, management
has shown little inclination to offer higher wages or
to invest in better working conditions, particularly
in small garment operations.
? Textile workers are among the least unionized in
South Korea. They make up 26 percent of the
manufacturing work force, but account for only 13
percent of the membership in the mostly govern-
ment-dominated unions.
Hinterlands Hit Hardest
Textile producers have reacted bitterly to the recent
bilateral accord that limits the growth of South
Korea's textile exports to the United States to less
than 1 percent per year until 1989. This restriction
has aggravated political discontent in provincial man-
ufacturing centers such as Teagu and Pusan where
several industries are already in a slump, despite
South Korea's generally booming economy. In Pusan,
for instance, shipbuilding is sagging, and nearby
defense-related industries are operating well below
capacity. Moreover, regions heavily dependent on the
textile industry for jobs tend to harbor smaller firms,
which, as subcontractors for the dominant firms, feel
the pain of falling orders most. Limits on textile
exports could also create trouble for the government
in what it views as a key constituency?the rural
sector?because money sent home by textile workers
is an important supplement to farm income.
17
The Chun government's commitment to an import
liberalization plan that pits foreign goods against
domestically produced products in the local market
also has fueled opposition in provincial industrial
centers, which have benefited from domestic import
restrictions. Antigovernment and anti-US protests in 25X1
Seoul sparked by South Korea's concessions on trade
issues have struck a responsive chord in regional
capitals, and economic problems in these areas could
fuel protests. 25X1
Increased political problems in the provinces could
further irritate a sore spot?the government's failure
to curtail the flight of capital from the provinces to
Seoul where bankers see a better return. The flow is
aggravating an already severe shortage of loanable
funds, thus restricting local development and job
growth.
Seoul's Plan To Bolster the Textile Industry
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To begin to deal with the textile industry's emerging
problems, Seoul has ordered the dissolution of 5
percent of South Korea's fabric companies and has
banned new firms from entering the business. In
addition, Seoul has increased loans to the textile
industry to $15 million in 1986, up from $4 million in
1985. These funds are earmarked for improvement of 25X1
facilities and replacement of aging equipment, rather
than for expansion of production. The loans, which
include a three-year grace period, are not a subsidy to
the textile industry?their 8-percent interest charge is
higher than LIBOR's 6-percent rate and Japan's
5-percent prime rate. 25X1
In our judgment, Seoul's plan will not go far toward
solving problems in the textile industry. The funds
available are a small fraction of what the industry
needs for a complete restructuring. The new plan,
along with tough action to put troubled business
groups on firmer financial footings, however, serves
notice that the textile industry is an increasingly
tempting target for a sweeping reorgnization program
under the government's direction.
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Outlook
The close linkage of the won to the weak dollar and
the underlying competitiveness of the textile indus-
try?primarily its low-wage, highly motivated work
force?will serve as a prop for the industry over the
next year or two. South Korean textile manufacturers
for the near term can continue to live off the fat of the
large increases in exports they have recently enjoyed.
According to press reports, textile factories are run-
ning at 97 percent of capacity, allowing cutbacks
without harming efficiency. While South Korean
textile producers remain among the most cost efficient
in the world, this advantage is quickly eroding?the
challenges from low-cost producers such as China will
increasingly hurt Korean textile sales.
The US and EC agreements that sharply limit South
Korean textile exports to these crucial markets cloud
the longer term outlook. Significant reductions in
exports would create problems for the government.
We believe Seoul needs a healthy textile industry to
act as a crucial employment bridge through the early
1990s to accommodate the youth bulge as it moves
into the ranks of new job entrants. Knowledge- and
technology-intensive jobs cannot pick up all the slack.
If employment in textiles continues to decline, it could
further complicate rural- and provincial-centered de-
velopment plans that the government considers a key
to continued political stability.
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sl Mixed Results in
China's Third-Quarter
Energy Production
Latin American
Debt Policies
Jamaican Pressure
on the IMF
Briefs
Energy
China's electric power sector scored an impressive 9.1-percent increase in produc-
tion through September, and oil production rose 3.1 percent, according to the State
Statistical Bureau; preliminary reporting indicates little or no growth in coal
production. Last year's record additions to thermal power capacity have allowed
China to boost power production?totaling 328 billion kilowatthours through the
third quarter?more than offsetting drought-related losses in hydropower output.
Oil production grew to 2.6 million b/d following the opening of a major new
production area at the Shengli field. Coal production has been stagnant, however,
as Beijing tries to draw down huge stockpiles. Between production and inventories,
China should have sufficient coal both to meet domestic needs and to reach its
1986 export goal of 10 million metric tons?a 30-percent increase over last year.
International Finance
Members of the Latin American Economic System (SELA) called last week for
linking payments on the region's $370 billion foreign debt to export earnings or
GDP growth. Meeting in Peru last Friday, delegates from the 25 member
countries stressed the need for a political solution to the debt problem that
recognized their "right to development," but neither specified a formula for
reducing payments nor committed SELA members to any common course of
action. The primary purpose of the meeting probably was to reinforce the signal
that Latin debtors want debt reschedulings that allow cutbacks in payments if
their economies weaken. Although the communique reflected a tougher debtor
stance, it also reassured creditors that each country will continue to negotiate
individually. We expect that Argentina, Brazil, and Venezuela?among others?
will seek some type of payment limit, similar to that in the Mexican-IMF
agreement. Almost certain resistance from lenders probably would provoke a
stronger restatement of Latin goals at next month's Non-Aligned Movement
conference on debt in Lima.
Prime Minister Seaga probably will use his threat to resign to pressure IMF
officials in current standby negotiations. According to US Embassy reports,
Seaga's recent threat to resign as party leader next month and as Prime Minister
next August and his recent Cabinet shuffle have rallied support within the ruling
party. Although opposition leader Manley stated recently that the government's
last claim to legitimacy is its abilit to ?roduce an IMF ace
?
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Vietnam Fails
To Renegotiate
Debt With IMF
South Korea
Seeking Increased
Regional Trade
LDC Concessions
and the US GSP
Secret
24 October 1986
party, Seaga's threat to resign probably was intended to alarm US and IMF
officials by holding out the specter of Manley's returning to power. The threat,
nonetheless, gives Seaga the appearance of a lameduck whose political position
would be undermined further without an IMF agreement soon.
The IMF has turned down Hanoi's request to restore Vietnam's access to IMF
credits suspended because of its failure to repay overdue financial obligations to
the Fund. Hanoi repaid $1 million of the country's $63 million debt to the IMF in
July
Hanoi also had sought
IMF assistance in obtaining an estimated $200 million in former South Vietnam-
ese assets frozen in US banks, which could be used to repay its overdue debt. Viet-
namese officials plan to return to Washington in January for further negotiations
with the IMF, but we believe there is little prospect that Hanoi will be able to re-
pay enough of its arrearages?some nearly three years overdue?to enable Fund
officials to restore credit access.
International Trade
South Korea recently hosted a negotiating session aimed at expanding preferential
trade arrangements with Southeast Asian LDCs, according to US Embassy
sources. The agenda included reduction of tariff and nontariff barriers and
enlisting new countries to be included in the agreements
Thailand showed interest and Seoul probably will pursue trade
agreements with Indonesia, Malaysia, and the Philippines. South Korea is
searching for export markets outside the United States and Europe, and views the
Pacific region as one of the most promising areas. The sharp appreciation of the
yen against the won has dramatically increased South Korean trade competitive-
ness in Southeast Asian markets?traditionally dominated by Japan?and Seoul
probably feels it can capture a significant part of Japan's export share. Seoul
probably hopes such trade agreements will boost its image in Southeast Asia.
As part of the review of the US Generalized System of Preferences (GSP),
Washington had requested improvements from a number of LDCs on their trade
practices in order to retain duty-free status for their exports. US bilateral
discussions focused on issues such as market access, intellectual property rights
(copyright, trademark, and patent laws), investment, services, steel, and textiles.
While the LDCs were reluctant to make concessions, reports now indicate
substantial gains for the United States. For example, Hong Kong, Malaysia, South
Korea, and Taiwan negotiated bilateral pacts on textile and apparel, while Brazil
negotiated an agreement on steel exports to the United States. Some, such as
South Korea, Thailand, and the Philippines, also made concessions on intellectual
property rights.
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Superfund Sparks
Strong Reaction in
Venezuela and Ecuador
Key LDCs: Issues and Products That Determine
US GSP Eligibility
? Concessions granted
a Concessions
requested but not
granted by LDCs
Market access
g
n
Trademark and
patent
Copyright
Textile and
apparel
T3
,),-.
*g. I
z A
?ct
g

?E
4 U
Subsidies
Taiwan
?
a
?
a
?
South Korea
a
a
?
?
?
,
Hong Kong
?
?
Thailand
?
?
?
Brazil
a
a
*
India
a
?
a
Indonesia
a
?
a
Malaysia
?
?
?
?
Mexico
?
?
Singapore
?
?
Philippines
?
?
a
a
Argentina
a
a
*
Peru
?
?
a
a
a

Ecuador
a
310704 10-86
Global and Regional Developments
The US decision to impose a tax on oil imports to raise revenues for environmental
cleanup?Superfund?has generated alarm in Venezuela and Ecuador that it will
be followed by more protectionism. Venezuelan President Lusinchi claimed that he
had been misled by US statements and press reports that President Reagan would
veto legislation calling for a tax on oil that discriminates against imports. In
Ecuador, Foreign Ministry officials assailed the tax as inconsistent with the free
trade philosophy espoused by the US administration. In both countries, govern-
ment officials acknowledged that the tax will have little impact on their foreign ex-
change earnings, but expressed concern that the tax could open the door for a $5 or
$10 per barrel tax at some future date. The Superfund controversy is likely to in-
tensify Venezuelan efforts to diversify its export markets by investing in refining
and distribution facilities in Western Europe. In addition, Venezuelans are likely
to amplify their charges that Caracas's support for US policy in the Caribbean Ba-
sin goes unrewarded. In Ecuador, the leftist-controlled Congress is likely to add
the US oil levy to its list of criticisms of President Febres-Cordero and his pro-US
stance.
21
Secret
24 October 1986
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Foreign Automotive
Manufacturers Invest
In Taiwan
Taiwan's decision last year to open its auto industry to foreign joint ventures has
attracted considerable interest. Thus far, six Japanese firms, France's Renault and
Peugeot, and one US automaker have set up joint ventures. In addition, one
Japanese and two other US auto manufacturers are eyeing possible deals. We
believe that the Taiwanese auto firms recognize that their products lack the
quality and technical sophistication to compete in the world market. Taiwan
produced only 157,000 vehicles last year but had the capability to produce at least
300,000. We believe that the recent spate of joint ventures will result in the export
of Taiwan-assembled cars, first to Canada and later to the United States?
possibly beginning in 1988.
National Developments
Developed Countries
Secret
24 October 1986
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Japan Rethinks
Rice Price
Supports
Japan's political leaders are seriously considering changes in the rice price support
system that would lead to large reductions in the number of farmers and increase
productivity of the agricultural sector. In a recent Upper House Budget Commit-
tee session, Prime Minister Nakasone blamed price supports for the high price?
currently about six times the world market price?that Japanese consumers pay
for rice
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Nakasone may have been reacting to the reported plans 25X1
of the opposition Japan Socialist and Democratic Socialist Parties to study the
possibility of pushing for reform of the subsidy system to win urban consumers'
support. Nakasone also may be trying to buy time on demands by US rice millers
for market access by proposing a domestic initiative on Japan's agricultural policy.
MITI Encourages
Basic and
Applied R&D
West German
Opposition's
International
Economic Policy
MITI's new industrial restructuring legislation will probably contain a proposal to
encourage business to increase spending for basic and applied research and
development. MITI's new incentives, if passed by the Diet, will become part of the
overall plan to enhance Japan's basic R&D infrastructure seen as critical to
maintaining competitiveness in the future. The proposed funds?including subsi-
dized loans and R&D tax credits?will assist businesses moving into new
technology areas and those established to carry out basic and applied R&D. These
business-oriented incentives will complement Tokyo's recent efforts to promote
basic R&D at government and academic research facilities
West Germany's Social Democrats support Washington's call for more expansion-
ary policies from Bonn?an ironic contrast to the party's usual demand for greater
independence from the United States. SPD economic spokesman Wolfgang Roth
recently stated that a reduction in the US budget deficit?which the SPD
considers a prerequisite for a reduction in the US trade deficit?would damage the
23
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West German Monetary
Expansion Still
Exceeds Target
London Continues
To Resist Full
EMS Membership
world economy unless offset by European and Japanese expansion. Roth urged
that Bonn play a leading role in this effort to demonstrate that West Germany
takes its international responsibility seriously. He also argued that, in any case,
expansionary measures are warranted for purely domestic reasons. Growth,
though respectable in recent years, has been insufficient to reduce unemployment
below the 2 million level. The SPD believes that both interest rate cuts and a reori-
entation of budgetary priorities to emphasize domestic investment are required.
According to another SPD spokesman, interest rate cuts are also necessary to
dampen US protectionist sentiment.
West Germany's Central Bank money stock (CBM)?the key indicator of
monetary policy?exceeded its official target range again in September. CBM
growth so far this year is about 7.4 percent, compared with the 5.5-percent upper
target; and for the year, will almost certainly overshoot the upper limit for the first
time since monetary target ranges were established in 1979. West German
financial officials continue to cite excessive monetary growth as the key factor in
their refusal to cut the discount rate, arguing that a rate cut would increase
liquidity, heighten the potential for inflation, and send the wrong signal to unions
renegotiating wage contracts next year. Although we do not expect the Bundes-
bank to tighten monetary policy to meet this year's targets, the overshooting will
complicate the setting of target ranges for 1987.
The British Government has indicated that it will not become a full member of the
European Monetary System before the next election, despite increased pressure to
join. Prime Minister Thatcher reiterated her opposition to joining the system's
exchange rate mechanism after meeting on 20 October with West German
Bundesbank President Poehl. The West Germans argue that participation would
demonstrate Britain's "European credentials" and will help London stabilize the
pound without raising interest rates. Thatcher also faces pressure within her
government to bring sterling into the EMS: Chancellor of the Exchequer Lawson,
Foreign Secretary Howe, and Bank of England Governor Leigh-Pemberton have
all expressed support for joining. The Labor Party also recently dropped its
opposition to membership provided the EC members undertake expansionary
economic policies?a condition Bonn opposes. Thatcher remains opposed, however,
because she prefers to keep monetary policy independent of West German actions
and is concerned that membership would not eliminate the need to raise interest
rates if the pound comes under pressure.
Secret
24 October 1986
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Norway's Labor
Government
Submits Budget
New Israeli
Economic Measures
Brazil's Fiscal Policy
Fueling Inflationary
Expectations
The minority Labor government will probably compromise enough on the 1987
budget to prevent the opposition from uniting and bringing down the government.
Despite the decline in energy tax revenues?from $5.3 billion in 1985 to below $3
billion in 1986 and even less in 1987?Labor wants to increase total spending by
10 percent to about $33 billion. Labor also is asking for 3-percent real growth in
defense spending?down from the 3.5 percent the previous Conservative-led
government had planned?but use of an unrealistic inflation assumption makes it
likely that more funds will have to be appropriated. The budget includes a variety
of tax hikes designed to raise revenue and dampen consumer spending in an effort
to control accelerating inflation and contain the current account deficit. Oslo also
wants a controversial progressive tax on gross income to finance social security. To
avert a concerted opposition attack on the government in the fall, Labor has sought
to accommodate the Center and Christian People's parties' support of increased
spending for social programs and rural areas, and has hinted it will compromise on
the progressive tax proposal. Labor's apparent flexibility and the inability of the
opposition parties to formulate an alternative budget will probably give the
government a breathing spell. The opposition may prefer to let a budget pass in the
hope that low oil prices will continue to disrupt the economy and further discredit
Prime Minister Brundtland's leadership.
Israeli officials have decided to clamp down on private borrowing to curb a surge
in consumer credit and spending. The Bank of Israel intends to raise the interest
rate on short-term loans by 4 percentage points over the next year, according to
press reports. The US Embassy reports that the government also is moving to
reform the capital market by making it easier for private companies to borrow
much-needed investment funds. These measures will provide an early test of
incoming Prime Minister Shamir's commitment to the economic programs
inaugurated during Peres's tenure as Prime Minister. Shamir probably will try to
continue the coalition government's economic stabilization program. Shamir
realizes that Peres's policies were responsible for slashing inflation to an annual
rate of about 20 percent, as compared with triple-digit inflation during the early
1980s when Likud last directed the economy. Easy credit has helped to spark the
recent boom in private consumption?an expansion that runs counter to the
government's attempt to contain imports and inflation.
Less Developed Countries
Swelling inflationary pressures are undermining the success of the Cruzado Plan.
In contrast to Brazilia's rosy projections early this year that its deficit would drop
to only 0.5 percent of GDP in 1986, it may exceed last
year's 4.3 percent. Although tax collections are up, overall government revenues
have not risen as much as hoped, largely because the Cruzado Plan's price freeze
has prevented parastatals, particularly public utilities, from implementing much-
needed rate hikes. Meanwhile, expenditures are rising, as the Sarney government
boosts spending on social welfare projections and transfer payments. Subsidy
payments also are up because of a bumper wheat harvest and the recent milk
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1--New Mexican
Wage Hike
Tanzanian
Foot-Dragging on
Economic Reform
t Philippine Financial
Rescue Package
Moves Forward
Secret
24 October 1986
subsidy, according to the US Embassy. Businessmen cite government reluctance to
curb spending as a major cause of their expectations that inflation will rise next
year, according to Embassy and press reporting. To restore private-sector confi-
dence, the government will need to move quickly after the Congressional election
next month to reduce the deficit. Brasilia is
considering an administrative reform package?including personnel reductions
and privatization of some state-owned enterprises. Based on past experience,
however, we believe reform efforts will be gradual, and that Brasilia will continue
to concentrate on raising revenues rather than decreasing expenditures.
A government commission has announced an unprecedented third hike in mini-
mum wages for this year, raising the cumulative wage increase to nearly 100
percent. Mexico's largest trade union is backing legislation that calls for even more
frequent wage increases. If it passes as expected, workers, employers, and
government representatives could negotiate minimum wage hikes as often as once
each month. Although real wages will fall again this year, the de la Madrid
government probably hopes the promise of more frequent wage boosts next year
will keep labor leaders in line. Monthly wage increases would exacerbate inflation,
already expected to double to at least 115 percent this year. This would increase
the prospect of wage and price freezes next year, although officials appear
reluctant to try to implement measures similar to those in Argentina and Brazil. In
any event, Mexico City is likely to postpone implementation of controls at least un-
til the next scheduled negotiation of wage increases in January.
President Mwinyi's failure to follow through on promised reforms is beginning to
erode support for his year-old leadership. The government has still not implement-
ed an IMF-recommended economic recovery plan, and
the much-publicized anticorruption campaign has stalled despite
evidence against many officials. Earlier this month university students boycotted
classes to protest corruption and the government's economic bungling. Mwinyi's
inactivity probably reflects in part continuing opposition of the party chairman and
former President Nyerere, who rejects the IMF reform program and sees the
anticorruption campaign as a vendetta against his followers. The economically
hard-pressed government, however, can ill afford to allow this impasse to
jeopardize the hard-won IMF agreement and accompanying bilateral aid pledges.
Mwinyi's indecision may also cost him the loyalty of senior ministers and
intelligence and military personnel who have investigated government corruption.
IMF approval of a $500 million balance-of-payments loan for the Philippines?
expected today?will pave the way for a $10-billion financial rescue package.
According to US Embassy reporting, the IMF's program is designed to generate
economic growth of 6 percent annually over the next four years, in part by
permitting the government to stimulate the economy with public spending this
year. Manila, in turn, pledges to make economic reforms that will reduce adverse
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Bankers Expect
Malaysia To
Devalue Currency
. Indonesian Concerns
About Stability
government intervention in the economy and establish a more competitive and
export-oriented business environment. The Fund's approval will trigger a $300
million World Bank loan, $350 million in new credits from foreign banks, and lead
to rescheduling nearly $8 billion in payments due over the next five years on
Manila's $26 billion foreign debt. In addition, according to US Embassy reporting,
Manila has requested that the IMF and foreign banks consider up to $1 billion in
contingency financing if import costs rise or exports slump unexpectedly. Despite
lower interest rates, stable prices, and relatively abundant foreign exchange,
Manila's economic team is almost certainly worried that the economy will fall
short of the 1.5-percent growth target this year. Moreover, lagging government
spending may hold growth to only 4 percent next year. Manila is counting on a re-
surgence in private investor confidence next year to sustain the economy's
recovery, however. To help achieve this goal, Manila reportedly is seeking over
$400 million in US economic assistance, up to $840 million from Japan, and a to-
tal of nearly $100 million from West Germany, Canada, Australia, and the EC to
finance investments as well as demonstrate confidence in the Aquino government.
Malaysia will devalue its
currency by 10-to-25 percent during the next few months because pressure on the
ringgit is forcing Kuala Lumpur to intervene almost daily to stabilize the currency.
the ringgit's drop is a result of the economy's sharp de-
cline?real GDP, which fell by 1 percent in 1985, will show little or no
improvement in 1986. A devaluation of this magnitude would probably relieve 25X1
pressure on the ringgit and reduce capital flight, which some international banks
estimate exceeds $2 billion annually and is increasing. It would also probably
forestall a rescheduling of Malaysia's more than $20 billion external debt, which
we believe is increasingly likely in the next two years unless the economy rebounds
sharply. Nonetheless, devaluation will not help commodity exports?which ac-
count for over 60 percent of total exports?unless demand abroad strengthens.
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Jakarta, increasingly concerned that Indonesia's deteriorating economy will lead
to unrest, is showing little finesse in restoring public confidence or in handling
criticism of its economic policies. The government last week closed the second-
largest newspaper and warned several others that speculative and critical economic
reporting threatened national stability.
Furthermore, the US Embassy reports
that there was little economic rationale behind last month's 31-percent devalua-
tion. Advocates of the devaluation apparently believed that its longer term benefits
would enable the government to enter the 1987 elections on an economic upswing
but underestimated the adverse near-term impact on inflation and unemployment.
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Sino-Soviet
S&T Cooperation
L, Efforts To Slow
Chinese Economy
Taking Effect
China Announces
New Foreign
Investment Incentives
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24 October 1986
Communist
Representatives of the Soviet and Chinese State Committees for Science and
Technology last week signed a protocol specifying fields for S&T cooperation
under a general agreement signed in December 1984. Scientists from the two
countries will reportedly work together on agriculture, fisheries, meteorology,
nonferrous metallurgy, petrochemicals, machine building, oil and natural gas, and
railways. The protocol made no mention of joint research in two areas proposed by
the Soviets earlier this year?space sciences and seismology?indicating Chinese
rejection. The protocol is one of a growing number of bilateral technical
cooperation agreements. Last June, for example, the Chinese and Soviet Acade-
mies of Science agreed to undertake joint research; a year earlier, Beijing and
Moscow signed an accord on industrial technological cooperation. Nonetheless, the
countries have had difficulty reaching agreement on areas for cooperation, and we
believe Beijing remains wary of Soviet assistance as well as skeptical about its
value?given China's access to generally more advanced Western scientific
research and industrial technology.
Industrial output increased at about a 6-percent annual rate through September,
reflecting Beijing's continued success in moderating growth after an excessive
18-percent jump last year. Figures released recently by the State Statistical
Bureau show that the slowdown has been at the expense of consumer durables; the
output of industrial and construction materials, such as steel and concrete, has
changed little. The new data also show inflation running at about 5 percent this
year, down from 9 percent in 1985. Last year, domestic opponents sharply
criticized China's reform leaders for allowing overly rapid growth that strained
energy supplies and transportation, and lowered production efficiency and quality.
Beijing reacted by restricting credit and ordering a slowdown in capital construc-
tion?up only 10 percent so far this year, as compared with a 40-percent increase
in the first nine months of 1985. More stable economic performance is one of the
main reasons reformers have been able to implement new economic experiments
this year and?if inflation continues to slow?Beijing may proceed with price
reforms that were put on hold a year ago.
Last week, Beijing announced long-promised incentives for joint ventures, aimed
at reversing a 20-percent decline in overseas investment commitments during the
first half of this year. The new guidelines apply primarily to enterprises that
produce mainly for export or that introduce advanced technology. Special
preferences include tax reductions, lower and more uniform rents, exemption from
import license requirements for essential inputs, and some exemptions from state
wage subsidies. The guidelines also reaffirm Beijing's commitment to management
reform, guaranteeing the enterprises autonomy over production, wages, bonuses,
and personnel?including the hiring and firing of workers and senior management.
The new guidelines, however, offer little relief on repatriating foreign exchange,
one of the key concerns for foreign investors. While most foreign investors will
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Vietnam
Planning for
Oil Exports
adopt a wait-and-see attitude toward the new regulations, according to the US
Embassy, these measures are a step in the right direction to improve the
deteriorating investment climate. The high-level attention afforded these changes,
moreover, suggests significant pressure will be applied at the grassroots level to
encourage successful implementation.
Hanoi is apparently confident that Vietnam will soon produce commercial
quantities of petroleum.
Although we cannot yet confirm whether Vietnam will be able to produce the
projected volume of crude oil, US firms discovered oil offshore South Vietnam in
1974, and since 1981 the Soviet Union has been helping Vietnam with exploration
and drilling in the same area.
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