INTERNATIONAL ECONOMIC & ENERGY WEEKLY

• Document Type: CREST
• Collection: General CIA Records
• Document Number (FOIA) /ESDN (CREST): CIA-RDP97-00770R000201430001-3
• Release Decision: RIPPUB
• Original Classification: S
• Document Page Count: 42
• Document Creation Date: December 27, 2016
• Document Release Date: June 6, 2012
• Sequence Number: 1
• Publication Date: December 4, 1987
• Content Type: REPORT

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Directorate of SeeFet
Intelligence
Seeret-
DI /EEW 87-048
4 December 1987
Copy 682
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International
Economic & Energy
Weekly
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OFMI CL
International
Economic & Energy Weekly
iii Synopsis
Perspective-West European Trade Outlook: Rethinking Policies
~-URA
3 West European Trade, Outlook: EC Motivations in the GATT Round
EURA
7 USSR: Holding Fast to the 12th Five-Year Plan
SOVA
OEA
15 Japan: NTT Operating in a New Environment
OGI
19 Peru: Dwindling Oil Surplus
IALA
23 International Financial Situation: Update on LDC Debt
DI Analysts
27 Briefs Energy
International Finance
Global and Regional Developments
National Developments
Comments and queries regarding this publication are welcome. They may be
directed to Directorate of Intelligence,
Secret
DI IEEW 87-048
4 December 1987
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International
Economic & Energy Weekly
Synopsis
We believe Western Europe's international trade performance will deteriorate
significantly during the next two to three years, impacting negatively on prospects
for economic growth, relations with trade partners, and the EC's negotiating
flexibility at the GATT Round. We believe the EC, over the next several years,
will attempt to move ahead on internal and external trade liberalization-but if
either fails, the EC will increasingly turn to protectionist policies.
Although the EC and the United States share a desire for enhanced competitive-
ness, the pace of the Uruguay Round trade negotiations in the coming year will be
increasingly slowed by sharp EC-US differences over negotiating strategies, the
Community's political need to match its GATT concessions with its own internal
market reform schedule, and competing member aims versus overall EC policy
objectives.
The Soviet economy, after a surge in 1986, this year has fallen well short of
Mikhail Gorbachev's ambitious goals of accelerating economic growth while-at
the same time-modernizing the USSR's industrial plant and equipment. Unless
some adjustments are made to give the economy time to adjust to the wide-ranging
changes being implemented, Gorbachev's efforts to simultaneously modernize the
economy and step up the rate of economic growth are likely to continue to
1 Perspective-West European Trade Outlook: Rethinking Policies
3 West European Trade Outlook: EC Motivations in the GATT Round
7 USSR: Holding Fast to the 12th Five-Year Plan
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Tokyo's gradual selloff of 10.4 million shares of NTT stock by 1989 is providing
substantial short-term gains to the government, which is using the revenues from
the privatization of the world's largest telecommunications firm to help stimulate
domestic demand and retire government debt. We believe longer term risks-
particularly increased volatility on the Tokyo stock market-may, however,
15 Japan: NTT Operating in a New Environment
NTT is responding to the end of its monopoly and privatization by making a major
effort to integrate information services and to explore such diverse ventures as
computer security and car rentals. Nevertheless, NTT's newfound requirement to
carefully protect its bottom line has not led it to procure equipment from abroad.
iii Secret
DI IEEW 87-048
4 December 1987
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.~cu VI
Lima's failure to adopt a comprehensive petroleum policy has led to steadily
falling oil production and exports, which is contributing to serious foreign
payments problems. Unless President Garcia takes the politically difficult steps
necessary to encourage foreign investment in the oil and gas sector, Peru could be-
come a net oil importer by 1989.
equity swaps.
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International
Economic & Energy Weekly
Perspective West European Trade Outlook: Rethinking Policies
for the EC as a leader in the free-world economy.
We believe Western Europe's international trade performance will deteriorate
significantly during the next two to three years, impacting negatively on prospects
for economic growth, relations with trade partners, and the EC's negotiating
flexibility at the GATT Round. Community trade policies will continue to be
driven by strong European currencies, high unemployment, and the relatively slow
start EC members have made at structural adjustment. The Community's real net
exports have been declining steadily since the second quarter of 1985, and in 1988
are expected to fall by a further $55 billion (in 1980 prices), roughly equal to 1 per-
cent of real GDP, helping to whittle down real economic growth to about 2
percent. This, plus a heavy dependence on imports of Japanese technologies and re-
lated investment, will probably lead EC officials toward new protectionist policies
and the negotiation of more market-sharing arrangements. The result probably
will be additional constraints on economic growth and a further tarnished image
assembly factories, and this will further reduce the EC's competitiveness.
Defensive responses will almost certainly focus on creation of additional bilateral
protectionism targeted at Japan. EC officials have concluded that Japan's export
offensive during 1986-87 against the EC, concentrated in motor vehicles and parts
and in several key high technology commodities, is overpowering existing protec-
tionist policies. Consequently, we expect that the Community's rising dependence 25X1
on Japan will lead to stiffer EC policies on imports and on Japanese investment in
We believe EC-US trade relations also will become more difficult. Disagreements
over specific commodity issues-agricultural products, aircraft, and telecommuni-
cations-and market-sharing arrangements (a euphemism for cartels) will domi-
nate the relationship. Most EC-US trade disputes probably will continue to be
intense because weaknesses in GATT's dispute settlement procedures leave both
sides with no effective alternative to bilateral confrontations. In response to US
leadership, however, Community expectations and preparations for the Uruguay
Round have escalated considerably during recent months. While the EC will be
forced to begin negotiating in 1988, it will try to delay early agreements and may
be tempted to await the arrival of the new US administration in 1989 before
beginning to negotiate in earnest. The primary short-term risk is that, if the
United States eventually adopts what the West Europeans perceive as a watered-
down but still protectionist trade law, the EC will most certainly fulfill its promise
to retaliate in kind and, in doing so, possibly stall the Uruguay Round negotiations.
EC trade-related conflicts with the LDCs probably will grow significantly, limiting
export income in the indebted countries and prolonging resolution of the global
debt crisis. These countries' shares of EC trade have declined rapidly during the
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1980s, and we believe further reductions are probable. In particular, we expect EC
imports from these countries to be weak because they compete with EC producers
in some commodities such as steel, and LDCs do not produce the higher quality
manufactured goods preferred in the EC. On the export side, lagging Community
product competitiveness in developed-country markets is likely to cause the EC to
develop further its trade with the Third World. In the GATT Round, the EC will
be extremely reluctant to grant any concessions to the LDCs without obtaining
reciprocal benefits.
We believe, however, that the EC's international competitiveness, relative to that
of the United States and Japan, will improve significantly over the long term as the
result of EC market liberalization. The EC's GATT policies will depend in large
part on its success in creating an internal market-involving eventual elimination
of nearly all remaining internal EC nontariff barriers to trade. Although the EC is
falling behind its goal for completion by 1992, we believe the Community will
continue to make measurable progress. As EC firms become more efficient in
order to compete within the EC, the Community will find it easier to make
concessions in the Uruguay Round.
The primary long-term risk to the Community's economic and trade outlook is the
possible loss of the political initiative to liberalize trade. This risk may be
minimized somewhat because, barring an unexpected recession during 1988-89,
global trade imbalances should gradually diminish and stabilize as a result of
improved policy coordination among major countries. In addition, the recent stock
market crash has convinced nearly all EC members that more effective structural
adjustment policies are needed to facilitate the transition to reduced global
external imbalances. Nevertheless, we believe a surge in EC protectionist policies
cannot be ruled out if either internal market reform or the GATT Round becomes
bogged down.
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West European Trade Outlook:
EC Motivations in the GATT Round'
dangering the GATT Round itself.
Although the EC and the United States share a desire
for enhanced competitiveness, the pace of the Uru-
guay Round trade negotiations in the coming year will
be increasingly slowed by sharp EC-US differences
over negotiating strategies, the Community's political
need to match its GATT concessions with its own
internal market-reform schedule, and competing
member aims versus overall EC policy objectives.
Agriculture, for which EC protectionist sentiments
run high, poses the greatest challenge for US negotia-
tors, although such issues as emergency import re-
straints, services, and dispute settlement also will
prove difficult. The EC almost certainly will continue
to press for market-sharing arrangements as an inter-
im solution to freer markets and will retaliate strongly
if the United States adopts what the EC perceives as a
weaker but still protectionist trade law, possibly en- .
West European leaders are committed at the Uruguay
Round to increasing the role of market mechanisms in
their domestic and international markets. They view
favorably the United States' initiative at the OECD to
promote structural adjustment, having embarked on a
program of deregulation and denationalization in
their own markets. Moreover, the effects of the recent
global stock market crash have heightened all OECD
countries' awareness of the need for additional, coor-
dinated structural adjustment policies. Although the
EC and nearly all other major GATT members want
to extend market liberalization internationally in or-
der to improve their own competitive positions and
increase their access to other markets, there is no
agreement yet on common goals for GATT reform.
' This is the first in a series of articles that will assess the West
European trade outlook. Other articles will cover the impact of
exchange rate changes and trade relations with the United States,
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The Community's strong commitment to the Uruguay
Round will not preclude the EC from working hard to
prevent the United States from dominating the nego-
tiations. While the EC has reacted positively to US
leadership by accelerating its participation and will be
forced to begin negotiating in 1988, it may want to
delay committing to the United States on difficult
issues as it awaits the arrival of the new US adminis-
tration in 1989. In addition, the EC is likely to adjust
its negotiating strategy to the progress made on
contentious bilateral trade relations, particularly with
Japan, the United States, and the LDCs. The pace
also will be affected by the Community's linkage of its
own internal market reforms-scheduled to be com-
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progress on all issues to achieve a balance of conces-
sions.
The Community opposes the US desire to single out
selected items now for a midterm agreement, before
substantive negotiations have progressed further. It
views the US attempts as premature, divisive, and
likely to delay substantive work. In particular, the EC
has been skeptical that sufficient progress can be
made on this Round's new issues-services, intellectu-
al property rights, and trade-related investment mea-
sures-to allow their inclusion in a midterm agree-
ment.
The expected deterioration of the EC's trade perfor-
mance during 1988 probably will limit the Communi-
ty's GATT negotiating flexibility. However, we be-
lieve the market-oriented negotiating agendas of the
15 primary GATT negotiating groups will facilitate
some interim agreements by the end of 1988, assum-
ing substantive negotiations are well under way. The
Community has viewed favorably work of the Func-
tioning of the GATT System (FOGS) Committee and
probably would support a midterm agreement incor-
porating some of the Committee's proposals along
with interim results on several other areas
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Domestic political priorities, institutional biases, and
a sense of lagging the United States and Japan
competitively will shape EC concessions on several
issues of US concern. Consistent with its bilateral
trade strategies, the EC is seeking to improve its
access to foreign markets through negotiated market-
sharing arrangements or cartels. Accordingly, we
expect the EC to continue to press its pre-Uruguay
Round arguments for expanded imports of EC goods
by Japan, the NICs, and CEMA.
FOGS. Although the EC would be willing to select
some of the FOGS Committee's proposals for an
interim agreement, the Community would prefer,
because of globality, that most of the work be per-
formed at the end of the Round. It has been most
interested in the issue of improvements in the linkages
between international trade and monetary policies, an
area that will require lengthy negotiations. Also, the
Commission, at least, would like to limit the participa-
tion of trade ministers-except occasionally to give
the negotiations direction-in order to minimize polit-
icization. While the EC is willing to consider enhanc-
ing the existing trade policy surveillance system, it
does not want to strengthen the legal clout of that
system.
Agriculture. The EC is committed to negotiating
major agricultural reforms, but is likely to obstruct
these discussions occasionally and probably would
never accept the full opening of its protected domestic
market. As an opening gambit, the EC has proposed
market-sharing arrangements to cut world grain sur-
pluses and gradual reductions in farm subsidies on an
unspecified timetable, while proposing, counter to
GATT's standstill and rollback provisions, an end to
duty-free entry into the EC of feed ingredients.
Serious disagreements among the member states will
hamper the EC's negotiating ability, although pres-
sures to reform agriculture and address the EC's
budget crisis will keep the Community at the negoti-
ating table:
? France supports major subsidy cuts, as does the
United Kingdom, but will almost certainly drag its
feet on the issue until after the French presidential
election next spring.
? Bonn, dependent on the farm vote, is even more
reluctant to cut subsidies, preferring production
quotas instead.
Meanwhile, the West Europeans doubt that even the
United States can deliver on its proposed worldwide
10-year phaseout of all agricultural subsidies because
of likely domestic political backlash. Consequently,
the EC has concentrated its initial efforts on garner-
ing credit for the limited Common Agricultural Policy
reform and other structural adjustment measures
already adopted as well as for its substantive contribu-
tions to other negotiating areas of the GATT Round.
Safeguards. The Community's support for import
restraints has intensified over the past year primarily
because of EC fears about growing reliance on key
Japanese high-technology products and investment.
The EC wants to protect its struggling industries from
external competition while it implements structural
adjustment programs to help those industries become
more competitive. Accordingly, the EC-which is
isolated on this issue-places high priority on con-
cluding an agreement that allows selective application
of those safeguards so that its negotiating leverage
with Japan is enhanced.
Services. The Community is seeking to advance its
competitiveness with respect to the United States and
Japan in the high-technology services industry, partic-
ularly in banking and insurance. The EC will continue
to push for a binding agreement on services, but its
negotiating positions are likely to be somewhat con-
fused because of internal EC disagreements over
negotiating tactics and the reluctance of key EC
members-especially France-to allow the less com-
petent Commission to negotiate for them in this area.
While France and the United Kingdom probably will
press the Commission for including services in a
midterm agreement, the Commission is likely to move
more slowly because of other member-country con-
cerns about pacing EC-internal structural adjust-
ments with GATT reforms.
Intellectual Property Rights. The EC believes the
problem of inadequate procedures and remedies in
this area should be addressed as a priority matter
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West Germany have been disinterested.
while avoiding solutions that create barriers to legiti-
mate trade. On the basis of its past efforts to block
imports of counterfeit goods, the Community has
proposed that the combating of counterfeiting and
other forms of piracy be made the initial focus of
negotiations. Consistent with its globality concept, the
EC has been emphasizing the importance of bringing
developing countries-especially the NICs-into the
negotiations. Internal EC disagreements are reflected
by France's pushing the EC to take a broader and
more dynamic role in the negotiations, while Italy and
Trade-Related Investment Measures (TRIMS). The
EC has been moving slowly on TRIMS-such as local
content requirements-because of internal disagree-
ments concerning TRIMS' effects on LDCs and their
debts. The French are supporting a broad mandate for
TRIMS negotiations with the hope that the results of
GATT negotiations can be used to encourage more
comprehensive talks on investment later on. In con-
trast, the United Kingdom and West Germany have
been moving slowly on TRIMS because of their
fear-not shared by France-that the discourage-
ment of export performance requirements may reduce
the LDC debtors' debt-servicing capabilities. In addi-
tion, the United Kingdom is reluctant to give the
Commission much negotiating authority on TRIMS.
than adjudication.
Dispute Settlement. The Community will maneuver
to maintain its options under any new dispute settle-
ment procedure, an area of major weakness under
current GATT rules. Consequently, although the EC
nominally is open to improving the GATT's settle-
ment mechanism, it continues to believe that those
procedures must rely primarily on negotiation rather
Other Issues. EC positions in the other GATT com-
mittees probably will be guided by the trade-offs the
Community feels it must make to reach a balance of
concessions. For example, the EC will press the LDCs
for greater trade liberalization in exchange for such
possible GATT agreements as stronger GATT rules
against agricultural subsidies, a non-country-specific
safeguards code, or tightened dispute settlement rules.
In addition, Japanese trade barriers probably will
become a more contentious issue at the negotiations
during 1988 as the Community presses Japan for
market access benefits that will balance whatever
concessions are offered by.the EC.
Although the EC may slow the pace of GATT talks at
various times to achieve a Community consensus, it
will remain committed to concluding a comprehensive
trade agreement. The pace probably will slow as
issues become more sharply defined and as the US
agenda comes into conflict with the EC's requirement
for internal consensus. The adoption of a US trade
law, perceived by the West Europeans as weaker but
still protectionist, would most certainly result in EC
retaliation, possibly precipitating a major rupture of
the Uruguay Round. EC Trade and External Rela-
tions Commissioner De Clercq has already informed
US officials that many measures in the proposed
trade bill are not acceptable to the Community.
A failure of the Round to adopt the EC's desired
market-sharing arrangements would probably cause
the EC to assume an even more defensive posture. An
economic recession in major countries during 1988-
89, more of a possibility as a result of the recent
turmoil in financial markets, probably would cause
the Community to pull back from negotiations as
members seek to protect their own markets. Any
major unexpected delay in the planned completion in
1992 of the EC's internal market would cause the
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Community to delay its approval of GATT reforms 25X1
under which it believed it could not yet be competi-
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USSR: Holding Fast to the
12th Five-Year Plan
are likely to continue to undermine each other.
The Soviet economy, after a surge in 1986, this year
has fallen well short of Mikhail Gorbachev's ambi-
tious goals of accelerating economic growth while-at
the same time-modernizing the USSR's industrial
plant and equipment. Although not without its bright
spots, the economy is sputtering again this year as the
leadership struggles to implement seemingly contra-
dictory economic programs. Still, the Kremlin has not
backed off the high targets for 1986-90. Unless some
adjustments are made to give the economy time to
adjust to the wide-ranging changes being implement-
ed, Gorbachev's efforts to simultaneously modernize
the economy and step up the rate of economic growth
technological advances.
The performance of the economy during the first two
years of the current five-year planning period general-
ly has fallen short of leadership goals. Nonetheless,
information on the 1988 economic plan indicates that
1986-90 plan targets have not.been lowered. The plan
for next year implies, for example, that GNP and
industrial output are to rise by 4 percent and 4.5
percent, respectively, over this year's plan targets-in
line with the 1986-90 goals but roughly double the
average annual rates of growth posted so far. In
addition, some new, even more ambitious, tasks have
been added. The leadership, for example, has raised
markedly goals for productivity gains and resource
conservation. Meanwhile, enterprise managers are
being directed to increase the use of second and third
shifts at their plants and to place greater emphasis on
Consumer Spending. A major feature of the 1988
plan is the increased emphasis given to the consumer.
The 12th Five-Year Plan already contained impres-
sive targets for improving the lot of the consumer. For
example, output of nonfood consumer goods was to
increase by 35 percent by 1990 and services by 50
percent. During the past two years the authorities
have raised the original goals for housing construc-
tion, and in 1987 the original target for production of
consumer durables was raised. Still, for the most part,
planned targets have not been met and the leader-
ship's actions thus far could be characterized as
looking for inexpensive ways to improve the consu-
mer's lot.
To judge from Gosplan Chairman Talyzin's recent
speech on the 1988 plan, this "on the cheap" approach
to meeting consumer needs may have changed:
productive sphere have been increased over that
originally called for in the 1986-90 plan. Housing
construction, in particular, is to be stepped up and
investment going to other consumer-oriented facili-
ties such as preschools, retirement homes, clubs, and
theaters is to be raised as well.
? Targets for the production of food, clothing and
textiles, and consumer services (including personal
care and repair, personal transportation, and recre-
ational services) have also been raised.
Investment. Meanwhile, the regime's investment poli-
cy seems to be largely on track. The 1988 plan calls
for new fixed investment to increase by 3.6 percent.
Although somewhat lower than the approximately
5-percent annual rate of increase planned for 1986-
90, this target is not unreasonable, given the larger-
than-average increases in new fixed investment in
1986 and apparently 1987 as well.
Nevertheless, the plan appears to put inordinate em-
phasis on a combination of large improvements in the
quality of fixed capital and the efficiency with which
it is used. The plan implies a sharp reduction in the
USSR's incremental capital-output ratio (ICOR)-
the increase in productive fixed capital required per
unit of growth in Soviet national income. The ICOR
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USSR: Selected Economic Plans and Performance Indicators, 1981-90
1986-90 a b
1986
1987 c
1988 b
Gross national product
1.9
3.9
3.8
1.0 to 1.5
4
Industry
1.9
4.6
3.1
2.0 to 2.5
4.5
Civilian machinery
3.5
7.4 d
4.9
1.0 to 1.5
7.1 d
Agriculture e
2.1
3.3
7.3
- 1.0 to 0
3.4
Transportation
2.3
2.3
3.9
NA
a Average annual growth.
b Planned growth based on gross value of output.
Estimate based on nine months of data.
d Soviet plan believed to include both civilian and military
production.
e Net of feed, seed, and waste; includes purchases from outside the
sector.
implied for 1986-90 is much lower than any ratio
since the 1960s. This may well be a major flaw in the
1986-90 plan because, we believe, the collection of
actions taken to improve the quality of investment or
management will not have a large impact during this
period.
Defense. The published version of the 1988 plan and
budget contain almost no information about defense.
As usual, the only data provided is the single line
entry for defense in the state budget. This figure is the
same for 1988 as in the previous year. We believe the
budget number is manipulated for propaganda pur-
poses-by Moscow's own admission, it covers only a
fraction of total defense spending. Nonetheless, given
the regime's investment and consumption goals, un-
less economic growth in 1988 exceeds this year's
lagging pace there will be little room for real growth
in defense spending.
Implications
Gorbachev may perceive pressing reasons to adhere to
his original output targets. Politically, the General
Secretary may feel that he is unable to impose plan
reductions, given his close association with the 1986-
90 plan. At the beginning of the planning period, for
example, he remanded the five-year plan to Gosplan
for revision before the 27th Party Congress, rejecting
at least three drafts as underambitious. More conser-
vative Soviet leaders-Ligachev, for example-have
warned of the perils of undue haste in implementing
Gorbachev's programs, and Gorbachev may be con-
cerned that any retreat from his rapid growth policy
might be perceived as an admission that his goals are
not attainable.
On economic grounds, as well, Gorbachev may believe
that retreat from his original growth targets is inad-
visable. Gorbachev realizes that his program for
revitalizating the economy depends heavily on the
support of workers. Initially, the regime relied on the
discipline and antialcohol campaigns to raise worker
productivity. Speaking at the June plenum, Gorba-
chev said that the momentum from these programs
has been lost. The increased attention being given to
the consumer in the 1988 plan seems to be aimed at
eliciting the kind of motivated work the regime is
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program.
counting on as a key element of renewal. In addition,
by trying to increase supplies of consumer goods, the
Kremlin probably hopes to soak up the excess pur-
chasing power in consumer hands brought about by
the reduced availability of alcoholic beverages and to
quiet public discontent over other aspects of his
targets.
Whatever Gorbachev's motives, the limited data re-
leased on the 1988 plan strongly suggest that he
intends to proceed full bore with the ambitious targets
for growth during the current five-year planning
period. In our judgment, the consequences of this
decision are likely to include a continuation of the
sputtering growth and quality control problems that
have plagued the economy in 1987. Growth is likely to
fall short of the General Secretary's plans and Gorba-
chev's modernization program-the cornerstone of his
policies for improving the performance of the Soviet
economy-is going to be delayed and could even fail,
unless there is some slackening of the 1986-90 plan
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Japan: Fiscal Bonanza
From NTT Stock Sale
NTT sale but may be affected by the risks.
Tokyo's gradual selloff of 10.4 million shares of NTT
stock by 1989 is providing substantial. short-term
gains to the government, which is using the revenues
from the privatization of the world's largest telecom-
munications firm to help stimulate domestic demand
and retire government debt. We believe longer term
risks-particularly increased volatility on the Tokyo
stock market-may, however, overshadow current
benefits. Foreign investors, whose participation in the
sale is severely limited, will benefit little from the
Benefits From the Sale
The Japanese Government's recent sale of 1.95 mil-
lion shares, which represents the second of a planned
eight-part selloff of two-thirds-or 10.4 million
shares-of Tokyo's ownership of NTT, brought in
nearly $40 billion. After the last portion of the stock
sale is completed in 1989, the government will contin-
ue to retain one-third of NTT's outstanding stock.
tion bonds.
The NTT stock sales, along with the selloff of Japan
Airlines stock, will help Tokyo stimulate domestic
demand without adding to the budget deficit. As the
principal recipient of most of the revenues, Tokyo will
use roughly one-fourth of the $40 billion from the
recent sale to finance Japanese fiscal 1988 public
works expenditures-18 percent of the total public
works budget-and the balance to retire government
debt. As a result, government interest payments could
decline by as much as $1.5 billion, which would trim
annual government expenditures by 0.5 percent. The
remainder of the public works budget-a key part of
Tokyo's much vaunted $44 billion domestic demand
expansion program-will be financed with construc-
The Japanese financial services industry, in particu-
lar, the large securities houses, also is profiting signifi-
cantly from the government's sale. The lack of any
competitive bidding for underwriting NTT shares, the
limitation on foreign involvement, and the continued
use of fixed underwriting fees, are ensuring large
revenues for participating securities firms, according
to press reports. We estimate the revenue from this
part of the sale to the four largest securities houses,
which alone are underwriting nearly 50 percent of the
sale, to be around $400 million.
The Tokyo Stock Exchange itself is benefiting from
the NTT sale. Most important, the NTT sale has
encouraged over 1 million Japanese individuals to
become, for the first time, active participants in a
market traditionally considered too speculative to risk
private savings, according to press reporting. Indeed,
the government's continued partial ownership of NTT
along with the firm's pervasive role in Japan provide
Japanese investors enough confidence to invest in
NTT shares. In addition, the size of the stock sale, the
largest single issue ever on any stock exchange, is
increasing both the size of the exchange and the level
of activity.
Opportunities for foreign buyers and underwriters, on
the other hand, are being severely limited. Foreign
securities firms may participate in the sale on behalf
of Japanese buyers, but their portion of the 1.95
million shares being sold is restricted to no more than
87,000 shares. Tokyo is prohibiting foreign investors
from purchasing NTT shares because of national
security concerns of losing control of the telecom-
munications sector
In comparison, when the Thatcher
government sold off 51 percent of British Telecom in
1984, Japanese investors alone purchased approxi-
mately 6 percent of the stock offered. Moreover,
British Telcom and AT&T are currently planning to
be listed on the Tokyo Stock Exchange to facilitate
Japanese investor trading.
Secret
D! JEEW 87-048
4 December 1987
25X1'
25X1,
25X1'
25X1
25X1
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secret
NTT: Average Price per Share, 1987
Feb Mar Apr May Jun Jul Aug Sep Oct Nov
The price of NTT stock has risen far beyond market
analysts' expectations, nearly doubling only two weeks
after the first sale last February. Indeed, the strong
demand has helped keep the price steady despite the
recent stock market crash. For example, the NTT
stock price declined only 10 percent from its 16
October price compared with a 20-percent decline for
the market as a whole. According to various press
reporting, the high demand is being spurred by cer-
tain investor groups including:
? Institutional investors such as insurance companies
and trust banks, who believe significant capital
gains will accrue from holding NTT shares.
? Corporations, particularly potential NTT suppliers,
that hope to use nominal ownership in NTT as
leverage to gain future business.
? Individuals, awash with cash and few investment
alternatives, see NTT stock as safer than other
stocks because NTT, as a firm that operates only in
Japan, is sheltered from fluctuating exchange rates
and foreign competition.
In addition, the rapid rise in the share price after the
first sale is attracting numerous speculators seeking
similar short-term gains again.
reports.
This high demand, in our view, is causing a significant
overvaluation of NTT shares as well as magnifying
the profits for the Japanese Government and under-
writers. For example, NTT's current price-earnings
ratio-an indication of a firm's potential earnings-is
greater than 250, four to five times greater than the
average ratios of most Japanese companies. Indeed,
the actual performance of NTT appears to be of
limited concern to investors. On the day after NTT
reported a 10-percent decline in profits for 1987, for
example, its per share price on the Tokyo Stock
Exchange actually rose by $560, according to press
Tokyo will receive a windfall of an estimated $300
billion by the time the NTT selloff is completed in
1989. This money will allow Tokyo to increase gov-
ernment spending while hewing to its policy of fiscal
austerity. The government probably will continue to
divide the revenues between public-works spending
and debt retirement. Tokyo will be able to adhere to
its promise to cease issuing debt to finance govern-
ment expenditures by 1990 and still be able to provide
funding for porkbarrel projects politicians have been
requesting.
Despite the many benefits from the NTT stock sale,
we believe there are some potential downside risks as
well. In our view, there is potential for greater stock
market instability because of the vast size of NTT and
the stock's inflated value. The dominance of NTT on
the Tokyo Stock Exchange-nearly 15 percent of the
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Secret
total capitalization of the first tier ' of the exchange-
is likely to produce a much greater impact on the
exchange than the price fluctuations of shares of the
largest firms on other stock exchanges. A rapid selloff
by the large number of individual shareholders who
are inexperienced in the market, could pose additional
problems for the stock exchange.
Tokyo is concerned that the overvaluation of NTT
stock may contribute to renewed inflation as well as
trigger a rise in interest rates, according to press
reporting. In anticipation, the Ministry of Finance has
undertaken certain measures to limit fluctuations in
the NTT share price including requiring cash pay-
ments by investors at the time of purchase and
prohibiting securities firms from trading from their
personal accounts.
'The Tokyo Stock Exchange is broken down into three tiers, the
first consists of the 225 largest firms on the exchange, which are
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Secret
Japan: NTT Operating in a
New Environment 1
Nippon Telegraph and Telephone (NTT) is respond-
ing to the end of its monopoly and privatization by
exploring new lines of business. In particular, NTT
plans to make a major effort to integrate information
services and to explore such diverse ventures as
computer security and car rentals. Nevertheless,
NTT's newfound requirement to carefully protect its
bottom line has not led it to procure equipment from
abroad. Preexisting relations with other Japanese
firms are hampering foreign competition for NTT's
business. Foreign firms interested in filling NTT's
and the new carriers' equipment needs will probably
have to continue to rely on government-to-government
pressure to increase trade opportunities, but such
pressure will probably become less effective as To-
kyo's stake in the company declines.
turing, or carry international traffic.
Since April 1985, NTT has explored new lines of
business in an effort to diversify away from telephone
service-some 90 percent of current revenues. NTT's
status as a semiprivate firm has reduced many of the
governmental restrictions-such as an excessive em-
ployment burden '-that applied to the former public
corporation. Now NTT is free to focus the firm and
its vast research resources on profitmaking products
and services. It may not, however, engage in manufac-
A key part of NTT's strategy and its plans for leading
Japan into the "Information Age" is its $135 billion
Information Network System (INS). Over the next
decade, INS would integrate a wide range of informa-
tion services such as electronic mail, telephone, high-
definition television, facsimile, business data, and
transaction services into a nationwide, fully digital
network. Japanese technical journals report that most
of the research for INS is being conducted by NTT in
In 1984 the Diet passed the Nippon Telegraph and
Telephone Company Law, initiating the privatization
process and enabling the government to sell its stock
over several years to the Japanese public. Two major
restrictions on the privatization are that the govern-
ment always retain one-third ownership and that no
foreign entity be permitted to purchase shares of
NTT.
The Diet also ended NTT's telephone monopoly and
brought competition to Japan's domestic telecom-
munications business by enacting the Telecommuni-
cations Business Law. Two forms of telecommunica-
tions carrier competition now are permitted in Japan.
Type One carriers may construct and own their
alternative networks and charge competitive tariffs
for telephone and data services. Foreign participation
in these direct competitors is limited to one-third
ownership, and each entrant must be licensed by the
Ministry of Posts and Telecommunications (MPT).
So far, six competitors have been licensed by MPT to
operate domestically-four to construct land lines
and two to operate satellites. Type Two competitors
rent their telecommunications facilities from Type
One carriers and resell telephone circuits to the
public. Foreign participation in Type Two carriers is
unlimited, and only registration of the company with
MPT is required.
concert with its family firms-NEC, Fujitsu, Hitachi,
and Oki. We believe NTT's suppliers, over the long
run, will gain an expertise in developing and integrat-
ing information systems that will help establish them
firmly in export markets. To date, there has been only
limited foreign collaboration with NTT on its INS
project.
help absorb excess employees.
NTT is also forming numerous subsidiaries and joint
ventures to explore new competitive areas that will
Secret
DI IEEW 87-048
4 December 1987
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Secret
Capitalization
(Thousand US $)
NTT's Share
(Percent)
Regional companies
Industrial Development Laboratory Corp.
41
9.1
CAPTAIN Aomori Corp.
593
7.5
Kurume-Tosu Wide Area Information Co.
370
5.0
Information Network Fukushima Co.
1,333
0.6
CAPTAIN Yamagata Co.
593
6.0
Kitakyushu Information Plaza Co.
741
10.0
Technology/service companies
Internetwork, Inc.
29,630
25.0
NTT PC Communications, Inc.
10,370
90.0
Nippon Information and Communication Corp.
17,778
50.0
NTT Kyushu Telecontrol Planning Co.
741
80.0
Nishi-Nippon Information Service Center Co., Ltd.
222
10.0
NTT System Technologies Co., Ltd.
741
100.0
INS Engineering Corp.
3,696
33.5
NTT Software Corp.
1,482
100.0
NTT Syscom, Inc.
148
51.0
Nippon Computer Security Corp.
2,593
45.0
NTT Tokyo Software Supply Co.
370
100.0
NTT System Service Co.
518
90.0
Nippon Telematique, Inc.
2,222
50.0
NTT Chugoku Media Supply Co.
185
35.0
Nippon Telemedia Service, Inc.
1,482
15.0
Hokuriku CAPTAIN Service Co.
222
40.0
General Communications Engineering Co., Ltd.
148
50.0
InfoCom Research, Inc.
1,185
50.9
NTT International Corp.
22,222
52.8
Advanced Technology Research Institute, Int.
2,746
54.0
Outside interests
NTT Leasing Co., Ltd.
1,852
40.4
NTT Rental Engineering Co., Ltd.
2,815
48.0
Kansai Teleca Co., Ltd.
222
50.0
NTT Ad Co.
370
75.0
NTT Travel Service Co., Ltd.
296
25.0
Japan Utility Subway Co.
7,407
39.5
Le Parc Co.
148
90.0
NTT Urban Development Co., Ltd.
22,541
100.0
Dynamic Admedia
148
85.0
NTT Legato Co., Ltd.
370
100.0
NTT Telemarketing Co., Ltd.
370
45.0
a Data for fiscal period beginning in April.
Secret 16
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JvI.ICL
Services. We estimate that about half of NTT's new
business activities are in nontelephone services that
range from computer security to videotex. In 1986,
IBM Japan and NTT formed a joint venture to
combine computer processing services with communi-
cations capabilities for business needs. The types of
services offered may include inventory management,
bank and sales transactions, data retrieval services,
and claim processing capability. NTT has also estab-
lished several consulting businesses. One,' called NTT
International, helps developing nations plan and in-
stall telecommunications networks.
priority in equipment procurement, thereby widening
the possible supplier circle beyond the traditional
Japanese vendors. Trade statistics indicate, however,
that foreign procurement constitutes only about 5
percent of the $5 billion NTT spends annually, with
some 90 percent coming from the United States.
Technology/Equipment. The Japanese press reports
that this year NTT and Corning Glass Works an-
nounced a joint optical-fiber development project. The
two are sharing research on fluoride fiber-believed
to be more efficient than current quartz-based fiber-
but applications are probably a long way off. Corning
will help market any products in the United States
that come from the cooperation.
Outside Interests. The Japanese press reports that in
1987 NTT began a car rental business to take
advantage of its nationwide sales force and large
number of vehicles in NTT's possession. Auto leasing
will provide employment for telephone operators dis-
placed from the telephone business. NTT also has
travel service and urban development subsidiaries.F-
Privatization and Procurement: Small Gains
for Foreign Firms
Since privatization, foreign equipment vendors have
not made substantial gains as suppliers to either NTT
or the new common carriers. Many industry observers
believed NTT might begin to consider cost as a
When NTT purchases from abroad, the equipment is
usually for a niche market with strict technology-
sharing and in-country presence requirements at-
tached. In 1987, AT&T sold its ATOMICS system to
NTT-a network management and diagnostic pro-
gram. NTT also purchased the source code from
AT&T and the two are to market ATOMICS to other
Asian telephone administrations.
To Tokyo's credit, some regulatory changes-includ-
ing simplified product certification and testing-have
made access to the Japanese telecommunications
market somewhat easier. Nonetheless, we believe
several factors beyond Tokyo's control could impede a
foreign vendor's sales success:
? Regulatory and legislative changes in the telecom-
munications sector have spawned a host of Japanese
start-up companies wanting to sell equipment to
NTT and others, thereby increasing the competitive
field for foreign manufacturers.
? Foreign firms are still viewed as threats to the
family of NTT suppliers.
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oca . ci
? The Japanese traditions of longstanding association
and proper introductions, combined with close scru-
tiny of foreign technology, work against newcomers
to the telecommunications market. Northern Tele-
com, for example, spent four years attempting to sell
in Japan before it won the large NTT switch
contract.
We believe Tokyo has recognized the spread of tele-
communications competition worldwide, and the ne-
cessity of encouraging competitive firms domestically.
The dual implementation of privatization and compe-
tition effectively permits NTT a freer hand in a
difficult marketplace. In our view, NTT's reorganiza-
tion and rapid diversification will allow the firm to
grow, despite the entry of new competitors into NTT's
main line of business-telephone service-and despite
its two main legal prohibitions-manufacturing and
carrying international traffic. The Diet has reserved
the option of periodically reviewing these restrictions
in order to adjust the regulations that continue to
govern NTT. Moreover, NTT's INS plan to integrate
digital technology into Japan's national network in
the 1990s should keep NTT at the commercial and
technological forefront of the telecommunications in-
dustry.
make competition for NTT business difficult.
We believe the high value the Japanese place on long-
standing personal relationships will continue to neces-
sitate an in-country presence for foreign firms intent
on selling. NTT does not appear to have significantly
altered the procurement practices of its monopoly
days and close, preexisting relationships with NEC,
Hitachi, Fujitsu, Oki, and others, will continue to
The prospects for continued opening of the Japanese
telecommunications equipment market are not prom-
ising. Tokyo is likely to
highlig t the high failure rate of US firms in the
Japanese market as evidence of unreliability. The best
hope for significant purchases of foreign telecom-
munications equipment is continuing yen apprecia-
tion. Politically, Tokyo still seems vulnerable to the
argument that Japanese telecommunications firms
are doing well in the open US equipment market. We
believe that Prime Minister Takeshita-whose power
base includes the telecommunications industry-may
be able to effect compromises that will marginally
improve telecommuncations market access, but he is
unlikely to be any more forthcoming than his prede-
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Secret
Peru: Dwindling Oil Surplus
promising oil regions.
Lima's failure to adopt a comprehensive petroleum
policy has led to steadily falling oil production and
exports, which is contributing to serious foreign pay-
ments problems. Unless President Garcia takes the
politically difficult steps necessary to encourage for-
eign investment in the oil and gas sector, Peru could
become a net oil importer by 1989, which would limit
economic growth and add to President Garcia's grow-
ing political problems. Because of the nationalization
of Belco, a US-owned petroleum company, in 1985-
which still has not been settled financially-foreign
oil companies are awaiting passage of pending petro-
leum legislation before seeking investments in Peru's
The Worsening Oil Equation
per day.
The Garcia administration's growth policies have not
been matched by measures to boost Peru's sagging oil
production, and, as a result, the country's once ample
oil surplus has contracted rapidly. In 1986, for exam-
ple, big wage increases helped boost real GDP by 8.5
percent and domestic oil consumption rose 7.3 per-
cent, but domestic oil production dropped 5.3 percent,
leading to a 13-percent cutback in oil export volume.
This year, although economic growth has slowed,
domestic oil use rose 11 percent during the first 8
months, compared with the same period last year,
while production dropped another 5 percent. In addi-
tion, although Peru remains a net oil exporter, imports
of petroleum products have more than doubled, and,
for the first time since 1978, Peru has had to import
crude oil. As a result, the country's net exports of
crude oil and petroleum products were down 36
percent during January-August 1987 to 40,000 b/d
We estimate the value of oil exports this year will
reach $310 million-up about 30 percent compared
with last year-but oil imports will triple this year to
$100 million if recent trends continue. This will leave
Peru: Crude Oil Production and
Consumption Trends, 1984-89
I. I I
100 1984 85 86 87 a 88b 89b
a Estimated.
b Projected.
Peru with net oil earnings about the same as in
1986-and $430 million lower than in 1985, when oil
was by far Peru's biggest export earner
Exploration Lagging
Negative trends in the industry are not likely to be
reversed soon, because of the lagging pace of oil
exploration. We estimate that oil reserves will drop 25X1
below 470 million barrels by the end of-1987--equal
to about eight years of production at current rates of
output. Industry experts estimate that Peru needs to
Secret
DI IEEW 87-048
4 December 1987
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Secret
All oil and gas activities in Peru are controlled by the
state-owned Petroperu, which is subordinate to the
Ministry of Energy and Mines. Petroperu negotiates
contracts with foreign oil companies, and all oil
producers must sell their output to Petroperu. In
September 1987, when Peru pumped an average of
161,000 b/d, production was distributed as follows:
Petroperu also operates the country's five refineries,
with a total capacity of 180,500 b/d. Because of the
slippage in domestic oil production and the increasing
share of heavier crudes, these refineries have been
unable to satisfy domestic requirements for some
petroleum products. To alleviate shortages, Peru has
had to increase imports of certain petroleum products
and light crudes from Ecuador in order to satisfy
refinery needs. Plans to convert 100,000 b/d of capac-
ity to improve the yield from heavier crudes are on
hold because they depend on World Bank financing.
Peru was cut off from World Bank lending in May
1987 when Lima failed to clear payment arrearages.
invest $2.8 billion over the next 10 years in order to
reestablish the healthy 10:1 reserves-to-production
ratio last achieved in 1983. Much of this investment
will have to come from foreign sources, given the
inadequate foreign exchange reserves and lack of
domestic technical capabilities.
This year exploration activity has diminished. In
August the head of Petroperu told the press that his
public corporation had scaled back its exploration
activities because Lima was diverting Petroperu funds
to finance other economic programs. He also com-
plained that exploratory drilling in Peru was at a
standstill; that month Shell Oil announced it had
fulfilled its multiyear contract for exploration. The
450 1981 82 83 84 85 86 87a
remaining major US oil firm operating in Peru-
which produces almost half of Peru's oil-however,
told the US Embassy recently that it is continuing
exploration in one of Peru's oil blocks, as called for in
its contract, but as yet had not made a commercial
find.
Without increased exploration Peru will become a net
oil importer within the next few years. At an engi-
neering conference held in Lima this fall, a local
representative of a US company stated publicly that,
if the government fails to move quickly to encourage
exploration, Peru will be a net oil importer by 1989.
Although Peru's Energy Minister quickly refuted this
assertion, recent trends support the projection. Oil
production is now more than 20 percent below the
200,000 b/d produced when Garcia took office in July
1985.
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Secret
In late 1986 while exploring for oil, Shell's Peruvian
subsidiary made a major gas find in the jungle, 290
kilometers east of Lima. The deposit contains 7-10
trillion cubic feet of gas, making Peru third in South
America-behind Venezuela and Argentina-in gas
reserves. In terms of energy content, the deposit is
equivalent to at least double Peru's oil reserves. If
exploited, the gas could displace 35,000 b/d of oil,
according to Shell, thus freeing this amount of oil for
export. Several foreign companies, including Shell,
are interested in exploiting the field, as is Petroperu.
Cost estimates for the project range from $700
million to $1 billion, depending on various options,
including a possible pipeline to Brazil. Given Peru's
poor relations with its creditors and the absence of
energy legislation, however, arranging a financing
package will be difficult.
Garcia's first major oil policy measure-the expropri-
ation in December 1985 of Belco, a formerly US-
owned subsidiary involved in offshore oil produc-
tion-lingers as a deterrent to foreign investment in
Peru's oil and other industries. Despite repeated high-
level assurances that the matter would be expedited,
Lima has yet to affix a value to the expropriated
assets, much less compensate the parent company.
Prospective foreign investors in the energy sector have
repeatedly cited the need for Lima to settle the
matter.
Despite the efforts of senior Peruvian and foreign oil
officials to raise alarms about the deteriorating state
of the industry, the Garcia administration has only
recently taken-tentative steps toward a solution. In
November, Lima modified its ban on profit and loan
remittances in response to complaints by the US oil
company operating in Peru that it could not pay its
overseas creditors, according to the US Embassy. In
addition, the government is now pushing forward
petroleum legislation that includes promises to pro-
vide improved financial rewards for oil investments in
Peru. According to the US Embassy, the Energy
Minister and several congressmen from the ruling
party have gotten behind the bill and introduced
modifications they hope will allow Peru to compete
with Ecuador and Colombia for investment dollars. In
mid-November, the legislation passed the Senate, and
it is now before the Chamber of Deputies, where the
ruling party holds a much larger majority.
Several policies make day-to-day operations in Peru
difficult for foreign and domestic oil firms:
? Oil companies must exchange their dollar earnings
at the lowest exchange rate prevailing for exports.
? Imports of basic oil field supplies and equipment are
delayed by a lengthy approval system designed to
ration foreign exchange, which often leads to pro-
duction losses.
? Several ministries overlap in financial and legal 25X1
questions related to foreign involvement in the
industry, leaving firms with considerable doubts
about their ability to operate profitably.
? Controls on domestic petroleum product prices have
squeezed Petroperu profits, and, in 1986, Lima
raised the share of the sales price that goes to taxes.
Even if the oil legislation passes, the US concession-
aire still has concerns about Peru's bureaucracy. The
company has repeatedly requested that Lima reduce
the bureaucratic hurdles and financial impediments to
its operations. Earlier this year the company told the
US Embassy that senior corporate officials of the 25X1
parent company were considering pulling out of Peru,
and more recently, the company began scaling down
operations out of frustration with Lima's inaction.
The company sees the recent liberalization on profit
remittances as a positive gesture, but is waiting to see
how the bureaucracy acts on its other concerns.
Moreover, Garcia's nationalization of remaining pri-
vate domestic financial firms in October has made
foreign firms wary of investing in Peru.
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Recent actions to improve the climate for investment
in Peru's energy sector suggest that the government is
becoming concerned about the oil problem. Nonethe-
less, President Garcia, who continues to dominate the
political scene, has yet to take a firm stand on energy
matters. He probably wants to avoid making major
concessions to foreign oil companies because this
would be seen as a reversal of his nationalistic eco-
nomic policies and earn him the wrath of the potent
political left. As a result, we expect Garcia to try, at
best, a gradualist approach that is unlikely to elicit a
sufficient investment flow.
Without firm action to speed exploration and extrac-
tion, the deteriorating oil account will exacerbate
Peru's foreign exchange woes. Lima expects its net
foreign exchange reserves to drop below $200 million
by the end of this year-the lowest since 1978-and
outside observers project a foreign exchange crisis as
soon as next spring. If the US-owned oil subsidiary is
unable to gain satisfaction from Lima and continues
to allow production to fall, the foreign exchange
squeeze will come sooner.
Even if Lima acts to head off the immediate threat of
a loss of production and exports, a steady deteriora-
tion in the oil trade in 1988-89 will increasingly act as
a brake on economic growth. In the first instance, the
dwindling foreign exchange earnings from oil will
force Lima to strengthen controls on imports, most of
which are needed as inputs to domestic industry.
Eventually, Lima will have to introduce serious ener-
gy conservation measures that are almost certain to
slow manufacturing growth because households are
not a major factor in energy consumption.
The neglect of the energy sector, once it becomes a
prominent problem, will also add to Garcia's growing
political difficulties, spawned by the slowing economy
and the expanding insurgencies. Although Peru's pre-
dominantly leftist electorate would not support a
major intrusion of foreign oil companies, Garcia's
inability to make his statist oil policies work will be
seen as another failure of the government.
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International Financial Situation:
Update on LDC Debt 25X1
Developments in LDC debt situations focus on the following countries:
? Brazil's Bank Advisory Committee (BAC) continues to experience problems in
arranging the $3 billion bank contribution to the $4.5 billion bridge loan
announced early last month.
The BAC typically encounters
difficulties lining up regional banks for new money packages, but expects to
obtain their participation by early next week.
Brasilia will not lift the moratorium until new financing is received in mid-1988.
Brasilia had earlier indicated it would resume payments on a normal basis in
January. Meanwhile, negotiations for the longer term debt rescheduling package
began on 1 December.
? Peru is stepping up its diplomatic efforts in order to improve its relations with
major foreign creditors, but Lima's ability to repay its debts is steadily dwindling
and the government's promised economic reform program is likely to be watered
down. Minister of Economics and Finance Saberbein met with World Bank and
Paris Club officials in mid-November to discuss Lima's plans to improve its debt
servicing and change its growth strategy. Although Saberbein did not make any
concrete proposals on debt servicing to the Paris Club, he told the group that by
moving away from consumer-led growth to a strategy based on exports and
investment-including foreign investment-Peru's hard currency earnings
would increase. His discussion with the World Bank encouraged the Bank to
send a team to Lima for three weeks to examine projects that would aid the ex-
port sector. Peru owes the Bank $150 million, however, and with foreign
exchange reserves dwindling, Lima will want assurances that major loan
disbursements are in the offing before it clears its arrearages. Meanwhile,
Lima's promised economic reforms will have to meet President Garcia's dictum
that they promote growth, according to Saberbein, and he told the US Embassy
that this already rules out the adoption of market interest rates.
23 Secret
DI IEEW 87-048
4 December 1987
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necrei
Key LDC Debtors:
Economic/Financial Indicators
Foreign
Debt a
(billion US $)
Months of Import
Coverage by
Reserves b
Brazil
114
3.3 (Jul 87)
1.9 (Apr 87)
Mexico
108
17.0 (Jul 87)
10.2 (Apr 87)
Argentina
51
3.0 (end-Nov 87)
2.8 (Jun 87)
Venezuela
31
8.7 (Aug 87)
7.1 (Mar 87)
Indonesia
39
8.7 (Dec 86) c
10.3 (Sep 86)
Egypt
31
1.5 (Apr 87)
1.4 (Jan 87)
Philippines
29
3.2 (Jun 87)
3.7 (Mar 87)
Chile
20
8.4 (Jun 87)
7.6 (Mar 87)
Nigeria
22
1.0 (Jun 87)
0.9 (Feb 87)
Peru
15
2.3 (Sep 87)
3.7 (Feb 87)
Other
Indicators
Inflation in November was 12.8 percent, year-to-date
inflation reached 308 percent; October trade surplus
$1.2 billion.
Peso strengthened slightly against the dollar early this
week after registering 40-percent decline since 18
November devaluation.
Wage and price freeze should enable government to at
least halve inflation in November from the 19.5
percent recorded in October.
Caracas revising 1988 budget; 20-percent drop in
government investment spending will help reduce
budget deficit by 38 percent.
Foreign exchange reserves fell from $10 billion to
about $6 billion as of mid-October, nonoil/gas exports
during first seven months of 1987 rose 14 percent
compared with same period last year.
Cairo is implementing second phase of its strategy to
consolidate commercial bank exchange rates by the
end of the year.
GNP rose 5.5 percent, exports fell 6.4 percent, and
imports increased 16.3 percent during first nine
months of 1987; House of Representatives approved
$8.3 billion budget for 1988.
Annual inflation rate in October was 18.8 percent,
well above Santiago's 15-to-17-percent target; $742
million January-September trade surplus is approach-
ing IMF's $950 million target.
Shortfall in oil revenues contributed to budget deficit
of about $3.7 billion for first-half 1987.
Trade deficit was $86 million during first eight
months of 1987 compared with $340 million surplus
for same period last year.
a Yearend 1986. c Foreign reserves, excluding gold, plus net foreign assets of
b Derived from the ratio of foreign exchange reserves, excluding commercial banks used in deriving months of import coverage.
gold, to imports.
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Secret
Boldface indicates change
over the previous update
IMF mission arrived last week to review economic
program; formal negotiations for a standby agreement
not expected to begin before January.
Salinas's tough stance with creditors as Budget Minis-
ter likely to carry over if he becomes President;
Mexico probably will not need new money next year.
Buenos Aires wants to negotiate a new debt accord
with banks; needs fresh funds to help fill a financing
gap of at least $1.6 billion.
Undrawn standby loans total about $2.3 billion, but
several credits expire soon; Jakarta may seek $300
million loan in early 1988.
Full debate on draft constitution-which contains
several nationalist economic provisions inimical to US
interests-to begin 13 December.
Salinas publicly avoiding the exchange rate issue;
Congress unlikely to pass tax package-badly needed
to meet IMF targets on deficit reduction-before
early next year.
Eduardo Fernandez nominated as presidential candi-
date of COPEI, Venezuela's main opposition party, for
December 1988 election; running against former Pres-
ident Perez; election probably will focus on political
reform and ways to reverse economic stagnation.
Recent demonstrations indicate growing student activ-
ism concerning regime corruption and the national
lottery.
Egypt agreed to reschedule $520 million of its debt to
West Germany, failed to reach agreement on debt
rescheduling with Australia, and began talks with
Spain to reschedule government debt.
Finance Secretary-designate Jayme said he expects
debt restructuring agreements with foreign creditor
banks will be completed by 22 December but hinted
that Manila may reexamine the agreements once they
have been signed.
World Bank Executive Board scheduled to vote on
Chile's third structural adjustment loan in mid-Decem-
ber.
Nigeria signed agreement with the London Club last
week to reschedule $4 billion of 1986-87 commercial
debt, freeing disbursement of $320 million in new
money.
Decision by most moderate Arab states to restore
diplomatic relations with Egypt is major political
success for Mubarak.
Recently approved military pay increase, scheduled to
appear in paychecks on 15 December, should ease
military discontent with the government; security con-
cerns remain high during planning for mid-December
ASEAN summit in Manila.
Military junta rejected Pinochet's proposal to sched-
ule plebiscite early rather than late next year; moder-
ate opposition continues its campaign against him.
Local elections scheduled this month, not engendering
much enthusiasm; first step in transition to civilian
rule.
President Garcia reportedly is pursuing his goal of
becoming president of the Non-Aligned Movement;
invited a group of Third World leaders to Lima for a
summit on debt issues in early 1988.
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L10%I OI
Debt-Equity Swaps: Limited Prospects in Early 1988
Strict regulations and political and economic uncertainty in several key debtor
countries bode ill for an increase in debt conversions over the next several months,
in our judgment:
? Mexico suspended swaps last month and may decide to slow down, limit, or even
cancel the program next year, according to the US Embassy. Presidential
candidate Salinas-who has never been supportive of the program-reportedly
requested the suspension, citing the swaps' inflationary impact on the economy.
? Brazil's National Monetary Council-after months of inaction-approved a
debt-conversion program last week, but legislators from the majority party
vowed to fight the measure. Moreover, the success of the swap program will
depend on how the Central Bank sets discounts for auctions and on the
commercial banks' willingness to convert the debts they hold into government
bonds.
? In the Philippines, a logjam at the Central Bank-only $253 million out of $1.3
billion in swap applications had been approved as of mid-October-a substantial
increase in fees on conversions, the chronically uncertain political climate, and
an increase in urban violence has discouraged investors.
? Chile, in an attempt to benefit from the steep discount of its debt in the
secondary market-also has tightened the terms of its program, according to
press reports.
Even Latin debtors that have loosened the strings attached to their conversion
programs face obstacles in attracting investors. Venezuela has agreed to pay full
face value for its debt-the current secondary market price is about 50 percent-
but its requirement that swaps be made at the official exchange rate is still a deter-
rent. Only one debt swap, worth $5 million, has been approved since regulations
were enacted last April. Argentina has dropped its requirement that investors
match converted debt with new money and has agreed to convert debt at the new
free exchange rate.. Nonetheless, the US Embassy reports that international
bankers believe the government remains generally opposed to making the new
program work successfully.
A number of other recent developments could also pose problems for debt-equity
swap programs. Foreign investors were dealt a substantial blow when world stock
markets crashed in October and may decide to cancel or postpone investment in
LDCs because of cash shortages. The prices of LDC debt on the secondary market
have dropped as much as 40 percent in the past six months. International banks,
who also sustained losses because of the stock markets' plunge, may be less willing
now to absorb the losses associated with selling debt at a steep discount.
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Energy
Big Seven Oil Demand Oil demand in the Big Seven-which accounts for about 60 percent of non-
Continues To Rise Communist oil demand-rose by more than 2 percent in first-half 1987, primarily
Brazil Approves
Debt-Equity Program
increased about 1 to 2 percent.
as a result of increased consumption of transportation fuels. Gasoline consumption
increased by 2.5 percent over year-earlier levels, offsetting a decline in heavy fuel
oil. Continued economic growth and relatively low gasoline prices contributed to
the increase. Gasoline consumption in West Germany showed the largest in-
crease-nearly 4 percent-followed by gains in Italy, the United States, Japan,
and the United Kingdom. Heavy fuel oil faced stronger competition from cheaper
coal and natural gas in most countries. In Italy, however, the shutdown of three
nuclear power plants led to a 19-percent increase in heavy fuel oil sales during the
first nine months of 1987. Preliminary data for the third quarter suggests oil sales
Brasilia's recently approved regulations for debt-equity conversions are not as
restrictive as previous proposals considered by the Central Bank, but numerous
problems will probably limit their attractiveness to foreign investors. Under the
new rules-to be implemented early next year-debt will be swapped for equity
through both auctions by the Central Bank and bonds. Brasilia acknowledges that
it intends to gain at least a portion of the secondary market discount-now about
63 percent-for its debt through both mechanisms, but it has not yet indicated if
the Central Bank will set a minimum discount in the auctions. Moreover, before
conversions can be made through bonds, Brasilia must gain acceptance for this
proposal from its commercial bankers in the current debt rescheduling talks-
creditors so far have been lukewarm to this scheme. Half of all swaps must involve
investments in Brazil's impoverished north and northeastern regions. If enforced,
this restriction is likely to significantly check total conversions: few investors are
interested in these regions, where infrastructure and skilled labor resources are
inadequate. Although the conversion regulations prohibit foreign investors from
acquiring controlling interest in Brazilian concerns and from repatriating the
investment for 12 years, many legislators, claiming there is still potential for
"denationalization," threatened to ban conversions via the new constitution
currently being drafted. Foreign bankers and investors, meanwhile, have com-
plained that the new rules are too restrictive. While the new program, once
implemented, probably will result in an upswing in conversions from the $200
million annual level of the past two years, the restrictions in the new program,
combined with general economic and political difficulties will probably keep
conversions well below the $1.5 billion annual level that Brasilia is projecting.
27 Secret
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4 December 1987
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secret
Mauritanian
Debt-Equity Swap
expressed interest. The deal will almost surely ensure further Bank funding.
Mauritania and the World Bank have arranged the first debt-equity swap in
Africa, according to press reports, involving $18.6 million in debt to Arab, West
European, and US banks. Nouakchott will use $5-8 million-the exact amount has
not been determined-provided in a World Bank loan to pay cash to creditors and
will pay the balance in equity in Mauritania's two largest banks. We believe the
swap will strengthen Mauritanian banks and give them increased access to badly
needed credit. Furthermore, World Bank participation will make additional
planned swaps attractive to creditors-West European bankers have already
Senegal Reschedules Senegal reached agreement last week with the Paris Club to reschedule its $80
Debt With Paris Club million of official debt due next year, according to US Embassy reporting. Dakar
-has a 16-year repayment period with six years' grace. The creditors reportedly
have been satisfied with Senegal's performance under an IMF-backed economic
reform program that calls for reduction of subsidies and price controls, privatiza-
tion of 15 parastatals, and trimming of civil service rolls. Dakar's tight fiscal
policies have helped reduce the budget deficit from 8 percent of GDP in 1983 to an
estimated 2.3 percent in 1986. The rescheduling agreement probably will ease
economic pressures on President Diouf as he campaigns for reelection for a second
five-year term in February.
Soviet-Western
Petrochemical Joint
Venture Announced
Global and Regional Developments
The Soviets signed a letter of intent late last month with Occidental Petroleum,
Italy's Montedison, and Japan's Marubeni for a $5-6-billion petrochemical joint
venture. The complex, to be located near the Tengiz. oilfield in Kazakhstan, will
use natural gas liquids to produce 500,000 metric tons each of polyethylene and
polypropylene annually. The facility also will produce up to 1 million tons of sulfur
annually along with other plastic materials. The Western firms will hold 49
percent of the equity in the venture, supply technology, and build and operate the
facility. One-half of the output is targeted for export. Construction is scheduled to
begin in 1989 with startup in 1992. If the project is built as planned, it will be one
New Cuban Aviatio Havana has recently concluded charter air service agreements with Brazil and the
Agreements Dominican Republic in an effort to promote tourism. Cuba and Brazil have
arranged to begin regular charter service between Havana and Sao Paulo on 11
December
IA
Cuban-Dominican Republic agreement signed on 23 November formalizes access
for weekly flights, which the US Embassy in Santo Domingo reports will serve as
the basis for package tours Cuba plans to offer in other countries. The Santo
Domingo and Sao Paulo airlinks are unlikely to significantly increase tourist travel
to Cuba. The new routes do, however, offer Havana the political benefit of greater
Secret
4 December 1987
governments in the region.
visibility in Latin America, buttressing Cuban efforts to improve ties to other
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secret
expanding national oil stockpile. MITI officials said the tax hike plan-if approved
by the ruling party and Finance Ministry after it is formally submitted in
December-will shift the current value-based oil tax system to a volume-based
one, a move the Ministry estimates will triple the tax on each kiloliter of oil.
MITI ~~ is forecasting instability in global oil supplies in the next decadej7
Domestic
industry has consistently opposed energy tax hikes, but with imported oil prices
29 Secret
4 December 1987
Iran Steps Up Economic Iran is financing a highly visible economic assistance program in Lebanon in order
Aid to Lebanon to bolster the Shia community's support for Hizballah and the fundamentalist
Japanese Export Price
Response to Yen
Appreciation
broaden support among the hard-pressed Lebanese population.
movement. the economic assistance funds are
allocated to provide staple foods, subsidized pharmaceuticals, and fuel oil to the
poor residents of the Bekaa Valley. Iranian financing allows Hizballah to attract
fighters through attractive salaries and
support families of Hizballah casualties. Financial inducements, combined with
Lebanon's economic turmoil, have encouraged increasing numbers of Amal
fighters to switch allegiance. As Lebanon's economy deteriorates further, Hizbal-
lah will use its relative financial strength to improve its position militarily and
25X1
25X1
dollar price of exports in coming months.
The Japanese Trade Ministry is concerned that the failure of Japanese firms to in-
crease export prices to more fully reflect the yen appreciation could lead to further
tensions between Japan and its trading partners. According to IMF data, Japanese
companies have increased the dollar price of their exports nearly 40 percent since
early 1985-indicating that they have passed through to overseas customers
almost half of the 80-percent appreciation of the yen over the same period. This is
virtually equivalent to the percentage passthrough during the 1981-82 depreciation
of the yen-when Japanese firms cut dollar prices by 11 percent in the face of a
20-percent depreciation of the currency-but is considerably less than the 70-
percent passthrough of the 1977-78 appreciation of the yen. In part, we believe
that Japanese firms have been more reluctant to pass on the yen appreciation this
time because they now face tougher competition-particularly from the Asian
NICs-in most export markets. In addition, Japanese firms have been able to
afford to hold down the dollar price of exports because profits until recently were
being buoyed by the huge capital gains corporations were earning by speculating in
financial markets. Since this strategy appears to have been severely curtailed by
the recent volatility of financial markets, firms could be forced to further boost the
Tokyo To Increase Tax The Japanese Trade Ministry last week announced a proposed tax increase on
on Imported Oil in 1988 imported oil in the fiscal year beginning next April in order to finance an
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secret
falling because of the strong yen, MITI probably views the time as ripe to push
through a tax increase. If approved, the hike will probably marginally depress
demand for oil, which is already nearly 20 percent below the 1979 peak.
West German Social Slumping growth prospects in West Germany have led many SPD members to
Democrats Urge Many urge Bonn to spur the economy, but the broad range of options they have proposed
Different Stimulus reflects the strong differences that continue to characterize the party's thinking on
Packages economic issues. Former Finance Minister Schiller is recommending a more
aggressive approach to tax cuts by calling for use of the Stability.and Growth Law.
This law, which Schiller crafted, enables Bonn to cut taxes by 10 percent across.
the board. SPD leader Vogel-who had initially opposed lower taxes on the
grounds that such a move would increase state budget deficits-has recently
supported cuts as a complement to his initial plea for greater government spending
at all levels. Other leaders are less precise. Both ex-Chancellor Schmidt and
Daimler chief Reuter-expected to be a minister in any future SPD government-
avoided specific prescriptions and did not associate themselves with either Schiller
or Vogel, but both have urged the Kohl government to show leadership by taking
measures to boost growth
Portuguese Tax Reform The Silva government has introduced a plan in Parliament aimed at simplifying di-
rect taxation as part of its overall program to revamp Portugal's antiquated system
of public finances. The proposal replaces Portugal's seven direct taxes-each one
connected to a different income source-with only two: an individual and a
corporate income tax. Primarily by reducing tax evasion, the government hopes to
avoid raising tax rates and still lower its heavy reliance on indirect tax revenues.
The plan represents a major step in streamlining Portugal's tax system, but it
probably will not take effect for some time. Even if-as is probable-Parliament
approves the proposal before the end of the year, the top-heavy Portuguese
bureaucracy probably will need substantial time to implement the new taxes.
Indeed, we doubt that Lisbon will be able to meet its 1988 target implementation
Spanish Spain's draft telecommunications law (LOT) was passed by the Congress of
Telecommunications Deputies in late October, but continuing opposition by various interest groups may
Bill delay its approval in the Senate until next year. Although in principle the law is a
move toward liberalization, most critics claim that the language is too hedged by
qualifications and exceptions. The Spanish employers' federation has expressed
concern over the limited liberalization of customer premises equipment, and the
major industry organizations have called for total deregulation of leased lines and
value-added services. Moreover, the proposal is likely to restrict foreign companies'
activities in Spain to a 25-percent ownership share in private telecommunications
entities. Meanwhile, rightist opposition parties in Congress have objected to
provisions calling for central government control over services such as private
radiobroadcasting and have threatened to challenge the constitutionality of the
LOT if it is passed by the Senate without major changes.
Secret
4 December 1987
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secret
Greek Efforts -
To Promote Exports
Ireland To Ease
Foreign Exchange
Controls
laws governing the firing of redundant workers.
Athens is trying to raise the quality of Greek exports in an effort to boost sales to
Western markets, especially the United States. The state-owned Hellenic Export
Promotion Organization has begun a program to encourage more small and
medium-sized Greek businesses to export quality goods, according to press reports,
in an attempt to improve on a tarnished image-resulting from incidents such as
the sale of shoddy footwear to the United States several years ago. The
organization is carefully screening potential exporters for competitiveness in
quality, pricing, and packaging, and enrolling the best manufacturers in the
Institute for Export Training to learn exporting skills, including marketing, the use
of banks, transportation, and labeling. Although entry into the EC in 1981 has
helped Greece compete with its European neighbors, the country still has trouble
meeting the demands of the US market-which accounted for only 7 percent of
Athens' exports last year, down from 9 percent in 1981. The program is also
further evidence of Prime Minister Papandreou's more conciliatory attitude to
business needs in recent months, including promises to lower taxes and change the
Dublin recently announced that it will ease foreign exchange regulations on 1
January, its first step in liberalizing capital controls. Finance Minister MacSharry
has proposed a series of measures that will allow individual investors to purchase
up to $8,000 worth of foreign stocks with an overall cap of $4.8 million, while insti-
tutions will be able to increase their foreign holdings to 12 percent of their cash
flow. Dublin will also increase the limit on the value of property individuals can
own outside the EC from $32,000 to $80,000. Other changes include an increase in
the personal travel allowance from $800 to $2,000 and elimination of the limit on
repatriation of assets by emigrants. The Department of Finance estimates that the
new regulations will result in a net currency outflow of about $100 million in 1988.
Nevertheless, the liberalization is a necessary start to comply with the EC's
requirement to abolish restrictions on cross-border private investment by 1992.
French Textile Industry
Unemployment
May Rise
The EC Commission's recent confirmation of a 1985 ruling that a $26 million
French textile industry modernization plan violated EC competition rules has
raised fears in France of plant closings and higher unemployment. The French
textile industry has been buffeted by lower cost overseas competition, reduced 25X1
exports to the United States and the Middle East because of the fall of the US dol-
lar, and the poor performance of its stocks. Many firms need to restructure their
operations and may have to lay off some of the industry's 454,000 workers.
Mediocre growth prospects, a contracting job market, and close public attention to
unemployment figures leave Prime Minister Chirac little room to maneuver.
Chirac already faces allegations that the government is underfunding jobs
programs in the 1988 budget. Under these conditions, significant additions to
unemployment from the textile industry could damage Chirac's electoral chances
this spring. Thus, any response to the EC ruling will probably be delayed as long as
possible. 25X1
Secret
4 December 1987
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necre[
Israel's Trade
Deficit Surges
Australian National
Wage Hike
agrees to waive at least part of workers' cost-of-living payments.
Israel's trade deficit widened to about $2.7 billion in the first 10 months of 1987
compared with $2.0 billion in the same period last year, reflecting a 22-percent in-
crease in imports and a 16-percent increase in exports. The figures contrast
sharply with the government's estimates for 1987 in which exports were forecast to
increase by 10 percent and imports by 7 percent. In our judgment, rises in real
wages and private consumption expenditures, relatively low domestic real interest
rates, the redemption of previously frozen bank shares, and the stable exchange
rate of the shekel against the dollar have contributed to the rapid import growth,
particularly in the last six months. With the larger trade deficit, Israeli exporters
probably will intensify their demands for a devaluation, arguing that the pegging
of the shekel to a basket of five currencies-a move implemented by the
government in August 1986-has harmed exports. While Bank of Israel Governor
Michael Bruno remains opposed to a large devaluation, he has left open the
possibility of a limited devaluation if Histadrut-the national labor federation-
11-percent pay rise for parliamentarians.
Canberra is supporting labor unions' request for a 1.5 percent wage hike to placate
labor leaders and counter the recent upswing in strikes. The small raise would
supplement the $7-a-week increase awarded to all workers under the first tier of
the two-part wage system implemented last summer. Australian unions are
pressing Canberra for the additional wage hike because employers and unions have
not yet agreed on the amount of second-tier raises, which are supposed to be based
on improved efficiency and production in individual industries. After several
months of negotiations, only 10 percent of eligible workers have received second-
tier raises, according to US Embassy reporting. Canberra's support for the
supplemental increase also follows an embarrassing media brawl between govern-
ment and national labor leaders over a proposed, but not implemented,
New Zealand Forms The almost exclusively Communist leadership of New Zealand's new Council of
Secret
4 December 1987
momentum of the Labor Party government's free-market policies.
Trade Unions will probably give strong support to leftist causes and seek affiliation
with international leftist labor organizations. The Council represents almost all
public and private sector unions in the country and replaces the private sector
Federation of Labor, which was disbanded last summer in favor of a more broadly
based organization. Former Federation leaders Ken Douglas and Jim Knox have
been retained as president and international labor lobbyist, respectively. According
to the US Embassy, Douglas is chairman of the small New Zealand Socialist
Unity Party and probably is a Soviet agent of influence. The Council probably will
not have a major impact on policymaking at the national level for sometime as it is
preoccupied with factional maneuvering for influence and the process of building
staffs. Moreover, any Council attempt to promulgate stronger socialist economic
policies will be hampered by its identification with leftist political parties that do
not have representation in the New Zealand Government and by the growing
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Secret
Iranian Economic
Difficulties
second and sometimes third jobs to meet food and housing expenses
cent persist, and shortages of gasoline and heating fuel apparently have increased 25X1
recently, Power outages in Tehran 25X1
continue, averaging about six hours a day, and most government employees have
Economic hardship in Iran appears to be growing worse as oil revenues drop from
last summer's peak. Unemployment and annual rates of inflation of at least 30 per-
Early last month officials increased their efforts to counter 25X1
Opposition Strikes
Hurting Bangladesh
Economy
33 Secret
4 December 1987
rising prices and recently announced increased penalties for trading on the black
market, according to Iranian press reports. A decline in Iranian oil revenues from
a high of $1.2 billion in August to about $800 million last month may force Tehran
to reduce civilian imports further. In addition, cold weather is increasing the
demand for heating fuel and probably aggravating hoarding. Iranian steps to
control inflation and fill shortages are not likely to have much effect, and Tehran
may attempt again this winter to divert public attention from austerity to the war
with Iraq or to the United States. Nonetheless, economic problems have not yet
become as severe as they were last winter and are unlikely to appreciably affect
Iran's ability to prosecute the war. 25X1
and to prevent disruption of foodgrain distribution.
Strike-related production losses and flood damage will slow Bangladesh's real
GDP growth to roughly 2 percent during the current fiscal year-which began in
July-compared with 4 percent last year. Flood damage alone is estimated by the
US Embassy at $1 billion, and production losses because of opposition strikes are
estimated at $20 million per day by World Bank officials. A state of emergency
was imposed last week, at least partially to prevent additional production losses
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Secret
the price of rice has increased by 25 percent compared with that of October
because of distribution disruptions and hoarding. Damage to railroads and
industrial units from random acts of sabotage amounts to several million dollars.
Sri Lanka's 1988 Budget Sri Lanka's FY 1988 (January-December) budget reflects both the administra-
To Boost Deficit tion's desire to avoid popular criticism and to provide those affected by the
prolonged Tamil insurgency with funds for reconstruction. Government expendi-
tures are expected to reach more than $3 billion-a 16-percent nominal increase
over last year-with defense, debt repayment, and social services such as housing
and rural development accounting for a significant share of the total. Colombo is
reluctant to meet rising government expenditures through major tax hikes, fearing
that such increases would aggravate popular dissatisfaction at a time when it is
trying to win additional support for the Indo-Sri Lankan peace accord. Colombo
plans instead to increase taxes only on luxury consumer goods and to ease export
licensing restrictions in order to boost revenue earnings. These measures, however,
will not be enough to make up for the loss of funds expected from the budget's pro-
posed income and corporate tax cuts. As a result Colombo's budget deficit is likely
to increase dramatically, heightening Sri Lanka's need for international financial
support.
Zambia's Pro-Western The appointment of Francis Nkhoma as Governor of the Central Bank on 25
Central Bank November signals Zambia's renewed interest in cooperation with the World Bank
Appointment and the IMF, according to the US Embassy. Nkhoma is staunchly pro-Western;
his predecessor was a Soviet-trained socialist. The appointment is also a public
relations gesture by President Kaunda, we believe, to demonstrate his commitment
to economic reform-even though he may find it politically difficult to implement
austerity measures before next year's presidential election. An outspoken critic of
Secret
4 December 1987
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Secret
Dominican Republic's
Worsening Electricity
Shortage
Afghan Ministry
of Transportation
Criticized
eventually lose Kaunda's support.
the government's socialist economic policies, Nkhoma publicly advocates budget
reductions, diversification away from copper-which accounts for about 90
percent of the country's foreign exchange earnings-and import reductions.
Because circumstances are not propitious for economic reform in the short term,
we believe Nkhoma is likely to become openly critical of the pace of reform and
because of the monopoly's poor record of paying its bills.
Santo Domingo is taking tentative steps to reform the state-owned Dominican
Electricity Corporation (CDE), but the measures appear insufficient to resolve the
country's worsening shortage of electric power. The traditional practice of
Dominican presidents to use the monopoly to reward political supporters with jobs
and to subsidize electricity for the poor is largely responsible for the company's
problems. Moreover, politically appointed administrators have long neglected
routine maintenance and planning to meet future eletricity demands. Over the past
few months the company has resorted to rotating daily blackouts in order to
compensate for inadequate generator capacity. According to the US Embassy,
President Balaguer recently appointed a new CDE administrator, settled a
contract dispute with a US firm over the completion of a new thermoelectric plant,
and provided funds to rehabilitate an inoperational thermoelectic plant. Despite
these measures, the monopoly probably will be unable to meet the growth in the
country's demand for electricity over the next decade. Moreover, although
Dominican officials believe that some privatization of the company is inevitable,
we doubt that such a move is a realistic option, at least over the short term; the
company's prolonged unprofitability is unlikely to attract investors. CDE officials
have suggested alternatively that private firms build generating plants and sell
electricity to CDE, but several private investors have refused the offer, probably
economy's two most dynamic sectors, tourism and industrial free zones.
25X1
Persistent shortfalls in generating capacity are likely to contribute to growing
social unrest and slower economic growth. We believe that continuing blackouts
could spark a resumption of the sometimes violent demonstrations that character-
ized protests over deteriorating public services in several major cities last summer. 25X1
At a minimum, the problem is likely to hinder the expansion of the Dominican
The Afghan Communist party central committee recently criticized the Ministry
of Transportation for failing to improve Kabul's public transportation system. The
need for mass transportation in the capital has increased substantially since the be-
ginning of the war because of the large influx of refugees into the city. The city
currently relies entirely on an outdated busing service run by the state-owned
Milie Bus Company. Party officials revealed that most parts of the city do not have
bus stops and a number of the city's roads are in disrepair. Bus transportation also
suffers from some of the same problems as most Afghan industries, including a
shortage of spare parts and labor. The regime hopes to solve the transportation
problem, in part, by attracting private investment but will probably meet with
35 Secret
4 December 1987
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Unification of Egypt's
Exchange Rates
Continues
trucking where profits are higher.
little success. Although the private sector is heavily involved in transporation-
about 70 percent of the transportation industry is privately owned, according to
Afghan Government estimates-most Afghan businessmen prefer to invest in
The transactions affected by the devaluation include payments for government-
supplied commodities and public-sector purchases of factor inputs and spare parts
as well as receipts from banking commissions and exports
Egyptian pounds per dollar-63 percent higher than the old commercial bank rate.
Egypt's Minister of Economy Mustafa has implemented the next stage of Cairo's
strategy to consolidate exchange rates-six weeks in advance of the target date set
in May in the government's standby agreement with the IMF. According to
Embassy reporting, the government will value another 40 percent of commercial
bank transactions at the new semiflexible rate, which now stands at about 2.2
Kuwaiti Securities Issue Kuwait has begun issuing treasury securities for the first time in order to generate
additional revenues. The US Embassy in Kuwait reports that the government
plans to raise over $700 million from the sale of short-term bills and medium-term
notes by the end of the year. The initial offering on 26 November was heavily over-
subscribed by local financial institutions with more than $1.1 billion bid for $400
million in bills, according to the US Embassy. Although primarily a revenue
generating measure, Kuwait's move provides a means to tap excess liquidity in the
economy generated by investors repatriating funds threatened by the turmoil in
foreign financial markets. It also enhances the government's ability to use
monetary policy to direct the economy, helps promote development of local capital
markets, and reduces the need to draw down government investments that have be-
come increasingly illiquid in recent years. The security offer highlights the
growing sophistication of Kuwait's financial planners and probably will serve as a
bellwether for other cash-constrained Gulf states.
Secret
4 December 1987
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~lCl:fCl
Soviet Bank Reform
To Be Limited
Recent statements by Soviet banking officials indicate that Soviet banking reform
will be slow and limited. A July decree creating three commercial banks and.
revamping the existing three banks emphasizes increasing the use of economic
criteria in lending and decentralizing banking operations. As of 1 January 1988,
local banks will go to "self-financing," which will stress operating according to
profit and loss criteria. These measures are meant to complement the move toward
enterprise self-financing and greater economic accountability planned for 1988-89,
but actual decentralization of financial decisionmaking over the near term
apparently will be small. The officials said that the central bank's control over the
banking system will be only gradually lifted in order to minimize disruption. They
acknowledged that ruble convertibility, even within CEMA, is a long way off and
China's New
Management Reform
Initiative
claimed that there will be no currency reform.
influence, would undoubtedly seek to stop or at least restrain such a move.
More conservative leaders, concerned about the erosion of party power and,
Local party officials in the northeastern city of Harbin recently removed party
committees from over 600 municipal-run enterprises and factories as well as some
schools and hospitals in order to curb party interference in management. Although
this move is in keeping with reform efforts to end party meddling in administrative
and enterprise affairs, it appears to go much further than General Secretary Zhao
Ziyang's proposals at the just-concluded 13th Party Congress. Zhao called only for
the transfer of authority over factory committees from state ministerial party
committees to local party committees. Harbin, which has been a center of media
attention for some time because of its experimentation with political reforms,
appears to have taken matters a step further by eliminating party committees
altogether from municipal enterprises, a move it would only have taken with the
concurrence of national party leaders. Should this latest experiment prove
successful in revitalizing local industries, Beijing reform leaders will probably
press hard to broaden it to provincial- and state-run enterprises in other regions.
37 Secret
4 December 1987
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ocw vL
Shenyang on
Leading Edge of
Chinese Economic
Reform
Secret
4 December 1987
maintain Shenyang's position as a reform leader.
Shenyang is at the forefront of China's enterprise leasing and bond market
reforms, according to the US Consulate in Shenyang. Originally confined to small,
bankrupt enterprises, the leasing program now covers nearly 900 firms, some of
them medium sized and profitable; China's largest leasing arrangement is the
Shenyang automobile corporation with 63 factories and some 50,000 workers.
Leasing contracts have given managers more operational independence, greater
financial rewards, and potential financial risks. The Shenyang Bond Exchange-
China's first bond market-has enjoyed similar success since opening in August
1986 and a secondary market for securities has developed. Most of the bonds are
small-denomination, short-term issues by enterprises to finance capital improve-
ments. About 80 percent are "lottery" bonds that offer very low interest rates and
a chance to win prizes; the remainder are "financial" bonds-issued mainly by
financial institutions, offering a higher return and appealing to more conservative
investors. Because of the well-publicized and well-received success of these two
reform measures, we expect a continued broadening of the experiments that will
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